National, International, Armenia, and Community News and Opinion

The Armenian Reporter | March 7, 2009 15
Armenia
Armenia prepares to privatize social security
World Bank, IMF
advise against
proposed pension
reform
Move is considered
risky
by Maria Titizian
YEREVAN – Starting in January
2010, workers in Armenia will see
part of their pay go into private
pension plans, under a decision
adopted on November 13, 2008, by
the Armenian government. Mandatory
retirement contributions
now go into a public pension pillar
similar to the U.S. Social Security
system. Workers born before 1970
can opt to remain in the existing
pillar, but younger workers will not
have the choice. (See sidebar.)
The change is understood to be a
way for the government to finance
the country’s capital markets.
“The focus of any pension system
should be the well-being of senior
citizens,” said the Armenian-American
economist Ara Khanjian.
“The purpose of a pension system
shouldn’t be to promote and generate
the financial markets of the
country.”
The stated intention of the government’s
pension reform is to increase
pension benefits and to link
benefits to the amount a worker
has contributed over the years. Under
the current system, benefits
are based on the number of years a
person was employed, but not the
wages earned during those years.
Armenia now has a pay-as-yougo
system. The mandatory contributions
workers make today fund
the benefits of current retirees.
The “system is based on the solidarity
principle between generations,”
Prof. Khanjian explained. With
pay-as-you-go, retirement funds
are protected from financial-market
risks. The government is able
to link benefits to the cost of living,
protecting retirees from inflation.
It is able to provide benefits
for as long as the retiree lives and
also pay survivors’ and disability
benefits. And the plan has significantly
lower administrative costs
than private accounts.
The Armenian government’s decision
comes at a time when other
countries – like Argentina, Italy,
and Chile – are moving away from
private pension funds.
International
organizations weigh in
The International Monetary Fund
and the World Bank, in the Joint
Staff Advisory Note on the Second
Poverty Reduction Strategy Paper
for the Republic of Armenia, argue
that Armenia should not privatize
its pension system.
The note suggests that Armenia
is not ready to adopt a mandatory
private pension system. Such a
system requires a domestic bond
market, which is not yet developed
in Armenia. It also requires the
administrative capacity to record,
manage, regulate, and supervise
the private pension accounts, a capacity
Armenia does not have.
In addition, the world financial
markets are in crisis.
Minister of Labor and Social Affairs
Arsen Hambartsumian told
the Armenian Reporter that he disagreed
with the position that having
a developed financial market is
a prerequisite for privatizing pensions.
“The opposite also holds true
Armenian pensioners. Photo: Photolure.
Pension pillars
Pillar is a technical term used by
pension experts all over the world.
The Armenian government’s proposed
reform entails four pillars
– pillars 0, 1, 2, and 3.
Pillar 0: The benefit allocated to
poor retirees. This is similar to
a welfare program designed for
the poor. If someone is at the age
of retirement and has very little
or no income to survive, the government
will provide that person
with some level of income.
Pillar 1: Represents the current
pension system that exists in Armenia.
According to the government’s
new pension plan, employees
younger than 40 in 2010
will not be allowed to remain
in or join this pillar. Employees
older than 40 have the option to
remain in this pillar. This implies
– that the initiation of any pension
reform will benefit the development
of capital in the financial
markets,” he said.
Prof. Khanjian confirmed, “The
financial markets, such as stock
and bond markets in Armenia, are
not developed because there aren’t
enough funds available to be invested
in these financial markets.
But when the mandatory private
pension accounts are created, in a
few years there will be hundreds
of millions and eventually billions
of dollars in these pension funds,
ready to be invested in these financial
markets, which will contribute
to their development.”
The decision comes
at a time when other
countries are moving
away from private
pension funds.
But that is not the purpose of a
pension program, Prof. Khanjian
said. The priority of the pension
system should be the well-being of
retirees, which the privatized system
cannot guarantee.
Prime Minister Tigran Sarkisian
and Minister of the Economy
Nerses Yeritsian have long been
proponents of implementing a
mandatory private pension fund
system in Armenia. The change
was considered but not adopted
when Mr. Sarkisian was chairperson
of the Central Bank of Armenia
(1998–2008) and Mr. Yeritsian was
with the bank.
Mr. Yeritsian was not available
to discuss the subject with the Armenian
Reporter. Written questions
that in about 25 years, no active
employee will remain in this pillar
because in 25 years the current
youngest member of this
pillar will become 65 years of age
and will retire. Therefore, this is
a temporary pillar.
Pillar 2: Represents the mandatory
private individual pension
accounts. Every employee
younger than 40 in 2010 will be
part of this pillar. This implies
that in 25 years every employee
will be part of this pillar. For this
reason, this is the main pillar of
the government’s proposal.
Pillar 3: Represents voluntary
contributions to private individual
pension accounts.
There is no controversy about
pillars 0 and 3. The controversy
has to do with pillars 1 and 2. f
submitted three weeks ago at the
suggestion of the ministry’s press
secretary had not been answered at
press time.
Theory vs. practice
In boom times, proponents of private
pension funds pointed to impressive
returns individuals could
get if their retirement savings were
invested rather than being used to
pay the pensions of current retirees.
At a time like this, with global
financial markets in a tailspin, the
argument has lost its force.
Across the globe, people who relied
exclusively on private pension
accounts are losing large sums of
money and being forced to postpone
their retirement – if they can
find continued employment.
Most industrialized countries,
including the United States and
Canada, do not have mandatory
private individual pension accounts.
Many Latin American countries
and some former Soviet republics
do have private mandatory pension
accounts invested in stock and
bond markets all over the world.
“With pension funds in Latin
America showing drastic losses as
a result of the global financial crisis,
Argentina has moved to nationalize
its private pension funds, while in
Chile, Colombia and Mexico there
are urgent calls for reforms,” Marcela
Valente wrote in an article
that appeared in the Global Information
Network on November 28, 2008.
“Many of the private sector pension
plans, created mainly in the 1990s . .
. followed the model adopted in 1981
by the dictatorship of Augusto Pinochet
(1973–1990) in Chile. In 1993,
Argentina adapted the model, without
eliminating the parallel public
system, which allowed workers to
choose either one. But on Nov. 20,
the Argentine parliament eliminated
the private pension funds, which
were in a state of collapse.”
Armenian society is not sophisticated
or market savvy enough to be
able to manage private pension accounts,
said Ara Nranyan, a member
of the Standing Committee on
Economic Affairs of Armenia’s National
Assembly. He recalled that
in the aftermath of the collapse of
the Soviet Union and its currency,
most people lost their life savings.
People are suspicious of the banking
system and are just starting to
open personal bank accounts and
learning to use ATM cards.
To force Armenian workers to
choose among private firms offering
competing pension plans is
irresponsible. Mr. Nranyan, who
holds a Ph.D. in economics and is
part of the ARF bloc in parliament,
told the Armenian Reporter that a
lack of money in the markets and
the strong desire on the part of the
government to generate the financial
markets has led to this new
plan. “Today, there’s about $500
million in pension remittances,
with a potential to increase annually,
which makes it very lucrative
for those in favor of this reform,”
he said. But, “during a financial crisis,
mandatory pension funds endanger
pensions and the security
of retirees,” he added.
There are many unknown variables
and questions about the new
system. Which companies will be
allowed to manage and sell pension
funds? How many pension funds
will be allowed to exist? Who should
choose the pension fund – the employee
or the employer? What kind
of assets should pension funds be
allowed to have? Should they have
bonds, domestic stocks, or international
stocks? How can the government
guarantee that a private pension
fund won’t become insolvent?
What will it do if it does? How will
women be treated when they leave
the job market to have children?
What kind of safeguards can be put
into place to fight potential corruption
in the new system?
In the name of the poor
Under the government’s plan, a
welfare system will back up the pension
system for the benefit of retirees
whose pensions underperform.
“What the state is indirectly saying
is that it doesn’t place value on
a person’s lifetime of work,” said
Smbad Sayian, head of the Pensions
Department at the Ministry
of Labor and Social Affairs. “The
government is saying, I will provide
you with a minimum benefit,
enough that you won’t starve, but
for the rest you are on your own.”
In 1981, Chile adopted a private
pension fund system which garnered
international attention. At
the time it was considered to be a
“great pioneering success.” Today,
almost a quarter century later,
Chilean workers at the cusp of
retirement are facing many crippling
challenges. According to
Armen Kouyoumdjian, an Armenian-Chilean
specialist, their
system encourages evasion by
employees and fraud by employers.
“For a system that was meant
to be universal and compulsory
for salaried workers, and has a
26-year track record, the fact that
only 51.7 percent of the 7.91 million
accounts at pension funds
called AFPs were up-to-date as of
September 30, 2008, says a lot,”
said Mr. Kouyoumdjian.
Just as in Armenia, workers in
The backup welfare plan does not
impress Prof. Khanjian. “An employee
who works [and contributes
to social security for] 30–40 years
should be entitled to receive pension
benefits. He or she shouldn’t
depend on a government handout,”
he said.
Funding budget deficits
Mr. Sayian is concerned about how
the funds will be invested. “Most of
these funds will be directed toward
government bonds and then these
bonds will be used by the government
to cover its current operating
deficit. This is where the greatest
danger lies,” he said, referring to
the possibility of default sometime
in the future.
Mr. Sayian is also concerned with
corruption, which increases the
risk to the most vulnerable people
in society. He notes that an employee
may choose to have her pension
invested with one financial
institution, whereas the employee
has cut a deal with another institution.
Realistically, the employer
may be able to coerce the employee
to go along. The Chilean experience
(see sidebar) suggests that some
employers may even pocket the remittances.
Reform is needed
Does the current pension system
in Armenia require reform? Everyone
across the board agrees that it
does. One issue is linking benefits
to lifetime earnings and contributions
to the pension system. Prof.
Khanjian notes that pension systems
in countries like the United
States use complicated formulas to
link pension taxes and retirement
benefits. “In Armenia we need a
much simpler formula or method.
In my opinion it should be much
simpler to generate such a pension
system, than to generate a pension
system which is based on individual
mandatory pension accounts,”
he said.
“It is safe to say that in countries
with mandatory individual
pension accounts all the workers
who are near their retirement age
are currently in a very precarious
situation because their mandatory
pension accounts have lost a significant
part of their value,” Prof.
Khanjian added. “This implies that
these workers are either going to
continue to work [if work is available,]
instead of retiring, or if they
decide to retire, they will live in
poverty.”
That’s a choice Armenian workers
might be faced with in the next
several decades if the government
decides to go ahead with this reform.
f
The Chilean experience
Chile didn’t know the workings of
the market well enough to differentiate
between available AFPs. “AFPs
employed thousands of people to
aggressively lure people from one
fund to another every few months,
with cash incentives or other gifts.
It was the gift rather than the
management quality or performance
that attracted the customers.
Now they have a much longer
compulsory waiting period and the
salespeople have been dismissed
(not before they rioted in violent
protest in the streets of Santiago),”
said Mr. Kouyoumdjian.
According to Marcela Valente’s
November 28 article in the Global
Information Network, “between
Oct. 31, 2007, and Oct. 31, 2008,
Chile’s private pension fund assets
shrank from 94.3 to 69.1 billion
dollars.”
f