In May, the 2nd Pillar for mandatory private pensions celebrated one year of operating in Romania. Over the same period, the region’s most relevant market, Poland, reached a special age: one decade. What are the most relevant lessons to learn from the experiences of the last decade on the private pensions markets from CEE? What does the current financial crunch add to these lessons? What are the future perspectives? The Private Pensions Day from FIAR 2009 planned to answer these questions.
Details are the key to success
Edition 2009 of the already traditional spring reunion of the private pensions industry enjoyed, for the very first time, the support and participation of a prestigious entity representing the interests of the private pensions markets at European level, EFRP - European Federation for Retirement Provision. EFRP was represented by Jaap MAASSEN, Vice Chairman of EFRP and Senior Vice President International of APG Group, the company managing the ABP fund, the largest European pensions fund and the world’s second largest fund, with a volume of managed assets amounting to over EUR 175 billion.
The crisis does not cancel the reasons for the need to implement the multi-pillar pensions systems. The European Union still needs a three pillar pensions model: the public one, then another one under private administration for employees (to make sure people save for their retirement) and an individual private one, intended for everyone, to diversify and supplement the retirement income, Jaap MAASSEN stated. The difficulties faced by the public pensions systems are not triggered by the crisis, but by independent factors, mainly the increasingly obvious demographic imbalance which makes systems operating exclusively on re-distribution unable to operate properly. Although the crisis enhances to a certain extent the resource deficit of the public systems, it does not provide enough reasons or rights to regress the pensions reform in Central and Eastern Europe, thus impacting to a large extent the interests of future retirees, while amplifying the future obligations of the state budget. EFRP is concerned about the freezing of the contribution level in certain states in the region, such as Romania and the Baltic States, or about the attempts of “opening” the 2nd Pillar, as taken in Slovakia and Croatia, the Vice Chairman of EFRP added.
As for the future effects of such measures on the participants’ retirement savings, suffice it to say that, according to the assessments conducted by EFRP, the increase by one percent of the contribution, for a 40 year accumulation period, causes a private pensions increase by almost 30%. The instability of contributions has a negative impact on the pension’s value, to a comparable extent. As a result, one of the messages Jaap dwelt on particularly referred to the fact that the participants’ return to the public system, while giving up on private pensions is not a viable alternative, and the customers’ financial education plays a vital role in preventing such circumstances.
In addition, Dragoş CABAT, Managing Partner, FINANCIAL VIEW, outlined that when establishing the level of the future contributions to the private pensions system, one should also consider the long term effects of the current crisis: high volatility, lower expectations regarding the return on investments, the use of dynamic models for the inflation trend, the exchange rate evolution and other aggregates. Actually, CABAT claims, the future investment context will change considerably, therefore we will witness a change in the basic concepts of geographical and sectoral diversification of investments.
An in-depth look at the development stage reached by the CEE private pensions markets and at Romania’s position in this context, as well as at the region’s current issues in this area was delivered in a presentation made by Daniela GHEŢU, Editorial Director, PRIMM Publications, and Mihai BOBOCEA, Secretary General, APAPR (the Romanian Association for Privately Managed Pensions), and a summary thereof is presented in the following pages of the magazine.
Guarantees come at a cost
The topic of guarantees in the private pensions system, again topical in Romania and even in the CEE region, could not be excluded from the discussions held on the Private Pensions Day. In principle, anything can be guaranteed, MAASSEN stated. However, let us not forget that any guarantee comes at a cost. The stronger the guarantee, the higher the cost. Therefore, if we propose the general public a guarantee for private pensions, the correct attitude would be that, before anything, we inform the public on the costs this guarantee implies. As for 2nd Pillar pensions, introducing such a guarantee would require an in-depth analysis to decide who bears, in fact, the cost of the guarantees.
Actually, according to an assessment conducted by MILLIMAN Consultants & Actuaries, even if we stay within the confines of extremely simplifying assumptions, taking into consideration very low operation costs, suitable only for funds with a very simple and conservative placement structure, the income generated by the funds from the administration commissions are not sufficient to cover all the costs they need to bear. It is obvious that something has to change in this respect: either the commissions go up, or the system’s costs go down, otherwise their distribution between administrators and participants must be re-analyzed, Adrian ALLOTT, representative of MILLIMAN in Romania, stated.
The opinions of the two experts narrow down into a common conclusion: in its current structure, the mandatory private pensions system cannot bear the additional, sizeable costs, required for the introduction of a new guarantee. In other words, rushing a decision in this respect, without a careful analysis, might easily cause the “blockage” of 2nd Pillar private pensions. Moreover, in terms of investment returns, introducing too strong guarantees proved to be extremely disadvantageous for the participants, who paid too high a cost for security, with massive losses in the investment performance of their pensions fund. The shorter the time horizon related to the guarantee, the tighter the control over the fund’s placement policy, thus calling for an exaggerated prudence and loss of investment opportunities, MAASSEN stressed.
It is easy to launch such ideas for the general public, as they appear to be generous and they attract the citizens, if you ignore – willingly or not -, the real actual conditions, Ion GIURESCU, Vicepresident of CSSPP (Private Pensions System Supervision Commission), pointed out, commenting on the actions taken by the Group for Applied Economy, with the unions’ support, for the introduction of an absolute return guarantee in the 2nd Pillar for pensions. Unfortunately, even at the level of political decision makers, who could be in the position of deciding on the opportunism of this endeavor, there are too few people with sufficient technical knowledge on this complex system so as to be able to correctly asses all implications. This is why the market and the supervisory authority must take actions together in this respect. We need to inform the public, while also persuading the political class about the soundness of the private pensions system, which already has an absolutely reasonable guarantee package, the quoted official stated.
In the spotlight: increasing the contributions
All those concerned with the development of the private pensions industry - operators, the regulatory and supervisory authority, consultants etc. – should get involved in a more determined action to support the joint interest of the industry and of the participants to the pension funds, so that the maximum threshold set by the law for the contributions to the 2nd Pillar, namely 6%, be reached faster, and even exceeded, Mihai ŞEITAN, State Councilor, stated. Although the private pensions system has already proven its functionality, so that the participants to the pension funds are able to really enjoy the system’s benefits, it is very important that they receive more considerable amounts in their accounts, to be invested. Thus, however high the returns, if applied to modest amounts, they cannot produce spectacular results.
The urge to take action, launched by Mihai ŞEITAN, overlapped with another idea, inspired from the practice of the Australian pensions system. Thus, according to Adrian ALLOTT, the employees might contribute themselves to a faster increase of the amounts accumulated in the 2nd Pillar for private pensions. A tri-party agreement between the Government, the employees and the trade unions might lead to a mutually agreed upon annual “sacrifice” of a point in the salary increase, a percentage that can be transferred in the contributions for the private pensions funds. Thus, the contributions would increase at a high pace, while salaries would experience a slightly flat increase over several years, ALLOTT explained.
3rd Pillar must be strongly stimulated
Most likely, in 2050, the state pension will not provide a replacement rate higher than 22%. For the final contribution level provided by the law, namely 6%, the 2nd Pillar will generate an additional 15.5 – 17.5% compared to the state pension. Therefore, under the current conditions of the system’s architecture, it is expected that the generation of employees now at the beginning of their career will benefit from a pension that does not exceed 40% of the salary, this value including both the state pension and the 2nd Pillar pension, Adrian ALLOTT demonstrated in his presentation.
According to the MILLIMAN analyst, in order to get a satisfactory replacement rate of approximately 70%, the contributions should be established at about 17% of the salary. Given that such an increase in the contributions is highly unlikely, the only possible solution is the accumulation through an voluntary private pension, and the state must encourage such an undertaking.
By definition, the voluntary pension includes a component less attractive for the participants: no free access to the savings in the pension fund, for a very long time. To compensate, the state must offer a strong enough tax incentive to offset this feature, perceived as a major shortcoming compared to other forms of saving, Adrian ALLOTT said. Currently, the deductibility for voluntary pensions is lower than 5% of the average salary, which is totally insufficient. Maybe tax incentives should be designed so as to allow middle class citizens to save approximately 10% of their income, the expert from MILLIMAN specified.
Who wants a voluntary pension?
Only 15% of the Bucharest inhabitants would be interested in contributing for a voluntary private pension, allotting about RON 135 per month, in average. Outside Bucharest, although the percentage of those interested is similar, the allotted amounts are lower, with an average of RON 105. We should point out that, compared to previous years, the popularity of voluntary private pensions seems to have diminished.
Presented for the very first time at the Private Pensions Day 2009, these are the conclusions of the survey recently conducted by the specialists from MEDNET Marketing Research Center, in partnership with Media XPRIMM. The results of the survey prove that, obviously, under the pressure of the current economic context, the public’s interest in the voluntary private pensions is decreasing compared to the previous years. In our opinion, the conclusion is that financial education remains a priority in demonstrating to the general public the importance and need for a private pension, Lăcrămioara Laura VOINEA, Managing DirectorMEDNET, concluded.
According to the quoted survey, most respondents who stated they plan to buy a voluntary private pension plan in the near future are women, aged 22 to 47, with a high school or university degree and a monthly income exceeding RON 500, working mainly in the private sector.
A matter of perspective
The crisis is here and its effects are not bypassing any industry. The private pensions industry is no exception either. Nevertheless, compared to other financial sectors, private pensions funds were less affected, Jaap MAASSEN stated, especially if we keep the right perspective, namely the long term one. It is essential that, in any judgment regarding this area, we keep in mind its basic coordinates: the stability and the long term perspective.
Certainly, “stability” and “long term” were the most common words used on the Private Pensions Day: legislative stability, long term investment horizons, economic sustainability and social usefulness ... In certain environments, it is said that economists only have solutions for the growth periods, Ioan VREME, CEO, GENERALI Fonduri de Pensii, moderator of the session, noted. Fortunately, the Romanian private pensions market has proven with tangible results that it has specialists who can find good solutions even in a crisis, that cooperation between stakeholders is possible, that all obstacles can be overcome. These good results should be an extra motivation to encourage the development of this system. However, the basis for its long term growth remains the education of the market. We shall work better if the general public, our customers, understand what we do, make an informed choice, take the right decisions ... The benefits will be obvious for all of us, on long term”.
