Attachment 8 - Annex 2.doc

Government of the Republic of Armenia

Decree N 1487-N

13 November, 2008

On Approving the RA Pension Reform Program and Pension Reform Implementation Schedule The Government of the Republic of Armenia, decides:

1. To accept the report of the working group formed by the RA Prime-Minister’s Decree N 599-A of August 4, 2006 on “Establishment of the Pension System Reform Working Group” (no longer in force by the Prime-Minister’s Decree N 618-A of August 15, 2008).

2. To approve:

1) the RA Pension Reform Program (hereinafter, program) as per Appendix N 1,

2) the schedule of events ensuring pension reform implementation (hereinafter, schedule) as per Appendix N 2.

3. To give tasks to the RA Minister of Labor and Social Issues, RA Minister of Finance, RA Minister of Economy, RA SRC head and propose to RA Chairman of Central Bank to take measures to ensure the implementation of the reform program within planned schedule by submitting suggestions for increasing the efficiency of work done, if needed.

4. To recognize the Decree of RA Government N 796-N of May 26, 2006 on “Approval of RA Pension System Reform Concept” no longer in force.

5. This Decree comes into force starting the day following official publicity.

December 23, 2008

Yerevan

Appendix N 1 of RA Government Decree N 1487-N of November 13, 2008

PENSION REFORM PROGRAM

OF THE REPUBLIC OF ARMENIA

The Program of the RA Government approved by the National Assembly has inscribed the political decision of authorities to introduce a multi-pillar pension system in Armenia. In order to execute this decision, implementation of the pension reform is anticipated in the 2008-2012 Government Action Plan which is targeted at the achievement of the following crucial outcomes:

1) Annual increase of the pension sizes thereby ensuring pensions equivalent to the minimal consumer basket, by ensuring the average occupational (insurance) pension amount.

2) Establishment of a link between the income of the individual and amount of the pension by introducing the mandatory funded pension system.

Problems of Existing Pension System of Armenia (situation analysis and findings)

Current Situation

1. Currently a PAYG pension system is operational in the Republic of Armenia. Before January 2008 it is financed from current contributions paid by employed citizens and the mandatory social insurance contributions of their employers. Mandatory social contributions accrue on the account of the Social Insurance (Pension) Fund and are fully used for payment of current pensions. The principle of “financial equilibrium of the Fund” is followed which implies that the payable pensions should be equivalent to the collected social contributions. This means that existing employees secure the payment of current pensions to persons of non-working age.

3. In 2008 pension expenditures will be 4.3% of the GDP thus constituting the largest component of social sector expenditures of the consolidated State budget which exceeds the expenditures for the health sector 3 times and those for the education sector 1.6 times. Even this level of pension expenditures is not adequate for ensuring an average pension which is equivalent to the minimum consumption basket. The upward adjustment of pension sizes can be feasible either by increasing the rate of mandatory social contributions or by other tax revenues. The commitment of ensuring the fiscal sustainability of the pension system is a constraining factor for increasing pensions significantly solely at the cost of collected mandatory social contributions not increasing their rates. Therefore, based on the Government Decree, in January 2008 the State Social Insurance Fund was reorganized as a service operating in the governance field of RA Ministry of Labor and Social Issues. The mandatory social insurance budget was taken away and mandatory social insurance contributions were included in the general revenues of the state budget which made it possible for a 60 percent increase in pensions which allowed a at the expense of general revenues of the budget. Obviously, further upward adjustment of pensions and their long-term subsistence will be a “heavy burden” for the State budget.

4. The situation will aggravate in tandem with the unfavorable demographic trends which are linked to the reduction of the birth rate, increase of the average life expectancy.

One of the reasons for the aggravation of the projected situation in the pension system is also the “birth boom” following World War II. It is the generation born during the “birth rate boom” period that will retire over the coming years. This will be complemented by the phenomena which occurred during the last 20 years, namely, the decrease of birth rate, increase of average life expectancy and extensive emigration of working age individuals in the 1990s. As a consequence, like in many countries of the world, aging of population is also recorded in Armenia.

5. In addition to the above described problems, the existing PAYG system faces the problem related to the absence of any direct link between paid contributions and pension sizes. Employees are not motivated to make pension contributions to a system. Employers also avoid paying mandatory social contributions and tend to conceal the actual number of their employees and to underreport the amounts of actually paid salaries.

6. Thus like other transition countries, Republic of Armenia faces three socio-economic challenges:

1) Demographic problems (“aging of population”),

2) Existence of a large informal economy,

3) Rapid and increased recovery of incomes.

The impact of these challenges on the pension system is demonstrated by a decline in the financial sustainability and measures of pension adequacy (replacement ratio), as well as deterioration of other pension system indicators.

Problems of Financial Sustainability of the System

7. The issue of financial sustainability of the pension system is crucial for any country facing the problem of aging population. Demographic analysis projections for Armenia also testify about serious shifts in the age structure of its population. Thus, compared to 1990, at the beginning of 2008 the proportion of children aged 0-14 in the overall population number decreased 1.6 times while the proportion of individuals aged 65+ increased 2.1 times. The financial sustainability of the pension system is directly dependent on these indicators because the quantitative potential of contributors to the system declines, and this is accompanied by an increase in the number of individuals “feeding” on the system. In fact, the dependency ration of the system is higher as in addition to the old-age pensioners the system also covers persons of non-retirement age (persons with disabilities, survivors, recipients of privileged pensions, etc.).

8. A key factor which influences the financial sustainability of the system is the number of contributors which are nearly 5 times lower than the indicators of working age (15-63) population. The analysis of the Armenian labor market shows that the gap between these two indicators is due to the fact that the real unemployment rate is around 3 times higher than the official rate, informal employment sector is large, and part of the formal employees do not pay social contributions (in terms of payment of social contributions, farmers are also “informal” workers since they are exempt from payment of mandatory social contributions.). As a result, the pension burden is distributed among a smaller number of working age population which in turn predetermines the trend of worsening the dependency ratio of the pension system. This ratio was close to 1 in 2008, i.e., one pensioner per contributor.

9. Expert estimations have shown that a system can be financially sustainable if this ratio equals at least 3:1. Actuarial calculations show that through 2050 the dependency ratio of the pension system will be in the range of 1.0-1.1 which means that the system will appear in a situation of “lasting financial crisis”, and over the period from 2050 to 2065 a financial collapse of the system is expected (If the share of shadow and informal economy to GDP remains unchanged, then the number of pensioners will be above the number of contributors as early as in 2011. However, in view of the measures anticipated under the 2008-2012 Government Program which are aimed to increase formal employment and reduction of shadow economy, the number of contribution payers will increase by 100000 persons). The major reason for this situation is, perhaps, the ratio of pensioners to contributors as a result of which the pension costs will significantly exceed the revenues from social insurance contributions.

10. The financial sustainability of the system is also dependent on the level of average salary and contribution rate calculated thereof. The higher the average salary rate, the broader the opportunities for financing the system. At the same time the question about which salary groups are the main payers of social contributions is important. Thus, analysis shows that in 2000-2008 more than 2/3 of contributors are concentrated within the group of workers whose salary is below the average salary. Furthermore, around 1/3 of contributors belong to the group of workers who are paid minimal salary. These data witness of the fact that the phenomenon of underreporting salaries by employers is rather common.

11. On the other hand, actuarial calculations show that regardless of the growth rate of average salary, if the dependency ratio of the pension system is close to 1 while the social contribution rate is 25-26%, then the average pension size in the country should not exceed 22-23 percent of the average salary in order to maintain the financial sustainability of the system. In view of deterioration of the dependency ratio any of the below actions should be taken:

1) Maintain the rate along with reducing the replacement ration( The replacement ratio expresses the ratio of average pension to average salary), or

2) Increase the rate along with maintaining the replacement ratio within certain preferable limits, or

3) Use other State budget revenues in order to cover the financial deficit of the system.

12. None of the above-mentioned, however, is a solution of the issue in terms of long-term financial sustainability. Despite the fact starting January 1, 2008 the RA Government increased the pensions by 60% at the expense of state budget general revenues, the demographic trends show that any “lump sum” increase of pensions will make the gap of ensuring financial sustainability of the system large and will not tackle the issue of providing adequate pensions to the population. Expert assessments - which are based on actuarial calculations - show that a continuous upward adjustment of pension sizes and securing minimal pension which is equivalent to the minimal consumer basket will lead to an irreversible deficit (given only the gap between social contributions collected and expenditures) of the existing system whose level will consistently grow thus reaching 1.4% of GDP in the 2020s. Under these conditions of budget deficit even the government may not succeed in preventing the decline of the pension replacement ratio. The gap between pensions and salaries cannot be filled if the existing system continues.

Breakup of the Link between Pensions and Incomes

13. A fundamental principle of pension insurance is the establishment of direct link between the contributions made by the individual and the size of paid benefits. But the existing pension system does not guarantee a replacement which is adequate to the individual’s income. The lack of the link between benefits and incomes is a disincentive in terms of contributions to the system. Presently only 37 percent of employed labor pay mandatory social contributions.

14. The existing system is particularly unattractive for high income groups of employed population. Pensions of persons receiving compensation which is above the average salary do not exceed 10 percent of their salary whereas the pension system ensures a replacement ratio over 75 percent for those who are paid a minimal salary. Employers also avoid paying mandatory social contributions by concealing the real number of their employees and underreporting the actually paid salaries. As a result, around 70 percent of social contributions are paid from minimal and below the average salaries.

15. The rapid growth of incomes of the population leads to even a greater gap between the sizes of pensions and salaries. At the same time, payment of social contributions from low salaries lessens the amount of collected contributions thereby restricting the financial possibilities for adequately increasing pensions against income growth. In this situation the issue of ensuring adequate pensions in relation to employment incomes encounters the impossibility of solving the issue of financial sustainability of the pension system. Experts estimate that the current pension system created under all equal conditions is unable to mitigate to disproportion between salaries and pensions without impairing the financial equilibrium of the system.

16. The current pension system should be radically reformed in the following directions:

1) To significantly increase of pension amounts, with the aim to firstly bring the level of poverty to a minimum, and then to eliminate poverty and poverty risk among pensioners.

2) To ensure the financial sustainability of the pension system linking the occupational incomes of the individual to the amount of pensions by introducing the mandatory funded pension system.

17. Within the context of the above-mentioned, the Government plans pension system reforms and formation of a new unified multi-pillar system based on the current state pension system.

Lessons Learned from International Experience of Pension Reforms

18. In problem of financial sustainability of “pay-as-you-go” pension systems is faced by many countries of the world as a consequence of rapid ageing of population. International experience shows that countries which have appeared in the above described situation respond to challenges by making three main transitions (transformations):

1) transition from the “pay-as-you-go” pension system which is financed by the principle of solidarity of generations to the “self-sustainable” funded system;

2) transition from the defined benefit (DB) model - where pensions are calculated based on formulas and political decisions – to the defined contribution (DC) model which is based on actual incomes(Mainly two models are used in pension systems of the world: defined benefit or defined contributions. In the former case initially the formula of the pension is defined by legislation. Then their source of financing is identified. In the second case the rate of contribution payable for accumulation is defined and the size of pensions is determined based on the amount of real accumulations and return on their investment.)

3) transition from a pension system directly managed by the State to the private pension system regulated and controlled by the State.

True to the principles mentioned above and based on the peculiarities of RA, the Armenian model of pension reforms has been designed.

19. The proposed transitions vary across countries. However, they are all covered by the general concept of “introduction of multi-pillar pension system” adopted rather by all countries which have embarked on systemic reforms. The Armenian model of multi-pillar pension system is developed based on the lessons learned from international experience and a comprehensive analysis of the social and economic situation in the country.

Description of Multi-Pillar Pension System

20. The multi-pillar pension system which will be implemented as a result of the pension reform will consist of four pillars with each pillar designed to serve its specific purpose, and each different depending on the number of years worked by beneficiaries and their age.

21. «0» pillar of the pension system secures an income from the state budget equivalent to the minimal consumption basket for the old-age, disability and survival of those persons who do not qualify for an occupational pension (do not have enough occupational (insurance) service).

22. 1st pillar compensates lost income from the state budget to persons who worked in the formal economy for the period specified by law and who paid corresponding taxes (social contributions) upon retirement, in the events of disability and survival.

23. 2nd pillar of the pension system compensates lost income from contributions made and their investment income to persons who make mandatory funded contributions upon retirement.

24. 3rd pillar secures additional income from voluntary funded pension contributions to persons of retirement age.

Pension System: Pillar 0

25. Social pension will be paid from Pillar 0 of the pension system for the purpose of ensuring minimal income in cases of old age, disability and survival to individuals who have not earned other pension rights, i.e.

1) they are considered social pension beneficiaries in accordance with the RA Law on State Pensions HO519-N of November 19, 2002 (hereinafter, current legislation).

The conditions qualifying for social pension will be maintained with increasing the minimal working service qualifying for occupational pension from 5 years to 10 years (List N 1).

26. Beneficiaries of Pillar 2 may also receive social pension, if the person does not have the required minimal work service. The assigning of the social pension does not depend on other, non-pension incomes.

27. The social pension is calculated based on the basic pension. The calculation methodology, differentiating types of pensions, as per the current legislation, will be retained.

2.1.2

Table 1. Terms for granting old age pension by length of service and years of retirement

28. The amount of the old-age social pension will amount to the 100% of the minimal consumption basked in 2018 and starting 2021, it will total 80% of the basic pension which will be in the amount of the minimal consumption basket. The size of the basic pension should be determined on the basis of actuarial calculations and the value of the minimal consumer basket.

The social pension should be granted by the State authorized body and be financed from the State budget.

29. The procedure for assignment and payment of disability and survivor’s social benefits will be maintained. In the framework of revising the model of disability status issuance the social pension calculation will also be revised.

Pension System: Pillar 1

30. Employment pension should be paid from Pillar 1 of the pension system. Employment pension represents a replacement of employment incomes of individuals.

31. Entitlement to the occupational pension corresponds to the entitlement of the current, insurance pensions i.e. the types of the insurance pensions, qualification conditions, calculation methodology will be maintained, with the exception of the above-mentioned changes.

32. The minimal working (insurance) service qualifying for old-age occupational pension will be 10 years instead of the 5 years of the current legislation.

33. In order to organize this transition smoothly the following schedule of minimal service year increase will be applied:

34. The occupational pension consists of the basic pension and additional amount calculated on the basis of the number of insurance (occupational) service taking also into consideration the individual coefficient of the pensioner.

The pension is calculated in accordance with the procedure approved by the current legislation.

35. For defining the amount of the basic pension and the value of one year’s insurance (occupational) service, the RA Government will apply the following rules and targets:

1) starting 2012, the average occupational pension shall match the minimal survival budget.

2) In 2018 the average occupational pension shall match 150% of the minimal survival budget, and the basic budget – to the minimal living budget.

3) Starting 2012, for the purposes of calculation, one year’s insurance (occupational) value, and starting 2018 the basic pension will be adjusted by the consumption price index (CPI).

36. Those individuals who wish to transition to the mandatory funded system, will also receive an occupational pension in correspondence to their service (insurance) duration before joining the mandatory funded system (before paying funded contributions), calculated in accordance with the procedure of Clause 34.

37. The government will simultaneously take measures to reform the disability and survivor’s pension system with the aim:

1) To pay this type of pensions through insurance companies,

2) To review the model of disability status issuance by transitioning to the model applied in the EU, i.e. definition of the degree of working ability. In this context the calculation methodology of disability pension will also be revised linking its amount to the degree of loss of ability to work.

38. The government will take measures to reform the long-service and privileged pension system with the aim:

1) to ensure payment of this type of pensions from the funds of the employer, including within the insurance scheme:

2) besides the mandatory professional service qualifying for the partial pension of long-service pension, to establish a requirement of minimum 25 years of total occupational (insurance) service.

39. Before making the relevant changes, assignment and payment of disability, survivor’s pensions of persons participating in the mandatory funded system and qualifying for these pensions will be carried out in accordance with the rules of the 1st pillar.

40. The occupational pension is assigned by the relevant authority and is funded from the state budget.

Pension System: Pillar 2

41. The mandatory funded pension will be paid from Pillar 2. Its purpose is to compensate the lost incomes of individuals of the retirement age in consistency with their paid contributions.

42. From January 1, 2010 the participation in Pillar 2 will be mandatory for those wage earners, sole entrepreneurs and notaries regardless of citizenship who are born on or after January 1, 1970 and/or who are below 40 at the moment of their first entry to the labor market.

43. Access to the mandatory funded component is open to: the individuals not included in the age group mentioned in Clause 42, as well as military servants and owners of agricultural land included in this age group. The individual can also voluntarily join the mandatory funded system, however will not have the opportunity to revisit this decision.

44. For those persons who became a participant of the mandatory funded system starting January 1st, 2010, the funded contribution rate will be defined in the amount of 10% of the wages and equivalent payments, half of which or 5% of wages and equivalent incomes, but not more than 25000 AMD will be paid by the state (i.e. if the wages are lower 500.000 AMD, then the state will pay in 5% of that amount, however in the event of wages higher than 500.000 AMD, the participation of the state will amount to only 25.000 AMD for each worker. Thus, the funded contribution by persons receiving wages higher than 500.000 AMD will in fact, exceed 5%).

45. For those persons who became participants of the mandatory funded system voluntarily, the funded contribution rate is defined as 5% of the wages, without the state’s participation (the state shall not make a funded contribution).

46. Regardless of his age, the participant of the mandatory funded component should pay income tax, and upon retirement the participant will be paid a basic pension against the paid income tax.

47. Individuals who have contributed to the mandatory funded Pillar 2 should receive:

1) a basic pension and funded pension if they have not reached 40 as of January 1, 2010, and at the moment of retirement have acquired the required service period.

2) a basic pension and credit for length of service (employment pension) and funded pension if they are above 40 as of January 1, 2010 and at the moment of retirement have acquired the required service period.

3) social pension and funded pension, if at the moment of retirement they did not have sufficient occupational service.

48. Individuals under 40 who have a certain record of employment service upon their entry to Pillar 2, will also receive a pension linked to his length of service (employment pension).

49. The rules for use of mandatory funded pensions are established under the respective legislation. The person may use the funded accrued on his individual account:

1) At his retirement age allowing for pension, as prescribed by RA law,

2) In the event of changing his RA citizenship.

50. Upon reaching the retirement age, the individual may use his pension assets in the following forms:

1) Programmed withdrawals, i.e., receipt of monthly pensions according to a specific scheme. In this case, the monthly pension is calculated by dividing the total accumulated amount into life expectancy at retirement (amount divided by number of months),

2) Annuities when the accumulated amounts are transferred fully to an insurance company, which undertakes to pay a certain amount of monthly pension to the person till the end of his life,

3) Lump-sum payment when in the legally prescribed specific cases the person obtains the right to receive his accrued funds through a single payment.

51. The individual may use his funded pension before reaching the retirement age only if he or she has such a disease – the list of diseases is established by the authorized body of the Government – which can lead to the death of the individual unless the health expenses necessary for treating such a disease are incurred or regardless of the incurrence or non-incurrence of these expenses the disease is terminal.

52. In case of not having or changing Armenian citizenship, amounts accumulated by the person could be used in the following forms:

1) They are transferred to the individual pension account opened in the country of new citizenship (for non-citizens – in the country of new residence), if a mandatory or voluntary funded system is operating in the given country and the appropriate legal grounds are in place for effecting a transfer of pension assets,

2) They remain in Armenia, if mandatory or voluntary funded systems do not operate in the given country and/or the appropriate legal grounds are not in place for effecting a transfer of pension assets. In this case the person should receive his accumulated funds in accordance with the Armenian legislation.

53. 2.3.14 The use of the funded (mandatory) pension should be limited to the following:

1) If the monthly annuity of accumulated funds of the person at retirement is less than 25% of the basic pension, then the person has the right to receive the accumulated amounts in the form of programmed withdrawals or lump-sum payment,

2) If the annuity of accumulated funds of the person at retirement expressed in the monthly amount is more than 25% of the basic pension, but less than the five-fold amount of that pension, then the person should use his funds by purchasing annuities,

3) If the annuity of accumulated amounts of the person at retirement expressed in the monthly amount is above the five-fold amount of the basic pension, then the person should pay part of his amount in order to purchase an annuity which covers five-fold amount of the basic pension. He may use the remainder of the amount through programmed withdrawals or lump-sum payment. Personal replacement ratio or minimal market price of the annuity may be also serve as criteria.

54. In order to calculate annuities and programmed withdrawals, the Central Depository of Armenia (hereinafter CDA) and insurance companies should use universal mortality matrixes for either sexes. The matrixes should be provided by the National Statistical Service of Armenia (NSS).

55. 50. Programmed withdrawals are calculated by dividing the sum of the accumulated funds by the number of months of life expectancy. Programmed withdrawals are calculated based on the rules approved by the Government of Armenia.

56. The main portion of the funded pension will be paid in the form of annuities, and the inheritability of annuities is a binding requirement. According to this requirement, the following types of annuities will be applied:

1) Single Life with Guarantee is the purchase of annuity for one person only, where payments stop after the death of the person. If the person dies during the guarantee period, then in accordance with the contract his heirs receive certain part (25, 50, 75%) of the amount that he has not received.

2) Survivor with Guarantee is the purchase of annuity by spouses, where after the death of the person his or her spouse receives a certain part of the person’s monthly payments (25, 50, 75%) until he or she dies. If both spouses die during the guarantee period, then their heirs receive a certain portion of the unpaid amount.

57. The mandatory funded contributions should be taxed at the time of their collection. This means that they are not deductible from the taxation base of the income tax. Incomes received from the mandatory accumulated funds should not be taxed. The mandatory funded pensions should not be taxed.

58. The mandatory accumulated funds are inheritable. Conditions of inheritance and proportions of inherited amounts differ across cases.

1) Where the person dies before reaching the retirement age, his or her spouse and other heirs as defined by the law should receive the full amount accumulated by the person. The inheritance of pension assets by the spouse and other heirs should be in conformity with the existing legislation.

2) If the person dies in the retirement age and he/she receives his/her pension in the form of programmed withdrawals, then the whole balance of the deceased person’s individual account should be received by his or her heirs in proportions set out in the existing legislation.

59. The inheritable shares of the accumulated funds can be transferred to heirs’ pension accounts if the heirs have any. It will be allowed to use a certain portion of the inherited pension assets in cash which will be specified in law. Legal entities may not inherit pension assets.

60. Mandatory funded funds may not be confiscated before being disposable in accordance with the procedure specified by RA Law.

MANDATORY FUNDED ASSETS MANAGEMENT

61. The asset management process starts with the collection of contributions and information. Employers on monthly basis develop and send information on employees making mandatory funded contributions to the State Revenues Committee adjacent to the Government of Armenia (hereinafter SRC). The information is entered into the SRC database.

62. The employer transfers calculated unified income tax and the amount of the mandatory funded pension insurance contribution to the treasury. In addition, the employer calculates the contribution needed for adjusting to the maximum state participation of AMD 25000 if the employee’s salary is above AMD 500000.

63. The employer must provide monthly and annual information to employers on their salary, paid taxes and funded contributions. SRC will match the data of individual reports and the unified tax and mandatory funded pension contribution’s actual amount paid (the individual report and individual record-keeping system will be described in a TOR). The data of the verified reports will be electronically sent from SRC to CDA. The latter enters the information on individual accumulations of persons, including the share of the state’s participation into the database. At the same time, the SRC based on its adjusted reporting data, should submit a request to the treasury on transferring the calculated funds to the CDA account held with the Central Bank. The portion of the funds on individual accounts, information on which was received from SRC, are transferred to the Asset Managers (hereof AM) by CDA during 24 hours. Based on the received information the CDA should update the pension account data of each individual.

64. The pension or individual account of the person contains the following information about the account holder:

1)first and last names, sex, 2)address(es), 3)serial and successive number of passport, 4)day, month, year of birth, 5)number of social security card (or a proof certifying that the individual does not have such a card), 6)bank account number, 7)contribution history of the individual (10 or 5 percent of the salary), 8)information about the choices made by the individual:

- names of asset managers,

- types of portfolios,

- number and amount of units.

9) information on the use of accumulated funds,

a) programmed payments, monthly pensions,

b) annuity, name of the insurance company, monthly pension.

65. The employees who join the mandatory and voluntary funded Pillar 2 voluntarily should complete and sign an application form. The application should be submitted in a sealed envelope to the CDA in the paper format through bank branches and/or post offices , and/or electronically. Based on the application, a pension account should be opened with the CDA and a respective notice should be sent to the beneficiary.

Once the pension account is opened, the mandatory funded system voluntary participated employee should submit a request to his employer on calculating and paying 5 percent funded contributions from his salary.

66. New entrant to the labor market must independently open a pension account with the CDA and file with their employer a proof about the opened account.

67. Holders of pension accounts should be provided with information about asset managers and their investment portfolios at the CDA or banks or post offices or online and based on this information make their selection (the selection should be done privately without the involvement of the bank or post office staff). The participants must submit the sheet/certificate indicating their selection to their employer. (The selection is deemed to be valid if the selection sheet is signed but the selection cells for the asset manager and investment portfolio are left blank.) The employer based on the appropriate data should include the selection sheet in the employee’s individual report.

68. The participants of the mandatory funded Pillar 2 may choose their asset manager and the investment portfolio. The selection of asset managers and investment portfolio should be performed by the participants through the CDA website, or banks and post offices. The participants may change their selected asset manager or investment portfolio no more than once a year. Changing of the investment portfolio more than once a year is a paid service, if amounts invested in the former portfolio are to be allocated to a new investment portfolio. Changing of the investment portfolio is a free service, if the participant shifts from one portfolio of the same asset manager to another one. The participants may not allocate their monthly contributions among more than one investment portfolios concurrently.

69. Participants are allowed not to make a selection. No selection is made by the participant if the corresponding fields are left blank in the completed application on opening the pension account, i.e., if the pension account is opened but there is no indication about the participant’s selection. In this case the asset manager is selected by the CDA through a specific software module. By using this module the contributions should be randomly assigned, distributed in proportion with the choices already made by others. 75. In addition, the participants are allowed also not to select the investment portfolio. In this case randomly selected asset managers must allocate the contributions of the given participant to a balanced investment portfolio.

70. On a monthly basis the employer should send individual reports on payment of the unified tax for participants of the mandatory funded component to the SRC. Parties who are responsible for the accuracy of information included in individual reports are:

1) The employee in relation to his provided information,

2) The employer in relation to the calculated and paid salary and unified tax, as well as other reported information,

3) The SRC in relation to reconciliations.

71. If the information about the employee’s individual account contains inaccuracies, then the employee should make corrections first with the employer and then with the SRC.

72. The CDA should issue units to each contributor. Units represent the stake or share in each specific investment portfolio. Based on the information on monthly contributions received from the SRC, the CDA should produce a certain number of units. Identification numbers of these units are encoded by using the algorithm of random numbers. The use of the algorithm is based on the numbers of the pension account and social security card of the participant.

73. The CDA maintains the encoded numbers which are attached to the participants’ units which prevent asset managers from matching each participant’s units with his pension account number.

74. The investment portfolios held at the CDA have their units. Every day these units are evaluated based on the current market values (asset management fees are deducted from the value of the units). Dependent on the evaluation, the unit value of the investment portfolio can either grow or fall. Each new contribution is translated into units. The number of units is recalculated based on their current value for the previous day.

75. At the end of each day the CDA should perform an evaluation of the assets included in investment portfolios. Based on the results of this evaluation the value of units of each portfolio is also adjusted. Assets are evaluated on the basis of their market value, and the evaluation procedure is defined by the Financial Markets Supervision Service of Armenia.

76. Daily information on the accumulated amounts (deposits) of the participants of the funded Pillar 2 in Republic of Armenia and foreign bank accounts should be provided to the CDA (for balances of funds held with foreign banks). The CDA should receive daily information about foreign securities from the global custodian thereby the CDA should perform the function of custody of pension assets.

77. CDA shall also register the payment phase, in other words, whether the person has selection a certain option upon retirement, which company has been selected and what the pension amount is.

78. The operational costs of the asset management process should be financed from collected fees. These amounts should be collected from contributions of the participants of the funded Pillar 2 and consist of the following types of fees:

1) Portfolio participation fees,

2) Asset management fees,

3) Unit redemption fees,

4) Fraud guarantee fund payment.

79. The state should define the maximal limits of these fees. Assets management fees may be set based on the size of assets and/or contributions made to the pension account. No additional fees should be collected against the yield on assets and effective management of assets.

80. The maximum unit redemption fee should be 1% of the net value of units. This fee is collected for changes to investment portfolios if it is done for more than once in a year.

81. Based on the results of the daily evaluation of investment portfolios, the CDA should record the current values of the pension assets for each individual, his contributions, and information on investment portfolios in his pension account. Beneficiaries should have a constant access to this information maintained on a daily basis electronically or in the paper format on an annual basis for free.

82. Once a year the CDA should provide the following information to beneficiaries:

1) Contributions paid over the year broken down by months,

2) Current value of the pension account over the year, i.e., its net asset value by months,

3) Return on assets in percentages calculated based on the defined rules,

4) Number of units issued over the year broken down by months,

5) Fees charged from contributions of beneficiaries by their types, amounts and interest rates,

6) Choice made by the beneficiary regarding the asset manager and investment portfolio,7) The asset manager and investment portfolio randomly selected by the CDA If these are not selected by the beneficiary.

83. The beneficiaries will receive current information about their individual pension account balances through the CDA website, at banks and post offices in paper format and/or through electronic access points.

Regulation of Pension Asset Investments

84. Investment portfolios should be formed in consistency with the criteria established by asset managers for investment portfolios and they should be registered by the Financial Markets Supervision Service of Armenia.

85. Asset managers can register three types of investment portfolios:

1) Aggressive portfolio, which should comprise at least 50% of instruments with fixed yields (bonds) and at least 50% equity securities (stocks),

2) Balanced portfolio, which should comprise at least 75% of bonds and 25% of stocks at the maximum,

3) Conservative portfolio, which may fully comprise of instruments with fixed yields.

86. During the first 3-5 years of operations of the funded component the asset managers should form only one investment portfolio, which should be balanced. Later, the asset managers must offer at least two types of investment portfolios, one of which should be balanced. Over time the structure of investment portfolios may change towards a more aggressive one along with increasing the percentage of stocks and including alternative investments.

87. Qualitative and quantitative restrictions should apply to investment portfolios in order to diversify their inherent risks. Quantitative restrictions mainly refer to the permissible ratio of bonds and stocks, the composition of the portfolio, etc. Qualitative restrictions include the criteria of solvency and creditability of issuers of debt and equity securities.

88. Based on the above mentioned principles, pension assets should be invested in the following categories of assets:

1) Deposits and bank accounts of financial institutions licensed and supervised by member states of the Organization of Economic Cooperation and Development (OECD),

2) Securities issued by OECD member states,

3) Securities issued by local governments of OECD member states,

4) Securities listed in stock exchanges which are registered and regulated by the authority regulating the capital markets in OECD member states,

5) Securities of investment companies registered and regulated by the authority regulating the capital markets in OECD member states.

The RA financial market controlling service may establish a list of countries where pension assets may be invested.

89. Pension assets in Armenia can be invested in:

1) Bank accounts and deposits of banks that are not under the enforcement action and are not subject to a suspension of their license,

2) Securities issued by the Government of Armenia,

3) Securities of Armenian organizations registered with the capital markets regulatory authority and listed in the security markets of Armenia or OECD countries,

4) Investment companies, which are supervised by the Financial Markets Supervision Service of Armenia.

90. Purchase of securities in the secondary markets must be performed by the assets managers only through stock exchange trading.

91. The composition of the investment portfolio is subject to the following restrictions:

1) The maximal volume of investment in securities issued by a single issuer or its affiliated issuers must be 5% of the total volume of issued securities and 10% of the total volume of issued bonds. This restriction does not apply to investments made in an investment company, if the investment company is otherwise compliant with these requirements, as well as to securities issued by the Central Bank, and government bonds,

2) In the investment portfolio the maximum share of securities issued by a single issuer and/or affiliated issuers must not exceed 5 percent. This restriction does not extend to investment companies, which are already compliant with this requirement,

3) The maximal volume of investments in foreign currency should be 30%,

4) Investments in debt securities issued by the Central Bank and the Government of Armenia must not exceed 70% of the portfolio,

5) Amounts invested in bank accounts and deposits should not exceed 20% of the portfolio.

92. The Financial Markets Supervision Service of Armenia may establish other intermediate restrictions with a view to neutralize any adverse effects in the financial markets. In particular, it may set temporary minimal limits.

93. The restrictions on investments in foreign currency and investments in governmental bonds for the period when only one investment portfolio will be offered by asset managers may be adjusted in view of newly arising investment opportunities.

94. Certain bans will also apply to investments of pension assets. In particular, it will be prohibited to invest in:

1) Non-listed securities,

2) Assets which may not be transferred or which are subject to other restrictions defined by RA law,

3) Derivative financial instruments (save for hedging purposes),

4) Immovable property or other tangible assets if these are not listed in organized markets and/or if their value is uncertain (for example, works of art, coins, luxury cars, etc.),

5) Securities issued by asset managers, custodians, members of their managerial boards, as well as their related parties, and in their property,

6) Other assets, which in the opinion of the Financial Supervision Service of Armenia are risky.

95. If portfolio restrictions are violated because of:

1) Revaluations resulting from changing market prices, or

2) Changes in foreign exchange rates, or

3) Impact of factors which are outside the direct control and influence of the asset managers, then within three months after the detecting the violation the asset managers must undertake corrective measures in order to align the composition of their portfolio to the established restrictions.

96. Pension assets may not be sold to the asset custodians, asset managers, members of the managerial board of asset manager and related parties of the above mentioned persons.

97. The board of the entity managing pension assets (AM) should approve internal procedures, which should include:

1) The measures which will ensure compliance with the requirements for the management of assets,

2) The types of assets where pension assets should be invested,

3) Scope of responsibilities and powers for making investment decisions, effecting investments and overseeing the process.

98. Asset managers may not announce and promise a guaranteed level of yield in their prospectuses and advertisement releases.

99. The state will ensure the safety of pension assets through introduction and application of strict supervision and regulatory mechanisms. A guarantee fund will be created in order to insure the operational risks as well as possible fraud of pension asset management and compensate resulting losses.

PENSION SYSTEM: PILLAR 3

100. Pillar 3 is the component which provides supplementary pensions within the multi-pillar pension system. Voluntary funded pension is paid out from this pillar in order to ensure a supplementary source of incomes for retired individuals based on their voluntary contributions paid during the employed period and returns on their investment.

101. Voluntary funded pension is the result of pension insurance, which is paid on the basis of a contract signed between the individual and the financial institution licensed for pension insurance.

102. The voluntary funded pension is paid in accordance with certain rules that are set forth in the pension insurance program.

103. The beneficiaries of voluntary funded pension are the persons, who will voluntarily save a part of their incomes in order to receive an additional insurance pension in retirement age.

104. Any declared personal income may be used for paying voluntary pension contributions.

Voluntary funded contributions paid from the declared personal income of the individual must be deducted from the income tax base subject to the ceiling of 5 percent.

105. Pension contributions made by employers for employees are considered as expenditures and deducted from the gross income tax base. However, the pension contributions per employee must not exceed 5 percent of personal income/salary. In addition, this ceiling must not be calculated as an average for the whole payroll, but individually for each employee.

106. The types, forms, terms and procedures for the management of voluntary funded contributions are laid down in the contract signed with the beneficiary. The State establishes certain binding requirements for the management of voluntary funded contributions which mainly are related to the terms and forms of funded pension disposal.

107. The beneficiary of Pillar 3 may manage the funds of his funded pension if:

1) he has reached the legally defined retirement age,

2) he has changed his Armenian citizenship and/or place of permanent residence (in case of absence of Armenian citizenship),

3) he is affected by a disease which is included in the appropriate list as established by the authorized body of the Armenian Government.

108. Upon reaching the legally defined retirement age the individual is entitled to manage his voluntary funded pension in the following manner:

1) planned withdrawals;

2) annuities;

3) lump sum payment.

109. The individual may use his voluntary pension assets in the form of a lump-sum payment before reaching his…