From: Stivi Canka
Comment: How Can the Albanian Pension System Escape from the Jaws of Insolvency?

It should come as no surprise that out of the cornucopia of challenges that Albania is currently facing, some problems oftentimes end up going under the radar.

One such problem is the deteriorating Albanian pension system, which currently finds itself in dire need of reform.

In order to have a better understanding of the current situation of the Albanian pension system, it is crucial to have a deeper insight into the way that most pension systems work. The majority of countries have designed their pension systems based on the World Bank Pension Conceptual Framework. This framework divides the pension system into three pillars.

The first pillar is the State-Administered Pension Plan. This type of pension plan operates using a pay-as-you-go (PAYG) system. What that means is that all public and private sector employees are required to dedicate a certain percentage of their incomes toward their retirement accounts, only for the government to then use those contributions to pay the pensions of the currently retired population.

When an individual reaches retirement age, their benefits are determined based on the number of years they contributed and by their average salary during their last years of work. This type of pension plan is also known as a defined-benefit pension plan because the beneficiaries know exactly the fixed amount of money they will receive when they retire. 

The second pillar of the World Bank Pension Conceptual Framework is called the Employer-Based Pension Plan. This second type of pension requires the employees and the employers to dedicate a certain amount of money to a retirement account. Then, the government uses financial institutions such as pension funds to invest these contributions across various asset classes such as blue-chip stocks or treasury bills in order to generate capital gains.

These capital gains are then channeled in the form of retirement benefits to the employees when they retire. This type of pension plan is also known as a defined-contribution pension plan because the beneficiaries determine the amount of money they want to dedicate toward their retirement, but they do not know the value of their future pension; that depends on the performance of their retirement portfolio. 

The last pillar is called the Private Pension Plan. Private pension plans consist of personal savings that employees set up and contribute towards on their own. These might include tax-assisted arrangements such as Registered Retirement Savings Plans or TaxFree Savings Accounts. Private pensions are also considered as defined-contribution pensions because their size depends solely on the employees’ discretion.  

Unlike most of the countries in Europe, the Albanian Pension System has only two pillars.

The first pillar is a PAYG publicly managed pension scheme, where benefits are calculated according to a specific formula based on the number of the workers’ working-years and the amount of wages earned. More specifically, with regards to the hired employees, the pension contribution equals 21.6% of the gross income, of which 12.8% is paid by the employer and 8.8% by the employee. In the case of the self-employed, the contribution is 23% of the minimum monthly wage, which currently stands at 30,000 lek (EUR 240).

The second pillar, as per the international definition of it, is nonexistent in Albania. Instead, there is a third pillar which consists of privately managed funds that people can use to make tax-free voluntary contributions toward their retirement. 

The current pension system in Albania is clearly heading towards catastrophic failure. That is because the predominant PAYG pension scheme is anything but sustainable in the long run. Life expectancy at birth has increased by 10% in the last 20 years in Albania, and it is most certainly going to persist and grow in the years to come.

What is more, as a result of low fertility rates and the brain drain phenomenon, the youth population is also shirking at alarming rates. A growing elderly population and a declining youth population have led to a substantial increase in the elderly dependency ratio, the number of elders aged 65 or above per 1,000 persons aged between 15 and 64. More precisely, the elderly dependency ratio has increased by 435% since 1990. 

In other words, the number of working-age people that support one elderly person has decreased significantly. This means that, in the not-so-distant future, the number of total contributions made by workers will not catch up with the expenditure required to maintain the retirement benefits that the current PAYG system promises. As a matter of fact, the Albanian government is already relying on deficit spending to sustain its pension system.

This leads many international experts to believe that government debt will accumulate, and once it exceeds a certain threshold, the system will go bankrupt, people will lose their retirement benefits, and the country will plunge into mayhem. However, just like with every problem, there are always solutions. 

Introducing Mandatory Employer-Based Pension Plans

Currently, the most effective policy that the Albanian government can enact in order to prevent a future dismantling of the pension system is the introduction of mandatory employer-based pension plans, i.e. the second pillar of the World Bank Pension Conceptual Framework.

Just like it was mentioned earlier, this type of pension requires an entity such as a pension fund to invest the monthly contributions of its clients across different secure assets. There are two major benefits that this policy can bring about. Firstly, the government will no longer be responsible for providing retirement benefits. That means deficit spending will be reduced significantly. Secondly, people will receive higher pension benefits, because a small initial investment in the stock market grows exponentially over time. 

In order to illustrate this, let’s consider a 22-year-old student that just landed her very first job. She decides to invest $700 in the top 20 companies of the S&P500 with the purpose of having a comfortable retirement. Let’s assume that this person is going to dedicate $50 (20% of the current minimum wage) of her monthly salary toward her retirement account.  If the market continues to generate its historical investment return of 10%, and if inflation remains at 3%, after 45 years, this student is going to have $190,000 in her retirement account. This goes to show the beauty of compound investing. 

Implementing Austerity Measures

Even though the introduction of a mandatory employer-based pension system will most likely save the Albanian pension system from collapse, it is going to take a lot of time and capital for it to gain the necessary momentum needed to generate palpable change. Therefore, in the short-run, the Albanian government will have to push through unpopular policies in order to pave the way towards the establishment of a robust employer-based pension system.

Increasing the retirement age is one of the policies that the Albanian government simply cannot avoid. Currently, the retirement age is 65 years old for men and 61 years old for women. 

Based on legislation passed in 2014, the retirement age for both men and women is going to be in the vicinity of 67 years old in the year 2056.  This increase is clearly insufficient.

If the Albanian government does not increase the retirement age to 67 years old for both men and women before 2040, the pension system will implode. However, even such a seemingly drastic measure is not going to be enough. The government also needs to implement policies such as increasing the contributions rate, significantly reducing the benefits of early retirement, and even increasing taxes for high earners.

Bonus Round: Bill Ackman’s Proposal

There is also another way that the Albanian government could reform the pension system – getting rid of it altogether.

It is a policy proposal made by the controversial hedge-fund manager Bill Ackman to the U.S government. Under Ackman’s plan, each child born in the U.S. would receive $6,750 which would be invested in a pension fund. By allowing that initial investment to compound for 67 years, the amount would eventually surpass $1 million.

This would in effect render the current pension system obsolete. At first, Ackman’s proposal might seem very appealing, but upon closer examination, it is very incomplete. That is because giving babies thousands of dollars at birth would require billions of dollars of deficit spending. This proposal might be infeasible for a country like Albania, but it is worth mentioning just for the sake of argument. 

It was the blood, the tears, and the sweat of our elders that put Albania on the prosperity highway. Now, it is our turn to pay them back. Unfortunately, there is no panacea that can revitalize our pension system at the snap of the fingers. However, our government can start improving the pension system by at the very least implementing the first two proposals outlined above. It is time for the political establishment to abandon the empty rhetoric and start delivering for those who struggle the most to make ends meet.