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July 28th, 2017

Free Market Pension Reform in Russia

The pension reforms that the Russian government introduced in 2002 signalled a major shift in pension provision from a defined benefit pension scheme to a contribution-based pension system.

The reform was intended to take account of the free market economy, changing demographic trends, and the problem of poverty among retired citizens. The Russian government was strongly committed to the reform, but the weak administrative and financial structure meant that it was significantly modified - and partially reversed - in 2013.

The initiative

The Russian government made preparations to implement pension reforms from the mid-1990s onwards, and adopted a number of strategic documents.[3]

The pension reform in 2002 introduced a multi-pillar pension system, and signalled a major shift in pension provision in Russia, from a defined benefit pension scheme to a defined contribution pension system. “The defined contribution system is comprised of:

  • “A notional defined contribution (NDC) pay-as-you-go pension scheme
  • “A mandatory funded second pillar
  • “A basic benefit that will meet the distributional objectives of the pension system.”[4]

The funded part of the Russian pension system had the structure of a provident fund with external asset managers and was operated by the Pension Fund of Russia (PFR).

The pension reform at the time was aimed at adjusting the system to the market economy, changing demographic trends, and dealing with the problem of poverty in retirement. The first part was a basic flat-rate pension, financed separately on a pay-as-you-go (PAYG) basis up to 1 January 2010. After that, it was integrated into the earnings-related, insurance pension, based on notional individual accounts, which is also known as an NDC and is financed by contributions on a PAYG basis.

A mandatory, defined contribution system was introduced to cover individuals born after 1967. In addition, "in 2009, a cofinancing scheme was launched to expand coverage of voluntary schemes and increase retirement savings. The state matches individual contributions made on a voluntary basis to the... PFR, on a rouble-for-rouble basis up to a ceiling and for a limited period."[5]

The government introduced significant changes to the system in 2013, which partly reversed the initiative. "New comprehensive pension legislation that was introduced in 2013 partially reversed the pension privatisation. While the financial-economic bloc dominated during the major 2002 reform, the social bloc had by 2013 enhanced its influence. For example, while the funded component was a compulsory element of the 2002 reform, it is now voluntary and its future uncertain.”[6]

The challenge

Russian pensioners were among those hardest hit by the economic transformation that occurred under President Yeltsin in the 1990s. People were faced with hyperinflation, an unprecedented drop in production and real income, and mass unemployment. “In the Soviet era, the Socialist pension system, although containing many shortcomings, served as a stabilising force for the Soviet society as a whole, and especially for the working masses and elderly people.”[1]

The existing pension scheme, however, was not working well. Some of its problems included:

  • “Very complex and overlapping benefit formulas and generous eligibility conditions, including early retirement for many occupations.
  • “Mixed distribution/insurance/savings objectives in the benefit formula which, combined with a high tax rate of 28 percent of wages, reduced incentives for individuals to contribute to the system, distorted labour markets, and increased incentives to retire early.
  • “Growing financial burden from a declining number of contributors and increasing numbers of pensioners, a result of increasing layoffs, tax avoidance, growing unemployment, and the ageing of the population.”[2]

The public impact

Several accounts indicate that the pension reform did not improve the financial situation of citizens in need, and in some instances their condition was exacerbated by the financial struggles of the country, with no appropriate guarantee to those affected:

  • “Since the reforms were initiated, the ratio of average pension payout to average pay has decreased. In 2000, this proportion was 33 percent, but fell to 24 percent in 2007 and 23 percent in 2008. According to the International Labour Organisation, the ratio should be not less than 40 percent.”[7]
  • "Already since 2000, the average replacement rate (the percentage of a worker's pre-retirement income that is paid out by a pension programme upon retirement) in Russia fell  by 7 percentage points, due to three factors: '(i) the declining share of the working-age population; (ii) the valorisation of the basic pension benefit and notional capital with prices that usually grow slower than wages; and (iii) the regressive UST [upper secondary threshold] scale, which, in the absence of price indexation, entails erosion in revenue'."[8]
  • During the economic struggles of the early 2000s, the public sector took on a huge burden by providing jobs for 30 percent of the workforce. "Three attempts at pension reform failed basically because of the government's indecision and unwillingness to abandon socialist principles. As a result, by 2015, the PFR's deficit amounted to 15 percent of federal budget revenues (approximately 3 percent of GDP)."[9]

Stakeholder engagement

President Putin announced the beginning of pension reforms after he took office in 2000, and created a dedicated team to review the situation and take the initiative forward. “In the spring of 2001, the creation of the National Council for pension system reforms was called for by the President. This Council was a sort of political device designed by Putin and institutionalised in order to consolidate all social forces and to reconcile opposing opinions to the realisation of pension reforms in Russia. This Council was headed by Prime Minister Mikhail Kas’ianov, and its members included almost all leaders of parliamentary factions together with heads of a number of social organisations such as independent labour unions.”[10]

Political commitment

Russia's president, Vladimir Putin, had a strong interest in completing the pension reforms, as evidenced by the creation of the National Council for Pension Reform. This led to a public debate about the pension reform plans and an attempt to achieve a consensus between the various government agencies, which seemed to have differing ideas on "the nature and speed of reform".[11] "The Council discussed and approved the revised Pension Reform Programme of the Russian Federation and the main pension reform draft laws which were developed by the Government and submitted by the President of the Russian Federation to the State Duma as a legislative initiative. In this way the issues of preparing and implementing the pension reform were moved from the level of executive authorities to the head of state and nationwide levels. This ensured key decision-making within a relatively short period (within one year) and enabled to achieve certain nationwide consensus."[12]

Some of the people who played key roles in the reform included the following individuals:

  • Mikhail Dmitriev, deputy minister of economic development and trade, who was a protagonist of "radical market-oriented reforms"
  • Mikhail Zurabov, considered to be a noted specialist in the field of pension business
  • Prime Minister Mikhail Kas'ianov, who was allegedly under pressure from President Putin to complete the reforms "as quickly as possible". He had a strong adviser, Evgenii Gontmakher, another specialist in social and labour policy, who worked as a regular secretary of the National Council for Pension Reform.[13]

There was also some opposition, however. “Former Finance Minister Alexei Kudrin, who was involved in creating the system in 2002, has led a chorus of criticism over the decision to halt transfers to it, arguing that the approximately 3.2 trillion roubles (USD47.7 billion) currently present in the system represent a rare and valuable source of long-term investment capital, something that Russia lacks but desperately needs.”[14]

Public confidence

There appeared to be an overall distrust of the government as a source of financial support and the system that it proposed. “Firstly, high payroll taxes meant that workers had an incentive to evade taxes as much as possible. This incentive would only grow as more workers evade taxes and the population ages. Secondly, the workers might not see any benefit from paying payroll taxes now, as it does not guarantee [them] a pension in the future. Workers of this generation have lived through a period of great upheaval and change, and quite probably distrust the longevity of the government, or even the government itself. Thirdly, a look at the pensioners around them would convince them that with inflation and ad hoc adjustments, pensions would be worthless by the time they really need it, which is when they are really old and sick. Nevertheless, this is all speculation that is not proven.”[15]

There were also many people who did not understand the pension system. “In Russia, it has been estimated that only 700,000 of 3.8 million eligible workers had chosen to invest their funds with private pension funds. This could be due to the sheer complexity of the new pension system, which workers could not comprehend. The default choice is for these funds to be invested in the state pension fund. At the same time, the 1998 financial crisis meant that workers no longer trusted the private financial sector.”[16]

Clarity of objectives

The objectives of the pension reform laid out in 2002 were quite broad, and did not establish any measurable targets. The initiative aimed to address some of the problems of the old pension system to improve participation and ultimately encourage economic growth. “The first objective of the reform is to reduce the complexity of the pension system through a simple benefit formula and transparent eligibility conditions. The second objective of the reform is to increase an individual’s incentives to contribute and work longer in order to improve the fiscal solvency of the pension system. Finally, the objective of the funded scheme is to increase the pension benefit, while deepening capital markets and promoting economic growth.”[17]

Strength of evidence

There is evidence that the pension system adopted in Russia took into account some of the characteristics of policies implemented in other countries. However, the prevailing economic conditions made them less viable for the Russian pensions market.

The government seems to have evaluated several existing pension programmes around the world for the development of the Russian reform. "In preparing a pension reform in Russia, efforts were made to study the pros and cons of pension system reform in Latin American countries, looking into details of decisions implemented in Sweden, Italy, Poland, and analysing the measures to reform pension systems of Kazakhstan, Kirgizia and Hungary.”[18]

However, it was not appropriately adjusted to the Russian context. “The new Russian pension system borrowed many aspects of international pension systems both in terms of organisation and principles of operation. However, specific decisions implemented as part of the pension reform were hinged on those problems which the pension system is expected to address in the public eye taking into account both the forthcoming demographic crunch and current economic challenges to its viability."[19]


Preparations for pension reform in Russia were ongoing from the mid-1990s, and a lot of legislative work was put in to make it feasible. However, the coordination on implementation was less thorough, and it faced significant administrative challenges.

There were a number of conceptual and strategic documents to reform the pension system which were adopted at the preparatory stage, and the legal framework of the pension reform was composed of four federal laws:

  • Federal Law No. 173-FZ ‘On Retirement Pensions in the Russian Federation' − regulates the terms and standards of entitlement to retirement pensions.
  • Federal Law No. 166-FZ ‘On Provision of State Pensions in the Russian Federation' − regulates terms and standards of entitlement to social pensions financed by budget transfers, pensions to victims of nuclear and manmade disasters, military conscripts and public servants, etc.
  • Federal Law No. 167-FZ ‘On Mandatory Pension Insurance in the Russian Federation' dated 15 December 2001 − defines the rights and obligations of insurers and insured individuals and organisations.
  • Federal Law No. 198-FZ ‘On Amending the Tax Code of the Russian Federation and Certain Legislative Acts of the Russian Federation on Taxes and Duties' − establishes tax deductions from amounts of uniform social tax for the amount of insurance contributions to mandatory pension insurance.[20]

However, the reform faced a challenge to ensure sufficient administrative capacity to achieve its objectives. Three parts of the reform had significant administrative implications: the new notional insurance benefit; the new funded benefit; and the shift in collection and payment responsibilities.

Changes would require the PFR to maintain much more information on the work history of each individual worker and maintain that information for a much longer period of time. “The reform poses three basic challenges for administration of the pension system:

  • "First, tracking each worker's lifetime contributions to the system and the returns on the accumulated contributions will require the PFR to maintain much more information on the work history of each individual worker and to maintain that information for a much longer period of time than under the old system.
  • "Second, the introduction of the funded component will require the agencies handling contribution collection and pension payment to become more accountable to the Russian people for their financial actions.
  • "Finally, dividing the responsibility for contribution collection and data management complicates the reform by requiring effective collaboration on a continuous basis of two independent agencies of government in order to reconcile data and financial flows, a difficult challenge for any government under any circumstances."[21]


There were administrative or organisational problems, which hindered the normal progress of implementation of the new pension system.[22]

A World Bank report later criticised its execution, stating that “the implementation process till November 2002, has been characterised by poor coordination, at least between the two major implementing agencies, as evidenced by the difficulties involved just in obtaining an agreement to inform the PFR of the existence of arrears... The implementation timeframes established in the legislation are arbitrary and unrealistic. The insurance portion of the new benefit took effect within a month of the enactment of the legislation. The target date for the implementation of worker choice appears to be two years hence, implying that the Russian pension fund will be able to design, procure, install and test the necessary data processing capacity in two years. This is far less time than was required to write and test software that Sweden needed to implement its reform.”[23]

Similarly, the regulation and supervision of non-state pension funds (NPFs) was an issue. A number of them were censured for violating investment limits, and inspectorate data shows that the majority of NPFs did not comply with investment principles such as diversification of risk and higher security of investment. “A number of funds invested up to 100 percent of assets into one class of assets; some NPFs overloaded their portfolio with government securities and others overloaded in bank deposits. NPFs were also breaking the limits on investment into shares, often concentrating in shares of the parent corporation.”[24]


There is no evidence of monitoring mechanisms or indicators being used to manage this initiative, and this was one of the main issues highlighted by the World Bank.

The management capacity needed for tracking the information effectively was highlighted as a key issue. “The final and perhaps most important challenge to the reform programme is ensuring that administrative capacity in the country is sufficient to implement the reform. Three parts of the reform have significant administrative implications: the new notional insurance benefit; the new funded benefit; and the shift in collection and payment responsibilities. The basis for benefits under the pay-as-you-go portion of the programme will gradually shift to the worker's full career, and the calculation will involve tracking each worker's lifetime contributions to the system. This change will require the PFR to maintain much more information on the work history of each individual worker and maintain that information for a much longer period of time than under the old system.”[25]


There was inadequate alignment between the key actors, the different cities, and the funding infrastructure.

Changes to the system made the process more complicated for the institution responsible for the implementation of this reform. “The shift in the responsibility for collecting pension contributions has greatly complicated the administration of the pension system, and the current arrangements may ultimately prove to be unworkable. One problem is that while responsibility for collecting contributions was shifted to the Pension Fund, responsibility for collecting employee-specific data was not. This kind of pension reform can succeed only if data and the contribution money are well coordinated, but they now will flow through separate channels and coordination will be difficult at best."[26]

There was a failure of alignment between the PFR and and a government ministry closely connected with the reform. "A second problem is that the PFR retains certain responsibilities associated with contribution collection that are poorly coordinated with the responsibilities of the Ministry of Taxation.”[27]

There was also ineffective coordination across the country. “As of the beginning of 2002, when the pension reform became effective, three subjects of the Federation had not yet reached agreements for the transfer of payment responsibilities, including Moscow City. In other areas, agreements had been reached but the actual transfer had not yet occurred. In all of these areas, the implementation of the pension reform is likely to take longer and involve more difficulties because of the need to implement the organisational change simultaneously.”[28]


Decline, Not Collapse: The Bleak Prospects for Russia's Economy, Andrey Movchan, 02 February 2017, Carnegie Moscow Centre

Developing a Funded Pension System in Russia - International Evidence and Recommendations, June 2013, OECD Publishing

Macroeconomic Effects of Pension Reform in Russia, David Hauner, 2008, The International Monetary Fund

Pension reform options for Russia and Ukraine: A critical analysis of available options and their expected outcomes, Marek Góra (Warsaw School of Economics and CASE), Oleksandr Rohozynsky (CASE) and Oxana Sinyavskaya (CASE), February 2010, DIW Berlin

Pension Reform in Russia: Design and Implementation, November 2002, The World Bank

Pension Reform in Russia: First Year of Implementing, S. A. Afanasiev, 22 February 2003, The PIE International Workshop on “Pension Reform in Transition Economies” IER, Hitotsubashi University

Pension Reform in Russia and Kazakhstan, Jiunjen Lim, April 2005, University of Pennsylvania

Russia is facing a pension dilemma as the country goes to the polls, Aadne Aasland and Linda Cook, 8 September 2016, The London School of Economics and Political Science

Russia's $100 Billion Pension System Is a Dangerous Zombie. Part 1, Ezekiel Pfeifer, 02 September 2015, Institute of Modern Russia

The failure of Russia's free-market pension reform, Vladimir Volkov, 17 August 2009, World Socialist Web Site

The unified social tax and its impact on social policy in Putin's Russia, Susanne Nies and Gesa Walcher, February 2002, Forschungsstelle Osteuropa an der Universität Bremen

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