15 years ago, the first Central and Eastern European countries introduced the private pensions systems, based on individual savings, on long term, privately administered by specialized entities. Since then and up to now, 11 states from this region applied similar reforms, following the model designed and recommended by the World Bank. Among these, the reform from Romania (2007) is the most recent one. You can find out how these systems have developed over 15 years and what Romania has learned from the rich regional experience by reading the following article.

15 years of private pensions

At the end of 2008, in the 11 states from the region (Czech Republic, Hungary, Bulgaria, Slovakia, Latvia, Estonia, Lithuania, Poland, Slovenia, Croatia, Romania) over 300 private pensions funds were operating, managing assets worth EUR 61.5 billion in total, for the benefit of over 38 million participants (individual customers). These statistics refer, cumulatively, both to the 2nd Pillar (mandatory private pensions) and the 3rd Pillar (voluntary private pensions).

At the end of last year, 30.45 million participants (+6.8% compared to 2007) contributed to the funds of the 2nd Pillar in the CEE region, the savings in this system amounting to EUR 50.3 billion (-7.7% compared to 2007). According to the number of participants, Romania is the region’s second largest market, right after Poland and before Bulgaria and Hungary, due to its population size. However, the assets collected in the Romanian system of mandatory private pensions still have a lot to catch up with, compared to the similar markets from the region, as this is just its first year of operating.

At the end of 2008, on the 3rd Pillar, the pension funds from the region were managing net assets of EUR 11.16 billion (+4.9% compared to 2007), for the benefit of 7.66 million participants (+7.5% compared to 2007). Romania is already positioned in the middle of the regional ranking, according to the number of participants, overtaking markets with a longer experience, but still very far from the system’s real potential. The most developed voluntary pensions markets in the region are located in the Czech Republic and Hungary. For the near future, although the impact of the financial crisis was seen on this market as well, in 2008, the forecasts are optimistic. Once the crisis is over, the private pensions markets will resume the accelerated growth (generated by the system’s design and relying first and foremost on the 2nd Pillar) and day might reach, in 2015, net managed assets of EUR 200-250 billion and approximately 50 million participants.

Where should we learn from?

Over time, Romania has “learned private pensions” from the neighboring states with experience in the field, after years of reform and after applying several “recipes” to find the most efficient saving formulas.

Poland was used as main “teacher” for the Romanian 2nd Pillar. After introducing the mandatory pensions in 1999, Poland became the region’s largest market in this area, thus turning into a benchmark for Romania due to the demographic similarities. The Polish pension funds proved to have the best performance in the region in their 10 years of operating and, despite a very tough 2008, they managed to reach aggregated performances higher than the inflation and the mutual funds industry.

At the moment, the Polish 2nd Pillar market is undergoing liberalization, due to the European Commission’s action to request the removal of certain investment restrictions. This year, the Polish 2nd Pillar starts the term pay out of the first private pensions, but the legislation is provisional and under improvement. Due to the success of the 2nd Pillar, Poland did not focus on 3rd Pillar as well, whose development is precarious. Still, new promises for significant tax deductibility might invigorate this market as well.

On the opposite side from Poland, the Czech Republic is the most developed market for voluntary pensions (3rd Pillar) in the region; however, it has not yet introduced a 2nd Pillar, but it is now debating on the opportunity of such a system, with initial contributions of 6%. The market’s main problem is the low contribution in the voluntary system, therefore the need to complement these contributions with a 2nd Pillar that could be launched in 2011 or later. Other plans for this market relate to reforming the 3rd Pillar to introduce the multi-fund model and eliminate the absolute performance guarantee (positive annual return), now required by law.

Hungary is half way between Poland and the Czech Republic, as it developed both the mandatory 2nd Pillar and the voluntary one. Hungary “experimented” in 1998-2002 the temptation of an excessive guarantee (the funds had to perform above an index calculated based on the Hungarian government bonds), which they later abandoned after it failed to protect the participants or improve the funds’ returns. On January 1st 2009, Hungary introduced the multi-fund model for the 2nd Pillar, with probably the most modern design in this field. The Hungarian 3rd Pillar has already reached the private pensions pay out stage, while the 2nd Pillar still has to wait until 2018.

Multi-fund, investments, performance

So far, 5 states in the region have applied the multi-fund model to protect the participants getting closer to their retirement age and to diversify the investment options, depending on the risk profile estimated for each participant: the Baltic States, Slovakia and Hungary. Also, another 4 states are getting ready to adopt this solution, Romania included.

But the system’s details are vital: the best solutions of enrolling, transferring and investing for the participants must be identified, with two objectives that can be reached simultaneously: a better protection of participants, as well as high returns on investments. Romania must look carefully into the regional and international experience in the field and choose the best models in this respect.

The practice of the 15 years of private pensions in the region indicates that the pension funds succeeded, on medium and long term, to reach significant performances above the inflation rate, despite the financial crisis that affected the stock exchanges (and not only) in the meanwhile: the Dotcom crisis from 2001-2002 and the subprime American crisis (with its effects) in 2008-2009. Thus, the pension funds from the Czech Republic, over a 14 years horizon, outdid the inflation by almost one percent per year (aggregated results), and the funds from Poland and Hungary (10, respectively 11 years) went beyond the inflation rate by 6.2%, respectively 0.5% per year. Actually, all private pensions markets from the region reached similar results.

The political risk overtakes the investment risk

Over the past year, almost all private pensions systems from the region were impacted by the political factor, which made uninspired decisions, thus destabilizing the private pensions markets. Whether it was a lowering of the contributions or commissions, or even the opening of the system and other measures, the private pensions systems experienced the shock of the hostile political decisions more than any other potential investment shock.

Under the pressure of imbalances caused by the economic crisis, the governments from the region considered the pension funds as a good source that can help overcome the crisis with their own assets. “An easy prey”, politically, compared to any other type of financial sacrifice with immediate effects that might be imposed on the population, the pension funds became increasingly interesting, as they collected more and more money. But the problem is that, by resorting to the money from the pension funds, governments actually undermine their potential to produce long term results, thus creating a new sacrifice generation, destroying the participants’ confidence in the system and essentially undermining its own future ability to successfully manage the pensions issue.

In response to these political measures, the international financial institutions restated their support for the private pensions systems in the CEE countries by issuing reports, surveys, recommendations on “the best practices” or even by taking concrete actions (Romania’s case, where IMF, the World Bank and EU conditioned/ recommended various measures to reform the state pensions and support the private pensions system).

The message of the international institutions can be summarized as follows: the economic crisis does not cancel the reasons that made the private pensions system a must, and the circumstantial shortcomings should not affect their development. Also, the performances of the pension funds must be assessed on longer terms, and over-regulation is counterproductive, as pension funds proved to be resilient to the effects of the crisis. The international institutions recommend the multi-fund solution to offer protection for the participants without “blocking” the return on investments. Last but not least, keeping the public informed is still a priority!

The material was written based on the presentation “Overview on private pensions in Central and Eastern Europe”, delivered on the Private Pensions Day at FIAR 2009 by Daniela GHETU (Editorial Director of PRIMM Publications) and Mihai BOBOCEA (Secretary General, APAPR).