Putting the cart before the horse
"We entered Romania in 2000 with the intention of being involved in the pension reform and therefore we are more than ever ready to enter this market," says Corina Cucoli, director of business development at Aviva Romania.
It has been a long wait, and it is not over yet. Earlier this year the Romanian president signed legislation to create third pillar voluntary pensions. But Aviva and its competitors are waiting for the introduction of mandatory second pillar funds.
Romania is among the last of the central and east European states to overhaul its pensions system, and while previous governments have made abortive attempts to augment its first pillar PAYG system with funded pillars, it has not only been overtaken by its economically more advanced northern neighbours but also by Bulgaria and Macedonia to the south.
"Until last year the parties in power did not see pension reform as a priority," says Mihai Seitan, president of the National Pensions House, secretary of state at the ministry of labour, social solidarity and family, and a moving force behind the reform process. "This was mainly because politicians were scared to introduce a reform like this because we have a history of financial scandals over the past 15 years - bank failures, troubled mutual funds and pyramid schemes - developments that have eroded public confidence. Nevertheless, you cannot stop the evolution of a country in the pensions field because if you try you create a time bomb."
Since taking office after the 2004 general election the current government has made important advances, Seitan notes. "A law for the third pillar has been passed," he says. "A commission to regulate and supervise the private pension system will finalise secondary legislation in the autumn by which time we will begin the licensing of the companies that will manage the funds. They can begin to collect contributions in January 2007."
But the potential pension fund management companies are not happy. "The problem from an industry point of view is that the third pillar is being introduced before the second," says Bram Boon, executive general director of ING Romania. "We don't expect the market for the third pillar to be big. We have undertaken qualitative research that shows there is not too much interest among younger people, who say that retirement is too far away, and older people of 35-45, who say that it is too late."
And the tax incentive on third pillar contributions is not generous. "Contributions can come from employees, employers or both, with a tax break of up to €200 a year for whoever contributes," says Crinu Andanut, director of Allianz Tiriac's pensions division. "But salaries are increasing in Romania so a percentage approach would be much more appropriate."
"A tax incentive of €200 is not a large amount considering that the tax rate is only 16%," says Boon. "This means that the actual tax deduction will be only €32 a year. Further, a qualitative study we undertook found that Romanians are not aware of the tax that they pay; they know only their net salary. Therefore, the ability to deduct €200 is not very important and would not provide a reason to take a private pension. But I think that €200 is an interesting tax incentive for the employers. Although not a big amount it is a psychological factor that will probably help us to sell the product to companies rather than individuals."
Cucoli is more positive about the amount, although concerned about another aspect. "Yes €200 is not much but considering it's a month's salary in Romania it is better than nothing," she says. "The problem is not the amount but how it will be managed. Is the employer to retain it and give it to the government or will it be declared in a tax return at the end of the year? Nobody knows yet. Romanians are fed up with bureaucracy, administration and administrative officers, and queuing up for a lot of things, so I think that this could be an issue."
Nevertheless, moving ahead with the third pillar before the second has serious implications. "It means that there is only a small market and it limits your budget for marketing," says Boon. "If the second pillar had come first or at the same time the outlook would have been better because the second pillar will be compulsory and so there would have been an obligation on the state to promote the concept. And then the industry could more easily leverage on the government's marketing offensive."
Seitan remains upbeat about the prospects for the second pillar. "The draft second pillar legislation has been approved by the government and has been sent to parliament," he notes.
However, companies are focusing on how to establish their third pillar pension operations. "Right after the legal framework is published we will decide whether we want to have a separate company to administer pension funds or whether, as is allowed under the law, we will make the administration through our existing insurance arm," says Andanut.
"After that we have to pass through the licensing process, which has various stages including licensing the company, depositing the social capital, nominating the structures, which in turn will have to be approved by the supervisory commission and vetting our personnel. Then we have to license the pension products and the funds, and we will have three or more options with different risk-approach products. We will tailor our offerings according to the findings of our market research and client segmentation. But as pillar three is voluntary, the clients will decide how much risk they want, our role will be to advise and explain having in mind such factors as age, occupation, how many years they have until retirement, but then they will make the choice."
Cucoli is also assessing the market. "Currently we are conducting a country-wide survey to establish people's understanding of what a pension is and what they anticipate it will deliver, both for individuals and companies," she says. "We have made a qualitative research with focus groups and the opinions that emerge are very important for us because they give us their expectations and their concerns. And now we are doing quantitative research."
Boon is also in for the long haul. "ING's strategy is to focus on emerging markets, pensions and direct banking," he says. "Romania is both an emerging market with the beginnings of a pensions industry so we are really focusing on this. We think we have to enter the market but we are very conscious that the Romanian public is not yet well informed about pensions so we have to invest in raising awareness."
"All the major players are confronted by these problems," says Cucoli. "From the beginning we began educating the population on what long-term savings mean and a lot of us have unit-linked products in our portfolio which are investment products and are very similar to a pension product."
So will the emergence of pensions products threaten this sector? "We commissioned a study on this situation from a consultant and the findings were that clients would stay with the life products and not move to a pension," says Boon. "So we are not worried that clients who have already invested in a life product will move to a pension fund because the life insurance products are more flexible in terms of allowing the payment of additional contributions and granting access to the money before retirement. In addition, there is a protection element in our existing life/pension products that that is completely neglected in this third pillar voluntary pension system."
ut not all financial groups are rushing ahead into pensions. "We have pension-like life products through our life arm, but the pensions legislation requires separate companies be established for pension fund management," says Romeo Jantea, president and CEO of BCR Asigurari, a member of the BCR group which is based around Romania's largest bank.
"This is a considerable investment and has financial requirements which do not parallel the 2% fee structure. It's really a disincentive. However, this is a development that cannot be left aside. It's obvious this is one market opportunity where, even if it starts with small numbers, first starters can have considerable success."
And this is an advantage that Andanut intends to fully exploit because wherever Allianz goes it likes to be No 1. "This is a big challenge," he concedes. "But I was appointed CEO of the future pension company because of my results on the general and life insurance side."
He feels he won't have long to see if he can repeat his success. "In the pension business you are number one in the first year when the market is up for grabs, or you won't be at all because after that you cannot grow anymore except by stealing clients from your competitors," he says. "In fact the main split will be in the very first month."
"For the companies entering this market success will be on the one hand about reputation and integrity, and on the other about distribution," says Cucoli. "One of the points that emerged from our focus groups was that people felt that if they were going to put their money into one of these companies it should be one from abroad, not one from Romania. They have to have confidence we will not take their money and run away. And the more distribution channels you have the faster you can move. So you have to diversify the distribution channels."
"Our customer acquisition strategy will be complex," says Andanut. "Being the leader in the insurance market, with a market share of about 20%, we will use our database and approach our existing clients, which we can do with our existing sales structure. But it is small compared with what we will have, we will build up a large number of sales distribution channels, including direct sales and agents, and multi-level marketing structures."
"It won't be easy to sell this product on an individual basis so we are investigating all sorts of possibilities for distributing it," says Boon. "We have to consider selling it through employers."
"We will target both companies and individuals," says Cucoli. "As yet we don't know whether there will be any vesting conditions or any vesting facilities. Nevertheless, a third pillar pension would be a very good additional benefit for companies to offer employees to build loyalty and retain their staff. But it would be interesting for individuals, especially those with not a very high income but who want something in addition to the state pension. Also I expect it will be less expensive than other unit-linked products."
"Of course the real money and the real returns will come from the second pillar because there we expect we will have a huge inflow," notes Boon. "But in this current environment we see the third pillar just as an investment to start with, and one with which we promote us as a pension company because if we don't do that now it may cause problems when we really want to jump into the second pillar. So if you look at the third pillar as an isolated business case I suppose that it would not bring enough return but if you see the second and the third pillar together then it will be a worthwhile investment for sure."
"The second pillar is something we dream about, although we don't know what form the law will take because as it passes through parliament there may be changes," says Cucoli. "I think that this will be the real pension reform because although it will cost employees nothing extra they will have an opportunity to add to their retirement provision - they will get their state pension, have their second pillars pension and may buy a third pillar pension to gain a better retirement income than today."
"The next step is to finalise and implement a mandatory second pillar," concedes Seitan, but he adds that current plans restrict its scope. "We will limit the number of people that have to go into the system," he says. "It will be compulsory for people under 35 and optional for those aged 35-45 because the contributions paid [to the managing companies] are part of the public social security payment and if they take a large number it would create a large deficit."
ut when will it be introduced? "The draft second pillar law has been signed by everybody involved, including the finance ministry, the ministry of labour and the ministry of integration," says Seitan. "We have to be realistic so we can't expect it to be approved before parliament's summer recess but it will be passed in the autumn and we will have a schedule for its implementation including the finalisation of secondary legislation. A lot of factors will be the same for the third pillar but the market will be restricted to dedicated companies. And then those who join the second pillar must choose which company will manage their pension assets. All that will take time, so we calculate that this system will be able to come into force in the second half of next year."
"We hope that the gap between the implementation of the third pillar and the introduction of the second pillar will be small because then the market will really take off," says Boon. "But I think that 2007 I much too optimistic." Seitan suggests it is possible but there are other sources here who think that this is unrealistic. The big problem is the collection system. There is hardly anybody working on this issue but if it is not in place it can cause a real disaster both for the customers and the industry. For example the pension supervision commission had only hired one IT consultant to deal with collection."
But when the funds are created, will there be investment problems? The regulations do not allow the pension companies to combine second and third pillar portfolios or aggregate them with their life insurance funds. "OK, they are small amounts of money," says Cucoli. "But it depends on how much you sell. If you sell more it's a bigger volume."
She sees other problems: "Asset price bubbles could be created in certain classes because guarantees and investment restrictions will force money into particular sectors where the supply of investment opportunities will not be able to keep up with the demand," she says. "In addition, investment return guarantees will force administrators to be very defensive with respect to short-term investment risk, at the cost of long-term investment performance and ultimately at the cost of pensions to be paid."
And for some reason real estate has been ruled out as an allowable investment class. Given that this is one of few classes of any depth in Romania, such a decision is unfortunate. With good controls over valuation there is no reason why a small proportion of pension assets shouldn't be invested in property.
"My only worry is that the size of the local capital market," agrees Andanut. "That's why the new investment regulations are very liberal and the options to invest abroad are high, in full compliance with the European free movement of capital regulations."
Boon is unconvinced: "The local capital market is underdeveloped, we have very few liquid equities, there are no long-term government bonds available, government bonds are not liquid because they are not listed on the Bucharest stock exchange so there's no secondary market for government bonds, and while there is for corporate bonds, only a very few of those are available.
"So looking at the investment opportunities we had this year there was almost nothing. Legislation allows us to invest abroad, but if we do we will run a currency risk on the balance sheet and we don't have long-term derivative instruments available in the market to hedge this currency risk. So we have to think twice about whether we will go abroad to invest or not."