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Impact Investing

IPE special report May 2018

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The pensions crisis - how it all went so wrong

While most European countries’ looming pensions crises stem from the demographic consequences of increased life-spans coupled with falling birth-rates, Romania’s problems are largely the result of piece-meal legislation grafted onto the chaos following the bloody collapse of communism in 1989. In 1990 Romania inherited a complex scheme of a main state system covering industrial workers alongside additional separate systems for farmers, creative artists, craftsmen, clergy, military and lawyers. It nevertheless had a relatively comfortable ratio of 3.5 workers for every beneficiary. By 2003 this had flipped to 0.75 contributors per pensioner. On the supply side, between 1990 and 2001 the number of contributors fell by 3.7m to 4.5m, of which unemployment accounted for around 1m while the rest disappeared into the non-tax paying informal economy. Inevitably, successive attempts to make up the benefits shortfall by ratcheting up social security contributions – these have risen from 14% of gross wages in 1990 to 37.5% by 2002 – only encouraged more employees and employers to evade payment. On the demand side the number of beneficiaries rose from 3.4m to 6.2m. In 1990 the government introduced an early retirement of five years as an unemployment buffer, and over the following year the number of retirees leapt by a third. This was followed by extending the both the definition of “hardship” professions and their early retirement provisions, as a result of which the number of retirees from this group rocketed from 300,000 to 3m. Another source of loss was the decision in 1992 to make farmers’ contributions to their scheme voluntary.
The pension and benefits systems went into deficit in 1995 and reached crisis point the following year when pensions were re-indexed to from nominal to current wages. The current government’s predecessor finally stemmed the rot with the pensions law of 2000, which introduced a gradual increase in the retirement age by 2014, from 60 to 65 years for men and from 55 to 60 years for women. The qualifying length of service for pensions eligibility was also increased, from 30 to 35 years for men and from 25 to 30 years for women, while qualification for early retirement from hazardous professions was tightened up. The law also established the National House for Pensions as the collection and distributing body.
In addition, the new law introduced a greater link to contributions by basing final pensions on the full length of service as opposed to the best five years of the final 10, and extended pensions coverage to the rest of the workforce, including the self-employed and farmers. Their incomes declarations can be no lower than 25% of the average wage.
The change has already had an evident effect on pensions payout, stabilising the pensions deficit in relation to GDP at 0.7% in 2002. The ultimate success of the first pillar reforms is critical to the subsequent introduction of a compulsory second pillar scheme as the savings here are to fund the so-called transition cost – the cost to the first pillar of contributions diverted to the second. The previous government’s Universal Pension Fund scheme envisaged a diversion of 10 percentage points.

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