COMMENT: Russia in search of solutions to rising pension costs

By bne IntelliNews July 6, 2010

Seija Lainela of Bank of Finland -

Recent years have seen a sharp increase in Russian federal budget spending to cover shortfalls in the state pension fund. Nearly half of the expected RUB2.4 trillion (€63bn) federal budget deficit this year will go to supporting the pension fund.

As the pension-funding problem looms large, the delicate question of raising the retirement age has finally been touched upon in public discussion. Russians still enjoy a Soviet-era legacy that allows women to retire at 55 and men at 60. Indeed, the actual average retirement age for men today is only 54 and 52 for women. This is due to the fact that 30% of retirees come from professions with lower retirement ages such as mine workers, lumberjacks, paramedics and pilots.

At June's international financial forum in St Petersburg, Finance Minister Alexei Kudrin said that the general retirement age would have to be raised in coming years. The increase could be phased in gradually over 5-10 years. With the approach of the 2011 Duma elections and the 2012 presidential election, however, observers are largely in agreement that the difficult decisions will be postponed for a couple years. Health and Social Affairs Minister Tatyana Golikova said it looks likely that there would be no change in the retirement age before 2015. Golikova noted that it could be difficult for the population to understand the fairness of a hike in the retirement age when the life expectancy of a Russian man is still only about 60 years. No official proposals on the new retirement age have been put forward.

Growing deficits

There are currently about 38m pensioners in Russia. Of them, about a quarter (10m) continue to work after retirement. Despite recent substantial hikes in pensions, Russian pensions are still paltry. The average monthly retirement pension in April was just 7,600 rubles (€200), less than half of the average wage of 20,400 rubles (€530). Working during retirement years has no impact on eligibility for receiving pension payments.

Since 2005, the pension fund has seen growing deficits. For the past couple years, the drain on the fund has been driven by large hikes in pensions as economic policy is focusing on social issues. The real year-on-year hike in pensions was 18% in 2008 and 11% in 2009. Pension hikes have continued this year and in the first quarter pensions were up 22% on qurater in real terms as the oldest pensioners received a major increase in their pensions at the start of the year.

The pension fund deficit was financed out the federal budget to the tune of RUB540bn in 2008 and RUB990bn in 2009. This year, deficit funding from the budget is expected to hit RUB1.15 trillion (€30bn). Next January, the employer pension contribution will rise 6 percentage points to 26% of the total wage bill, which should defuse the issue somewhat.

Russia's pension system was fundamentally overhauled in 2002. The change abandoned the traditional pay-as-you-go system funded by employers for a three-pillar multi-source scheme. A worker's pension is now formed by three elements: the first pillar comprises the insurance part and the second pillar the funded part of the pension, both financed via employers' pension contributions. The worker can designate whether the insurance element will go to a state-managed or privately managed pension fund. Finally, the third pillar is a non-state voluntary contribution by the worker. The reform is regarded as a failure, partly due to its ongoing under-funding as the employer pension contribution was lowered substantially in 2005.

Problems have also arisen with the second pillar that allows the worker to elect between a state-operated or privately operated pension fund. Measured in real terms, the cumulative value of fund contributions of workers has been constantly falling, as the average return on invested contributions has remained significantly lower than inflation. The cabinet is currently considering changes to the pension system, and should decide on them next year.

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