Slovakia’s Pension Reforms

January 24, 2006 • Commentary

Politicians in Europe and America who remain in denial about the huge black holes at the heart of their state pension systems should take a look at the remarkable reforms pushed through by Slovakia. That tiny Eastern European country, already famed for its flat tax, launched its pension reform on 1 January last year.

Under Prime Minister Mikulas Dzurinda’s new ­system, Slovakia’s 2.2m workers were given a choice: they could either remain fully reliant on the pay‐​as‐​you‐​go pension system or take a part of their social security contributions and invest it in personal retirement accounts managed by a number of different investment funds.

Social security contributions in Slovakia amount to 28.75% of gross wages. Workers can now put 9% into their personal retirement accounts and 9% goes to the old system. The balance covers other types of insurance or administrative costs.

So far, roughly 1.1m people, or 50% of the eligible workers, opted for the personal retirement account, and it is expected that an additional 300,000 to 400,000 people will switch before the 30 June deadline.

Their savings, currently worth about 8.5bn Slovak crowns, are managed by eight investment funds created for a single purpose – management of the pension savings. There are eight pension companies in Slovakia, with two of them being taken over by stronger competitors.

Each of those pension companies manages three pension funds, tailored for “growth,” “balance” and “conservative” returns. Up to 80% of the “growth” fund portfolios may be constituted by equities, while “conservative” fund portfolios may contain no equities at all.

Young workers can choose from all three funds, while older workers, 15 years or less from retirement, can only choose from the last two. The pension companies can make a majority of their investments abroad, but 30% must remain in Slovakia.

The reforms have gone smoothly, except for the performance of Socialna Poistovna, the state‐​owned social security provider, which has been charged (unwisely, it turns out) with the collection of pension contributions and passing them onto the investment funds.

Once Socialna Poistovna’s antiquated IT system, which caused time‐​consuming backlogs, gets its long‐​promised overhaul, the pension contributions should flow from the state coffers to the investment funds more easily.

The popular opposition to the government’s pension plans was negligible. The public disenchantment with the economic mayhem left behind by Dzurinda’s predecessor, Vladimir Meciar, allowed the governing parties to make the pension reform a part of their electoral platforms in 2002.

The Slovak people also liked the fact personal retirement accounts constituted their inviolable private property – safe from politicians. Prior to the launch of the personal retirement accounts, the government embarked on an extensive media campaign, explaining the details and potential benefits of the pension reform to the public.

Finally, many of the reform proposals were adopted early on, allowing the new laws more time to set in, become more widely accepted and, in some cases, amended.

But the current government is unpopular and some of its members stand accused of corruption. In September, Slovakia will therefore face one of its most important elections since independence in 1993.

Though he needs to do much more to fight corruption, Dzurinda’s pro‐​market policies have ushered in high economic growth and rapidly declining unemployment. In 2005, the economy grew by 5.6% and is forecast to grow by 6.2% in 2006. Unemployment fell to 11% in 2005, down from 18% in 2000.

Robert Fico, Dzurinda’s socialist opponent and the leader in opinion polls, is to be congratulated for keeping the government transparent and accountable.

The same cannot be said of his determination to reverse many of Dzurinda’s policies, including the flat tax and greater labour‐​­market flexibility. Having already undertaken the reforms that others will eventually face, the Slovak people would be poorly served with a step back into the past.

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