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At the end of May 2010, a new Government took office and, having identified that reform of the mandatory pension system was urgently required, it presented legislation to Parliament, which was passed in December 2010. The new law transforms the terms and conditions of the two-pillar mandatory pension system established in 1998 (consisting of the pay-as-you-go and the funded pillars).

The 1998 reform had followed the World Bank concept of a three pillar system: a public pay-as-you-go first pillar, a mandatory private funded second pillar and a voluntary private funded third pillar. At its introduction in January 1998, anyone entering the labour market for the first time had to participate in the mandatory private funded second pillar while those who had already paid contributions to the old system could choose to participate in the funded second pillar or to remain fully in the public pay-as-you-go first pillar. Members of the second pillar pension system would receive about one quarter of their total pension from the private funded system and about three quarters from the pay-as-you-go system. The contribution rates to each pillar corresponded approximately to this ratio. Although successive governments made further changes the mandatory private funded second pillar remained in place.

The need to reform the 1998 pension system

It had become evident that the pension system created in 1998 had failed to live up to expectations. Although the overwhelming majority of the population strongly supported the pension system when it was first introduced (between 1999 and 2010, in addition to the 25 per cent of the workforce that were mandated to join, a further 50 per cent of the workforce joined voluntarily), the reality of poor private pension fund performance had eroded that support. The most recent data published in March 2011 reveals that the average return on the investment of members’ contributions over the past 13 years was below the rate of inflation. In fact, only a small fraction of members would claim that their mandatory private pension fund would contribute to their income security in old age.

At the national level, the burden on the state budget imposed by the costs of introducing the 1998 system – the transition costs – had increased year on year. These costs are included in the calculation of state budgets under the European Union methodology and resulted in an additional increase of more than 10 per cent of GDP in the sovereign debt by the end of 2010.

The pay-as-you-go pillar of the compulsory pension system received lower revenues in the form of contributions, in an amount corresponding to the value of the contributions paid to private pension funds by their members. In 2009, the shortfall in contributions required to pay benefits under the public social security pension system reached nearly 1.3 per cent of GDP.

The underpayments to the Pension Insurance Fund from which the pay-as-you-go system is financed have to be found from other state budget resources. This obligation to make up for the shortfall in the revenue of the pay-as-you-go system would have to be maintained for dec-ades to come. In essence, it would have continued until the saving arising from lower pay-as-you-go pension benefits payable to those who were also private pension fund members equalled the amount of contributions underpaid to the pay-as-you-go system. As stated, under the original plan, members of the second pillar pension system would receive about one quar-ter of their total pension from the private funded system and about three quarters from the public pay-as-you-go system.

Objectives of the 2010-2011 reforms

In addition to addressing the immediate funding issues for the public pension scheme and the mounting sovereign debt, the reforms are intended to encourage people to work longer and to support family life – a major priority for the government and country since the total fertility rate of 1.3 is well below the replacement rate.

It is designed to create a mandatory pension system that is financially sustainable in the long term and which will strengthen the contributory principle by linking the amount of an individual’s pension benefit more clearly with the contributions made by that individual.

Measures addressing the immediate financial issues

In November 2010, Parliament repealed the regulations on compulsory membership in the private funded second pillar. New entrants to the labour market were no longer obliged to join private pension funds and all members of private pension funds were given the opportunity – irrespective of the date of entry to the labour market or whether membership was made on a compulsory or voluntary basis – to transfer fully to the public pension scheme.

Members of private pension funds had one and half months from the date of announcement of the transfer terms and conditions to make their decision. By the deadline of 31 January 2011, only 3 per cent of the members had declared their intention to remain a member of the private second pillar pension scheme. This figure underlines that the overwhelming majority of fund members doubted that the private pension scheme would provide income security in old age, preferring instead to place their trust in the public pension scheme.

Those who transfer to the public scheme will have their pension rights restored as if they had never been members of the private pension scheme – meaning that they will receive 100 per cent of their pension entitlement from the public scheme, and not 75 per cent as was formerly the case. In parallel, they will lose their entitlement to the balance accrued in their private second pillar individual accounts (except for certain amounts).

The process of switching back to the public pension scheme, including the transfer of the funds from the private individual accounts, takes place during 2011.

Pension entitlements of women with high pension insurance contributions

The law passed in December 2010 modifying Act LXXXI of 1997 on Social Security Pen-sion Benefits brought in measures specifically to improve the situation of women. As from 1 January 2011, women who have a qualifying service period of 40 years or more may claim their old-age pension irrespective of their age (i.e. before the standard retirement age). The 40 years may include periods spent raising children but must include – as a rule of thumb – at least 32 years of qualifying paid employment.

Future perspectives for the Hungarian pension system

The key priorities for Hungary are to ensure the state budget is sustainable in the long term, that sovereign debt is reduced and to encourage job creation as the basis for economic growth.

It is in this context that the pension system must continue to develop. Future measures must focus on discouraging early retirement (except for special circumstances such as for women who have 40 years of service as described above), extending working lives, and ensuring that insured persons understand that the benefits they will be entitled to depend on the contributions they have paid into the system. With regard to the latter, it will be essential in future to provide insured persons with regular and straightforward information on the pension rights they have accrued including the amount of the pension they would be entitled to were they to receive it at that moment. The information provided should make it clear how much more pension they could earn based on the future payment of contributions and how much they would lose if they fail to pay those contributions.

These issues can only be properly addressed if and when Hungary introduces individual accounts for each person registered with the state pension system to record the pension rights each individual has accumulated. The relevant preparations are already underway.

The ISSA is grateful to the Central Administration of the National Pension Insurance, Hungary for this reform analysis article