As parametric reforms, which have been gradually coming into force in Portugal since 2002, are set to reduce the first pillar state pension benefits, the government needed to bring in a system to compensate for loss of income.

And so in March 2008, the Regime Público de Capitalização or public capitalisation system was introduced.

A unit-based fund is managed by the State Fund Management Institution (IGFCSS), which is also responsible for the administration and management of the €9.5bn Portuguese Social Security Financial Stabilisation Fund (FEFSS).

The voluntary and supplementary fund is completely independent from the reserve fund and open to all Portuguese employees. Subscribers need to contribute with either 2%, 4% or 6% of their monthly salary in return for units in the common fund. The fund has one portfolio only, meaning there is only one level of risk for contributors.

Once they hit retirement age and are able to claim the social security state pension, participants can choose between buying a life annuity and withdrawing the lump sum from their personal account in the capitalisation fund.

“The expectation is that essentially participants will be able to complement their state pension through this fund,” says Manuel Baganha, chairman at the IGFCSS. “Due to economies of scale, buying annuities from insurers as a group will be more cost-effective or come with better conditions than buying them individually, such as with the existing personal pension plans (PPRs). At the same time the purchase of annuities also helps us deal with the longevity risk.”

The new fund also brought changes to the organisational structure of IGFCSS.

“Until March 2008, we had only been managing the social security reserve fund and therefore had no contact with the general public,” says Baganha. “But now we too engage with the participants of this fund.” IGFCSS also hired two more people to help manage the fund.

Despite the difference in size - the capitalisation fund currently has around €8.5m under management - Baganha says the two funds are run in parallel.

“It is one of the reasons why we were assigned the managing of this fund at the time,” he says. “The two funds have similar characteristics with regards to their portfolios, which also means they are managed in a similar way. Both have close to 77% invested in fixed income - with two thirds being in Portuguese public debt and one third in European and US government bonds - and 16-17% in equities, which are distributed among the main economic areas the EU, Japan and the US similar to the respective market capitalisations. However, the social security reserve fund also has 3% invested in real estate, which is not the case for the capitalisation fund due to its small size. And so diversification is a little bit harder to obtain for the capitalisation fund at the moment.”

Its small size also means that other investment strategies do not apply as of today.
Baganha refers to the fund as an instrument of social security policy and classes the fund as somewhere between second and third pillar.

After its introduction, Portuguese employees initially flocked to subscribe to the fund but member rates then stabilised. At the end of last year, more employees joined, encouraged by the tax benefits associated with all Portuguese savings products in the private sector, which currently are 20% of contributions up to a maximum of €350 per year. The current member tally stands at just over 6,500.

“The people who have been subscribing to it tend to be the ones who are very interested in their pensions,” says Baganha. “But it is not just people who are close to retirement, it is members at various stages of their active working life. The participants in the fund tend to be worried about the long-term sustainability of their pensions and social security in general. Most surprisingly to us have been subscribers in the low-income bracket that we did not expect to have a lot of capacity for savings.”

Although the fund plans to recruit more members, as an instrument of social security it does not undertake any kind of active advertising in order to avoid spending funds derived from contributions to social security. Instead it issues a monthly newsletter describing the size and composition of the portfolio and its return, similar to the information that private funds provide to the market.