Iain Morse surveys Russia’s nascent occupational pensions market
In 2002, the Russian Federation implemented a universal pension reform which corresponds more than less to the three pillar World Bank model.
All employers make a ‘social insurance contribution’ equal to 34% of gross payroll; of this, 8% goes to meet state medical and social security costs, the remaining 26% to the Pension Fund of the Russian Federation (PFRF). This is further divided with 20% going to finance first pillar state pensions on a pay-as-you-basis, and 6% to a defined contribution (DC) second pillar.
The second pillar DC element hypothecates contributions to individual accounts with contribution levels adjusted to the individual’s income within upper and lower limits. There is a default option for contributions, the state administered fund managed by the state owned Vnesheconombank (VEB), although individuals can also choose to divert their premium to one of the non-state pension funds (NSPF). The VEB holds 80% of accounts with assets under management of RUB1.06trn (€254bn), while the NSPF’s manage assets worth RUB301.5bn. NSPF’s tend to be taken up by better paid employees and those working in large companies.
The VEB offers two fund options; one is ‘conservative’, invested in cash and rouble denominated bonds, the second is ‘extended’ with greater exposure to equities. In 2009 , their respective net returns were 0.95% and 9.05%, and for 2010, 4.73% and 6.95%. Both the VEB and NSPF’s are obliged to declare an annual net rate of interest on their respective portfolios as well as a net asset value for assets under management. Given that Russian core price inflation (CPI) ran at 8.8% and 7.3% in each of these years it is easy to see why the VEB has a poor reputation but harder to see why members fail to exercise their right to transfer to one of NSPF’s which yield higher returns. “Part of the reason is a general lack of confidence in the pension system, although when savers look at the actual returns from NSPF’s compared to the VEB, they often transfer,” says Elena Gorshkova, executive director at Raiffeisen Bank, Russia. Raiffeisen Bank’s NSPF, for instance, yielded a net return of 10.46% and 10.82% for the same period.
“Most NSPF’s are conservative in their asset allocation,” warns Polina Novoselova, head of marketing at Troika Dialog Moscow. “Few invest more than 5% in equities, with the balance held in rouble deposits and bonds. Yields tend to be low in real terms and often less than inflation.” Gazfond, for example, has 65% of it’s portfolio in domestic bonds originated from corporate and municipal issuers, with a further 9.5% in Russian treasury bonds. Over 7% of assets are in cash deposits, just over 13% in shares issued by Russian companies. The balance is in alternatives.
Pension reform is ongoing. The State Duma, has just passed new pension laws carrying significant refinements to previous legislation. These include a pensioners’ right to opt for a lifetime or relatively short fixed term pension and a right to inherit individual accounts if the pensioner dies early. Meanwhile the state offers a minimum ‘zero yield’ on pension savings but guarantees a return of capital equal to that of contributions made for the individual.
One option under discussion and likely to take force is that of allowing pensioners to take VEB/NSPF accounts as tax free lump sums at retirement. This needs to be placed in context; average male mortality is 63, for women 74 with average life expectancy falling sharply among the poor and in the hinterlands. One can see why many pensioners would prefer a lump sum. Meanwhile, Vladimir Putin, when president, and his successor, Dimitry Medvedev, have both faced angry pensioner protests. In Russian terms, this is a political hot potato.
Elsewhere, there is a heterodox third pillar of employer pension and ‘total remuneration’ packages which has grown rapidly and which is currently estimated to manage assets of RUB640bn. Employers have wide discretion in constructing these pension arrangements. “Some are 100% employed financed, some based on matching contributions and more, some have vesting periods of three years some of five, and so on,” notes Gorshkova. Eligibility criteria also vary widely; these include career banding and performance related criteria. The notion of uniform pension rights for all does not apply.
This can look chaotic. Much depends on the common structural features of nearly all major Russian companies, which seems oddly anachronistic to western eyes, combining high levels of vertical integration around a core business with apparently random collections of non-core acquisitions made sometimes for political or ‘diplomatic’ reasons. A number of Russia’s largest vertically integrated companies, some state controlled, some privately owned, combine the ownership, extraction and processing-to-market of natural resources like oil, gas and other minerals in structures that might be regarded as sub optimal in more efficient, transparent capital markets.
Examples include Gazprom, 50.02% owned by the state, or Basic Elements, majority owned by Oleg Deripaska, but heavily in debt to the state after a ‘bailout’. Both have their own non state pension funds (NSPFs) as well as owning or having owned banks and insurance companies and running third pillar pension schemes. Basic Elements also owns Russian car, caterpillar tractor and plant manufacturers. These structures are unlikely to evolve until companies are fully listed and a strong community of institutional shareholders emerges.
The largest and most successful of the NSPF’s is the Wellness fund founded by the Trade Unions of Railwaymen and of Transport Construction. This is the industry fund for Russian Railways, which runs Russia’s rail network, stations and rolling stock, employing over 976,000 people. Like other NSPF’s it also accepts non railway workers and is affiliated to several smaller NSPF’s. It also offers third pillar plans to other employers, and a variety of pension options, ranging from fixed terms after retirement to full life pensions. Wellness employs eleven asset managers, including Alfa Capital, Troika and TKB BNP Paribas Investment Managers.
Other NSPFs are managed by corporates like Lukoil Garant Norisk Nickel, to financial services groups, others were established by municipalities, while still more are designed to cater to an industry such as NSPF ‘Defence’ or NSPF ‘Ports’. The majority of these funds are tiny, their survival has to be in question, there is an emerging pattern of consolidation, which is likely to accelerate.
Behind the NSPF’s there are currently fifty seven management companies which must be Russian domiciled and owned. Capital Asset Management, Troika Dialog, and Alpha Capital are major players in this market. All also manage third pillar pension assets and have substantial market shares in the burgeoning private wealth management industry. They form an important lobby group, amplified by Putin’s declared strategy of turning Moscow into a globally competitive financial centre to rival London or Hong Kong.