Market-friendly faces needed
Hungary’s change of government following the April elections heralds more changes for the pensions industry. The centre-right Fidesz government of prime minister Victor Orban lost by a narrow majority to the Hungarian Socialist Party/Alliance of Free Democrats coalition headed by former finance minister Peter Medgyessy. Although left of centre on many policies, the Socialists are nevertheless seen as more market-friendly than Fidesz. “We expect the new government to improve the possibilities for the private pensions industry,” predicts Jerry Wouterson, CFO of ING Hungary and managing director of ING Nationale Nederlanden Pensions Fund Savings Company.
While the outgoing government made some valuable changes in the transparency of the state system, such as transforming the first pillar into a notionally defined contributions scheme based on individual accounts, it was not friendly to the privately run system. Members paid a total 9% of their income into the state pension scheme, of which 6% was diverted into the second pillar. While it was originally envisaged that the portion would rise in increments to 8%, Fidesz froze the contribution when it came into power in 1998.
Last year the government further undermined the second pillar by removing the compulsory element. Hungary’s second pillar was only mandatory for new entrants into the labour force as of 1998, making it the least compulsory of the region’s reformed pensions. Under the amended law members who joined voluntarily had their deadline for switching back, already closed in mid-1999, reopened to the end of 2002. Those who were forced to join now have until the end of this year to opt out, while new employees have until the end of the year 12 months from entering the labour market to decide whether to join the second pillar. Funds built up in an individual’s second pillar will be returned less cost but with the accumulated rate of return, and with the first pillar insurance period deemed unbroken.
“For people over age 40, it is questionable whether joining the second pillar was a good decision because of the short accumulation phase,” notes Mihaly Erdos, senior pensions fund adviser to the president at the Hungarian Financial Supervisory Authority (HFSA), the country’s pan-financial regulator. There were also constitutional issues about the legality of forcing employees into private pensions scheme. However, the main reason was budgetary, with the Fidesz government deeming the cost of the transition deficit or shortfall in the first pillar (planned at a maximum 1% of GDP and estimated at 0.6% in 2001) too high.
The Socialists have already promised to improve inflows into the second pillar. Speaking at an ING investment conference shortly after the election, finance minister designate Csaba Laszlo promised to raise the 6% contributions level to 8%. Although he mentioned no dates, the new government will most likely implement it at the beginning of 2003 so as not compromise existing budgetary obligations.
The new government has not signalled whether it will overturn Fidesz’s relaxations on opting out of the second pillar schemes. Early figures suggest that there has been some switching out but no mass exodus as yet. According to Wouterson, around 1.9% of second-pillar members left in 2001. At ING-Nationale Nederlanden Mandatory Pension Fund, the number was even less, about 1%. “We expected more to leave, and they may do at the end of 2002, but we’re hoping the risk is over. Had the previous government remained in force, we expected it run a PR campaign to encourage shifting,” he says. “Trust in the mandatory system is high,” adds Andras Kozek, managing director of Allianz Hungaria’s pension funds. “The mandatory system is more transparent than the state scheme and more flexible, with different types of benefits available at retirement.
By no means all the legislation passed last year has been has been retrograde. The Capital Markets Act passed at the end of last year clarified the roles of custodians and in-house asset managers. As of July 2002 the larger funds will be obliged to report daily net asset valuations, and the act has also extended derivatives use to arbitrage as well as hedging, and defined netting of underlying and derivatives. In addition funds will have to offer their members a choice of portfolios with different risk profiles.
There are still outstanding issues in the pensions system to address. There is a guaranteed return for second-pillar members of 25% of their first pillar contribution, which amounts to very little for younger workers but is significant for those over age 40. In addition, the return cannot under-perform a benchmark portfolio of long-term government bonds by 15%, which has been criticised for skewing investment into government securities. Under the Hungarian system there is no legal separation between pension fund members and its management. Unlike Poland, where the fund management company has to make up the shortfall from its own share capital if the fund under-shoots the legal benchmark, Hungarian asset managers cannot be held responsible for underperformance because there is no legal separation between the pension fund and its management.
In Hungary pension fund members pay for their own minimum rate of return through a reserve fund financed from the fee. This is not reimbursed if a member switches funds, and is an issue currently been examined by the HFSA. Erdos also wants to see more flexibility in the types of benefits paid out from voluntary pension funds. With the first payouts due in 2004, the deadline for this issue is looming. The HFSA is also trying to ensure a uniform IT platform to comply with the law passed last year obliging all employers to file reports to the mandatory pensions funds electronically.