A system under attack
While for investors market risk is a clear and present danger, political risk appears easy to overlook. But it can be just as corrosive, finds George Coats
October's nationalisation by Argentina's President Cristina Fernández de Kirchner of the country's 10 private pension funds, with some $30bn (€23bn) in investments, has underlined that governments can be as unpredictable and quixotic as markets. Fernández said her grab was intended to protect the pension assets from the global market turmoil, although analysts claim the real motive was to assist with this year's $21bn debt servicing requirements.
However, while Argentina has a tradition of financial imprudence and Fernández had long shown an ideological hostility to private pensions, surely such a thing could not happen in Europe.
Well no funds have yet been seized. But Slovakia's populist premier Robert Fico has made no secret of his antipathy to the country's pension reform that, following the World Bank model similar to that adopted in Argentina, introduced a funded second pillar. And since taking office in 2006 he has launched a number of initiatives that taken together look very much like a concerted attempt to undermine the system.
The second pillar was launched in January 2005 and was mandatory for new labour market entrants but voluntary for those already working. Under it, half of the 18% of a gross wage paid to the social insurance agency, the Sociálna poist'ovna (Sp), that runs the state PAYG pension system, is redirected to the second pillar private pension company chosen by those who opted to participate. On retirement, pension fund members receive a reduced state pension in the expectation that their private pension would have more than made up the difference.
In opposition Fico continually opposed the reform but refused to say what he would put in its place, although Slovakia's fledgling pension funds feared he would reduce their level of funding from 9% of a salary to 6%. And such an attempt was among his first initiatives in office. In the event, he backed down because the system's 1.5m participants, out of a working population of 2m, understood that such a move would undermine their pensions savings over the long term and they were just too big a constituency to alienate.
However, Fico continued to attack the system, referring to the pension companies as "non-banking institutions" - a pejorative term used to describe fraudulent financial schemes that flourished in the early post-communist days - and publicly stating that the funded system was not trustworthy.
"He does not only attack pension funds," says Ivan Miklos, finance minister in the government that introduced the reforms. "He also attacks utilities for raising prices, the media and private health insurers."
"In 2007 the government passed legislation requiting private health insurance companies to return any profits to the health sector," explains Ján Záborsky, (pictured right) who writes on pension issues for Bratislava-based economic weekly magazine Trend. "And he attempted to buy back the gas utility. The moves appear irrational until one sees that Fico's aim is solely to gain the support of a not very sophisticated electorate - then they are rational."
Also in 2007 the government passed a law allowing those who had opted to join the private pension funds to leave and return to the Sp during an ‘opening' of the second pillar in the first six months of 2008. At the same time the law extended the minimum saving period in the pensions schemes to 15 from 10 years, meaning those with less than a decade before retirement would not be able to draw their pension. This had the effect of forcing the more elderly participants to leave the funded system.
The money accrued in their fund was returned to SoDra. "The transfer was the current value," says Alojz Marsina, director of the department of pension savings, at the labour, social affairs and family ministry. "But their pensions will be calculated as if they never entered the second pillar and will be based on the nominal amount that was transferred to the second pillar rather than the amount that is paid back."
"The first opening of the second pillar showed that there is a very small number who, having chosen to join the private system, will voluntarily opt out of it," says Záborsky. "Some 105,000 people left, but of them 75,000 to 80,000 were directly affected by the increase in the minimum time one has to spend in the second pillar to receive a pension. The government had estimated that for 300,000 people the second pillar was a bad option, as they would receive less money from it than had they stayed only in first pillar."
Nevertheless, at the time Fico said pension fund clients needed stability and that the government would not open up the system again. However, less than three months later, the cabinet decided to do exactly that. In October it as announced that it would be re-opened from 15 November 2008 until 30 June 2009.
The ostensible reason was to protect fund members from the impact of the market downturn. However, Peter Socha, (pictured left) chairman of the Association of Pension Fund Management Companies (ADSS), recalls that before the announcement Sp director Dusan Munko told parliament that the second pillar should be reopened because the first pillar was in a huge deficit. "Then after two or three weeks the opening was announced because of the market downturn," he says. "And when we looked at the state budget for 2009 we saw that its calculations were predicated on 150,000 people leaving the second pillar system."
"This is absolutely unrealistic because the cohort that had to leave has gone," says Záborsky. "But there are proposals to extend the minimum time people must stay in the first pillar to 20 years from 15, and if this was extended to the second pillar another five-year cohort would have to leave."
Munko told the daily newspaper Sme that people who had entered the second pillar had already lost their savings. But the central bank, the private pensions regulator, has said that it did not foresee any serious threat to clients of the second pillar. In fact, notes Socha, the funds' performance has been reasonable. Nominal performance for sector from inception is about 13% for conservative funds, 5-6% in balanced funds and 3% in growth funds. "If you don't know how many clients will leave your company, you have to keep higher liquidity than usual," he says. "So the cash position is higher than normal and we are not very involved in equities."
However, there is a downside. "From a purely asset management point of view, over and above the market turbulence the major problem is that the system is not yet stabilised," says Peter Karcol, member of the board of Allianz dss, the largest pension fund asset management company. "So we cannot manage the fund in the way it should be managed. For example, a pension fund is a long-term business but you cannot run an investment strategy with a 30-year horizon if you don't know how many people will leave the fund over the next six months and what impact having to make payments to the social security will have on the assets."
"Fico's effort to destroy the system is very irresponsible because due to demographic developments the first pillar is unsustainable and if these changes recur, the second pillar will also be unsustainable," says Miklos.
Marsina says it is not a question of destroying the system, but he sees fundamental flaws in its design. "We all believe that in the future it will require an accumulation of capital and that a reform was necessary," he says. "The question is whether the parameters were set correctly, whether it was the only way we could have done the reform." He identifies the key problems as misselling by commission-hungry brokers to people who were too old to benefit from the system or did not understand that it was an investment rather than a savings product, and the contribution level to the private pensions.
And he speaks as a poacher turned gamekeeper, having been a board member of Sympatia-Pohoda, a smaller pension company that was later merged with ING. "When we started we thought the second pillar would make sense for 750,000 to 800,000 potential members," he says. "People entered who were lied to or misled, and the law said that once they had joined they could only leave after a court decision."
But would the first opening not have resolved those cases? "According to calculations from our actuaries, a client would have to be in the second pillar for approximately 30 years with 4% growth for it to give a higher pension than the first pillar," Marsina says. However, that presupposes the first pillar conditions stay as they are today in the teeth of an ageing population. He adds: "Suggestions that the contribution level should have started at 3% or 4% are not far wrong. Then increase progressively."
Will the system survive the onslaughts? "Until the end of June it will be very hard," says Socha. "But if after the second period of opening there are still more than 1.4m clients then I think the government will leave it because we will enter a pre-election period and they will focus on other problems."
Resistance to cuts in contributions
Lithuania's new government intends to cut contributions to the second pillar pension system as part of an economic crisis plan to tackle a 2009 budget deficit of 4% of GDP. The plan, which was approved by the four-party conservative-led coalition that came into office after winning last October's general election, is intended to save LTL5.3bn (€1.53bn). Among its proposals is a reduction in the contributions to the private pension funds to 3% of a salary from 5.5% in 2009 and 2010.
New premier Andrius Kubilius said the situation the government had inherited was like a ‘time bomb'. But market players claim the government is overlooking an explosive demographic problem. "The demographic situation is not changing," notes Jonas Irzikevicius, (pictured right) managing director of SEB Investiciju valdymas, one of Lithuania's largest pension fund managing companies. "And the government is not proposing any other solution to solve the pension issue as a whole. And that is a worry."
"This is very hazardous because it could undermine pubic confidence in the whole private pensions system," says Aurimas Mazdzierius, CEO of Hansa investiciju valdymas, another major pension fund managing firm. "People joined it in the expectation that they would be making contributions at a certain level and they will understand that lower contributions mean that their eventual pension will be smaller. This may make them question their decision to participate. It is also dangerous because it sets a precedent for some future government with funding problems."
The cut is seen as reversing the pension reform, which many see as one of the most successful reforms undertaken since Lithuania emerged from the Soviet Union in 1991. Some 70% of Lithuania's eligible population has signed up to private second pillar pension plans. The pay-as-you-go pension scheme is funded by the payment of 18% of salaries to the State Social Insurance Office (SoDra). Under the reform, individuals participating in the private pension scheme divert 5.5 percentage points of this into a private pension fund of their choice, and SoDra retains 12.5%.
Saulius Racevicius, president of Lithuania's investment management companies association which represent the pension companies, says the government is taking a tough stand on its plan, pointing out that the cut in private contributions was one of the pledges approved by parliament in a vote of confidence in December.
"We still have a window of opportunity," says Racevicius. "We have proposed to accept that SoDra only transfer 3% to the pension funds, but that the remaining 2.5% be treated as a loan from the pension funds to the social security system, to be repaid in three or five years. We are working on the wording."