When the state bows out
Latvia’s fledgling second pillar pension funds expect to receive a much-needed shot in the arm over the coming year if a plan to withdraw the State Treasury from the market is approved by parliament.
“The State Treasury became involved in funded pensions because our pension reform was implemented in the wake of a 1995 banking crisis which was followed by the 1998 Russian debt crisis, so trust in the private financial sector was very low,” says Dace Brencena, who was a project manager with the State Treasury during the pension reform process.
The pension reform enacted in the 1990s and implemented in July 2001 provides for a second pillar funded through the redirection to licensed fund managers of part of the contributions to the state social security fund. It also created a private third pillar funded by additional contributions from employers and/or individuals.
Contributions to the state pension amount to 20% of an employee’s gross salary, of which 18 percentage points go to the PAYG system and two to the funded second pillar. By 2010 each will receive 10 percentage points. The second pillar is mandatory for new labour market entrants and those aged under 30 when the reform was implemented and optional for those aged between 30 and 49 while those aged 50 and over were not allowed to join.
“Until private providers started to work in this field in 2003 the State Treasury had a monopoly,” recalls Normunds Igolnieks, CEO of SEB Unifondi, one of the licensed pension fund management companies.
“When the reform was implemented no investment company or investment professionals had been working for long enough to be licensed as an asset manager,” says Brencena. “So private asset managers were given 18 months to prepare before they started managing people’s money, and they entered the second pillar in 2003.”
Since then participants have been able to choose the manager of their pension money from among the licensed pension asset management companies, with the State Treasury remaining one of the choices and being the default option for those that failed to specify a preference.
But the private fund managers saw the State Treasury’s presence in the market as a block on the industry’s progress. “Private players fought for this stake and the government agreed that it would exit the market by July 2007,” says Igolnieks. “However, it has not yet been passed into law.”
“We at the welfare ministry would prefer that the State Treasury continue in this market but the decision is the result of a compromise with the private sector,” says Jana Muizniece, director of the social insurance department of the welfare ministry. Those participants that are currently registered with the State Treasury “will join the private sector but just how they will do that is not yet clear”.
“It has 15% of all members; that’s quite a large market share especially compared with some smaller asset managers,” says Sergey Medvedev, vice-president of Parex Asset Management. “We expect there to be some sort of auction where the various asset managers bid for the portfolio, or maybe it will be distributed between all existing players.”
“We favour a share out, not an auction,” says Igolnieks. “An auction would have an impact on fees as the winner would want to recover the money. When people heard that the State Treasury was to withdraw from the market they started to leave and in the year until this happens its market share will fall to around 8%.”
“The State Treasury customers and their assets are a target market,” says Alexander Makienko, CEO at Astra Krajfondi. “We expect that we will gain 10,000 of them by doing almost nothing, just by having a license. We will raise our client base by acquiring a share of those that don’t choose a private manager and in addition we can increase our market share by attracting those that actively make a choice.”
Indeed, the withdrawal of the State Treasury may offer a lifeline to some of the smaller players. “The main problem for all second pillar pension market participants is how to sign up clients,” says Marina Baranovska, a member of the Baltikums AM board of directors.
The funds have not been in existence long enough to show meaningful contrasts in investment performance, while regulatory restrictions and the relatively small pools of assets garnered so far mean that investment strategies for active, balanced and conservative funds are broadly similar.
Consequently, asset management companies rely on their parent banks’ distribution networks to gain clients. The emergence of banks as the key players was assisted by a government policy to restrict expenditure on promoting the pensions system. “Several banks have an agreement with the Social Welfare Agency under which, without remuneration, they collect application forms for people who want to join the second pillar,” says Medvedev. This approach has been one that the banks have been happy to exploit. “The largest second pillar pension funds by numbers of clients are run by Hansa, Parex and SEB Unibank, the largest banking groups and largest financial service organisations with the largest sales forces,” says Medvedev. “And that is the major driver for sales.”
“We acquire most of our clients through the branches of our partner bank, Latvijas Krajbanka, and now we are also considering other ideas on how to enlarge our agent network,” says Makienko. “We are going to launch two new pension plans, including a balanced plan, in addition to our existing conservative and active investment plans. This will attract State Treasury clients as currently there are only three balanced plans on the market.”
Others offer deals to attract customers. “We sell through Komercbanka Baltikums and through the group’s client services by, for example, offering our product together with an insurance policy provided by Baltikums Insurance,” says Baranovska of Baltikums AM, one of the smallest players. And SEB, one of the big three, is pursuing a similar strategy. “People coming to SEB Unibank branches are offered the possibility to join our second pillar pension plan,” says Igolnieks. “Existing customers are offered another service at a cheaper rate if they sign up. Also we differentiate ourselves from our competitors as being part of SEB, a very big Swedish group.”
“Generally we don’t emphasise such hot topics as last year’s return,” says Raimonds Veseris, director of asset management for Hansa in Latvia. “Rather we emphasise the reliability of our banking side.” And Hansa offers other inducements. Earlier this year it was offering LVL500 (€711) worth of travel to those who applied for its pensions by 19 March.
But being part of a major banking group is not a guarantee of success. Suprema, which is owned by Evli, Finland’s largest private banking group, boasted in 2003 that it was ‘the largest pension asset manager in the Baltic countries’. The same year its subsidiary Suprema Fondi was authorised to manage second pillar pension assets and signed a partnership deal with Nordea under which its plans were available at all Nordea bank’s Latvian branches. Yet it remains the smallest player despite giving its funds evocative names that hinted at the retirement lifestyles they could furnish investors.
Nordea has about 10% of the Latvian banking market, according to Thomas Neckmar, Nordea executive vice-president in charge of the Baltics and Poland. So why was Nordea not able to repeat the success of its Nordic competitors Hansa and SEB, which top the pensions listings? “This product has not been a focus for us,” says Neckmar. “We needed a product for some of our customers, but you may notice we are not playing in the second pillar pension fund arena in the other Baltic States.”
But whatever the cause of Suprema Fondi’s poor performance, what local informed sources call a “restructuring” is expected. “A strategic decision on second pillar funds will be made in near future,” confirms Veikko Maripuu, Suprema’s Estonia-based head of asset management for the region.
And Baltikums is in the process of seeking a new owner. “We are looking to universal banks,” says Tatjana Dorofejeva, chairman of Pirmais open pension fund, the third pillar unit of the Baltikums Bank. “Baltikums Bank is a pocket bank not a universal bank and we don’t have the resources to develop our pension funds. So we are looking for a new owner that has a banking network with a sales force that can sell pensions. I expect it will be a bank with a presence in Latvia but without a pension fund.”
Recent months have already seen a shakeout of the market. In May alone Latvijas Krajbanka bought out its joint venture partners in Astra Krajfondi and Lateko Bank, having gained Iceland’s Landsbanki as a strategic investor, bought second-tier pension plan investment management company LVA. Indeed, the pattern for consolidation has not been for stronger pension funds to acquire smaller pension funds to gain market share as elsewhere in east and central Europe but for banks without a pension arm to buy the smaller pension management firms.
“There are certain licensing conditions so it is much easier for banks that are not already in the second pillar to buy their way in by acquiring a small existing company.” says Veseris. “Actually it does not cost so much to acquire such a small company.”
And although contributions are low it is clearly a business to be in. “Somebody joining the system aged 49 will not take money until they retire at 65, that 16 years, while it’s 35 years for somebody of 30,” says Brencena. “So it will be 16-35 years of taking 2% of gross salaries, rising to 10%, without any pay outs. That’s a huge amount of money, a huge business and a huge profit.”
Being voluntary, third pillar funds face even greater customer acquisition problems and their complaints at the government’s neglect in promoting the new system are more strident.
“Our major challenge is the unwillingness of people to save,” says Tina Kuse, chairwoman of Hansa open pension fund, Hansa’s third pillar fund. “After the collapse of the Soviet Union most people’s monetary situation was so tight they simply had nothing to put aside. Now that the population in general can afford to start saving we have to motivate them again. The government could help by educating people about the demographic situation and promoting ways to save at private and company levels.”
Brencena, who left the State Treasury three years ago to join SEB where she is executive director with oversight of its pension funds, agrees. “There has been absolute silence on the part of the state about the third pillar and its tax advantages. So now we have banks explaining state policy on pension schemes, and that’s not good.”
“Third pillar plans can be bought by companies, employees or a mix of both,” explains Andris Balodis, chairman of Parex open pension fund. “But currently, only 5% of Latvian companies offer third pillar provision to their employees. We are affiliated to the Parex banking group and so we cross-sell. We are looking to large clients because they are more receptive to various banking products, and we can provide a whole package. That accounts for some 80% of our clients.”
“Employees of a company that is wiling to offer a third pillar pension often say they would rather have the contribution as a salary increase; they would like to have money today, not for their future,” says Dorofejeva. “However, there are very good tax advantages for companies paying into a pension. But it is the better developed large companies with more than 200 employees that show interest, and in Latvia there are only around 300 of them.”
Nevertheless the Baltic Trust Bank is not deterred, having entered the market with an open pension fund in May last year. “With Latvian labour flocking to better paid work abroad it is difficult to find and retain professional and motivated employees,” says fund chairwoman Inara Dundure. “So, employers will be forced to pay higher salaries and to provide better social guarantees, including the accumulation of pension provision for old age.”
Balodis notes that encouraging staff loyalty is not targeted at senior levels. “We have a large number of hospitals as clients that are interested in keeping their lowest-level employees – nurses, for example, who are not very well paid and so are always looking where they get more money. Rich people have other options to augment future wealth, like investing in property, but for working class and lower middle class people the third pillar is interesting.
“Even more interesting is that since the beginning of last year private individuals can pay into a third pillar pension. They will receive 25% income tax reduction, not only when paying but when the money is paid out.”
“We have focused on the private individual,” says Brencena. “If private persons are interested in individual savings employers will use them as incentive schemes. And this has changed the profile of our clients. When I started we had 3,000 clients, of which 300 were individuals. But the 2,700 did not understand what they had, that their employer had contributed on their behalf, and the annual account statement triggered calls asking us what it meant. So we stopped trying to sell to employers and began just selling across our bank counters. Now we have more than 30,000 clients and only 7,000 are through their employer. And because people are increasingly interested to make their own retirement savings we are finding it easier to sell to employers as an incentive scheme for their employees.”
Gaining clients is not a problem for Rudite Zvirgzdina, executive director of the Pirmais closed pension fund established for two major utilities, telecoms company Lattelekom and energy supply group Latvenergo, and four affiliates that will shortly increase to six following an acquisition that will add a further 400 members. “A closed pension fund may only take contributions from shareholder companies and their employees if they wish to make supplementary payments,” says Zvirgzdina. “By asset capital we are the largest pension fund in Latvia, with more than LVL20m under management and about 12,000 clients.
“The main challenge for us is to retain our members,” she adds. “Somebody leaving Lattelekom to go to a company that has a pension arrangement with another provider, for example, has the right to transfer their pot from our fund to another or to belong to two pension funds, and of course the new pension fund would be interested in taking the money from us and adding it to their assets. So we must be more attractive to our members. We do this by communicating what members can get from us. We were the first pension fund to give members monthly information on their account through our website, which is on two levels – a public level accessible to all where we include information about third pillar funds and legislation and have a glossary, and a level for registered plan members where using their personal code they can access further information about investment policy and about our shareholder companies. And members making additional contributions are helped to get the resulting tax relief each month rather than having to apply to the authorities for it at the end of the year.”
But Zvirgzdina is also concerned about the government’s apparent neglect of the pension system. “We have asked the authorities to mention when talking about the pension system that we have three levels. In Latvia you can’t find the person who is responsible for pension policy for the three pillars together. And I’m afraid that a future government might change the tax policy, especially if there are budgetary difficulties.”