Providential approach taken in Cyprus
Cyprus has developed its own particular vehicle for defined contribution (DC) occupational pension schemes. This is the provident fund, the most commonly used type of retirement plan in the private sector.
The island’s labour unions promoted provident funds to supplement state provision at a time when there was no legislation for old age or retirement benefits. The legal framework, the Provident Fund Law, was introduced between 1981 and 1995.
Provident fund benefits are secured through collective agreements between the workers’ and the employers’ organisations. Currently, most of Cyprus’s collective agreements provide for some form of provident fund.
The provident fund is a DC arrangement which provides lump sums to employees on retirement, end of employment, permanent disability or death. The funds are financed by contributions from employees and employers. Many funds have a minimum compulsory contribution rate with an option for employees to pay more if they wish. Joint employee-employer contributions are typically between 5% and 6% of total earnings.
The fund is structured as a separate legal entity, so that fund assets are kept separate from those of the employer. It is run by an administration committee which technically ‘owns’ the fund. Parts of the fund are then allocated notionally to members.
The committee is obliged to keep individual accounts for each member showing the contributions collected from the member and the employer, and the interest credited to the member.
As an ‘exempt approved’ fund, a provident fund attracts tax relief on contributions, investment income and some of the retirement benefits. It provides a tax-free lump sum on retirement.
However, the provident fund has a number of weaknesses, according to Marios Argyrou, employee benefit consultant at the Nicosia-based actuaries Warren FAM, an associate of Bacon & Woodrow Channel Islands.
The major areas of weakness are to do with administration management and investment issues, he says. There is no legal requirement for appointment of professional advisers other than auditors. The law specifies the minimum number of individuals required on an administration committee but does not require people with appropriate experience or a professional qualification in pensions management.
“The problem is that members of the administrative committee are sometimes not aware of even the basic financial issues. And even if they are financially aware only a few are taking expert advice on financial investment,” says Argyrou.
There is no requirement for members of the administration committees to seek professional advice. This means that there are unlikely to be investment objectives or target benefits or any measurement of whether these objectives and targets are being achieved. Nor are there likely to be objective criteria for the selection of investment managers and the monitoring of their performance.
Communication with fund members is also poorly developed, says Argyrou. “Some of the larger provident finds might give benefit statements to their members, but this is just an account balance. There are no projections or illustrations of future benefits.
Finally, investment choice is not available to members. “One reason is that the administration systems cannot handle this complication,” says Argyrou. “They cannot cope with members switching funds or changing levels of contribution.”
The Ministry of Finance has the duty of setting guidance notes on investment limits. So far it has not done so. So there is still, in theory, complete freedom of investment.
However, provident fund administration committees are unlikely to make use of this freedom. Currently, there is a wariness of equity markets and investment managers, says Argyrou. “After the 1999 stock market crash in Cyprus there is no confidence in the market. Committees don’t want to make any investment decisions or pay any money for investment advice. They think they will do fine simply by keeping the funds in bank deposits or government bonds.
“This is what we call ‘reckless conservatism’. Unfortunately, it seems that most provident funds committees are not well informed or have not understood the long term impact of such policies on the eventual level of members benefits. Thus, the need for more pension education and reform in Cyprus.”