Central & Eastern Europe: Croatia bucks the trend
In contrast with Poland, and despite the poor state of its economy, the EU’s newest member backs second-pillar pensions and is making proactive changes to the system, as Krystyna Krzyzak outlines
Croatia’s second-pillar pension system has so far remained isolated from regional developments. While heavily publicised, the asset swoop on Poland’s second-pillar funds, and Hungary’s earlier nationalisation of its system, have not dented the Croatian government’s backing for the system.
“The [assets in] pension funds are treated as personal property under Croatian law, so a Polish or Hungarian solution would not be constitutionally possible,” explains Dinko Novoselec, CEO of AZ Mandatory Fund and president of the Association of Croatian Pension Funds Management Companies and Pension Insurance Companies. “The government is supportive and looks positively to us to increase investment in domestic assets. We’re better alive than dead.”
Crucially, the government has left the 5% contribution level unchanged since the system launched in 2002, despite its economic problems. Croatia joined the EU in July 2013 as the poorest member in terms of per capita GDP. With the exception of 2011, it has been in recession each year since 2009, and its finances are in poor shape, with the European Commission likely to impose an Excessive Deficit Procedure shortly.
“There have been discussions on raising the contribution rate practically from the start of the pension fund system, and this was part of the projection of pension reform before implementation,” explains Damir Grbavac, executive board president of Raiffeisen Mandatory Pension Fund Management Company.
“This was not included in the initial law and was not realised during the time of high growth rates,” Grbavac continues. “Now, with recession present for the last five years and our budget deficit and public debt problems, it is not realistic to expect this, but it represents a target of the government for the future and will hopefully be realised once we have at least a 2% annual growth rate. There are of course opposing ideas as well, but they have not had significant support so far. We felt the strongest threat to mandatory pension funds back in 2009 when the prime minister at that time, Ivo Sanader stated that the second pillar was a failure.”
The current government is changing the second-pillar system, moving away from one-size-fits-all funds to lifecycle plans with appropriate risk programmes, as well as altering some investment regulations and separating out second and third legislation. “The changes are definitely positive and open the space for further development of Croatia’s pension fund industry,” observes Grbavac. “It represents one step further in contributing to the sustainability of the national pension system in the long run.”
Fund managers will run conservative plans invested largely in government bonds with a small share in non-government securities, balanced funds with a 35% limit similar to existing fund profiles, and active funds investing up to 55% in equities.
Workers with 5-10 years left until retirement will only have the option of balanced or conservative funds, while those with five or fewer years will have to move to a conservative plan. “It’s important that no-one ends up by default in an active fund,” stresses Novoselec.
Some key investment limits are being changed, including the 10% investment limit on a single company’s total outstanding shares that made pension fund investment in any smaller Croatian company unfeasible. This limit rises to 20%. There will also be the option to remove the ownership limit as long as it does not exceed 5% of a fund’s portfolio. The use of derivatives, which in practical terms was confined to foreign exchange forward contracts, is being extended to aid efficient portfolio management.
Balanced funds will still be limited to a maximum 40% investment in non HRK-denominated assets, a cap increased from 20% ahead of EU membership. Adoption of the euro would broaden the funds’ horizons. However, according to European Commission forecasts, the government deficit is projected to rise from 5.4% of GDP in 2013 to 6.5% in 2014, and public debt from 59.6% of GDP in 2013 to 69% in 2015. With the Maastricht deficit and debt criteria set at 3% and 60% respectively, membership of the euro-zone remains some years down the line.
Foreign investment accounted for some 12% of mandatory fund aggregate portfolios as of the end of October 2013, the bulk of this in equities and open-ended funds. Government bonds accounted for 82% of domestic assets, shares and GDRs 14%. Noveselec hopes the new system will benefit the local economy by raising investment in domestic equities.
The law introduces infrastructure investment as a new asset class, opening the way for the funds to participate in projects such as the government’s monetisation of the debts of Hrvatske Autoceste, Croatia’s national motorway authority, Autocesta Rijeka-Zagreb – the state-owned company that operates the Rijeka-Zagreb motorway – and the marina chain ACI.
In marked contrast to Poland, where the second-pillar funds were blamed for the ballooning deficit and public debt, the Croatian government sees pension fund investment as key to helping reduce debt levels. In the case of the highway monetisation project, the two highways bodies had accumulated debts of some €4bn that could not be rescheduled. The successful consortium would relieve the state of around €3bn under a concession of 30-50 years in return for toll and service facility fees. While these schemes are widely used across western Europe, the project has nevertheless attracted considerable local opposition.
Management fees, a historically contentious issue in both Hungary and Poland, will from 2015 be reduced incrementally from 45 basis points to 30 basis points after six years. “The programmed predefined cuts were our idea,” said Novoselec. “Previously the regulator had carte blanche, which was a high risk for us.”
A Balkan success story
Croatia initiated its pensions reform in 1999 with a law on mandatory and voluntary pensions. second-pillar funds (OMFs) started operating in 2002. The system was mandatory for those under 40 years of age, and voluntary for 40-50 year olds. The contribution rate is 5% of gross wages, out of a total pension contribution rate of 20%.
In 2002 seven funds were set up, but since 2003 only the four that met the minimum membership requirement have remained in operation: AZ (a joint venture between Germany’s Allianz and local, Italian-owned Zagrebačka banka), Austrian-led Raiffeisen and Erste Plavi, and PBZ/CO, a joint venture between Privredna banka Zagreb, now part of Italy’s Intesa group, and Croatia osiguranje, the country’s largest insurance group.
According to the Croatian Financial Services Supervisory Agency (HANFA), assets totalled HRK57.2bn (€7.5bn) as of the end of September 2013, a year-on-year rise in kuna terms of 16%. Membership over this period rose by 3% to 1.7m. Alongside a range of investment limits, the funds have to meet a minimum guaranteed performance – the weighted average three-year annualised return minus six percentage points – or make up the difference from the company’s share capital. Returns averaged 6.12% year on year in September 2013, and an annualised 5.43% since April 2002.
Third pillar pensions also started operating in 2002. As of the end of October 2013 there were six open-end (ODMFs) and 17 closed-end voluntary funds (ZDMFs), with membership, respectively, of 201,743 and 23,019, and net assets of HRK2,148m and HRK486m. Annualised returns since the funds started business ranged from 3.1% to 8.1% for the open-end funds and from 2.1% to 12% for the closed-end ones.