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The attempt to make Slovenia's pay-as-you-go system respond better to the challenges posed by population ageing was made in 1999. The thrust of the reform followed the scenario already put in play elsewhere in Europe. In simple terms, a gradual raising of the retirement age and a decrease in replacement rates, i.e. the level of pensions as a percentage of average earnings over a defined period of employment, which means that Slovenes have to work longer only to end up with lower public pensions. This is what any self-respecting pension reformer strives to achieve.

Reform!

The reform, although not radical enough by the standards of its critics, has been a moderate success. Immediately after its implementation in 2000, the share of public pension expenditure in GDP started to fall (see chart), relieving the budget of some immediate pressure. Around a quarter of all public pension expenditures (projected at around EUR 900 m in 2008), is financed from government coffers; the rest comes from the compulsory social security contributions of the employed and employers.

Judging by the projections of the European Commission, however, this perceived sustainability of the pension system will prove to be a short-lived mirage. As baby-boomers retire, they will claim an increasing share of national output to maintain their living standards. Pension reformers thus have their work cut out for them: they have to devise a way of marrying the expectations of a happy and secure old age with sustainable public finances.

Stretching it

From the perspective of the pay-as-you-go system, these two objectives cannot be realistically achieved simultaneously. With such systems, demographics are destiny. In 1960, there were 100,000 pensioners in Slovenia, while today there are more than half a million. The vast majority of current pensions are dependent on contributions to the system by those currently employed, whose number is projected to fall from 790,000 in 2000 to 690,000 only 15 years from now. Population ageing is taking its toll.

As the number of contributors to the pension system dwindles, the living standards of pensioners can be maintained either by burdening the employees and employers with higher contributions or closing the financing gap by increasing taxes. Both measures would cut into workers' disposable income and make it more difficult for companies to make a profit: hardly an enviable prospect in these turbulent times.

If current demographic trends continue and Slovenia sticks with existing policies, economists calculate that a male worker retiring in 2025 can expect a public pension amounting to no more than a half of his average wage over the highest-paid 18 years. Taking into account the fact that by the same year each member of the workforce will have to support one pensioner, such a reduction of pension entitlements seems like the only way of keeping the inter-generational contract in place.

Squeezed

By lowering pensions, the reform of 2000 shifted significant responsibility to individuals themselves for providing for their old age. Workers are expected to come up with a significant amount of savings at the time of their retirement, so that it can be converted into an annuity supplementing their public pensions. The Slovenian pension system thus essentially rests on two pillars: compulsory contributions and individual pension funds savings. Research shows that Slovenes are very well aware that they will have to supplement their public pensions with their own savings. The question remains, however, whether the state has put enough incentives in place to allow for the faster development of private pensions.

Economists warn that tax breaks have not induced people to contribute enough for private pension plans to guarantee a comfortable old age. In addition, as stock markets around the world falter, pension funds, most of them heavily invested in equities, are taking losses. The SBI 20 Slovenian stock index has already lost more than half of its value since August 2007.

Not only do the pension funds have to worry about their declining net worth, the looming recession will likely force them to revise their overly optimistic assumptions about yields. Moreover, experts warn that their liabilities might be undervalued, as life expectancy will increase faster than expected. Some Slovenian pension companies have already tried to soothe the jangled nerves of savers, saying that they have enough cash to cover their obligations towards future pensioners.

Some country for old men

One would expect that coalition negotiations that have been taking place for more than three weeks would focus on pension reform issues. Instead, Borut Pahor, the leader of the Social Democrats and probably the future prime minister, succumbed to the demands of the pensioners' party (DeSUS), granting a special bonus to those pensioners whose pensions do not exceed EUR 500. Nobody says that pensioners' lives must not be made easier, but such measures should be adopted as a part of a wider agreement on pension reform.

Karl Erjavec, the president of DeSUS, has obviously been very efficient in exploiting his position as a king maker. Without his support, the centre-left parties do not have a parliamentary majority. But is it worth EUR 60 m?