General elections in late September, returning a reformist centre-right government of four parties, briefly interrupted Slovakia’s pensions reforms. This was an important poll as governing victory for the party which got the largest overall number of votes, the Movement for a Democratic Slovakia led by the controversial former premier Vladimir Meciar, would have compromised Slovakia’s potential membership of both NATO (the reason why it was excluded in 1999) and the European Union.
With the polls out of the way, Slovakia is set to address its demographic crisis, which is grave even by regional standards of declining birth rates and rising life expectancy. Already, a workforce of 2m supports 1.2m pensioners, a situation which can only deteriorate. According to recent data from the Slovakia’s statistical office, under the worse-case scenario its population of 5.4m is set to decline to 5.1m by 2025. Meanwhile, the Social Insurance Agency (SIA), the pensions and benefits provider, has, since 1997, run a deficit. Last year the pensions deficit totalled 0.4% of GDP, but the Ministry of Labour, Family and Social Affairs has estimated that if the current system is left unchanged, the deficit will reach 6% of GDP by 2050. In the short term Slovakia’s high unemployment rate, close to 18%, has exacerbated the shortfall in contributions to the SIA.
In May parliament approved changes to the first pillar state system. These come into effect in July 2003 and will progressively equalise the female retirement age – ranging from 53 years for women with four children to 57 for those with none, to that of the male 60-year level. This would still be a low age by EU standards, where the average is 64.7 years for men and 63.3 years for women. Furthermore, full equalisation would only take place by 2019. “This is too long a period to catch up with the aging population, and we will probably have to make new amendments, and also raise the retirement age for men,” predicts Marek Lendacky, expert at the Ministry of Labour’s Social Insurance Reform Department.
Other changes to the first pillar include the introduction of a link between earnings and benefits. Currently, the system is a pure defined benefit system (DB), with the final full pension, SKr6,395 (E152) a month, accounting for between 50% of earnings for a worker on average wages to 20% for those at the upper wage scale. The full pension is computed on the highest five earning years of the last 10 years of employment. The May amendments introduced a ‘wage points’ system that reflects a lifetime of earnings, although it retains the DB system.
Slovakia, which has had a defined contributions (DC) third-pillar system in place since 1996, is also set to introduce a compulsory second pillar. Two versions, one drafted by the Labour ministry, the other by the Economy ministry, have been folded into a legislative intent. While both envisage a compulsory system based on capitalised funds run by private asset managers, they also have important differences. Currently 28% of gross wages (21.6% from the employer, the remainder from the employee) are diverted into pensions, of which approximately 18% finances the old-age pension, 6% disability pension and the remainder a survivors pension. The Labour ministry has proposed
diverting 3.7% of the old-age portion into the compulsory system, rising eventually to 6%, while the economy ministry wants a higher amount from the start. In either case the transition cost for the first pillar will be met by SKr62bn (E1.5bn) from the privatisation of Slovakian Gas Company earlier this year and currently earning interest on deposit at the National Bank of Slovakia. This sum will last until 2010-2011 according to Lendacky, but assumes additional first-pillar reforms such as a higher retirement age, strict benefits indexation rules and tighter qualifications for disability benefits.
Both proposals envisage the diverted contributions coming solely from the employer’s side, which has attracted some criticisms. Marek Jakoby, analyst at MESA10 Centre for Economic and Social Analyses, an independent think tank in Bratislava, points to the recent build-up of arrears from employer contributions in the first pillar, estimated at around SKr40bn as at the end of last year. “If second-pillar contributions were transferred completely from the employer, these problems of payment discipline would be reduced,” he believes. “It is much easier to control individual payers than large companies.”
The Labour Ministry also wants the SIA to administer collection, payout and account management, with a single committee, similar to the Canadian and Quebec pension plan investment boards, choosing the asset managers, while the Economy Ministry wants the SIA to restrict itself to collecting contribution, with the asset managers, chosen by the clients themselves, to handle the rest of the business, as is the case in Hungary and Poland. “But the risk of political interference is high, especially in transition countries,” explains Marek Lendacky. They differ on the choice of final annuity provision, with the Labour Ministry opting for a single provider – as in Sweden. The Economy Ministry wants competing private companies in the scope of the second pillar, which the Labour Ministry wants restricted to old-age pensions while the Economy Ministry wants it extended to provide disability and survivor benefits.
The full scope of age coverage and extent of the compulsory entry have not been decided. In waiting this long for introducing pension reforms, Slovakia at least has the benefit of learning from the mistakes of other countries. For instance, it wants its computerised system of notional accounts in place before the second pillar gets implemented and avoid Poland’s notorious experience with its social security system, which has still not cleared up its delays in diverting second-pillar contributions from the first into individual accounts. In February, the World Bank lent Slovakia $23.5m for the establishment of a unified contribution and collection system between the National Labour Office and Social Insurance Agency, and for the development of a client database.
According to Lendacky, the operation of the third-pillar system will also provide lessons on how to structure the second pillar. Currently, there are four supplementary pensions funds, Tatry-Sympatia with SKr3,015.5m in assets and 146,383 clients, Stabilita with SKr1,183.2m and 69,733 clients, Pokoj with SKr452m and 26,505 clients, and Lipa with SKr315m and 22,141 clients according to data from Trend Documentation for the end of 2001. Although total assets still lag behind those of the mutual funds, which had a net asset value of SKr6,233.8bn, and life insurance industry, with SKr13,779.7bn of written premiums in 2001, they grew by 66% over the year. The net rate of return allocated to the clients was less impressive, averaging 5.1% against 7.1% average inflation. Only Lipa, with a return of 8.6%, exceeded inflation. In November the local credit rating agency, Slovak Rating Agency, will publish an updated analysis of the four funds, including a comparison of their investment portfolio. More competition would be welcome, adds Lendacky, as would a reduction in overhead costs, which are currently unlimited in the first two years, a maximum 6% up the fifth year and 3% thereafter.
With the exception of government securities, the funds have limits on their investments, including 20% on quoted shares, debentures, unit trusts and other stock exchange instruments, 10% on real estate, 15% on overseas investments and a 10% limit on the securities of any one issuer. To prevent conflicts of interest they are barred from any investments in either securities companies performing transactions on their behalf or shares in the fund’s depository bank. The single issuer cap is considered fair, while the equity restriction has made little impact given the moribund performance of the Bratislava Stock Exchange. However, by the same token the cap on overseas investment is considered highly restrictive, and draws the inevitable criticism that the state is using the system as a captive market for government securities. The compulsory second pillar will most likely have tighter restrictions.
Initially, the funds could only provide plans for employees of companies with whom they signed contracts. These already include many of Slovakia’s industrial giants. Since the beginning of 2001, a much broader range of workers has been able to sign up, regardless of whether their employers have a contract, including those in the budgetary sector and the self- employed. However, the 100,000 to 150,000 potential clients employed by the state still have to wait for the new budget to be drafted. Certain occupations, including the military, customs and police, have their own schemes, and are thus expected to be excluded from subsequent second pillar plans.
An attempt earlier this year to make supplementary pensions compulsory for workers in hazardous professions such as mining – essentially to replace the special status they lost in the first pillar – was returned by to parliament by President Rudolf Schuster on the grounds that it enforced compulsion within a voluntary system.
Supplementary pension fund contributors receive tax advantages not available to competitive savings schemes such as life insurance and unit trusts. On the employer’s side, in the case of those that have signed contracts with supplementary funds, up to 3% of an insured person’s gross salary in contributions is tax exempt, representing a sizeable benefit to the employee when compared to a taxable wage rise. In the case of employees, the tax treatment was changed in 2001, on the one hand limiting the exemptions on the insured person’s annual contributions to SKr24,000 or 10% of gross salary, on the hand reducing the income tax on benefits from 15% to 10%.
The tax benefits and employers’ contributions have essentially accounted for the funds’ recent growth, while employees in company schemes account for the bulk of clients according to Pavol Hrin, head of the office of the board at VSP Tatry, the administrator and one of the three asset managers of Tatry-Sympatia fund. As of the end of September the fund, the oldest of the four, had more than 205,000 clients. Corporate clients that have signed contracts include the Slovakian postal service, the electricity and gas utilities and most of the chemical companies. Marketing to the self-employed, who account for 5-10% of the total workforce, has proved more of an uphill struggle. “These workers generally pay the lowest contribution rates to the SIA, so when they retire they will get literally peanuts and they do need us,” notes Hrin.
The supplementary funds are regulated jointly by the Labour and Finance ministries, the former governing the contributors and beneficiaries, the latter investment compliance and other financial plans, as well as the depositary banks. Many question the sense in two ministries having overlapping responsibilities and would prefer the Financial Market Authority, the country’s securities regulator, whose remit includes asset managers and which is the likely second-pillar regulator, to take over. This is likely to happen as Slovakia is in any case moving to establish the authority as the pan-financial regulator.
The potential relationship between the third and second-pillar funds remains uncertain. “It is not clear yet whether we will be eligible for the second pillar,” notes Pavol Hrin. “But we would like to be. We are natural partners and have the expertise, the sales network and the staff.” Three of the four funds, including Tatry-Sympatia, outsource to asset managers. There has been some speculation about whether Slovakia’s existing asset managers will be allowed to manage the second-pillar, or whether new legal entities will have to be set up. “It would be a waste of money to create new entities; these licensed asset management companies are good and competent players on the capital markets, and their status is sufficient to protect investments,” says Marek Jacoby.
At the same time he would like to see a more competitive market than the four-company third pillar market, and additionally have the provision of annuities transferred from both the existing third pillar and proposed second pillar funds to insurance companies. “Pension funds currently run both capital market risks (the savings phase) and an insurance risk (on retirement),” Jakoby explains. “These should be separated. It is questionable whether in the future, when the pension companies have more clients claiming benefits, they will have enough funds from newcomers to finance the system. This could result in lower benefits or even solvency problems for the funds.”

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