Last year the outlook for Austria’s pension schemes, the Pensionskassen, was not very promising.
“The Pensionskassen started in 1990 as a way to enable companies to shift the risk of corporate pension funds from their balance sheets,” recalls Kurt Bednar of Mercer in Vienna. “They gained in popularity as equities boomed in the late 1990s. But the subsequent market collapse shook confidence in funded pensions and reawakened old insecurities.”
The ‘old insecurities’ in question were the collapse of the Austro-Hungarian Empire at the end of World War I and the disastrous participation in Hitler’s Third Reich, both of which obliterated any form of retirement saving. Such memories are handed down within families and have left Austria with a high propensity to save and a cautious approach.
The reputation of the Pensionskassen suffered a second blow when the government responded to their complaints about how onerous guaranteed rates of return were proving in the wake of the market crash by abolishing them altogether.
These developments have occurred against a background of pension reform. “The last years under a right-of-centre coalition government were really adventurous and challenging for the Austrian pension market,” notes Elisabeth Hengst of consultant Aon Jauch & Hübener. “Almost every month new pension laws were introduced, having an impact on social security pensions and private life insurance as well as occupational pension benefits and severance pay.”
Pension reforms introduced since 2000 have been designed to reduce the fiscally swinging generosity of the state system. “The replacement rate of the PAYG pension was very high, some 80% of a last net salary to a ceiling on insurable values of €3,630, so €2,340 a month,” says Bednar. “In an attempt to make the pension system financially sustainable the retirement age was raised and the calculations were changed to an average for a whole working life from the best 15 years.”
“The most significant effect of the new legislation was to increase awareness that social security pensions will be reduced drastically in the future and at the same time people will have to work longer,” agrees Hengst.
This served to raise an awareness that people had to make personal provision. “If people were not aware of this they must have been in hiding,” says Wolfgang Lehner, assistant to the management board of Österreichische Pensionskasse AG (ÖPAG). “It was in the news and the political world has been stressing that making additional retirement provision is an important thing to do. And insurance companies are doing a lot of advertising.”
Indeed, throughout last year the prospect of competition from insurance companies was seen as a potent threat to the Pensionskassen. The government gave a kick-start to the third pillar by creating private pension funds to be offered by banks or insurers but withš the tax benefit coming not from a tax allowance but via a bonus directly from the annual budget to ensure an interest rate of between 8-9.5% of the annual contributions. In addition, under legislation implemented in September 2005, insurance companies were given the right to enter the corporate collective pensions market.
So as recently as the closing months of last year the Pensionskassen looked under severe pressure. But since the beginning of 2006 there has been a marked turnaround.
In part this is due to the good returns for 2005. “Last year was the Pensionskassen sector’s second-most successful year in terms of investment returns, with an average across all our plans of 12.1% within a range of 11% or so to 15%,” notes Günther Schiendl, head of investments at APK Pensionskasse AG. “So over the more than a decade and a half that the Pensionskassen have existed, their average annual returns have been 7%, which is more than three times the risk-free rate and more than double the yield on government bonds.”
“We had a decent market environment, therefore it would have been difficult not to have a good return,” adds Wolfgang’s SRI activities and in-house managed funds.
But for Schiendl it is also a result of the Pensionskassen raising their game. “After, and indeed during, the years of the market crash we refined our investment strategy and included a risk-management process for all major market risks that was not fully in place before then,” he says. “So now we are managing currency, equity and fixed income risks via overlay strategies that are not in place permanently but as they are required.”
The failure to take these steps earlier contributed to the impact of the crash, notes Bednar. “Beginning in 2000 we saw poor performance because of the market collapse but also because we did not have the right instruments at hand,” he says. “For example, we had been fighting for the introduction of the asset liability tool since 2000.”
But did that repair the dent in confidence arising from the crash? “The fact that we took an active approach and did not try to stifle people’s concerns by saying we had a long-term strategy and that it has been determined by the actuaries, and so on, was very much appreciated by the plan sponsors and the plan members,” Schiendl adds.
And the competition from insurance companies has yet to materialise. The third pillar offering has been well received. “In the third pillar insurers have a massive advantage,” says Schiendl. “In terms of distribution and placement this product has been successful. The distribution power of the insurers is much higher than ours, and there are traditional distribution channels that always welcome a new product. In fact, insurance companies need to feed a new product into the distribution channels year by year. And if you are selling a financial product in Austria and can tell prospective clients that it is being subsidised by the finance ministry or they can reduce their tax load, they will buy it.”
But there has been little evidence of the feared inroads by insurers into second pillar provision. “So far they have not managed to get their second-pillar product, the corporate collective insurance scheme or Betriebliche Kollektiv Versicherung, out into the market,” says Pinner.
Schiendl agrees: “We think this has to do with the fact that the second pillar pension product is much more complicated to sell than they would like it to be. Moderating discussions between plan sponsor, workers councils and/or trade union representatives requires experience and depth in various fields that cannot be learnt in a short period. A company pension is not a retail product that can be sold overnight by the same people who have been selling insurance products for 20 years. It requires more sophistication.”
“The market has largely been divided out already so it is difficult for insurers to find new clients, at least among the big companies,” adds Pinner. “Consequently, they have had to focus on the small to medium-sized enterprises and it seems that they over-estimated the demand in this sector. Maybe it just takes time; perhaps it is a question of explaining and building up the market because SMEs are not really familiar with pension funds or this new product. Or maybe it is that there is no demand for the product. We had estimated that it would be a rival for us but that has not materialised.”
And Lehner is upbeat: “We don’t see a direct threat here. It is an individual retirement product with an occupational aspect and we assume that the Pensionskassen product is better. It may mean more competition but we don’t fear that, indeed we see it as positive because it will increase popular awareness to be benefit of the whole system.”
But have pension funds shaken off the stigma of the flight from guarantees? “In 2000 the guarantee worked fine, but in 2002 when it was needed the owners of the pension funds did not want to pay it, and the government ruled that it only required action from the providers of the funds if at the moment of an individual’s retirement money from his or her account was missing,” says Bednar.
“From their beginning in 1990 pension funds were required to guarantee a 1.5% interest rate over the previous five years,” adds Josef Woss of the Arbeiterkammer, which represents workers’ interests. “In 2002 the pension funds said that they could not pay the guarantee. Before a compromise could be reached the government indicated that it had no interest in an accommodation with the social partners and announced that it would change the legislation. So while that solved the problem for the funds, the workers were left with even bigger cuts than otherwise. You cannot establish confidence with such measures.”
“A lot of different arguments were included in the discussion on the minimum yield guarantees, and a lot of arguments were simply wrong,” says Lehner. “There were changes in the calculation method in 1996, the revised formula was complicated and made it much more difficult for Pensionskassen to achieve the goal compared to the initial formula from 1990 which had the function of securing a smooth development of the assets, but not to avoid any pension reduction. The unforeseeable situation on the capital markets in 2001 and 2002 made it obvious that the change was simply a mistake and it became clear that the amendment had to be reversed and the formula adapted to the new situation on the capital markets and its initial function. But while we welcomed the decision to amend the minimum yield guarantee once again in 2003, it was the government’s decision not ours.”
Bednar thinks the second pillar will not only survive but will grow as a result of the reduction in the state pension. And there is scope as Austrian corporate pensions make up a very small universe. “There are six multi-employer funds and a dozen single-employer funds, essentially for large companies like Shell,” says Bednar. “Altogether they have about €10bn. It’s very low by European standards.”
There have been advances. “The banking sector made a collective bargaining agreement to introduce a pension fund for the industry six years ago, but it is not a major industry,” he says. “Then last year the paper industry agreed to establish a compulsory industry-wide pension fund and we expect the second pillar to be compulsory within five years or so as a result of collective bargaining. The next industry may be metals or chemicals and among the last will be tourism, textiles and retail.”
The pension reforms also included the shifting of civil servants into an occupational pension fund for state officials.
“Civil servants have their own single employer pension fund, so this will not have a direct impact on multi-employer pension funds like us,” notes Lehner. “But for spreading knowledge of the system among the population it is a very good thing. When the state decides to put civil servants into an occupational scheme it shows that the state trusts the system and thinks it is successful. This will boost confidence as people would not think the state would invest in a system that would not have a positive development in the future.”
Employers’ groups have raised doubts about the feasibility of paying occupational pensions contributions on top of those for the state pension. “If employers have to pay both sets of contributions we will have additional labour costs to the disadvantage of Austrian competitiveness and attraction as an investment target,” claims Manfred Engelmann of the Federal Economic Chamber, employers’ grouping. “Most Austrian industry is small and medium sized, with only 15% employing 500 or more people. Collective bargaining at a branch level is limited to wages, flexible working time, periods of notice and sometimes training questions but not pensions.”
But Schiendl is dismissive. “The fact is that the plan sponsor’s contribution payments into the pension fund are tax deductible so I do not agree with this argument,” he says.
And Lehner thinks the sector will grow. “Right now 20% of Austrian employees are in an occupational scheme but the European average is 50% and we don’t see any big difference between the Austrian system and common European practice,” he says. “The need is definitely increasing because the benefits from first pillar pensions will decrease, and the changes mean less pension for the coming generations. So there is a need to get from 20% of employees to 30% or 40% and consequently we see an increase in our beneficiaries.”
“The market has largely been distributed already and most large clients have already found their partner,” says Pinner. But he also sees possibilities for growth in the sector. “There is some outstanding business, for example the City of Vienna is expected to appoint a Pensionskasse for its municipal employees later this year, and that would be huge.”
In addition, construction group PORR is blazing a trail for the provision of an occupational pension for building workers. It already has a pension fund for its white-collar employees, through VBV. But it has introduced a corporate pension to build a closer relationship with its blue-collar workers. They are laid off in the winter, but a pension is seen as a tool to help keep good workers bound to the company when recruiting resumes in the spring when the weather improves.
But while the pension fund sector looks to have weathered the storms expected as late as the fourth quarter of last year, there are still potential challenges on the horizon. “Regarding uncertainties, there is the outcome of the general election in November,” says Pinner.
Pension reform is a work in progress and public opinion polls indicate that the current right of centre coalition will be impossible to recreate due to a collapse in support for its junior member. They also suggest that neither the social democrats (SPÖ), which have traditionally favoured a strong state system and in the past has expressed reservations about funded pensions, nor the conservative People’s Party (ÖVP), which formulated the reform agenda, will gain a majority. So it looks as if the outlook for pension funds rests on the parliamentary mathematics after the ballot.