Pensions in Iraq

53574

The World Bank

Concept Note

For

Pension Reform Implementation Support Technical Assistance: Improving Old-Age Income Security in Iraq

(P114647)

November16,2009

Vice President
Country Director
Sector Director
Sector Manager
Task Team Leader / Shamshad Akhtar
Hedi Larbi
Steen Jorgensen
Roberta Gatti
Ghassan Alkhoja

MIDDLE EAST AND NORTH AFRICA REGION

HUMAN DEVELOPMENT DEPARTMENT (MNSHD)

List of Abbreviations

DBDefined Benefit

DCDefined Contribution

ESPPEmergency Social Protection Project

GDPGross Domestic Product

GOIGovernment of Iraq

IMFInternational Monetary Fund

ISNInterim Strategy Note

ISRBIraq Strategic Review Board

ITFIraq Trust Fund

MENAMiddle East and North Africa region

MOFMinistry of Finance

MOLSAMinistry of Labor and Social Affairs

NBPNational Board of Pensions

PRISTAPension Reform Implementation Support Technical Assistance

PRMOPension Reform Management Office

PROSTPension Reform Options Simulations Toolkit

SOEState-Owned Enterprises

SPFState Pension Fund

SPSState Pension System

SSSSocial Security System

USAIDUnited States Agency for International Development

Table of Contents

I.Background and Rationale

II.Key Development Objectives

III.The Technical Assistance Program and Summary Costs

IV.Critical Risks

V.Implementation Arrangements

Annex I :Summary of Law 27/2006 as amended in 2007 (new Pension Law)

Annex II:Key Terms of Reference

Annex III:Detailed Costing

Annex IV:Implementation Schedule

Annex V:MOF And ISRB Approvals

Republic of Iraq1

Pension Reform Implementation Support Technical Assistance

Project Name / Pension Reform Implementation Support Technical Assistance (P114647)
Region / Middle East and North Africa
Country / Republic of Iraq
Sector / Social Protection
Implementing Agency / The World Bank
Concept Note Preparation Date / September 11, 2009
ConceptNote ReviewDate / September 24, 2009
Regional Vice President Approval / November 20, 2009
Expected Closing Date / April 30, 2013
Source of Funding / Iraq Trust Fund
Technical AssistanceAmount / US$5.8 million

I.Background and Rationale

The Pension Reform Implementation Reform Technical Assistance (PRISTA) responds to the Government of Iraq’s (GOI) request for assistance to support implementation of the new Pension Law.Efforts to reform Iraq’s pension system started soon after April 2003. This culminated in the passing of Law 27/2006 in January 2006. Implementation of Law 27/2006 was suspended as it was widely deemed to be unsustainable and did not benefit from significant international experience. Subsequently, GOI amended the law in December 2007 (referred to as theUnifiedPension Law in the text of the Law), with support from the World Bank, the IMF, and USAID, to improve financial sustainability and alter the design of public sector pensions in line with good international practices. The amendmentsto Law 27/2006 also mandated the unification of the currently distinct public and private sector pension schemes. While the Pensions Law presents a significant improvement, there remain substantial challenges in terms of GOI’s capacity to implement the law, and in ensuring a sustainable old-age income protection mechanism for Iraq.GOI subsequently requested World Bank support for the implementation of the new law. For the remainder of this Concept Note, Law 27/2006 as amended in December 2007 will be referred to as the “new Pension Law”.

The multi-year technical assistance (TA) is part of the Bank’s assistance strategy under the third Interim Strategy Note (FY09-FY11) for Iraq. The technical assistance falls under Themes 1 and 2 of the ISN:“Continuing to support ongoing reconstruction and socio-economic recovery efforts” and “Improving the management of public resources, including human, natural, and financial” respectively. The technical assistance also incorporates key features that illustrate the proposed approaches in the ISN to institution building (see Section IV). This activity is also complimentary to the existing Emergency Social Protection Project, financed by the Iraq Trust Fund (ITF), and the proposed Social Safety Net Implementation Support Technical Assistance. In addition, the TA will benefit from development expected to take place from the World Bank-financed Public Financial Management and Banking Sector Reform projects.

The macroeconomic and fiscal standing of Iraq calls for new approaches in leveragingdonor resources, stressing the focus on technical assistance and knowledge transfer to assist the Government of Iraq to better utilize their own resources.The main binding constraints facing economic development in Iraq lay with the security situation, the slow political reconciliation and the capacity to utilize the country’s resources effectively. In view of these constraints, the next phase of donor assistance will focus on technical assistance and knowledge sharing that support the GOI to build capacities that are capable of effectively utilizing Iraq’s own resources, including provision of budget support accompanied by robust technical assistance to support implementation of reforms. An appropriate project financing arrangement at this stage is one in which donor resources are focusing on technical assistance and knowledge transfer coupledwith financial commitments from the GOI to invest in the physical infrastructure associated with the reform areas of the knowledge transfer to spur growth in the economy. Changes in the security situation and the progress with political reconciliation is outside of the scope of this technical assistance program, but recent improvements in these fields also improved the development impact potential of the technical assistance program in the area of pensions.

The area of assistance in improving old-age income security in Iraq presents a case for a cost-sharing financial arrangement: donor resources to be spent on technical assistance and knowledge transfer while the investment in systems and infrastructureare to be financed by the GOI. The described financial arrangement in the new stage of development assistance to Iraq is appropriate in the context of improving the system of old-age income security. There are a lot of knowledge areas related to pension reform where the GOI needs technical assistance, including the knowledge base on how to improve the physical and IT infrastructure, but the actual investment in the information technology network and the improvement of the national and regional office network of the NBP are to be financed by the GOI. Throughout the discussions during the preparation of the technical assistance, MOF has continually signaled its commitment to provide the needed resources for these “hard” investments.

The GOI formally requested World Bank-executed technical assistance in the area of pension reform implementation: the main directions of such support have been mutually agreed with the client counterparts through a workshop focused on implementation issues held in January, 2008 in Amman, Jordan. The workshop addressed completely new aspects of pension administration needs in Iraq such as contribution collection and individual account based pension record keeping through the involvement of international experts and USAID. During the workshop the participants developed a high level implementation action plan, which was subsequently refined during missions in 2008 and 2009 resulting in the current approach. This action plan provides the framework for the technical assistance program to be initiated under this Concept Note.

The needs of the implementation for the new Pension Law, the withdrawal of USAID, the improving security situation and the recently improved performance of the Emergency Social Protection Project (ESPP) suggest the expansion of the World Bank work program in Iraq in the pension area. World Bank presence in Iraq has been limited and the World Bank social protection missions to work with the Iraqi counterpart have been taking place outside of Iraq, typically in Amman, Jordan, where the World Bank’s office supporting operations in Iraq is located. These constraints in the past have been alleviated via strong donor contribution, in particular, the cooperation with USAID given the extensive USAID operations on the ground. USAID informed the World Bank that its operations supporting the GOI in pensions were discontinued in April 2009. Continuity in the client support could only be maintained if the World Bank extended its technical assistance program parallel with the withdrawal of USAID. The constraints towards World Bank activities remain to be present, but the improving security situation and the accelerated use of ESPP resources suggest that the World Bank operations could be extended with improved development impact potential, along the implementation arrangements suggested in Section V of the Concept Note. The World Bank’s leadership in the technical aspects of the support in pensions has been established, no single other donor organization is in the position to address the challenges the GOI faces in this policy area.

Features of the Pension System in Iraq

The system of old-age income security in Iraq faces massive challenges: the pension reform legislation of the existing public sector pension scheme, the new Pension Law became effective in December 2007, without prior consideration for implementation arrangements.The main short-term challenges of the Iraqi pension system originate from the need to implement the amendment of Law 27/2006. A comprehensive amendment modernizing the public sector pension system, previously known as the State Pension System (SPS), was approved by the Iraqi legislature in October 2007 and enacted in December 2007.However, the new provisions of the Law affect every public sector employees retiring on or after January 17, 2006. The comprehensive amendment became effective without consideration for the administrative needs of implementation. A summary of Law 27/2006 as amended is shown in Annex I.

The recent pension reform legislation requires the merger of the public and private sector pension schemes by 2010; a difficult taskto accomplish in such a short time span, since the intent of legislation is to alleviate the existing labor market segmentation. The amendment to Law 27/2006 includes a provision on the merger of the public and private sector pension schemes by January 1, 2010. In particular, the National Board of Pensions (NBP) has been established as the unifying body of the mandatory pension schemes. The NBP absorbs the Pension Directorate of the Ministry of Finance (MOF), which used to administer the SPS. Those retired prior to January 17, 2006 will see little effect due to the reform. However, a new State Pension Fund (SPF) has been established to provide pension benefits to public sector workers retiring on or after January 17, 2008. The SPF is an administrative unit within the unifying umbrella of the NBP. Furthermore, theexisting Social Security System (SSS), the private sector pension scheme is to be transferred under the authority of the NBP. The envisioned merger is desirable as much as it alleviates the segmentation of the labor market along the public/private divide, but the feasibility of the implementation within the legislated deadline poses a substantial challenge.

Even if all the implementation issues of the new Pension Law are resolved, the mandatory pension system in Iraq will cover only roughly one fourth of the labor force representing alowlevel from a social protection point of view, and is 10 percentage points below the already low average coverage rate in the Middle East and North Africa region. The coverage level of the national pension systems in MENA is below that of the one in Iraq only in two countries: Yemen and the West Bank and Gaza. The coverage rate reflects upon the capability of the pension system to prevent old-age poverty. A low coverage rate does not only reflect limited overall access to the pension system, but it also signals that only the already advantaged social groups have access to this social protection instrument. The primary beneficiary group of the pension system is public sector employees who already possess a solid and secure source of income compared to the uncovered masses in the informal sector. Both the goals of poverty alleviation and accelerating private sector led economic growth would point into the direction ofextending social insurance coverage on the medium- to long-term. Addressing the implementation challenges of the new Pension Law is only an intermediate step in this long-term context.

Rationale for World Bank Involvement

The World Bank has been involved in pension policy development in Iraq since the early stages of the Iraqi reconstruction efforts and it identified the massive risks that the implementation of Law 27/2006 would have imposed if it were implemented in its initial form. Reinstating the functionality of the pension system in Iraq was a first order priority of the reconstruction efforts. The Government of Iraq adopted Law 27/2006, which redesigned the provisions of pensions in the public sector. Unfortunately, the adopted design was not in line with the basic generally accepted design features of “good” defined benefit (DB) pension schemes. Pension payments in 2005 amounted to 5.6 percent of the GDP, representing the largest social protection program by far, and the new design quickly would have further deteriorated the financial sustainability of the scheme. If Law 27/2006had been implemented in its initial form it would have required government subsidies equivalent to 60 percent of the GDP for the period 2007-2020. Beyond the considerations of affordability and financial sustainability the system imposed disincentives towards work effort and the nontransparent mechanism also suffered from undesirable equity issues. The World Bank policy note “Pensions in Iraq: Improving Financial Sustainability, Efficiency and Equity in the Iraqi Pension System: A Concept for Reform” contributed to the agreement between the GOI on one side and the donor community (IMF, USAID and World Bank) on the other side to suspend the implementation of Law 27/2006 until a significant amendment improving the design takes place.

The World Bank has also been involved in the administrative capacity building efforts in the field of pensions through the Emergency Social Protection Project (ESPP). ESPP was initiated to reinstate and then to improve the capacities of the MOF and the Ministry of Labor and Social Affairs (MOLSA) to carry out crucial administrative and policy roles in social protection, in particular, in the areas of pensions and social safety nets. The pension component of ESPP has contributed to building capacities through training and the provision of IT equipment starting in 2006. In addition, the ESPP includes a work program component, which is designed to improve the reliability of pension policy decisions through making the necessary data available for actuarial projections. In particular, a beneficiary and a contributor survey is underway as part of the ESPP activities.

II.Key Development Objectives

The objective of this TA is: (i) In the short-term, to support GOIin implementing the provisions of the new Pensions Law; (ii) in the medium-term, to support the unification of the public and private pension schemes; and (iii) in the long-term, to support the development of long-term old-age income strategy for Iraq. As described earlier in the Concept Note, GOI faces substantial challenges in implementation of the new Pensions Law and thus the immediate objectives of the technical assistance is to support its implementation. However, to contribute to long-term sustainability, and as described further below, the technical assistance also has medium-term objectives to support unification of the public and private pensions systems; and long-term objectives to support the GOI to develop a long-term old-age income security strategy for Iraq with a focus on the expansion of social insurance coverage.

“Good” examples of pension provision and pension system design show features of desirable equity outcomes, adequate benefits without imposing massive economic distortions; they are also affordable, financially sustainable, and administratively efficient and provide access to a large share of the population.A “good” pension system is expected to offer adequate benefits, i.e., at a minimum the income replacement level of the pension scheme should robustly protect from old-age poverty. At the same time, the benefits should be moderated by the principle of affordability, i.e., the pension system should not impose a burden on economy so that it constraints economic growth. The rules of the pension system should be consistent with economic efficiency, i.e., it should not discourage work effort and it should not distort labor supply decisions significantly. Pension systems typically redistribute income across plan members. This redistribution is necessary to offer a minimum standard of living for all compliant pension plan members, but the redistribution should be transparent and progressive. Furthermore, the pension system should be financially self-sufficient on the long-run; it should comply with the principle of financial sustainability. Finally, in countries with developed financial infrastructure individuals should have options to diversify savings for old-age within and outside the mandatory pension system.

A “good” pension system, or a social insurance system in a broader sense, does not only offer social protection benefits, but it is also a precondition for a desirable private sector led economic development path.At higher levels of economic developments individual welfare is increasingly more reliant on the employment relationship with an employer organization, the role of the family as an informal safety net becomes less important. The exposure to certain shocks such as loss of productivity and income generating capacity due to old-age, disability, death, work injury or unemployment can be effectively protected against by large scale mandatory savings and risk-pooling mechanisms. These protection mechanisms ensure the development of the human capital of the labor force, a key production factor, and they also contribute to the efficiency in the distribution of the gains achieved through economic activities. Alternatively, “bad” pension and social insurance systems constrain economic development. Such examples of pension systems segregate the labor force across the boundaries of the various pension schemes, create disincentives towards work, increase labor costs beyond reason, impose massive burden on economic activities and government budgets, and ultimately fail to provide protection to a large, often most vulnerable, part of the population.

The amendment to Law 27/2006 in 2007, compared to the original Law 27, represents a significant improvement in terms of financial sustainability and certain defined benefit pension design features; however, the Iraqi pension system will still need significant improvements to live up to the general principles described above even after the implementation of the now applicable legislation. Both the public and the private sector pension schemes in Iraq are so called defined benefit pension schemes, i.e. the primary determinants of the pension benefits are the length of contribution/service, some measure of the individual’s wage and a policy parameter setting the generosity of the scheme, the so called accrual rate. The financial sustainability of such scheme can be maintained if the contribution rate assessed on wages (i.e. the determinant of revenues) and the dual set of the generosity parameter (the accrual rate) and life expectancy patterns (i.e. the determinants of expenditures) are derived simultaneously in a forward-looking manner. Other parameters of the defined benefit system, such as the minimum pension guarantee, the indexation rules, the ceiling on covered wages, etc. also affect the financial sustainability. While the amendment to Law 27 in 2007 brought about changes that improve financial sustainability, the lack of reliable data about the demographic, contribution and retirement patterns of the covered population made it impossible to carry out robust actuarial projections in 2007. Once more reliable data becomes available a comprehensive review of the legislation should be carried out, at the earliest after the completion of the contributor and beneficiary surveys carried out under the ESPP. Not only the design in the 2007 amendment of Law 27 may need adjustments from a sustainability perspective, but there is also room for improvement in the overall defined benefit design, in particular, the benefit formula, the provisions of disability and survivor pensions may benefit from a revision.

Despite the shortcomingsof pension system design in the new Pension Law, the short-term activities of the technical assistance program will focus on supporting the implementation of this legislation and on the associated capacity building. The uncertainty caused by incompleteimplementation may undermine public belief in the pension system. Developing a pension administration system, which can reliably determine the pension benefits of new pensioners, is a first order priority. The data recording needs of the new pension benefit formula also must be accommodated without further delay. This is a demanding task as the new legislation makes the pension benefit conditional on an average wage measure that gradually extends the number of years in the wage history considered in the average wage measure. The reserves the SPF is expected to accumulate during the early maturation of the scheme should be protected by prudent investment management policies and investment management practices. Ultimately, the pension administration requirements of the new Pension Law are systems that will accommodate further improvements in the pension system design. It is clear that any future innovation in the pension system will have to rely on currently nonexistent contribution collection and individual record keeping systems as well. As the implementation process is primarily constrained by the existing institutional capacities, the implementation support will be focused on identifying and unlocking the dormant capacities within the NBP, and in building the needed institutional capacity to sustain operations. As such, the technical assistance will front-load much of the capacity building efforts of the NBP, to allow for more robust interactions and implementation for the latter parts of the technical assistance. In addition, all activities envisaged under the technical assistance will incorporate training and knowledge transfer.

Medium- and Long-Term Objectives