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Salary and Pension Reform in Cyprus: A Pedagogical Example
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In 2013, the Republic of Cyprus, a European Union member state, grappled with profound financial challenges. To address its fiscal woes, the Cypriot government entered into a memorandum of understanding (MoU) with the European Commission, the European Central Bank, and the International Monetary Fund, collectively known as the Troika. This agreement aimed to secure essential loans to meet the country's debts and fulfill other financial obligations. The MoU mandated the adoption of substantial austerity measures, including:
Elevating the retirement age for public employees from 63 to 65 years.
Implementing a
10% reduction in salaries and pensions.
Imposing a freeze on salaries and pensions for five years.
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4. Mandating a three percent (
3% ) salary contribution to public pension funds.
To streamline the calculations for this case study, let us consider that the Memorandum of Understanding (MoU) took effect on January 1, 2013. Additionally, make the following assumptions:
Salaries and pensions are disbursed once per year, specifically at the year's end.
In the absence of the MoU, salaries and pensions would experience a yearly increase of
2.5%.
Following the freeze period, salaries and pensions will undergo an annual growth rate of
2%.
The anticipated average long-term annual interest rate in the economy is
4%.
4 The formula for annual pension pavments at the time of retirement is:
PMT = 0.5 * min(1, Months of employment /400) * Last Annual Salary * (1 g),
5 where
g is the annual growth rate pension payments.
Before the commencement of the Memorandum of Understanding ($190U), Ms. Carol, aged 47 at the time, had accumulated Twenty years of government service. In the year 2012, she
Case Study Worksheet
Example
Before the commencement of the Memorandum of Understanding (MoU), Ms. Carol, aged 47 at the time, had accumulated Twenty years of government service. In the year 2012, she received an annual salary of 50,000 euros. Ms. Carol has expressed her intention to remain in the workforce until retirement. Life expectancy in Cyprus is 80 years.
Calculate the current (present value) value as of the beginning of 2013 for all salaries and pension payments if the Memorandum of Understanding (MoU) is not accepted.
Determine the present value of all salaries and pension payments, assuming the adoption of the MoU.
Assess the overall financial gain for the government of Cyprus.
Estimate the anticipated total savings from the reforms, considering the scenario presented as representative of the average public employee in Cyprus (assuming approximately 50,000
7 public employees).
Modify accordingly the entries below and answer the questions presented in the pdf file Case Study TVM - Questions & Instructions.pdf. You may have to add/delete rows from the tables below depending on the years to retirement and the number of pension payments. Be careful not to mess up the embedded formulas.
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DATA SUMMARY
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Long-term interest rate in the economy,
k
4.00%
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Without the MoU
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Retirement age in year
63
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Salary Growth (Annual)
2.5%
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Pension Payments growth (Annual)
2.0%
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With the MoU, Austerity Measures
Case Study Worksheet
Example
123
2%
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C
D
2. Present value of all salaries and pension payments, assuming the adoption of the MoU
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113
114
Years to retirnment, n=20
Salary freeze, years
=,5
From 45 to 65 years
115
116
Salary cut
=10.0%
k=4.0%,g-SAL=2.0%
119
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Table 3. Salaries until Retirement and their Present Values with the MoU in Place
Case Study Worksheet
Example
Case Study Worksheet
Example
