RETIRE AT YOUR OWN EXPENSE

Changes in the pension scheme in Azerbaijan have had a regular nature in recent years. Gradually, by amending the basic law "On Pensions", the government tries to eliminate the inequity in calculating pensions for those who retired before 2006 (the law was passed) and to improve the system of calculating pensions for "modern" and future pensioners. However, it is believed that the implementation of the concept of pension reform in Azerbaijan can be accelerated so that the system is fully consistent with good examples of foreign countries. In this context, for example, there is a proposal to increase the work on the adoption of a funded pension scheme, which would benefit not only potential retirees, but also the State Social Security Fund, in particular in the issue of self-financing. However, the State Fund itself is convinced that the third and final component of the reform concept is not yet ripe.

The third and final component

The Central Bank of Azerbaijan (CBA) suggested expediting the transition to a funded pension scheme. In particular, the chairman of the CBA Board, Elman Rustamov, said that the budget deficit of the State Social Security Fund continues to grow - in the last ten years it has grown ten-fold and reached 1 billion manats. And now the population is aging, which means that the life expectancy is increasing, and if today 6 people provide for one pensioner, this figure will decline in the future and reach the level of one to three in coming years. As a result, the load on the state will increase, which, of course, will create problems for the state budget.

According to Rustamov, Azerbaijan has a good pension strategy, but its timing should be reviewed. "The transition to a funded scheme and reduction of the load on the budget will lead to fiscal consolidation. When we say that our economy lacks financial resources and long-term investment resources, we must bear in mind that the main sources of loans issued by banks in the world are pension and insurance funds and fees from the population. The fees are large and are practically on a par with the population's deposits," the country's chief banker says. In his opinion, Kazakhstan, which began pension reform earlier and managed to collect $ 13 billion in pension funds, could be an example in this case, and this money became an important source of financing the economy.

The funded pension scheme is stipulated as the third and final phase by the concept of pension reform in Azerbaijan, which covers 2009-2015. The pension paid by the state to current pensioners and the old age pension to be paid to future pensioners consists of three parts: base, insurance and funded parts. The base part is the smallest component of the pension and consists of the minimum pension, former compensatory allowances and bonuses. This amount is assigned to all persons who have reached the retirement age and have a minimum work experience of 12 years. The main function of the base part of the pension is to provide some basic social guarantee. Although the base part is formally funded by fees from employers, it is actually paid from the state budget and does not depend on the specific size of the fees collected. Its size is 85 manats for today. By the way, the State Social Security Fund says that after the recent changes to legislation in Azerbaijan, there are no pensioners who receive the minimum pension.

The second component of the pension - the insurance part - plays the role of a mechanism to escape pension levelling and to link the size of the retirement pension to wages and work experience. All future retirees will have the same responsibility for financing it and the same rights regarding the conditions of its awarding and size - without any exceptions and exemptions. The size of these fees should be recorded for each insured person in the form of so-called pension capital. Thus, the pension is made up of deductions from wages for the entire career (currently the 22-per-cent fee from the wage fund paid by employers, and the 3-per-cent fee deducted from the employee's salary). The more money accumulates in a personal account, the higher is the pension in the end.

The funded part of the pension, in fact, is a form of insurance, but in this case, the funds allocated for accumulation are not spent on the payment of current pensions and will be invested in securities and other investment assets to generate income, which will be transferred into the individual accounts of insured persons. This will be another bonus to the pension in the long-run. It is important that the additional funded pension is voluntary and is intended primarily for people who want to maintain the habitual standard of living at an old age.

Discretion is the better part of valour!

As to when this component will be introduced in Azerbaijan, the State Fund plans that the legal framework for funded pensions will be prepared in 2014-2015. After national legislation is brought into line with European standards, the State Fund will be ready to give people the opportunity to place surplus funds in the SSSF as a payment in their accounts, in which interest will accrue. Upon retirement, they will receive some funds from the funded account in addition to the basic pension.

Is it really necessary to accelerate this process, as suggested by Rustamov? On the one hand, of course, the volume of transfers from the state budget into the State Social Security Fund is large enough today - in 2012 it is 1.044 billion manats. Moreover, this amount is growing every year as the pension reforms in the country require new funds that cannot be covered with payments under the state compulsory social insurance system. Consequently, the State Fund needs a new source of income - an additional financial instrument that would facilitate the state budget's "contribution" to citizens' pensions.

On the other hand, at a time when the world expects a second wave of economic crisis, it is too early to think about such a risky enterprise as the accumulation fund. As is known, during the first wave of the crisis, these structures were one of the first to be hit. The crisis affected funded pension schemes primarily through the depreciation of investment assets. In 2008, the value of pension fund assets in member countries of the Organization for Economic Cooperation and Development (OECD) fell from $ 18.7 to 15.3 trillion - by 19 per cent. According to the OECD, due to the rise in financial markets in 2009, the pension funds in OECD countries recovered $ 1.5 trillion - less than half of these losses.

It is no accident that after the crisis, countries with funded pension schemes accelerated the replacement of plans involving fixed-rate payments with fixed-rate fees. The latter are more stable financially, but redistribute the risks of changes in the value of assets among employees. Funds themselves moved assets from stocks to bonds, in particular in countries where funds actively invested in shares (Ireland, USA and UK) until recently. Several countries reduced payments into the pension system, reducing rates or allowing employers to temporarily pay fees to retirement accounts of employees on a parity basis.

Thus, the crisis showed that funded pension schemes with fixed-rate fees entail the risk that someone who retires during the crisis may receive a pension lower than anticipated, as the value of their accumulated assets plummets.

It is these risks that are a major obstacle to the establishment of a funded pension scheme in Azerbaijan. According to the chairman of the State Social Security Fund, Salim Muslimov, in addition to the implementation of this phase, it is planned to raise the volume of mandatory fees. He noted that among the CIS countries, Azerbaijan has the lowest rate (25 per cent) of the compulsory social insurance fee after Kazakhstan (21 per cent).

"Reducing this level will reduce the accumulation of funds in the individual pension accounts of employees, which will adversely affect their future pensions. In such a situation, the best option would be to increase the share of employees themselves in the rate without changing it for employers. But it would be advisable to do so after a certain time, because the priority currently is to increase wages," Muslimov said. According to him, the government shares this view with regard to the probability of inflation risk, as well as the reverse process in many countries around the world. "At the moment, the question of increasing the level of social benefits is not being considered, although, according to current practice, excluding transfers from the state budget, this level should be increased to 35 per cent to finance pensions," Muslimov said.

In addition, experts say, it is necessary for the domestic securities market to become stronger and be brought in line with the level of developed markets. Another important factor is the interest of potential retirees in these funds, which requires certain educational work to be carried out among the population.

In short, there are more reasons not to hurry to create independent pension funds in Azerbaijan than reasons to accelerate the implementation of this component. However, globally, the question will still depend on the pace of economic development in the country as a whole, as well as its ability to reflect external negative developments in the next couple of years.