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The source of the major challenge for Portuguese pension funds is clear: it’s the state. But not in the way seen elsewhere in Europe, where governments place investment and other restrictions on pension funds. Rather it’s its all-encompassing presence in the pensions arena and the resulting universally held belief this has engendered that the state will provide a generous retirement income so that additional occupational or voluntary pension provision is unnecessary.
“If there is an expectation that social security will pay around 80% of a last salary, which for some is more or less 100% of a net salary, people don’t feel the necessity to make extra pension provision for themselves because their retirement is paid for by the state,” says Maria Isabel Semião, director at BPI Pensões, the pension fund manager of the BPI banking group and of 80 other companies.
“Relatively few companies have a pension fund, a second pension pillar fund, in Portugal,” says Bernie Thomas of Watson Wyatt in Lisbon. “There are something like 200,000 companies registered in Portugal and only between 1,000 and 2,000 have an occupational plan. It’s a relatively small number and it’s not growing. Because it’s not compulsory, because trading conditions are quite difficult and the economy is not very strong, I don’t think that pension plans are high up on the priority list for company finance directors.”
And there are other factors. “One of the reasons why most companies do not have a pension fund is because they have an office trade union rather than a sector trade union,” says João Salgado, head of the corporate centre at cement company Cimpor-Cimentos de Portugal. “And they know that the majority of Portuguese companies cannot afford a pension scheme. They have no money.”
And with unemployment running at 7.5% employers don’t feel the need to offer a pension plan to attract workers. “Companies say that when they are negotiating with a new employee they are asked whether they will get a company car or a mobile phone but nobody asks about a pension plan,” notes Semião.
This has not changed despite parametric reforms to the PAYG system made in 2002. But the government of the day portrayed the changes as a solution to a pending problem rather than as part of a strategy to fend off a potential pensions crisis. Consequently, the material impact of the changes went unnoticed. “We estimate that the new law will pay around 60% of a last salary, so people will receive less,” Semião adds.
“The average person who does not read the economic press will probably be unaware that there is a pensions crisis,” says Luis Veloso, director of Energias de Portugal (EDP) pension fund. “There is very little coverage of the issue on TV, although there is an increasing debate on the state of the economy, pointing out that we are in a difficult situation and there is a lack of discipline in the public accounts.”
And it is Portugal’s dire fiscal situation that led a previous government to withdraw the tax incentives it had earlier extended to third pillar voluntary savings.
However, tax relief has been a crucial factor in the establishment of pension schemes. “Pension funds began in 1988 when new regulations offered fiscal incentives to companies that introduced them,” recalls Veloso. “I think that for the government it was part of a process of catching up with the rest of Europe.”
Leonardo Mathias, director general at Schroders in Lisbon, agrees. “Most of the company plans came into existence in the late 1980s because between 1985 and 1991 they drew huge fiscal benefits,” he says. “But when the fiscal benefits stabilised the plans fell away. So you could say that companies were building the pension plans for the wrong reasons - for fiscal motivation and efficiency - and with the wrong long-term objectives.”
“Employers make the contributions, typically between 2% and 5% although it varies widely,” says Thomas. “Employees pay 11% of salary to the social security system and so the perception is that a
further 5% or so for a pension would be too much.”
“There is no legal obligation too have a complementary pension plan,” notes Semião. “Of course it would be very good if our market was bigger, but we are in an environment of small clients and small businesses. Most companies do not offer pensions because they don’t want extra costs. They pay the salary and the social contribution, so why offer a pension plan too? And the employees don’t see the need to have a pension plan; they would prefer to have any extra payment in their salary.”
As a result, the assets of the pension plans that do exist are relatively paltry. “Pension plans are still relatively small in Portugal, all of the second pillar schemes together have assets in the region of €15-16bn, or 10-12% of GDP,” says Thomas. “Of this, 50-60% belongs to banks’ pension funds which have their own pensions structure. Bank employees do not belong to the social security system and so their pension provision in effect provides a combined first and second pillar provision. So true second pillar pension plans that act as top-ups to the state pension have assets that amount to about €5bn.”
And this has implications for the asset management choices available to pension funds. “Each of the big banks has its own pension asset manager,” says Thomas. “In addition insurance companies can do it, and major second pillar pension funds, like those for the energy and building sectors, have similar organisation. They are profit-making organisations that charge what they think the market will find appropriate.”
“This was the way that the Portuguese financial system was rebuilt after the nationalisations of 1975,” says Mathias. “We have universal banks, each with its own leasing company, factoring company, retail business, wholesale business, brokerage business, asset management business and pension fund business. Whereas elsewhere there is a clear differentiation between retail and investment and even within asset management between mutual funds, retail and institutional, in Portugal it’s all you can eat. So a bank that holds its own pension fund may manage it as if it were its own, to the extent of using pension fund money to invest in companies where the bank has what it considers strategic capital participation and even investing in its own shares. If its shares are going down its pension fund will start buying them, it’s as simple as that. So there is no sense of keeping the pension investment side at arm’s length. And this is approved by Portuguese law.”
Mathias adds: “Up until now an open Portuguese pension fund has had to be approved by the local regulator and domiciled here and do the admin and reporting locally. So in practice foreign-based asset managers like Schroders were cut off from the market as people chose a Portuguese manager because they provide actuarial services and do the reporting directly to the regulator as well as manage the assets”.
This has a knock-on effect, according to some local pension fund directors. “There is no investment culture in Portugal,” says Veloso, “So not only are individuals not prepared to take their own decisions but neither are the asset management companies. They want to keep their market share, to keep the investment conditions and the agreements with certain entities the way they are. So not only are they not open to change, indeed there is some resistance to change and to a move towards international standards of competition. There’s a lot of dead wood in the market and they have a long way to go by international standards, and this is one of the problems the system has to deal with over the next couple of years.”
But even where a company offers a pension plan, it may not fully understand its financial implications, says Mathias. “The pension fund has always been taken care of by the HR department, and one could question its competency in developing retirement benefits,” he says. “And a lot of CFOs don’t realise that they actually have a balance sheet risk. And that will hit the P&L in due course. In the late 1990s many of the pension funds made a lot of money with a huge exposure to equities, but these days with returns much closer to each other and an open market these companies may have an issue. I found one company pension fund that actually paid a subscription of 1% every time it made its regulatory contributions to the pension scheme.”

There has been a trend away from risk. “Companies responded to the fall of the stock market by switching from DB to DC three or so years ago,” notes Semião. Of the 80 company pension fund BPI Pensões manages in addition to that of the BPI banking group, 50 are still DB and 30 DC, she says.
“In 2004 the EDP system was changed to DC from DB for new employees,” says Veloso. “But the pension was combined with a number of other social benefits where people can put their credits towards paying for insurance protection, medical assistance or education for their children. EDP contributes up to a certain percentage and employees also have incentives to contribute up to 10% of their gross salary, with EDP matching the employee’s contribution above 2%. We did this to enable new employees to have access to conditions that were the equivalent of those on the DB plan. The overall cost to EDP is the same, but this way we can reduce the risk to EDP.”
Cimpor-Cimentos de Portugal has also made the switch to DC and closed its DB plan. “The DC scheme has 275 members, compared with 440 members for the DB scheme, and their average age is 44, younger than those in DB programme,” says Salgado. “But of our €70m of assets under management, €60m belongs to the DB plan. We are considering creating two different funds, one for each plan, where we can have different allocation criteria, less risky for the DB plan where the return is not so important, and a more risky allocation for the DC scheme.”
In general, most pension funds do not feel restricted by regulatory constraints on investment allocation. ”We can invest anywhere in the euro area,” says Semião. “So the proportion of Portuguese equities in our portfolio has fallen dramatically from around 10-20% to something like 2%, and that is a little higher than the Portuguese stock exchange’s weighting in terms of euro zone bourses.”
However, there are still restrictions and the expectations are that they will be retained in the delayed legislation implementing the EU pensions directive, which is expected by early next year.
“Currently we have a maximum limit on equity investments of 55% of a portfolio, up from 50% last year under a programme of increases formulated in late 2002 or early 2003,” says Semião. “It is expected that the legislation will introduce the prudent person concept, but we still anticipate that it will be formulated in line with what we have today, with perhaps some minor adjustments so we are expecting what we might call ‘prudent person plus’. We still anticipate restrictions on equity exposure and on non-listed assets.”
Salgado does not see this as a problem. “Ultimately, what we want to do with our pension plan is to have a fund that meets our obligations,” he says. “And as we can control our responsibilities – they are long-term obligations and we know what we have to guarantee – we don’t want to have more. If we have a fund of €70m with 20% in shares, 50% bonds and the rest in real estate and so on it will meet our obligations. If we changed it to, for example, 50% shares we could have a return of, perhaps, 10% rather than our current average of 5-6%. But why should I accept the extra risk? Why not maintain the less-risky situation where I know that I will have 5% a year that will match our liabilities. We don’t have the fund to make money, we have the fund to meet our obligations, and if it does that we don’t have to change.”
So is change likely? “I have been working in pensions for 14 years and when I entered the industry we were discussing the same issues as today – the social security system and the government taking measures to implement other types of funds like in Sweden, the UK and a lot of European countries,” says Semião. “The immediate future is not particularly bright. It is fundamental that the government change the guidelines and introduces a pension plan as an alternative to financing the state pension. We need that the government take the responsibility of saying that it cannot pay everything and so people must make their own provision.”
Veloso agrees: “People who are in pensions the business have responsibilities to promote the pension fund regime and they also have a role to play in helping government to achieve society’s goals, because this is an outstanding problem.”

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