Mandatory pillar raises the stakes
A year ago, in January 2005, Slovakia launched a mandatory fully funded pillar pension system to augment a state pay-as-you-go scheme that has been in deficit since 1997. A law laying the basis of the second pillar had been passed a year earlier and the establishment of the schemes was rapid. Throughout last year eight pension management companies were engaged in fierce competition to sign up clients.
Second pillar participation is compulsory for new labour market entrants but others with more than 10 years to retirement have had a choice, and must decide by June 2006 whether to open an individual pension account with one of the private asset management companies licensed to manage pension funds or stay wholly with the state system.
Each pension company, or dôchodková správcovská spolocnost (dss), is obliged to establish three funds, the different portfolios reflecting individual preferences and the age of the members. Growth pension funds can invest up to 80% of their assets in equities and 80% of assets must be secured against currency risk. Balanced pension funds can have up to 50% in equities and at least 50% of assets must be secured against currency risk. And conservative pension funds can only invest in bonds and monetary instruments and they must be fully secured against currency risk. The minimum saving period is set at 10 years.
Employers contribute 18% of the gross wage of their employees to Sociálna poist’ovna, the social insurance agency that runs the state PAYG system, which then transfers half to the pension company chosen by those who have joined the second pillar and retains the rest to cover the employee’s state pension obligations. Those who opt for the second pillar will receive a reduced state pension on retirement.
Members have been encouraged to sign up to one of the new pension funds by a series of intensive advertising campaigns and aggressive marketing by agents assuring people that the pension funds will deliver a higher pension than the state system.
For the companies the success of their campaign is literally a matter of life or death. Those that fail to gain a minimum of 50,000 members by June will lose their licences and their members will be transferred to other funds that meet the minimum requirement.
In fact the marketing has been
surprisingly effective. By early March last year, just over two months after the launch of the funds, more than 600,000 members had signed up, twice the number predicted by industry analysts. The hope had been that the funds would have garnered up to 800,000 clients by the end of their first year but
in the event the total reached 1.2m out of an economically active
population of 2.1m. And a further spurt is expected in the second quarter of this year just before the June deadline.
But the success has been at a cost. “The pension reform has two parts,” says Viktor Kouril, a member of the CSOB dss board. “The first, which we are still in, is the division of the market when the primary goal of all the pension companies is to get as much market share as possible. And here the business practices have been astonishing.”
In addition to their own sales teams, pension companies have recruited agencies to sign up members, Kouril notes. “So the marketing was driven more by the desire of agents to gain commission, which was high compared with that of other products, and less by the willingness of clients to enter the system. And the process is very simple because the only thing the client has to do is sign. It is probably the first product where no money is asked from the client. So the market was driven by the salesmen.”
“To sell pensions agents have to pass a special exam,” says Mário Adámec, investment manager at Aegon dss. “Nevertheless, there are cases of pensions being sold by unauthorised agents in return for commission from licensed advisers.” But little advice has been given. “About two-thirds of clients have chosen growth funds, irrespective of age and even if it’s totally inappropriate,” Adámec adds.
And having gained its clients, the funds must keep them. “After one year, so from February, clients can switch to another fund and after that they can change every six months,” says Mario Schrenkel, chairman of Prvá dôchodková sporitel’na (PDS) dss. “So the greatest challenge is the stabilisation of the clients.”
At the heart of this problem is a change in legislation, according to Richard Kolárik, deputy chairman of Allianz-Slovenská dss. “When we entered the system the regulations included provision for transfer fees,” he says “But they were dropped.”
For Kouril, “The question is not how to retain the clients in the short run, it’s how to retain your agent. Most salesmen make their recommendations based on commission and agents may be disloyal and tell clients another fund is better. From the sales point of view there were two approaches: external agent networks, which was the way that most of the companies went, and having an internal network from the group, which was our route, and some 95% of our clients were brought by our own network. We only risk individual agents encouraging clients to defect, some companies risk distribution firms trying to switch their client base to someone else.”
The rewards can be substantial, Kouril adds. “Commissions to the agents went from around SKK1,200 (e32) to SKK3,000 (e79)-plus per new client.”
“At the beginning of the process the critical issues were not widely known but we identified them as
the size of the distribution network and advertising,” says Dusan Doliak, chief operating officer at Winterthur dss. “So we undertook a very good advertising campaign and we recruited a lot of distribution channels.”
Like Allianz, Winterthur applied for its licence when there was an exit fee but by the time its business plan was approved it had been lifted. “Most of the investment was already completed. We had signed contracts with distribution channels and so it was impossible to pull out,” Doliak says. “I think a system should be introduced with some form of threshold so it is not so attractive for people to change after half a year.”
Schrenkel agrees: “We want to establish new rules for this process. It’s dangerous; it could threaten the economy. But for the intermediary it’s great.”
As a first step, pension funds are lobbying political parties to include in a new social security law a delay of the start of the period when clients can switch to next January to have an additional six months to consider how to retain clients.
Kolárik raises another issue: “Funds are not allowed to pass on any other costs to the clients, the asset management company pays them all. And a pension management company receives only two kinds of income from the clients: an account-keeping charge of 1% of the contribution rate of each client and an asset management fee from the assets under management on a monthly basis, which in our case is 0.07%.”
According to Kouril’s analysis, the second phase is gathering and investing the money. “This will be what the pension reform is all about and this is how to retain clients in the long run,” he says. “Currently, the amounts are not enough to make investments in individual equities, so maybe three-quarters of all funds, from conservative to dynamic, are invested in term deposits and government bonds, and where they have equities they are invested in instruments that copy an index.”
“During the first one or two years all of the funds will invest very conservatively, even in the growth funds,” says Adámec of Aegon. “The level of equities is less than 10% of NAV for a growth fund and about 5% of a balanced fund. And the requirement that a conservative fund be fully hedged against currency risk means in practice that no security can be issued in another currency other than the Slovak koruna because it is impossible theoretically to hedge 100%. The hedging levels for the balanced and growth funds won’t pose problems because companies will not invest heavily in foreign assets this year.
“On the bond side, we have limited choice. We don’t expect the Slovak government to issue significant volumes of bonds because the budget is in good shape, and there is a lack of domestic corporate issues. Several foreign entities have new Slovak koruna-denominated eurobond issues and although they usually have ratings of A or AA so the spreads are not very attractive we have few other possibilities.”
“The average contribution in our company is in the region of SKK1,300 so at present we have a just a couple of hundred million Slovak koruny, which in portfolio management terms is really not enough to make investments and to do it effectively,” says Gabriel Hinzeller, portfolio manager at VÚB Generali. “But that’s normal when you are starting and we have already bought some bonds and some shares on US, Japanese and European markets through ETFs. However, money is flowing in every month and the portfolio is growing, so by the middle of the year we should be able to move to direct investments in equities and a little later have a full portfolio invested in equities and bonds.”
By that time, regulatory restrictions might start to pinch. “We are currently enjoying a special situation and we can invest in foreign currency securities,” says Adámec, “But by 22 March we will have to liquidate these positions and the limits placed on investments that will then come into force pose another challenge. We will be allowed to invest only up to 3% of securities per issuer, although this is lifted to 10% for mortgage bonds and 30% for EU and OECD state bonds, and up to 80% in Slovak state bonds provided there is a minimum of six issues with a maximum value for each issue of 30%. There will also be a minimum of 30% by value of domestic bank deposits, down from an initial proposal of 50%.”
“Practically we are allowed to invest only in standard tradable securities, and into very liquid investment bonds, whether corporate or government, and some money market instruments provided by Slovak and overseas banks,” says Kolárik. “We have a broad scope to invest abroad or within Slovakia but this has to be in the form of tradable securities.”
But the local market’s lack of liquidity is another issue. “It simply doesn’t provide us with enough investment opportunities,” says Adámec. “While there are 40 or so stocks quoted on the Bratislava exchange we can invest only in five because of a requirement that each security must be assigned an investment-grade rating. And we are indirectly barred from buying real estate funds and cannot invest in any kind of hedge funds.”
“Not only the investment process but the whole industry is very strictly regulated,” says Kouril. “The dss companies are the most regulated of all Slovak financial institutions because the second pillar is compulsory; once a person joins they can switch fund but are locked into the system.”
So with agents dominating the marketing process and restrictions on investments, how can the funds differentiate themselves from the others?
“We have a product that has been positively received by clients,” says Hinzeller. “It’s a credit-type card that you can use in an ATM to access all the details of your pension account, including whether money paid by your employer has been transferred to your pension by the social security. It’s also a way of ensuring that there are no other unpleasant surprises later, for example, people whose name has been misspelled or small details with a social security number because it enables customers to track down any problems at the beginning of the process rather than when they retire.”
“The law says that we cannot provide any additional benefit to clients, so we cannot give them cash or extra services, discounts for other of our activities or a bonus card,” says Doliak. “So we must give them as good a service as we can. Clients can have information via telephone, branches or our website, we publish information in the newspapers and we have issued a VÚB -type card.”
“We believe that our clients will prefer to stay with a strong company with a strong name,” says Kolárik. “And they will also be influenced by the other aspects of our service. For example, Allianz was the first company to present our portfolio to the public. Each month we publish a short commentary on portfolio development and reveal the structure of the portfolio on our website. Of course the performance of the funds is one of the factors that they will take into account when they consider switching.”
“It is too soon for performance to be a major factor in client acquisition,” says Adámec. “Performance can be used to some extent in the future but for the first one or two years it won’t be enough to provide a base for serious judgement.”
Nevertheless, it has its dangers. “If the performance of the pension asset management company is below the average of the others, if it is below the benchmark, it has an obligation to pay the difference,” says Schrenkel.
“If a company falls below the benchmark range of the competition, its assets will have to contribute to the fund to increase the yield”, explains Kouril. “In a few years there will be billions of koruny in the funds, so even a half a percent of yield would mean hundreds of millions.”
Doliak queries the calculations underlying the benchmark. “At the moment we are calculating on the basis of the arithmetic average, so with eight pension funds they take the sum of the interest of each fund and divide by eight. The issue is that some companies have very small assets and some, as in our case, have substantial assets. And with small assets you can use special papers to show a very high return. We want a weighted average.”
And Kouril sees a further danger. “Because the benchmark for each company consists of the performance of the remaining companies, your yield has to be around that of your competition. While this guarantees that the companies will do nothing too risky, it suggests that the yields of the funds will be around the same level.”
“I don’t think that all the funds look the same,” says Kolárik. “We check the development of pension units of each fund on a weekly basis and we see that certain funds, even growth funds, are constantly rising at approximately the money market level. This indicates that the small funds are not able to diversify and so they keep the money in the money market. Then there are funds that we can tell are investing in equities because we see a high volatility, and we are one of them.”
Schrenkel agrees differences are emerging: “Of course, it will be dangerous to be out of the range, especially of you are underperforming. But I am convinced that in our market there are people who are creative and who will put together very good structures and who will make money for their savers. It means that they will outperform and lift the benchmark for the rest. There are always market leaders who are very closely watched by the rest.”
Just which company is the market leader in terms of clients is an open secret at the moment, the government having banned pension funds from announcing how many clients have registered with them until the June deadline – the idea being to prevent a bandwagon effect.
But business newspaper Hospodárske noviny regularly publishes totals that are accepted as being accurate. Throughout most of last year Winterthur had the largest market share, with Allianz and VÚB Generali running close behind, and ING, CSOB, Aegon, Sympatia-Pohoda and PDS trailing some considerable way behind. All had exceeded or were close to the legally required 50,000 clients, but with acquisition costs having soared during the year economies of scale, not client numbers, had emerged as the crucial issue. “Having around 50,000 clients doesn’t deliver economies of scale,” says Kouril. “Experience in other countries suggests there is probably space for four or five pension funds in Slovakia.”
And the shakeout is already under way. Last summer ING, the largest of the minnows, bought third pillar fund Tatry Sympatia from TBIH Financial Services Group, says Jiri Rusnok, ING director of pensions for the Czech Republic and Slovakia. “The deal also included a 34% stake in Sympatia-Pohoda,” he says. “We opened talks with the Slovak majority owners and eventually agreed a joint venture under the leadership of ING, of which they will have 15%. We will merge the ING and Sympatia-Pohoda operations.”
At the same time PDS, the smallest of the funds, was put on the market. The shortlist came down to ING and Allianz. The asking price, thought to be around SKK10,000 per client, was seen as steep but both suitors are thought to have offered PDS’ parent a distribution deal for its core building savings product. In the event, although larger, Allianz proved to be hungrier. The market leader in all other financial sector in Slovakia, it resented being number two in mandatory pensions.