Hungary is at the forefront of countries in Eastern Europe working to develop a western-style private pensions system. With an active work force of 4.7m and some 2.5m-3m pensioners, there is acute pressure on the government to relieve the state pension burden.
According to Tibor Parniczky, vice president at industry regulator State Private Funds Supervision (SPFS), legislation passed in September 1997 introduced the concept of mandatory private pensions. In line with the classic three-pillar pension structure, these new defined contribution private pension funds (second pillar) will operate in addition to the traditional pay-as-you-go social security pension fund (first pillar) and the voluntary private pension system (third pillar), or voluntary mutual benefit/pension funds (VMBF) in-troduced in 1993.
Contributions to the social security pension fund stand at 22% of wages for the employer, while employees pay an additional 1%, as long as their income is twice the average wage. There are around 250 private pensions, or VMBFs, in operation, according to Parniczky and this sector has shown rapid growth. By the end of 1997, the VMBFs had amassed some Ft57bn ($270m) in assets, estimates the SPFS, increasing at a rate of some Ft3bn a month. These funds, with some 550,000 total members, are organised along trade union or employment lines and there is no specified minimum size.
Parniczky believes that around 10% of the funds have fewer than 100 members, although he has recently noted a tendency for smaller funds either to merge or be amalgamated into larger ones. Thus the number of funds has decreased slightly, although membership continues to grow steadily. Investment decisions are made by an elected board of trustees. An estimated 60% of voluntary funds outsource the management of their assets, and although most hire a single manager, Parniczky has noted an increased propensity, particularly by the larger funds, to outsource to one or more managers.
After only six months, inflows into the new mandatory pensions have been sizable. They have already attracted 900,000 participants to 46 funds. The law requires members to pay 8% of their income into these funds (in addition to the 1% paid to the pay-as-you-go system), although the amounts will be phased in over the next three years, with the contribution at 6% this year, rising to 7% in 1999 and 8% in 2000. Existing workers will have the option to shift to the new second pillar from the social security system, but as of July 1998, employees under the age of 42 and new entrants into the workforce will be required to participate in the second pillar. Although the legislation was passed in September 1997, the first contributions to these new funds weremade in January 1998. The mandatory funds will be controlled by a part-elected, part-delegated board of directors and the legislation stipulates a minimum of 2,000 members.
Looking ahead, this sector is sure to show very dramatic growth, affirms Agnes Matits, office head at William Mercer Consulting in Budapest. Because almost all of these funds are expected to outsource their fund management, she also anticipates that by the end of this year there will be heated competition among fund managers for a piece of this pie. Peter Holtzer, managing director of CAIB Securities in Budapest, agrees that competition will be fierce.
Although the final details of the investment guidelines that will apply to the mandatory funds have yet to be fully clarified, continues Matits, she expects them to be largely similar to those in force for the voluntary funds, although the latter are allowed a slightly riskier asset mix. Broadly, the investment limits that will apply to the mandatory pension funds are as follows: no more than 10% (20% for the voluntary funds) can be invested in the securities or instruments of any single issuer, except for Hungarian state instruments (risk class 1). A maximum 60% (70% for the voluntary funds) can be invested in risk class II - including bonds issued by local financial institutions and companies (with a bank guarantee), A" stocks listed on the Budapest Stock Exchange, and bonds issued by international financial organisations. Finally, a maximum 30% can be invested in risk class III - stocks and bonds issued by Hungarian companies, local governments, and OECD countries, "B" stocks on the Budapest Stock Exchange, investment fund units issued by funds registered abroad, real estate (not directly but through a mutual fund), and futures and options contracts (but only for hedging purposes).
Although the funds remain conservative in their investment philosophy, Holtzer affirms that there has been a shift toward heftier domestic equity holdings, and that these have risen from an average 2-4% of the portfolio as of the end of 1996 to 15-20% a year later. While the market performed well in 1997, so far this year there has been virtually no increase in dollar terms, although Holtzer estimates that the average portfolio still has around 15-20% in equities. SPFS statistics bear this out, indicating that at the end o f 1997 the average voluntary fund had 19% in stocks and bonds and around 62% in government securities.
Although the voluntary funds are theoretically allowed to invest up to 20% of assets overseas, very few have taken advantage of the allocation. The new mandatory funds' overseas allocation will be phased in gradually over the next three years. This year, no overseas investment is permitted, but the cap will rise 10% each year thereafter to a maximum of 30%, equivalent as Parniczky notes, "to the average in Britain". Although "there is very slow movement towards foreign investing", Holtzer predicts that, by the end of 1999, there will be foreign equities in the portfolios of most pension funds. Part of the impetus, he explains, comes from the lesson learned in last autumn's financial crash, when market volatility was in fact higher within Hungary than outside. The overseas investment category will be limited only in that only one-third of the total can be sourced outside the OECD.
Managing these funds are a plethora of banks and insurance companies. Holtzer estimates that around 75-80% of the market is controlled by the pension fund divisions of the 'big four' insurers - AEGON, Allianz, Nationale-Nederlanden and Winterthur. Most of the major players in the market have at least some foreign ownership, a legacy of the privatisation of many of Hungary's banks and insurers. Names like CAIB (Creditanstalt), ABN Amro and ING Barings are also prominent in the market. The SPFS requires all asset managers to be registered as Hungarian companies and they must also be licensed by the Banking and Capital Market Supervision, or the Insurance Supervision of Hungary."