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Different this time around

Romania’s government has reinstated private pensions into the political agenda having cancelling its predecessor’s plans in 2000 shortly after taking power, but with a difference. While the previous government drew up an extensive project for a compulsory second pillar privately funded system, the new project focuses on a third pillar. The proposed scheme was to be fleshed out last month, proposed to the government and thereon to parliament for debate. It could even become law before next year’s elections.
According to Petre Ciotlos, secretary of state at the Ministry of Labour and Social Solidarity and president of the National House for Pensions – the entity that administers collections and distribution of the state pension system - despite disagreements over launching with a second or third pillar, “everyone agrees that it is necessary to have a supplementary pension scheme”. The new funds will be voluntary, occupational plans based on agreements drawn up between the employers and employees of large companies, managed by dedicated pensions societies, and at maturity converted into annuities supplied by a separate group of dedicated provider. The pensions societies’ investment criteria are still under discussion, as is the level of the additional contribution, which will be tax exempt. The new law would also establish a supervision commission charged with licensing and all other private pensions regulations.
Romania’s powerful trade unions are expected to play a key role in negotiating the agreements, and as the proposals stand the most feasible initial candidates are the large and largely state-owned companies. However, Romania is one of the poorest of the central and east European countries, and although it has been accepted for accession into the EU in 2007 – three years later than the 2004 expansion of eight fellow central Europeans – the union has still not designated it a ‘functioning market economy’. Net monthly wages at the beginning of the year averaged a mere $143 (E130).
“Given the current living standards, few people will be able to afford to pay the supplementary contribution, so it’s possible that initial coverage will be low,” adds Richard Florescu, human development specialist at the World Bank’s office in Bucharest. Meanwhile, Florescu continues, additional contributions from the employers, in the first instance the large state-owned companies, will further compound their existing financial problems and potentially result in calls for further state subsidies.
The World Bank has a long involvement in Romania’s pensions reforms including, through the Employment and Social Protection Project, some $2m financing technical assistance, $3m in establishing the National House for Pensions, and $8.5m for automation of the public pensions system. It has also been involved in formulating legislation for the second pillar, and will be also be providing technical assistance and finance for the establishment of the pensions regulator once the third pillar law is approved.
Ciotlos explains that the occupational scheme would enable the government to build the infrastructure for the second pillar, which would be launched once Romania’s economic conditions permit it. “We’re confident that the government will come up with a second pillar, and the importance of the third pillar proposals is that they will put in place the supervisory and licensing bodies needed in both cases,” adds the World Bank’s Florescu. “These will also enable politicians and the population to regain trust in mutual investment funds, with which we have had unfortunate experiences.”

The government’s cautious ap-proach, and the main reason why its cancelled its predecessor’s second-pillar scheme, is largely the result of Romania’s troubled fund history, which continues to taint public perception of private fund management. The scandals included the collapse of the infamous Caritas investment pyramid scheme in 1994, a dramatic decline two years later in mutual fund valuations, and in 2000 the collapse of FNI, the largest and supposedly government guaranteed investment fund, which caused the number of overall mutual fund investors to shrink from 239,000 to 41,700 the following year, while
net asset value plunged by 93% to ROL196.4bn (e5.6bn).
While the putative pensions industry has given the occupational pensions proposals a cautious welcome, it remains deeply disappointed that the second pillar remains on hold. “A mandatory private component would have been more advisable as the present pensions system see_box is approaching a disaster,” notes Marius Christian Barladeanu, associate lawyer at legal firm CMS Cameron McKenna’s Bucharest office. The legal firm worked on the draft of the Universal Pension Fund (UPF) system, the second pillar programme adopted by the previous government as an emergency ordinance shortly before the 2000 elections and then subsequently cancelled. As Barladeanu explains, the design of the UPF included extensive input from many civil foundations as well as international bodies such as the World Bank, and questions whether Romania will attract the same level of international support when it does finally adopt the more-than-necessary compulsory privately managed scheme.
Romania’s life insurance companies would also have preferred to kick off with the second pillar. “The proposals for the occupational scheme, which refers only to a selected target market, do not fit the needs of the Romanian population,” notes Violeta Ciurel, general manager of ING Nederlanden Life Insurance, the largest Romanian insurer in terms of written premiums last year. Ciurel also argues in favour of more uniform fiscal treatment of savings, as preferential tax exemption proposals in the occupational scheme would place existing insurance-related pensions-style products, which do not qualify for tax relief, at a disadvantage.
The low level of savings in Romanian society – gross written life insurance premiums last year totalled an estimated $126.5m against a population of 22m – is a further argument in favour of a compulsory system. “Unfortunately Romanians tend to focus their retirement provisions on short-term placement of their available resources and rolling over at maturity,” adds Emilian Laur, head of marketing at Aviva Asigurari de Viata (life insurance) in Bucharest. “It’s an educational issue and also reflects lack of trust. There is still a big maturity gap between their pension horizon and placements. Another way is to invest in real estate and hope for a steady rental income or a good reselling value. Only a few Romanians have understood the need for a long-term scheme for pensions and bought life-insurance, eventually unit linked.”
Although the thought of a privately managed quasi-state system makes many Romanian officials queasy, a second pillar would also address another flaw endemic in the system. According to Ministry of Labour data, last year some 70% of companies examined had either not paid or underpaid social insurance and unemployment contributions, with the large state-owned companies the major offenders. The direct link established between contributors and their supplementary accounts encourages workers to declare their income, and monitor their employer’s compliance.

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