Contexto histórico y claves de lectura

Chapter 3 is the heart of the report. It summarizes the findings of a review of more than 30 pension schemes across 13 countries. The chapter pres- ents the main features of pension systems in the region and the key chal- lenges along five dimensions: (a) institutional organization and coverage; (b) the size and shape of the schemes; (c) incentive problems; (d) equity, including gender equity, problems; and (e) financial sustainability.

Pension Systems Are Fragmented and Coverage Is Modest

None of the countries surveyed has a national pension scheme that cov- ers all categories of workers. Even Jordan, which has recently integrated the schemes for private sector workers, civil servants, and the military, excludes the self-employed and workers in the agricultural sector. Egypt, Morocco, and Tunisia have the largest number of schemes: six, five, and four, respectively. This fragmentation is an important policy issue because it constrains the mobility of the labor force within and across sectors, increases administrative costs, and generates an unequal treat- ment of different categories of workers.

There is a large variation in coverage rates among the countries included in the analysis (between 10 and 70 percent of the labor force) explained mainly by the structure of the labor market (for example, public or private sector) and institutional arrangements that cover different cat- egories of workers. In Libya, for instance, coverage rates are high (above 70 percent of labor force) because a large majority of the labor force is employed in the public sector or state-owned enterprises. In Morocco, in contrast, a large agricultural sector keeps coverage rates depressed

Overview 7

(around 20 percent of the labor force). Algeria, Egypt, and Tunisia achieve higher-than-average coverage rates through special schemes.

In general, the prospects for expanded coverage rates are limited, and governments need to think creatively about mechanisms to protect the old-age income of vulnerable population groups. Better incentives to enroll or better administrative capacity to track contributions could improve coverage at the margin, but the impacts are likely to be limited. Without an expansion of the formal sector of the economy, coverage rates are unlikely to increase substantially. In this context, noncontribu- tory pensions (also called social pensions) could be used to guarantee a basic level of retirement income to vulnerable groups.

Pension Schemes Have Large Mandates

The chapter presents an assessment of targeted replacement rates across pension systems in the region. The replacement rate is defined as the pension divided by the last salary. It indicates the share of total gross income that is replaced or preserved at retirement. On average, the mandates of pension systems in terms of income replacement are more onerous in the Middle East and North Africa than in other regions. The Islamic Republic of Iran, Iraq, and the Republic of Yemen have the highest replacement rates in the world for the average full-

career worker (above 100 percent).4_{The average gross replacement rate}

for the region is 75.7 percent. This is much higher than the pension promise in 24 high-income Organisation for Economic Co-operation and Development (OECD) countries, in 10 countries in Eastern Europe and Central Asia, and nine countries in Latin America and the Caribbean, where pension replacement rates average 57 percent.

Net replacement rates, which include the effect of taxes, are even higher. Hence, in Egypt, while the gross pension represents 80 percent of the gross wage, the net pension represents more than 100 percent. In essence, the average worker has more disposable income after retirement than while working!

Schemes for civil servants target, in general, higher levels of income replacement than schemes for private sector workers.

The targets for the basic pension also tend to be among the most gen- erous in the world. Moreover, Middle East and North African countries rarely place ceilings on the covered wage or ceilings are high. As a result, replacement rates that are flat across levels of income. Basically, the pension system guarantees the same level of income replacement to a low- as to a high-income individual.

The problem with having large mandates is that few people will want to save for retirement outside the mandatory pension system,

8 Pensions in the Middle East and North Africa:Time for Change

including middle and high earners. This means that retirement savings are not diversified, making them more risky for individuals than they need be and hampering the development of capital markets through long-term savings institutions. Finally, high mandates are simply un- likely to be affordable, since, to be financed, they will require contribu- tion rates that the economies cannot sustain.

Benefit Formulas and Eligibility Conditions Damage Incentives

The mechanisms used to compute and award pensions affect the behavior of individuals, including retirement, labor supply, and savings decisions. Chapter 3 assesses incentive problems by reviewing implicit rates of return on contributions. Indeed, since individuals make contri- butions during their active life (an operation similar to depositing savings in a bank) and receive pensions when they retire (an operation similar to withdrawing savings from a bank), it is possible to compute the implicit interest rate (or rate of return) on the contributions (savings).

The results show that, across countries and schemes, current benefit formulas and eligibility conditions provide incentives for retirement over work. This is reflected in implicit rates of return that are higher for individuals retiring early than for individuals retiring late. The reason for this pattern is the lack of actuarially fair reductions in pensions for early retirement and actuarially fair compensations for delayed retirement.

Ceilings on replacement rates, or pensions, can also lower the rate of return for individuals retiring late and thus discourage additional years of contribution. Indeed, once the ceiling is reached, additional contribu- tions do not bring additional benefits. These ceilings are pervasive in the region, since most countries use them to reduce costs.

The systems also provide incentives to manipulate salaries stra- tegically, since only the last few salaries count toward the pension. With the exception of the RCAR (Régime Collectif d’Assurance et de Retraite) in Morocco, none of the schemes uses a full-career average of salaries to compute the pension. In general, the schemes use the last salary or an average of three to five years. The problem is that workers have an incentive to declare lower wages early in their career and higher wages late in their career.

All of the pension schemes in the region reward individuals who evade or game the system. This is again explained, in part, by the fact that only a few wages count toward the pension. Ceilings on replacement rates also contribute by reducing the implicit rate of return paid to workers who have long contribution periods (to avoid the ceiling, individuals might choose to delay enrollment). In general, a weak link between contribu- tions and benefits reduces the incentives to enroll and contribute.

Overview 9

Redistribution within Pension Systems Is Nontransparent and Can Be Regressive

When it comes to redistribution, a primary source of inequality within generations is also related to the fact that only a few wages count toward the pension. Manual workers have relatively flat earnings across their career. Managerial and especially professional workers tend to see their pay rise more rapidly over their lifetime. Basing pension values on final salary favors workers with steeply rising earnings. In Algeria, for instance, a 25-year-old man whose salary grows at 2 percent a year will receive a rate of return one percentage point lower than a colleague whose salary grows at 4 percent a year.

In all pension schemes, there are implicit transfers from young to old workers, regardless of the level of income, because implicit rates of return on contributions are allowed to vary by the age of enrollment in the system. In Tunisia, for instance, a 20-year-old male retiring at age 60 will receive a 4.5 percent real rate of return, while a 30- and a 40-year- old male will receive a 7 and 9 percent real rate of return, respectively.

Regarding gender equality, pension laws across the region have attempted to provide women with more flexible retirement decisions and more secure survivor benefits, driven by the assumption that men are the principal breadwinners. Standard eligibility ages and vesting pe- riods for pensions are either equal for men and women or favorable to women. Early-retirement rules tend to be more generous for women than for men. Thus, in general, women receive higher implicit rates of

return on their contributions and a higher pension wealth.5

This special treatment, however, also makes women more vulnerable to pension reform. Indeed, if the goal is to have a pension law that treats women and men equally, then adjustments will tend to affect women more than men. Thus policy makers need to devise mechanisms that mitigate the impact of pension reforms on women. Some alternatives are discussed in chapter 4.

Pension Systems Are Financially Unsustainable

The sustainable implicit rate of return that a pay-as-you-go system can af- ford to pay on contributions is a function of the growth rate of the covered wage bill. Over the long run, a good proxy for this sustainable implicit rate of return is the growth rate of the economy (3–4 percent a year). In the large majority of cases, pension systems are paying rates of return well above these levels. These high implicit rates of return reflect a misalignment of the accrual rate, the retirement age, survival probability at retirement, and contribution rate. Basically, current replacement rates are too high given the retirement age, contribution rate, and life expectancy at retirement.

10 Pensions in the Middle East and North Africa:Time for Change

As a result, all pension funds have accumulated large implicit pension debts. Under conservative assumptions, normalized estimates of accrued-to-date pension liabilities range between 6 percent of GDP (RCAR in Morocco) and more than 170 percent (Social Security Corporation—SSC—in Jordan). The average implicit debt in the region is close to 80 percent of GDP, often linked to a small segment of the labor force. These liabilities refer to the present value of pension prom- ises to current retirees and the pension rights accrued to date by current contributors. Large implicit pension debts threaten macroeconomic stability and the credibility of the fiscal framework. They also represent a potentially large intergenerational transfer. Indeed, in the absence of any intervention, future generations will have to finance the implicit pension debt in the form of lower pension benefits, higher taxation, or reductions in the budget for other items (for example, education and health).