No. 32

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Impact of Estonian Pension System Reforms on Intragenerational Distribution of Pensions *

14 December 2015

Studies

RiTo No. 32, 2015

  • Magnus Piirits

    Magnus Piirits

    Analyst, Praxis Centre for Policy Studies, PhD Student, University of Tartu

  • Andres Võrk

    Analyst, PRAXIS Center for Policy Studies, Lecturer at the University of Tartu

During the last two decades, several important reforms have been carried out in the Estonian pension system.

Changes in pension system have a long-term impact; therefore it is necessary to predict the outcome of changes for a long time. The article analyses the impact of pension system reforms on intragenerational inequality, and discusses how the inequality of pensions will change in the future due to the introduction of the insurance component depending on salary (in 1999) and mandatory funded pension (in 2002) into the national pension scheme. Today, the old age pensions in Estonia are among the most equal in Europe, i.e. in comparison to the rest of Europe, the pensions in Estonia are more alike. The purpose of this article is to fid out and show how great the inequality of pensions will be after the large-scale pension system reforms which made the size of pension to a great extent dependent on the size of salary.

The analysis uses the real data of men born in 1980. The data have been provided by the Social Insurance Board and have been made anonymous. The sample consists of 10,286 men. The sizes of old age pensions have been calculated on the basis of the scenarios of four reforms and using the dynamic distribution of salaries.

In 2013, the inequality of the income of pensioners in Estonia was small (Gin coeffiient was 0.1) and the replacement
rate of pensions was modest (around 40 percent). On the basis of this article, it became clear that that replacing of the component depending on the length of working time (before 1999) by the insurance component depending on
salary in 1999 and establishing of the 2nd pillar in 2002 will increase the inequality of pensioners retiring in the future. Gin coeffiient of simulated pensions of those who will retire in 2045 increases from the level 0.1 to the level 0.27. Reform of the changing of pension index (since 2008) reduces the inequality of pensions, because the base amount, which is equal for everybody, increases faster than the value of the insurance component. As a result of this reform, Gin coeffiient will be a little lower – by 0.03. On the other hand, the inequality of the replacement rate of pensions will also be lower due to the pension reforms, because pensions are more and more closely connected with the contributions of persons.

If the formation of pension is closely connected with salary, it may bring the inequality of future pensions to an unreasonable level in such a country like Estonia, where the differences of salaries are great, unemployment rate is high and many people use the possibility of receiving an early retirement pension. The easiest way of reducing this inequality is to increase the re-distribution of the 1st pillar (e.g., increase the growth of base amount even more or, by way of an exception, to raise the level of base amount). Establishing a ceiling on social tax would also reduce the inequality of pensions, because then the persons whose salary is especially high would no longer earn such a large insurance component, and their payments to the 2nd pillar would also be smaller.


*Peer-reviewed article
**This article is a shortened Estonian version of an article in English: Võrk, A., Piirits, M., Jõgi, E. (2015). “The Impact of Introduction of Funded Pension Schemes on Intragenerational Inequality in Estonia: a Cohort Microsimulation Analysis”. Longer Estonian version can be read in the blog of Praxis Center for Policy Studies (http://mottehommik.praxis.ee/). The English version of the article is connected with the MOPACT (Mobilising Potential Active Aging) project, which was fianced from

Full article in Estonian

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