Attachment 8 - Annex 4.doc

October 3, 2008 USDAID/Armenia Comments and Recommendations on the White Paper on

“Pension System Reform Program”

This document comments on the White Paper of the Pension Reforms Working Group (PWG) on “Pension system reform program: Main principles, strategic directions, tactical steps and actuarial forecasts for 2008-2080.” We begin with a summary of the recommendations.

1. Summary of Recommendations

Unified Tax

Zero Pillar

First Pillar

Second Pillar

Third Pillar

Tax regime is not stated.

EET tax regime is appropriate.

Management of the System

Implementation of the Reforms

Issues for Future Discussion

2. General Reform Design

The White Paper articulates a clear vision of the overall goals of the pension system, and the objectives and methodology of each pillar in the system. Overall pension reform objectives include:

· Social safety net for the vulnerable

· Sustainable pension system

· Reduction of informality – changing incentive structures for contributions

The PWG proposal for pension reform is as follows:

· for those with at least 10 years of social tax payment, some of which are prior to the effective date of the reform, an Employment Pension (First Pillar) financed by a unified tax of 21% of wages; the First Pillar consists of two parts: 1) a flat Basic Pension, this pension is the basis for all other benefits; and 2) an amount reflecting years of contributions prior to the reform;

· for those whose years of social tax payment are entirely after the effective date of reform, only the Basic Pension is to be paid to those with 10 years of social tax payment;

· a social pension (Zero Pillar) for those without 10 years of social tax payment, set to be 80% of the Basic Pension;

· individual funded pension accounts (Second Pillar) financed by contributions of 10% of wage, 5% paid by workers and 5% by the state, up to a ceiling; when the ceiling is reached high income workers will pay more than 5% in order to reach the full 10%;

· individual funded pension accounts will be administered in a Centralized Depository and invested by licensed asset managers;

· collection of the unified tax and Second Pillar contributions by the State Tax Service (now merged with the Customs Service into a combined State Revenue Committee, hereafter SRC);

· transfer of Second Pillar savings to asset managers chosen by workers; and

· a Third Pillar voluntary individual pension system.

The new Second Pillar system will be mandatory for those 40 years and under, while those over 40 can choose to participate. Those over 40 who choose to participate will not receive any contribution from the State. An additional amount based on length of service will be paid to those over 40.

The broad concepts of the reform are sensible and follow a number of recent international reforms. In particular, the reform provides a social safety net for the vulnerable and incentives for higher income individuals to return to or remain in the formal sector. It is also not overly expensive, coming to about one half of one percent of GDP. The SPSS modeling team, using a different statistical tool, but similar approaches, data and assumptions, has produced a broadly consistent model scenario. Both groups have concluded that the fiscal costs of reform are about half a percent of GDP in the near term, with savings emerging about 2050. See Appendix 1.

The overall tax burden in the proposed system is relatively high. The current system has an average combined employer rate of 26% (income tax and social insurance contribution) and an employee contribution of 3%. The proposed system would have 26% employer contributions and 5% employee contributions, an increase in the overall rate. While this resembles average OECD rates, as a regional comparison, the combined Georgian income and social tax is 25% without a Second Pillar contribution. It would be preferable to improve labor market incentives and lower the employer contribution rate, certainly not increase it. As an example, our calculations show that lowering the employer rate to 23% would increase the cost of the reform by 0.5% of GDP. See Appendix 1.

The draft White Paper is detailed and makes the case very clearly for reform. The description of the current situation, Chapter I, Section 1, is both eloquent and well founded. It describes pensions as a sector that lags behind growth in the country. Chapter II outlines the proposed reform, as summarized above it is to be a multi-pillar system following international practices. Chapter III, Sections 8 - 10, describe the pillars in some detail. Chapter IV addresses the institutional framework.

A surprising omission in the discussion is the issue of gender. The low wages leading to lower pensions for women, and the prevailing number of women retirees, makes this a critical issue. Due to shorter work histories on average, female workers tend to receive lower replacement rates from second pillar reforms.

Recommendations:

· Examine parameters of system and implications of burden on labor

· Reconsider tax increase and review feasibility of lowering tax

· Review implications for different groups of the population, in particular consider gender implications of the reform

3. Implementation Imperatives

While the White Paper describes a management structure for the new system, there is no discussion of the plan for putting it into place. It is imperative that there be an implementation plan and a senior level official (a manager) in charge of putting the plan into place, accountable to the GOAM and authorized to make requests to all affected agencies. In Poland such a person was called the “Plenipotentiary for Pension Reform.” We are not recommending a particular title, but we do believe it must be an individual with a rank equivalent to at least a Deputy Minister who is authorized to act with respect to several state institutions. Attached as Appendix 3 is an organization chart showing proposed working groups; Appendix 2 is a description of the positions on the chart. Appendix 3 also shows (through shading) that there are several working groups already acting at the periphery of the reform effort, but that the central management core is not active. We have been informed that there is a working group established for pension reform implementation, but that most members of the group have other full time tasks and are therefore not devoting a substantial amount of time to pension reform.

SPSS has received requests for assistance from several working groups addressing pension reform: on Information Technology, Legislative Drafting and Public Information. We have responded to assist all three requests and are pleased to do so. However, we believe that there is a grave risk that individual groups will work separately without overall coordination and strategy. We therefore suggest that a unified implementation plan be adopted with strong central management by a single responsible individual and not management by committee.

Another glaring omission is the absence of an implementation budget or even of a listing of the items that will be major expense items (information technology for the SRC, public information, regulation of asset managers, etc.) There is a discussion of the costs of reform in terms of benefit funding, but not in terms of the funding of administrative costs. The paper does not need to have a detailed implementation plan, but should identify who will be accountable for implementation, provide a high level timeline and a cost estimate for inclusion in the GOAM budget.

Recommendations:

· Appointment of one high-level manager of the reform implementation process

· Detailed implementation structure (proposal attached)

· Develop budget for implementation

4. The Design of the Unified Tax

The White Paper proposes a complex contribution and information collection process. Social insurance contributions and the income tax are to be replaced by a unified tax of 26% of wages paid by employers to the Treasury, with individual data reporting to the consolidated tax and customs agency (SRC). This is in principle positive as it will link the First Pillar Pensions to years of service for which a tax was actually paid. Persons who are required to participate in the Second Pillar, those under age 40, will also make a contribution of 5% to the Second Pillar, collected by employers. The total tax and contribution burden on labor will therefore be 31%. This is a tax increase, since the current rate of income plus social tax is an average of 26%.

In addition, the Treasury will transfer 5% (up to a ceiling) for those individuals who are required to be in the Second Pillar. The employers of individuals over age 40 will pay the same 26% tax, and those individuals may also opt to make 5% contributions for their own Second Pillar account, but will receive no 5% match from the Treasury. We have previously stated our concern about the tax rate being too high, and propose a reduced rate.

We are concerned that the process is complex and will lead to numerous errors and difficulty in reconciliation. This will have particular implications for Second Pillar contributions as noted below in Section 9.

We also have noted our concern about funds intended for individual pension accounts being collected as a tax and paid to the Treasury. Their legal status can be questionable. The additional transfer will not facilitate accuracy. It is not clear how the individual records will be maintained in the Treasury. No justification for this new arrangement has been provided, and few countries have such a tax. Particularly for the Second Pillar, individual recordkeeping and reconciliation is crucial, and accurate collection will not be easier through the proposed method.

The PWG has explained that this approach is necessary to demonstrate to participants that the state is contributing 5% to their Second Pillar savings. We think that this explanation could be given through public information and need not require an additional step for transmitting funds to asset managers.

Another rationale given is that the Treasury will hold funds until they are reconciled. Employers will pay to the Treasury and report individual data to the SRC. The SCR will check the information and confirm its accuracy, instructing the Treasury to make transfers for those individual records that are in order (correct identification number, correct amount of contributions). Records that are not reconciled will be corrected and only then will transfers be made. Unallocated funds will remain in a Treasury account.

While the White Paper specifies that the CDA will transfer amounts within 24 hours, there is no time limit specified for transfers from Treasury to CDA. This can be addressed in legislation, and needs to be thought through as part of the overall business process.

Finally, the White Paper notes that the unified tax will allow for flexibility of state pension policy, section 7.2.11. It is also mentioned there that the unified tax will be levied on incomes and salaries. It is not clear what is meant by flexibility. Furthermore, the imposition of a social tax on incomes that are not related to work (such as rental income for example) is not common practice. Usually such taxes are levied on salary income in order to create a length of service for which a pension is due.

Recommendations:

· Second pillar funds should not be sent through the Treasury

· Collection and reconciliation process is complex and can lead to implementation difficulties; consider simplification

5. Zero Pillar Design

The design of the Zero Pillar is generally appropriate, serving as a safety net to prevent extreme poverty. This is a social pension to be provided to all residents (whether or not they are citizens) of Armenia who do not have 10 years of social tax paid on their behalf, section 7.3.4.3. It will be 80% of the basic pension, and the basic pension will be comparable to the minimal consumer budget, section 7.2.3.

The White Paper notes that collection of information about income costs more that payment of social pensions, section 8.1.3. We agree that means testing should not be done except for verification that no First Pillar pension is paid. A means testing process could be adopted for persons who receive other income, such as pensions from other countries, but only when cost-effective access to appropriate records exist.

There needs to be clarification concerning residency and citizenship requirements for the social pension. It appears from the White Paper that the social pension will be provided to persons who move to Armenia at pension age, do not have a pension in Armenia, but may have pensions from other countries. Whether and how to require residency and citizenship is an important social choice and needs to be discussed further.

Payment of the social pension should be through the banking system to individual accounts or through a system like the ARCA Card. The SSSS has expressed its opinion that current law prohibits this. While we disagree, we note that this issue should be resolved definitively in the revised law.

Recommendations:

· Adopt as proposed

· Develop electronic payment system

6. First Pillar Design

The PAYG pension will require 10 and not 5 years of covered service. This is an appropriate change encouraging participation, section 8.2.1.3. However, there is some concern is that the Zero Pillar social pension is the same for persons with no tax paid on their behalf and for persons with some years of service when tax was paid. Some differentiation by length of service could be considered (for instance a 90% benefit with at least 5 years of service).

For persons who already have service credit at the time of reform, the PAYG pension will consist of two parts: 1) a flat basic pension, and 2) credit for length of service (LOS). Those who are under 40 and must join the Second Pillar, as well as voluntary participants in the Second Pillar, will receive LOS credit only for years prior to the reform. Those over 40, who do not join the Second Pillar, will receive credit for all years according to the current system. Those who enter the new system after its adoption will only receive a basic pension (they will receive no credit for LOS). There will be no link to income, section 7.1.4.5. A number of commentators have observed that this does not provide sufficient incentives for employees to work in the formal sector.

The pension system remains unattractive for highly compensated individuals generally, and is especially unattractive for highly compensated individuals over age 40. We recognize that the income-based differentiation of First Pillar pensions would either increase the cost of the entire system, or require reducing low-income pensions in order to increase high-income pensions, and we do not recommend it. Income differentiation should be addressed in the Second Pillar.

Indexation of the First Pillar Pension raises incentive issues. The White Paper proposes that the Basic Pension and the LOS credit be indexed separately. From 2008-2012 pensions are indexed in order to equal the minimum consumer budget as required by the projections of PRSP-II, appropriate as a poverty alleviation measure. After 2013 the year value for LOS is to be indexed by consumer price index. However, after 2022 the Basic Pension is to be indexed by the annual average wage growth rate, section 7.5.7.6, while the LOS accrual factor will remain linked to inflation, the consumer price index. The result of this indexation proposal is that the value of the LOS will gradually decrease and that the First Pillar pensions will over time become less differentiated. This is a reversal of the previously proposed indexation scheme and raises questions. One view is that this approach dilutes the main function of the Basic Pension, which is to prevent old-age poverty, and may act as a disincentive to labor force participation and membership in the pension system generally. As is demonstrated in Appendix 1, it is still possible to achieve the GOAM targets for the average pension through 2021 with an alternative indexation scheme. In the long run, indexing the Basic Pension to prices, as opposed to wages, generates substantial fiscal savings, albeit at the price of lower pensions (e.g., a total Pillar 1 plus Pillar 2 replacement rate of 17% in 2060 as opposed to 30%). The trade off between fiscal space and lower pensions, and the impact of different indexation schemes on incentives, deserve further analysis and discussion.

Recommendations:

· Further development of data to study long term effects

· Review incentive structures for participation, which are not strong

· Adopt First Pillar as proposed for new entrants

7. Second Pillar Design

The objective of the Second Pillar is to provide a higher income in pension age, reflecting income and contributions as well as investment return. The addition of a Second Pillar to the program is positive. It will serve as an incentive to higher participation. 10% is an appropriate level for second-pillar contributions in a pension system where the First Pillar is primarily for poverty reduction and the Second Pillar serves as the principal vehicle for accumulation reflecting income.

Incentives However, several aspects of the program deserve some further consideration since they may serve as disincentives. The GOAM will co-finance Second Pillar contributions in the amount of 5% of income, but not more than 25,000 AMD. As a result, persons with a salary at or above 500,000 AMD will have to contribute more than 5% of their income to reach a full 10% contribution. This approach discriminates against higher income individuals and could be discouraging, whereas the reform program specifies that state participation should be encouraging formalization of income, section 7.3.1.3, step 2. Persons with salaries at 500,000 AMD or more will already contribute disproportionately to the First Pillar system while receiving a flat benefit unrelated to income. To require them to contribute a greater proportion of salary to the Second Pillar as well will stimulate them to under-report income over 500,000 AMD.

Tax Regime A similar concern occurs with respect to the tax regime proposed for the Second Pillar. The regime is TEE (taxation of contributions, exemption of taxation for investment income and for pension payments), sections 10.2.5 and 10.5. This is not international best practice, for several reasons. An EET regime is recommended, with exemption of taxation for the individual’s and employer’s contribution. This stimulates individuals to participate. In addition, an EET regime in the long run brings more resources through taxation of final payments, which will include contributions and investment. The proposed regime obtains taxes sooner, but in smaller amounts, and discourages participation. We expect that if this tax regime is adopted there will be almost no voluntary participation in the Second Pillar by persons age 40 or older. It is interesting to note that a different regime is recommended for Third Pillar pensions, section 11.2.

Asset Management As we have noted before, the asset management regime proposed for the Second Pillar will lead to higher administrative costs and consequently lower rates of return. The White Paper proposes that participants choose asset managers, each offering (initially) one to (later) three portfolios, from which participants can choose. Asset managers could be Armenian or foreign firms but would be licensed and operate in Armenia.

The White Paper indicates an assumed projected rate of return of 5%. For the sake of comparison, an OECD study concluded that Central and Eastern European country average real rates of return ranged from 1.5 to 9.6 per year, before payment of asset manager fees.

The assumed projection is in line with that experience. The issue of asset fees is very important, as noted below, and high fees can result in negative returns to participant accounts.

The asset management arrangement requires review, with particular attention to costs and how much choice should be provided. One view is that use of a single portfolio in the early years of reform has lead to a reduction in administrative costs and complexity, such as in the Kosovo Pension Savings Trust.

Another view is that the White Paper is too restrictive and that there should be more investment choice in general. Possibilities would include:

· allowing asset managers more flexibility in the number of portfolios provided (i.e. more or less than three);

· allowing more scope for inclusion of additional equities in each of the conservative, balanced and risky portfolios;

· banking deposit option (similar to an Individual Retirement Account); and

· allowing employees to split contributions among options.

Section 10.8.2.4 provides that only 30% of assets can be in foreign currency denominated instruments. However, section 10.8.2.6 provides that this restriction can be eased at a time when asset managers offer only one portfolio, based on investment opportunities. We recommend that the 30% restriction be lifted or eased further, and that for investments made abroad, in the early years of the system, the Central Bank (or financial service regulator) select portfolios such as index funds provided by international financial institutions.

Asset management costs also require attention in order to improve rates of return. A recent IOPS study of fees and costs in private defined contribution systems concluded that voluntary systems tend to have higher charge ratios. Some (but not all) systems where there are a few providers show relatively lower fees. Thus, even with a few providers other issues need to be considered. Fees decline over time, making older pension systems generally less expensive. Regulations, particularly those limiting asset based fees, can reduce costs in pension systems – but opportunity costs (of potentially higher returns) may be sacrificed. Regulations imposing minimum guarantees imply higher costs. Higher contribution rates and higher wages deliver higher final balances and therefore lower costs.

The White Paper proposes reconciliation of individual accounts and immediate investment in the chosen portfolio. In earlier versions a 15 day reconciliation time frame was proposed, and this is going to be difficult to acheieve. Assets should be invested immediately, however, in an interim portfolio, as is done for instance in Sweden. According to the proposed plan, assets will remain in a special Treasury account until transferred to CDA. We recommend that the issue of investment during the interim period be addressed.

The White Paper proposes that participants who do not select a portfolio or asset manager be randomly assigned, distributed in proportion according to choices already made by others. This risks the possibility that a large share of the population will be allocated to choices made by a very small segment of the population, which may or may not be prudent. The portfolio of participants who do not choose an asset manager or portfolio is unclear. Section 10.7.3.5 provides that those who do not choose will be randomly assigned to asset managers and their accounts invested into “balanced” portfolios, while section 16.1.1.3 provides that they will be randomly assigned to “conservative” portfolios. A default portfolio should be established (or at least default portfolio parameters specifying proportions in types of assets) in order to ensure prudent investment across asset types, including internationally.

Other Issues Several other important matters are not addressed sufficiently. The participation of foreign citizens in the Second Pillar is mandatory (section 10.3.2.3) with transfer of assets to a similar account in another country upon departure, if a legal basis for this exists. Otherwise, assets remain in Armenia until retirement. It will be difficult to find regimes with a similar legal basis for transfers, especially because most developed countries use an EET tax regime. A foreign citizen transferring assets to the US, for example, would have double taxation or TET. One possibility is that foreign citizens participate voluntarily in the Second Pillar; another possibility is a more lenient regime for withdrawal of savings (such as phased withdrawals over a term of years). The matter requires clarification.

Another legal issue to consider is whether assets on individual accounts will be joint spousal property in cases of divorce. We believe that they should be considered joint property at divorce and that this should be specified in the law governing the Second Pillar.

The White Paper proposes a guarantee fund for operational risks; a better option would be a bonding requirement. As noted above, guarantees tend to reduce rates of return.

Management of the Second Pillar system is discussed in part 9 below.

Recommendations:

· 10% is an appropriate level of contributions for Second Pillar pensions

· Streamline and simplify system for sending contributions to individual accounts

· Proposed asset management arrangements through domestic asset managers risk being costly

· Adopt simplified less costly arrangements for international asset management

· Cap asset management fees

· Default portfolio is needed

· Tax regime is inappropriate, adopt EET tax regime

· Ceiling will serve as a disincentive to participation to high income individuals

· Poor incentives for voluntary participation by individuals over age 40

8. Third Pillar Design

We have several comments with respect to the Third Pillar proposal. First, we believe that corporate pension schemes provided by employers should be included. The White Paper states in section 7.1.5 that this is untimely because there are no strong labor unions in Armenia. In international practice, corporate pension schemes are not only established by labor unions, but also by employers. A comprehensive funded pension law should provide for appropriate regulation of such schemes, even if at first there will only be several of them. The white paper appears to anticipate this as it refers to contributions by legal persons to the accounts of their employees, sections 11.2.4 and 11.4.2.

Second, while the White Paper correctly refers to the lack of actuarial expertise at present, such expertise is critical for defined benefit and not necessarily for defined contribution pensions. Corporate defined contribution pensions can be set up without actuaries. In any case, the absence of accurate data, rather than the absence of actuaries is the greater long term difficulty.

Third, we think that the definition of providers of Third Pillar pensions is too narrow. Section 11.4.1.2 indicates that providers of voluntary pension insurance must be licensed companies and cannot be involved in other business. This will prevent economies of scale and a development of the sector. We believe that licensed banks, asset managers and insurance companies should be able to provide this product and that the creation of separate companies should not be required.

Recommendations:

· Include employer provided pensions on a defined contribution basis

· Permit all licensed financial institutions to provide Third Pillar pension products

· EET is the appropriate tax regime

9. Management of the System

The management of the reformed pension system (as discussed in Chapter IV, Sections 14 and 15) is based on three principles:

1) reducing the intervention of the state;

2) using existing structures; and

3) delegation to NGOs and others.

The state solidarity and funded systems require separate management structures. The state solidarity component will have the following management structure:

It is noteworthy that the proposed system will transfer the individual registry responsibility from the SSSS to the SRC. The reasons for this have been explained in the White Paper, section 2.2.7 and Box 7; the system established in SSSS is not fully operational. The SPSS project has concluded that its operating system and functionality is not state of the art (separate reports on this were filed). The obligation imposed on SSSS by Article 65 of the law of the RA “On State Pensions” to provide information to participants concerning their individual accounts twice a year has not been met. In the new system the collection and reconciliation function will be performed by SRC and the CDA will provide annual statements to participants. However, SSSS will continue to make pension awards of First Pillar and Zero Pillar pensions.

It is important to assure that SSSS and SRC will exchange data as necessary. The following function should be explicitly added to the SRC functions listed in section 14.2.4.3.:

· Providing information necessary for assigning and calculations of Zero and First Pillar pensions to SSSS in electronic format on a regular basis (through access to required data in the SRC database) Similarly, SSSS must transfer its database, in an appropriate format, to the SRC database, and needs to share its database with the State Labor Inspectorate.

The White Paper also grants a role to the State Labor Inspectorate (SLI) in validating documents presented for pension awards, section 14.2.3. SLI will inspect the accuracy of documents provided to SSSS by persons and organizations for assigning and paying pensions. It should be noted that this will be a function of decreasing necessity as adequate personified records replace these checks. However, for years prior to reform, such document checks will be critical. SLI will conduct inspections only based on SSSS requests if there are doubts or inconsistencies in documents. Since the SSSS does not have any inspection powers of its own, it seems rational that it should rely on SLI for investigating or verifying any pension related labor issue or fact at its own discretion. However, the White Paper also proposes “new functions” for SLI. If the SLI will be used only in cases requested by SSSS and limited to labor related documents, there is no need for any “new functions” for SLI. Under current law, SLI can check any document related to labor law. Additional functions - meaning additional regular inspections of businesses - contradict the principle of reduced inspection burden on businesses.

Cooperation between SSSS and SLI must include regular standard data exchanges. This will eliminate the need for the employers’ annual report to the SLI and will help implement risk-based enforcement. SLI will be able to use SSSS data to analyze variations in the duration, costs and incidence rates of short-term work related disabilities. It will be able to track differences according to length of service, occupation and industry to determine where these disabilities are occurring more often, last longer and cost more than expected (based upon industry and number of employees) and include these businesses in the planned inspections. This will reduce unnecessary burdensome reporting for businesses and will also strengthen SLI capacities.

The private funded component will have the following management structure:

We have previously identified a principal difficulty with this structure. There is no single strong Second Pillar governance structure to protect participants, issue information, receive complaints and select asset managers (the Swedish PPM is a good example of such a structure). The tasks are dispersed and some tasks are not adequately described.

Second Pillar contributions should be conveyed electronically with data on a monthly basis. The proposed collection structure which has assets going to Treasury, data to SRC, and then transmission to the CDA, presents many opportunities for mistakes and poor attribution of contributions to participants.

Sections 14.2.1 and 14.2.12 mention public awareness and education programs. Responsibility for these critical functions should be indicated. Related to this issue is the statement in 14.2.8 that “No state structure will provide direct financial advisory services for selection of investment portfolios and asset managers.” While the state should not provide advice, it should provide objective information on asset managers enabling participants to make comparisons. What will be the equivalent of the PPM website where rates of return are provided? This could be the CDA, but this is not indicated as one of its functions and is not currently an area of its expertise. Another option is for asset managers to provide this information by themselves, but then it needs to be regulated for accuracy and objectivity. The reform program could then indicate that asset managers will be regulated in how they provide information in order to protect consumers and be comparative, and identify a state agency responsible for monitoring such information and/or also providing impartial information on the asset managers.

The White Paper does not specify how the asset managers will be selected but mentions that there will be no more than 3 or 4, section 16.1.1.3. This presumes a tender process, or some other selection process. This needs to be clarified.

At Sec 10.7.2.1, the White Paper specifies that an individual must apply for an account with the CDA and that the CDA will notify the individual. We suggest that the social card number should be used as the account number for Second Pillar. Although the CDA may need to use an internal number within its system, we believe that introducing another account number to individuals who have only recently received a social card number would create unnecessary confusion. In addition, it is possible that using the social card number in conjunction with data already held at the NORK center, might be able to simplify the initial enrollment process for individuals.

Recommendations:

· A stronger governance structure is needed to protect participants

· Provide regular automatic structure for data exchange between SRC and SSSS, necessary for Zero and First Pillar pension awards

· Individual participant data and contributions should be conveyed monthly and electronically

· Implementation planning for business process change, integration of systems and redundancy needs to begin immediately

· The development of a system and training of personnel for individual recordkeeping is critical and should begin immediately; in most countries this process takes well over a year, and in some cases several years

· Unified public message on pension reform is needed

10. Reorganization of State Agencies Addressing Other Social Sector Needs

The White Paper proposes the reorganization of other social services as well (Chapter 14). This is very appropriate as a number of social services need to be integrated with provision of pensions. The GOAM has sought integration of social services previously as part of its commitment to European social insurance principles. The efforts have not been successful because services have been co-located without integration of information or business process. The changes now proposed require business process and information technology changes, and redundancy planning. A World Bank project has been scheduled to provide MLSI a corporate network. Without the information integration that this network will provide, integration will be impossible to realize. If the World Bank project will not provide the corporate network, the GOAM must acquire it and this should be part of implementation budgeting.

Employment Services Improved provision of employment services is integrally related to a sustainable pension system. Quality jobs in the formal economy must increase for the pension system to be robust. SESA provides cash benefits for the unemployed as well as non-cash employment related benefits. The non-cash active labor measures have been a particular focus of SPSS technical assistance. The current financing system of SESA requires SESA to obtain financing from SSSS which in turn obtains it from Treasury through the budget. The reform proposes direct financing of SESA through the budget, and this seems a streamlining and rational reform. SESA currently has 51 regional offices, and these will remain providing all employment services. We note that in the past the GOAM has indicated a plan to shift to one-stop-shop social services and that leaving SESA separate contradicts this. It is important for SESA and SSSS data exchanges to take place, and for there to be virtual integration of services even if the services are not physically integrated.

Social Assistance The current social assistance program similarly provides for cash benefits to the vulnerable and non-cash social services. Cash services are mandated by national law and paid from the national budget; they are administered by social assistance regional divisions located in various marz, municipality and local government agencies (38 at the marz level and 17 in communities). These social assistance regional divisions also provide non-cash social services, some funded by the national government and some voluntarily funded by local government.

The staff administering these benefits is funded by both national and local budgets. The reform proposes to merge the social assistance regional offices with the 51 SSSS offices. As written, the proposal raises several fundamental questions.

1. Will the merger of the regional offices include both cash and non-cash activities?

2. Will the Department of Social Assistance in the MLSI continue to provide policy direction for regional social assistance activities?

3. Will financing of non-cash benefits presently financed from the national budget change?

This could be a rational reform leading to streamlining and improved services. It is appropriate to make cash payments of a national cash assistance program through a single integrated process within SSSS. This will require integration of the social assistance and SSSS databases, which should be feasible with a corporate network. It will also require planning for staff reorganization and redundancies at the local level because staff at 55 regional offices may become partially redundant. The recent work on business process improvement at SSSS can be expanded to address the additional function of social assistance payments. Most significantly, the non-cash social services must be developed by local authorities to serve the vulnerable. Removing the cash benefit from these offices may result in focused attention to non-cash social services and development of the social worker function. Consideration can be given to whether some services ought to be mandated.

Recommendations:

· Clarify status of non-cash social assistance benefits – we do not recommend that they be moved to SSSS along with cash benefits

· Implementation and transition planning is required for business process change, integration of information systems, and redundancy Appendix 1

SPSS Modeling Team Comments on PWG White paper

We have worked with the PWG modeling team in recent months to compare approaches, assumptions, and results. For the years 2008-2021, both teams have followed assumptions in the Government Programme. The most important of these from the pension point of view are those related to GDP growth, unemployment, informality, the wage rate, and the basic pension and annual accrual value according to which pensions are calculated. Having both employed Government assumptions, it is not surprising that the SPSS and PWG teams’ baseline scenarios are reasonably close (see Table 1) through 2020. In the longer term, there is some divergence.

Table 1: No-reform baseline scenario comparisons

Total insurance pension beneficiaries (000)

Average insurance pension (AMD)

Insurance pensions expenditure (AMD mill)

Number of contributors (000)

Total contributions (AMD mill)

Balance, all programmes (share of GDP

The main source of divergence is uncertainty related to the number of pension system contributors and pension system beneficiaries. Specifically, the PROST model does not take explicit account of unemployment, informality, and the sectoral composition of output (especially agriculture vs. non-agriculture). In the longer term, the assumptions regarding these variables built into the SPSS scenario suggest that the PWG is being too pessimistic about social insurance coverage. Even in the absence of reform, structural trends will favour expansion of the contribution base.