Incentives needed to boost second pillar
ortuguese pension funds managed nearly €19bn as of December 31, 2005, a growth of 25% compared to the previous year.
This figure is important, especially in that it comes in the wake of two years of small or even negative growth caused by the integration of several pension funds into the CGA (Caixa Geral de Aposentações, or civil servant pension scheme) as a means of keeping the budget deficit under 3% of GDP).
Despite being significant, particularly when its weight as a proportion of GDP is compared with the figure for other EU countries, the sum under management could be misleading to the extent that 72% (2004 figures) doesn't take into account complementary schemes or the second pillar of social security, but rather substitutes the state in guaranteeing the members' pensions, thus financing the plans under the first pillar.
The figures show that only 25% was in
respect of the second pillar.
On the other hand, within the scope of the third pillar there is a product known as PPR (Retirement Savings Plan) that has seen sharp growth. This segment, open not only to pension funds but also to investment funds and insurance products, accounted for nearly €11bn at the end of 2005, or more than twice the estimated value of the complementary schemes of a corporate nature.
It can therefore be seen that there is, as yet,
no relevant pension fund market financing complementary schemes of a corporate nature. Here lies the first great challenge of the Portuguese market: to stimulate and lend dimension and visibility to this segment.
Stimulation of the pension fund market
must necessarily involve incentives, tax incentives in particular. Alternatively or cumulatively, the answer may also lie in the transfer of part of the contributions paid by workers and employers into the public social security scheme, channelling it to pension funds managed on a capitalisation basis. The Associação Portuguesa das Sociedades Gestoras de Patrimónios e de Fundos de Investimento (APFIPP) has already had the opportunity to present a number of suggestions to the Portuguese government in this regard.
The announced reform of social security that the government has promoted had created expectations to the effect that the complementary schemes provided for in the present Social Security Framework Act, approved in 2002, would foster the pension funds market, particularly in the area of the second pillar.
However, for the time being, the Portuguese government has opted to make only limited adjustments to the present system of allocation with a view to adjusting the level of liabilities, such as the introduction of a sustainability factor that will reduce future pensions with the increase of average life expectancy. This reduction of the value of pensions could be cancelled out by larger contributions by the workers or by means of longer contributory careers. A rule planned for 2017 has been brought forward, connected with the calculation of new pensions, which will come to be based on the entire contributory career. The association, which took part in an ample public debate on the perspectives of social security reform, drew up a comparative study of the schemes in several EU countries with a view to helping reflection on the best system for Portugal. The APFIPP also prepared a proposal on the basis of a mixed system.
Up to a threshold of twice the national minimum wage (NMW), contributions would continue to be allocated in accordance with the alterations introduced by the government's proposal; between two and 12 NMWs the contributions would be managed as a capitalisation system.
However, to allow the government to maintain, initially, a satisfactory level of revenue, the proposal assumes that 50% of these contributions would be handed over to the state to meet current expenditure but would be recorded in an individual virtual account to be capitalised at a pre-determined rate. At retirement age, the final amount would be converted into an annuity. Above 12 NMWs, contributions would be voluntary. The association also suggested that incentives be established to encourage voluntary contributions both by employees and by employers.
Recent changes to legislation. Decree Law 12/2006 of January 20 transposed to Portuguese legislation Directive 2003/41/EC of June 3 in respect of the business and supervision of professional pension plan institutions (IORP)..
The legislator took the opportunity to review the entire legal framework of the pension funds. Of the main alterations, emphasis is given to the creation of the members' ombudsman for individual contributors to pension funds and to the creation of a steering committee for closed pension funds and collective contributions to open funds intending to allow greater intervention by members and beneficiaries and, at the same time, making pension funds more transparent through improved governance practices.
The introduction of the ombudsman and of the committee thus constitutes a first challenge related with the new regulations, in that they are new structures that require a certain adaptation by all those involved.
Another novelty is the possibility of the pension funds financing health benefits for members following the end to their active lives. This would naturally have an impact not only on the development of the industry but also on the form of managing and guaranteeing these benefits.
Another alteration has to do with the possibility of cross-border pension fund management, which could affect the domestic market to the extent that many of the present pension fund customers are subsidiaries of multinational companies.
Challenges of the Portuguese market
The more specific challenges facing the Portuguese market have to do with the smallness of the complementary, or second pillar, pension fund market, the reform of social security and the way in which the pension funds can become involved as a potential solution; and the new regulations, which introduce new governance structures, provide for the financing of health benefits and allow cross-border management of pension funds.
Furthermore, there are still issues of major importance, related to defined benefit (DB) plans, that the sponsors will be unable to comply with owing to the inherent costs, the result not only of market volatility but also of the introduction of new accounting rules and the significant demographic alterations that have been seen and will continue to be seen in the future.
As in other countries, there has been a
trend in Portugal towards replacing DB plans with defined contribution (DC) plans or mixed plans, and there are companies that, for example, maintain DB plans for old employees and set up DCs for new staff.
With or without the transfer of the financial risk from companies to individuals, the central issue remains: how to ensure profitability that will allow companies not to be unduly overburdened (in the DB schemes) and, at the same time, ensure that, on retirement, the beneficiaries will enjoy a pension in keeping with the contributions they paid.
New forms of management and new financial instruments will have to be developed on an ongoing basis in an endeavour to solve this eternal matter.
The heterogeneous nature of pension fund members, in terms both of age and of careers, also brings about additional difficulties since the techniques employed in the construction of the asset liability management models could introduce significant distortions.
The next challenge lies in the post-active stage and in the way of paying the contracted benefits. The traditional transformation of accumulated benefits through buying an annuity from the insurance companies, particularly in the DC plans, has been questioned. The pension funds will have to find alternatives, taking into account at all times the pensioners' increasing longevity and the guarantee of their pensions over the entire retirement period.
Lastly, portability is another issue on the agenda these days, both at EU and at national level, one that raises very considerable concern for the pension funds. This dossier must be closely monitored to ensure that portability is brought about in such a way that common sense will prevail and costs will not be created that the funds will be unable to bear, for this would have very grave consequences for the industry and, consequently, for members and beneficiaries alike.
Manuel de Vasconcelos Guimarães is president of the APFIPP