The reforms of the social security systems undertaken in many Latin American countries have been a model to follow for many eastern and central European nations facing the collapse of their own provision systems.
The individual capitalisation savings account established during the last two decades in many Latin American countries, has been seen as the most effective way for reforming pension systems in this European region.
As happened in Chile 20 years ago, the social security systems in eastern and central Europe are bankrupt and a thorough reform has been badly needed for some time.
“The cost of the pension provision system in Poland is enormous if you compared this to that of other western European countries, and this situation was similar in Chile 20 years ago,” says Pawel Wojciechowski, CEO at PTE Allianz Polska, the pension fund management company of the Allianz group in Warsaw. “In general we have opted for this compulsory defined contribution system based on individual capitalisation accounts to lower substantially the cost of the system.”
Poland reformed its pension system in 1999, and this has probably been the most aggressive reform in the region in terms of the assets accumulated in the pension funds.
“The fundamental principles behind the reform were firstly the situation of the social security and secondly that people were enabled to make wise choices regarding issues such a tax breaks which voluntary systems required,” Wojciechowski says. “So we thought that the way forward was to introduce these compulsory schemes.”
The establishment of private pension funds in central and eastern Europe has not been accompanied by the reform of the old pay-as-you-go system as opposed to what has happened in many Latin American countries. Although the Chilean reform meant the substitution of the old pay-as-you-go public system for these new privately managed schemes, in central and eastern Europe the old systems are coexisting with the new regime, following the approach of other countries like Argentina. In Poland, for instance, affiliation to the individual capitalisation system is compulsory for those workers under 30 and voluntary for those between 31 and 50. Those over 50 stay in the old public system. Contributions to the system represent 36.5% of salary of which 7.3% goes to the private pension fund and 29.9% to the PAYGO system.
Other countries such as the Russian Federation, Bulgaria, Hungary, Macedonia, Kazakhstan and Ukraine have followed a similar path although some of them have not yet introduced compulsory scheme. Ukraine, for instance, is now discussing is now going to the reform process and it’s discussing the possibility of introducing a new compulsory pension system. At the moment some voluntary private pension funds operate in the country, but there are still not regulated under a specific pension law.
In 1999 Bulgaria approved fundamental laws to reform their social provision system, establishing a mixed system including both individual capitalisation and PAYGO systems. In September last year the authorities issued the first licences for the Complementary Voluntary Pensions companies and started registering occupational and universal pension funds.
In general, most of the countries in the region have the development of new social provision systems on their agenda, and as it happens in the Latin American country, they are looking at what their neighbours are doing. The question is not only that of transfer to their own countries of what has been done already elsewhere, but also to improve those aspects that have failed in other systems.
“If we look at the Chilean system we see many things that have worked really well and others that should be improved,” says Wojciechowski. “When you introduce such a system which will be managed by private asset manager houses, the main concern is how it will operate,” he adds. “It is very important to know how the transfer between funds will be, how the premiums will flow into the system and how efficient everything is going to be. Everything to do with the operating environment of the system is crucial for us.
“Secondly, we have to focus on everything to do with costs, to increase efficiency, setting up the right infrastructures to allow us to keep costs downs and ease funds flows. It is about setting up the right infrastructure to support the system so it doesn’t fail.”
In terms of investment, eastern and central European are also following the Latin American path in order to keep risk down. The pension fund portfolios are conservative, with significant restrictions on equity and foreign investments. “In Poland, for instance, we have a 5% limit on foreign investments and in my opinion we have to move towards a more liberal approach,” Wojciechowski says. “There are always pros and cons about liberal investment policies, but the whole system has been set up to be competitive,” he says. “Issues like free transfers between funds should ensure the good management of the assets because competition would translate into efficiency and safety.”
But it is also true that these systems are usually less transparent and more short-term focused than those collective schemes operating in the west.
In this respect, Kees van Rees, chairman of the European Federation for Retirement Provision has some doubts about the future of these individual capitalisation schemes: “The Latin American systems are very tempting for eastern and central Europeans but I think they should look at the long-term consequences of what they are doing.” He continues: “The Chilean system was really good to get the capital markets of the country started, but they failed to adjust the system to the developments that were taking place in the economy. You have to look at what is ultimately the best solution in macroeconomic terms.”
He adds: “One of the solutions is to choose the option that costs less money and this applies to both Latin America and eastern Europe, where they have been transferring the first pillar into these privately financed accounts managed by companies who have been created to make a profit. And there is nothing wrong about that, but there is a downside risk.”
This risk would be underperformance as a result of not investing in long term assets efficiently. “The duration of these portfolios is too short in comparison to the duration of the liabilities and it’s this short-term outlook what they should change, “ van Rees says.
The impact that these systems will have on the rest of Europe, especially taking into account the enlargement of the European Union towards the east is also crucial. “We are now having discussions about a new directive and these systems will not fall into it,” van Rees. “They will be covered under the UCITS area and also they won’t promote the cross-border mobility which is so important for eastern Europe. In terms of pensions they are moving back instead of forward.”
Although, the growth expectations of the central and European pension market are significant, at the moment its impact on this country’s economy is still very limited. In 20 years’ time, however, the picture could completely change.
Whatever happens in the near future, any development will be closely followed throughout the region. It is clear that during the last few years, and at the same time that several reforms were being implemented, exchange of experiences among neighbouring nations and Latin American countries have been crucial. In this regard, the International Federation of Pension Administrators (FIAP) has played a key role. With members from all around the world the FIAP has been used as a means of interchange of information since its creation. “Eastern Europe has been looking at the developments in pensions in Latin America because our economic situation has been very similar,” says Pedro Corona, president of FIAP in Santiago. “It’s true that our systems can be improved and that’s why it’s so important for these countries to see what we have done and implement the best solutions in their own regions. It is all about improving the conditions of workers all around the world and they way we did it here was the best solution we could find,” Corona says. “It’s now up to the different countries to find the best answer to their own realities.”

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