CEE pension funds face an unexpected source of volatility - politicians, George Coats discovers

Just over a decade ago the countries that emerged from Soviet control in the late 1980s and early 1990s began to implement reforms to their pensions systems as part of the transition from centrally planned to market economies. Hungary was the first, in 1997, others followed and last year Romania belatedly joined the convoy.

From Estonia to Bulgaria, they all adopted variations of the World Bank model. A proportion of the money paid to their respective state social security institutions to fund their PAYG old age pension was redirected to private sector pension fund management companies that invest the contributions on capital markets.

The reforms often proved controversial and the same criticisms were repeated across the region. Opponents warned reformist governments that the system would leave the social security system with a deficit as existing pensions would have to be paid from a reduced contributions flow, that the people’s money would be invested abroad rather than used to fund development at home, and that the investments were vulnerable to market risk - if the markets turned sour the pension contributions could be lost.

But recent years have revealed that another threat should not be overlooked - political risk.

This can be illustrated by developments in two countries. Slovakia’s general election in June 2006 replaced the reformist right-of-centre coalition with a government led by the left-of-centre Direction - Social Democracy (SMER) party led by Robert Fico. The previous September, the Polish general election had seen a left-of-centre government ousted by a coalition led by the conservative Law and Justice (PiS) party.

In opposition, Fico had been a frequent critic of the pensions reform but had refused to spell out his alternative. In government, it soon became evident that he intended to dismantle key elements of the new system.

Initial attempts to reduce the percentage of a salary going from the social security agency, Sociálna poistovna, to the private pension managers to 6% from 9% were dropped after opposition from existing pension savers afraid of the long-term impact on their pensions, says an industry insider.

Instead the government passed a law allowing existing members of the funds - those who had previously opted to join private pension funds - to opt out and return totally to the Sociálna poistovna during a six-month ‘opening’ of the second pillar from the beginning of this month to the end of June.

Prior to the legislation, Fico claimed that the funded system was “not trustworthy” and that savers were taking a lot of risk. He referred to the pension companies as “non-banking institutions”, a pejorative term used to describe fraudulent financial schemes that flourished in the early post-communist days. He told a TV talk show: “I personally would not invest my money in the second pillar,” adding that those who stayed after the six-month period would have to take any risks resulting from their membership of the funded pillar.

The law also extended the minimum saving period in the pension schemes to 15 from 10 years, meaning that those who joined a decade before retirement will not be able to draw their pension. “We don’t expect many people will opt out but the change in the savings period rules will affect maybe 3-4% of the client base, and they will react to it,” says one industry member. “This will have an impact on the sector’s profitability and will push back our break-even point by some years.”

Poland’s PiS-led government soon became known for its eccentric foreign policy. At home, one of its chief characteristics was a failure to pass key pensions legislation and the retention of regulations way past their sell-by date, according to industry sources.

One of the key oversights was a failure to legislate for the payout stage, with the first pensions due to be paid next year (see page 24). This was a long-standing oversight, according to a seasoned observer. “This is a much delayed business,” he says. “It could and should have been done some five or six years ago. Then it would have been easy, we could have done it in a way that would have allowed us to test everything and have a public debate, but that time was lost.”

A more pressing problem for Polish pension funds was the failure to relax investment restrictions imposed at creation. This was accompanied by an apparently arbitrary decision to block consolidation in the pensions arena, that the number of players should stay at 15, and that they should be the current 15 irrespective of any rationale behind merger proposals.

Two factors were seen as culpable for the state of affairs. The first was the allotting of the labour and social affairs ministry to a junior coalition party, the Self-Defence (SRP) party. “Until then it was always the practice to have somebody that was linked to the pension reform team to oversee social security issues within the government,” says one insider. “But the SRP and PiS-nominated minister and deputy ministers had no such expertise and the ministry was subordinated to a coalition party that was not linked to pensions issues in general. They first had to gain the knowledge, so nothing could be done quickly.”

The second factor was an evident policy from the pensions supervisory authority, a political appointee, to retain investment restrictions. This hampered diversification as well as merger proposals blocking consolidation by a management fee structure that negated economies of scale.

“The last two years were lost for us and for our industry because it was not possible to even talk about our problems,” says one industry player. “And they are not just our problems but the problems of our clients.”

Last month new premier Donald Tusk, whose administration replaced the PiS-led team after October’s general election, sacked the vice-chairman of the Polish Financial Supervision Authority (KNF) with responsibility for pensions, Iwona Duda, a PiS nominee.

Some in the market saw this as a signal that the new government would be more receptive to their views. However, a disturbing signal came when the labour and social affairs ministry was again given to a junior coalition party, the Peasants Party. The new minister, Jolanta Fedak, has no pensions expertise.

“This ministry is considered second league, not one of the more important ones,” says another market player. “This is crazy because everybody knows our system is inefficient, just look at the situation over the pension payouts. I don’t understand how it could all be so messy.”