Pension System in Romania

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Pension System

The road to pension reform in Romania has been a bumpy one. Throughout the 1990s, there were several attempts to reform the pension system, but a law was first approved in 2000, focusing on reforms in the public system. Four years later, laws were passed that paved the way for the introduction of a voluntary pension pillar and a mandatory second pillar. Implementation was delayed, however, and the voluntary pillar became operational in 2007, while the mandatory pillar is expected to be up and running in 2008. In Romania, the voluntary pillar differs from those of other CEE countries, as it does not feature private pensions. Instead, it comprises Western European-style occupational pensions.
Romania will not be spared from the effects of demographic change. Between now and 2050, the country's population will shrink from 21.7 million to 16.8 million. The old-age dependency ratio will rise from 21.7% to 49.6%, which is slightly lower than the projected EU-27 average of 52%. According to the convergence programme Romania submitted to the European Union, public pension expenditure is expected to increase only marginally, from 6.7% of GDP in 2004 to 7.0% in 2050. The EU-27 average will increase from 10.6% of GDP to 12.8% over the same period.

Once the second pillar has started operating, assets will grow quickly. By 2015, second pillar assets will amount to a minimum of EUR 2 billion,
or to EUR 3 billion in the optimistic scenario. Third pillar assets will reach EUR 869 million.

Public Pensions
Romania's first pillar suffered from the typical problems of an Eastern European transition country. Unemployment rose and the number of contributors to the public system fell. In addition, retirement age was low and early retirement easy and widespread, as it was used as a means of avoiding a further increase in unemployment. Transparency was low, especially regarding the link between contributions and benefits. Furthermore, there were different pension systems in place for different occupational groups. Emigration was high, which made the contribution problem even worse. Between 1990 and 2004, the number of pensioners grew from 3.5 to 6.1 million, while the number of contributors fell from 8 to 4.5 million.

The pension reform that was passed in 2000 addressed these problems and created an integrated system. The new approach included the self-employed, the unemployed, policemen and farmers (on a voluntary basis), none of whom were included in the previous system. Previously, several systems for various occupational groups existed alongside the public system. These continue to exist for lawyers, military staff and the clergy.

As of May 2007, retirement age was 63 years and 1 month for men and 58 years and 1 month for women. It is gradually increasing and will reach 65 for men and 60 for women in 2015. Early retirement has been made more difficult, and the required contribution period has been increased from 25 to 30 years for women and from 30 to 35 years for men. Romania has also introduced a point system that calculates benefits based on contributions made throughout the entire working life rather than taking only the last few years into account. Pension points are calculated as the ratio of the individual's monthly gross wages and other compensation to the national average for that year. The employee's pension is determined by multiplying the pension points with the pension point value, which is determined each year in the social security budget law. The reform also created the National House of Pensions and Other Social Security Rights, an institution that aims to coordinate and manage the public pension system. These parametric reforms were implemented as a means of coping with short-term financial pressure.

Employers' pension contributions amount to 20.5% of gross earnings (higher for workers in dangerous occupations), employees contribute 9.5% and the self-employed carry the full contribution rate themselves. Contributions have to be paid for income up to five times the national monthly average, which was RON 1,077 (EUR 307) in 2006. Early retirement is possible from five years prior to normal retirement, provided that the employee's contribution record exceeds the required time period by 10 years or more. Pension benefits are indexed to inflation and adjusted quarterly if prices have increased by at least 5% on an annual basis.

These Parametric reforms in the first pillar managed to ease financial pressure on the system and incorporate almost all segments of the Romanian population. However, since the reforms led to frequent changes to the law, the confidence in the system has been reduced. Between 2000 and 2004, the law reforming the public system was changed 23 times.

The Second Pillar – Mandatory Individual Accounts

Institutional framework
Following the decision to introduce a funded and mandatory second pillar in 2004, another law was added in 2007 that focused on the licensing procedure, investment limits and classes, the guarantee fund and the role of the supervisory authority. The second pillar was set to start operating on January 1, 2008. Since then, a portion of social security contributions is directed to funded individual accounts, which are defined contribution schemes.

During the first year of operation, contributions to the funded part of the system amount to 2% of wages. They will then increase by 0.5% each year until they reach 6% after 8 years. Contributions to the first pillar will diminish at the same rate. Participation in the mandatory pillar is obligatory for all people under 35 and voluntary for the 36 to 45 age cohort. Assuming that 50% of those who can join voluntarily do so, 2.6 million participants could be enrolled in the scheme from the very beginning.

Mandatory pension funds are not yet in operation in Romania. Once they get going, these funds will be civil companies, defined by Romanian law as non-commercial companies without legal liability. Such companies can be established by a minimum of 100 founding members and must be approved by the Pension Fund Supervision Commission. A pension fund must have a minimum of 50,000 participants one year after it has been founded. Individuals can only join one private pension fund at a time.

Since pension funds have no legal liability, separate administrative companies are needed to manage them. The exclusive objective of administrators is the administration of pension funds, they also calculate and pay out benefits. An administrator may manage only one mandatory pension fund.

Investment regulations
Once mandatory pension funds start operating, the main investment limits will be as follows:
- Up to 20% of assets can be invested in money market instruments
- Up to 70% can be put into state bonds issued by Romania, EU countries or states from the European Economic Area (EEA)
- Up to 30% can be invested in bonds issued by local public administrations in Romania, the EU or the EEA. The maximum for bonds from other states is 15%
- A maximum of 50% can be invested in equities listed on Romanian, EU or EEA markets

Administrators must achieve a minimum rate of return, which is set by the Pension Fund Supervision Commission. The Commission also has the power to appoint a Special Surveillance Board, which is created when the fund's profitability rate has been lower than the minimum rate of all pension funds for four consecutive quarters. Private pension funds must establish a reserve fund, which aims to ensure the minimum profitability level. The details of this reserve fund have not yet been finalised.

Benefits and withdrawal
Benefits will be paid out as annuities. Those who do not have sufficient assets to qualify for a pension will receive a lump sum or periodic payments for up to five years. Benefits are adjusted based on the consumer price index.

Romania will run an EET system for the taxation of future mandatory accounts. Employee contributions will be tax-deductible and investment income tax-exempt. Pension benefits will be subject to ordinary taxation.

The Third Pillar – Voluntary Occupational Pensions

Voluntary pension funds
In terms of its institutional structure, Romania's third pillar bears a strong resemblance to the occupational schemes prevalent in Western Europe. After the basic decision was made to introduce voluntary occupational schemes in 2004, a new law replaced the previous legislation in 2006. The new law regulates occupational pension schemes and determines tax and investment regulations. The law was adopted to align legislation with EU regulations.

Employers and trade unions can establish voluntary occupational schemes, which are DC plans, at the industry, group or plant level through collective bargaining. In the absence of a collective agreement, employers can either establish pension schemes individually or at the industry level. Employers can choose whether or not to set up a scheme, as long as they have made the appropriate tax or other contributions to the state. Participation in occupational pension funds is voluntary for employees.

Contribution levels are established in line with scheme regulations. They are collected and paid by employers or the participant themselves. Contributions are deposited into the employee's individual account and can amount to 15% of gross salary. They can also be shared between employers and employees, depending on scheme regulations or collective agreements.

An administrator runs voluntary occupational plans, which is a pension company, an investment manager or an insurance company. Administrators can manage as many occupational schemes as they wish. The pension funds are subject to the same investment and reserve regulations as mandatory funds. There will be also minimum return guarantees for occupational pensions, the details of which have not yet been defined. The funds will be obliged to establish reserve funds to cover possible shortfalls. Benefits will be paid out in the form of annuities, provided that participants have contributed for more than 60 months. Otherwise, contributions can be paid out either as a lump sum or in instalments for up to five years. Further regulations for the pay-out phase will be developed within the next three years.

Occupational pensions are subject to EET taxation. Employer and employee contributions are tax-deductible up to EUR 200 a year, investment income is tax-exempt and benefits are subject to standard taxation.

Once the voluntary pension system is operating, it is estimated that 500,000 people will participate during the first year of implementation.

When it comes to pension reform, Romania is a late bloomer compared with other Eastern European countries. First pillar restructuring took place in 2000 and the launch of the private pension system took place in 2007 and 2008. Romania adapted the World Bank's multi-pillar model. Occupational pension market development will depend on employers' willingness to provide occupational schemes, and on whether employees and unions will push for this type of pension. Potentially, occupational schemes could become an interesting tool for employee retention.
Romania will become an attractive market for asset managers. It has the second biggest population in Eastern Europe after Poland and has enormous catch-up potential. If Romania manages to sustain its current growth rates, it may well become one of the key growth markets in Eastern Europe.