Pension Reform in Hungary: A Preliminary Assessment
31 Pages Posted: 20 Apr 2016
Date Written: July 2001
Hungary's pension reform package has been largely successful, significantly reducing imbalances in the pay-as-you-go system and the implicit pension debt while introducing a mandatory, funded, privately managed pillar that seems to be operating fairly well despite initial problems in the payment and registration systems and some regulatory weaknesses. Current shortcomings can be corrected by restoring the original 8 percent contribution rate to the second pillar and strengthening the regulatory and supervisory framework.
Hungary is entering the fourth year of a multi-pillar pension reform that has proved popular among workers despite initially lukewarm support from the government that succeeded the reforming government, and despite the poor initial performance of capital markets because of Russia's crisis in 1998. Roughly half the labor force joined the new system voluntarily. Most who switched were younger than 40.
Many people switched to the system because it offered more risk diversification. The pay-as-you-go (PAYG) system, which had been severely damaged by repeated manipulation of its parameters, clearly offered a low return on contributions. The new system is still predominantly PAYG. The first pillar accounts for more than two-thirds of the total contribution, but the new second pillar offers the chance of higher average returns on contributions.
Most workers probably intuited the risk and returns inherent in a pure PAYG system and mixed system, including the capital market risk in the second pillar and the political risk in the PAYG pillar. The new system offers better prospects of long-run risk-adjusted returns for young workers, and most young workers effectively opted for the new system. But the new system was probably oversold as well, making older workers - who would be better off staying in the reformed PAYG system - switch, too. The government has so far decided not to increase the contribution to the second pillar from 6 to 8 percent, as originally planned, so efficiency gains in labor and capital markets may also be smaller than expected. Addressing projected deficits in the PAYG system may require further adjustments, such as delaying the retirement age and shifting to indexed prices, reducing net benefits to future generations. Reform has sharply reduced the severe initial bias against future generations but hasn't eliminated it altogether.
The voluntary switching strategy achieves the same outcome as a forced switch based on an arbitrary cutoff age, while preventing legal problems and contributing to reduction of the implicit pension debt. But it leaves a few individuals worse off than if they'd chosen their best option - a problem a well-designed public information campaign can reduce. This paper - a product of the Private and Financial Sectors Development Unit, Europe and Central Asia Region - is part of a larger effort to disseminate ongoing research on pension reform in the Central European region.
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