Croatia's model system
After a year of operations, Croatia’s compulsory pension system has been judged a success. As of the end of 2002 the seven compulsory pension funds accumulated 938,310 members and net assets of HRK2.04bn (E285m). More than that, virtually all contributions are in the correct place and most of the future beneficiaries are in the system, no small feat for a country that was at war in the early 1990s and suffered extensive population migrations.
“Technically, the system works very well,” notes Dinko Novoselec, board member of Allianz ZB, which runs AZ OMF, Croatia’s largest compulsory fund. Credit for this goes to the Central Register of Insured Persons (REGOS). In designing their programme, the Croats were anxious to avoid the serious problems that the Poles encountered – and still face, in using an inadequate back office system. Many Polish second-pillar accounts have still not had their full amount transferred from their first-pillar, a good number are empty or belong to the so-called ‘dead souls’ – the dead, the fictional or the ineligible, who were signed up by commission-hungry salesmen. In Croatia, by contrast, 98.5% of contributions reached their correct destination according to Vladimir Puskaric, assistant director at the Pension Funds and Insurance Supervisory Agency (Hagena), the industry’s regulator. REGOS used databases from both the Ministry of Interior and the Pensions Institute (which collects and administers state pensions, disability, health and other benefits) to avoid multiple or fictional applications. Members also signed up with REGOS and not the salesmen themselves.
The system has relieved the pensions fund industry of the costs of contributions collections. “That’s why we can survive on low management fees,” explains Dinko Noveselec. Comparing with Poland again, fees of 5-6% have eaten away at an otherwise good fund performance, while Croatian pension companies currently charge only 0.8% in management fees. “I would recommend any country setting up a pension programme to employ a similar system to REGOS, as the pension fund company can then focus on its core business of asset management,” adds Damir Lamza, CEO of Raiffeisen OMF. “The back offices in Poland and Hungary employ around 100-200 people, mainly for collecting contributions, whereas ours has four, and they are the engineers specialising in informatics.”
One of the features of the Croatian compulsory system is that REGOS assigns those who cannot or will not make up their minds to one of the seven funds. The allocation is proportional, with the funds with the highest number getting the highest number of assignees. However, some 90% of eligible workers chose their own fund.
The market has become heavily concentrated, with two of the seven funds, AZ (jointly run by Allianz and Zagrebacka banka, Croatia’s largest bank), and Raiffeisen, accounting for more than 70% of members and assets. Only three have more than 80,000 members, the minimum number that a pension fund must acquire within two years. Although this requirement is set to be lowered in the proposed legal changes this year to 50,000, three funds still face problems meeting this given that the only new source of business – new entrants into the workforce – will find the larger funds more attractive. “The legislators obviously wanted a diversified market but forgot that fund management is a volume-driven business, with a limited number of members and profitability,” observes Puskaric.
Although the funds have another year to meet their legal requirements, other developments may enforce mergers before the deadline. The law allows an entity a shareholding in only one pension fund management company. In addition, a bank cannot simultaneously hold a stake in a pension fund management company and be its custodian. Erste Bank is in this position as in addition to its eponymous fund it acquired a shareholding in Adriatic Invest (which manages the Plavi fund) after taking over Rijecka Banka, an Adriatic Invest shareholder, in 2002. The custodian for Erste’s fund (as well as Raifeissen and AZ) is HVB Bank, part of the Bank Austria Group and which acquired a majority stake in Splitska banka, another Adriatic Invest shareholder. Puskaric predicts that mergers will eventually shrink the number of funds to four.
The fund companies’ main preoccupation is that the investment limits (see box), while seemingly on a par with those of most other central European countries, are severely constrained by the size of the local capital markets. The official list of the Zagreb Stock Exchange contains only three shares. Add to that a limit of 5% on investment in any single security, and it is easy to see why the fund managers are concerned. “And there are no municipal bonds, and not enough corporate bonds,” adds Raiffeisen’s Lamza. “It means that we cannot diversify our portfolio.” Meanwhile the funds have not been ready to tackle the overseas market because they need to reach a critical size to afford the entry fees.
In 2002 bonds have performed better than stocks because of interest rate falls and lower volatility, and it has not been difficult to make reasonable returns. According to Raiffeisen’s Lamza nominal returns averaged 10-12% in the first seven to eight months of operation, and 16% on an annualised basis. In the meantime the fund companies have been talking with the government and major companies about the benefits of exchange listing as a capital-raising exercise. “If we don’t create equity supply, mandatory pension funds will face great problems in the future because equity is the only way to create real value.”
The pension funds, along with mutual funds and life insurance companies, have meanwhile had a marked impact on the government bond sector of the capital markets. With some HKR55m of new monies a month to invest, the pension funds represent steady as well as sizeable demand. Prices have fallen as have spreads. In 2002 the government’s 10- year issue included a tranche targeted at pension funds, which received a preferential allocation and were able to buy directly and bypass brokers. While Croatian pensions law is similar to legislation in a number of central European countries in banning the use of derivatives, it inadvertently exposes funds to currency risks as government bonds are denominated in euros. “The government has recognised the need for kuna-denominated issues,” notes Puskaric. “A HKR700m bond is planned for 2003 and warmly expected.”