Over 38 million pension plan members, net assets under management of about EUR 64bn, hundred of pension funds – that’s a brief description of the CEE private pensions market - an emerging region that apparently includes countries with extremely similar pension systems. For sure, a common trend and threat is visible: the pensions companies now face a risk much more severe than investment or market risk – its name is political risk.

All in all, financial figures show that the financial and economic crisis set the region’s private pension assets back by a year and a half, by cutting growth and depreciating assets caused by the brutal fall in equity markets worldwide. However, pension funds in the CEE countries took a less severe shot from the crisis than the mature markets and funds. The annual Watson Wyatt survey on the top 300 largest pension funds in the world showed a two year setback in the level of assets under management – combined assets at the end of 2008 returned to the 2006 levels. In the CEE countries, after pension funds’ assets depreciated by 15%- 20% on average during 2008, the region generously benefited from the recovery in the financial markets in the first half of 2009, and combined assets grew consistently, having already recovered more than half of the “losses” registered in 2008. Currently, pension funds in the CEE only have about 8%-10% still more to grow so that the recovery can be considered complete – and in an optimistic scenario, this can happen by mid-2010.

But private pension systems in the CEE countries were not hit to the same extent by the crisis. The least affected was the youngest private pension market of Romania, where funds consistently posted positive, double-digit returns, by investing prudently in fixed income and by taking advantage of the increased market volatility. Also, the voluntary pension funds of the Czech Republic suffered significantly less than the regional average, the traditional conservative approach to investments (due to the guarantee requirements) having paid off during 2008, albeit with the cost of moderate returns in other years. At the same time, Hungary, Slovakia and the Baltics have been more severely affected by the effects of the crisis, namely the fall in both local and European equity markets. So... how did each pension system in the CEE area do in the last 1-2 years?

POLAND

Poland is by far the largest private pensions market among the CEE countries, its mandatory pension funds (2nd pillar) representing about 55% of the region’s combined assets under management. Although the mandatory pension funds are well developed by regional standards, the voluntary ones (3rd pillar) are still in their early stages of development, partly because of the broad coverage of the 2nd pillar funds, and partly because of the quite unattractive fiscal stimulus offered for joining the voluntary pension funds.

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During 2008, the Polish mandatory pension funds posted a 14.2% negative return, while the main index of the Warsaw Stock Exchange (WIG) suffered a 48% fall. However, the depreciation in assets started a bit earlier, in July 2008, after the first signs of turbulence on the global financial markets. In 2008 alone, the negative returns translated in a EUR 5.5bn fall in assets’ value for the mandatory funds.

But recovery proved to be just as fast – in the first 8 months into this year, mandatory pension funds already posted a 10.5% average return, thus being only 10% behind the maximum fund unit values reached in July 2007. The level of net assets under management regained its growth and reached new historical maximum values (in Polish zloty), only the national currency’s depreciation against the Euro making the recovery results look less impressive. While the Polish mandatory pension funds’ equity exposure was 38% before the crisis hit, it went to an all time low of 18% in February this year, to strongly increase to 25% and beyond, in the following months. Thus the funds took advantage of the market recovery, although their comeback with new money into the Warsaw stock market was done in different phases.

On the front of legislative changes in the system, Polish pension funds management companies had to take a drastic decrease of they fees they take out of contributions, from a maximum of 7% to 3.5% of contributions, and now the marketing agents’ involvement in both fresh sign-up of participants and transfers between funds is considered to be forbidden. Thus, both sign-up and transfers in the 2nd Pillar would be made on a personal decision basis, to avoid any mis-selling and also to reduce the operating and marketing costs of the system, in order for it to support lower fees. The next legislative priority would seem the introduction of lifecycling funds (multifunds), but for now the Polish authorities, bearing in mind the depreciation of assets in 2008 and ignoring the comeback of 2009, don’t see the scope for equity-aggressive funds for younger participants, thus thinking multifunds on a 2-fund basis, the current balanced one and a new, more conservative fund for each provider, to reduce market risk exposure for participants closer to their retirement age.

Also, the funds already started entering the payout phase, although the system runs on provisional legislation. It only sees for phased (programmed) withdrawals on fixed periods (i.e. monthly payments for 5-10 years), this system’s biggest problem being it cannot address longevity risks. More sold legislation, also providing different types of annuities, was heavily debated in 2008, but reached a dead end after the Presidents’ veto on the draft law – discussions on this will be resumed in the near future, the first consistent wave of payouts only being expected in 2014. As for the 3rd pillar (voluntary private pensions), Polish authorities currently take into consideration a consistent increase in tax deductions for this product, in order to further stimulate personal savings through private pensions.

HUNGARY

Hungarian private pension funds are second the second largest in the region: mandatory funds are second after the Polish ones, while voluntary ones are second after the Czech ones. Just like Polish pension funds, the Hungarian ones had a very volatile and agitated year. The introduction of lifecycling funds (multifunds) in January 2008, just before equity markets plunged to new and new lows everyday, brought a lot of “emotions” to the Hungarian pension market, as equity exposure rose after the introduction of lifestyle portfolios. But unlike Polish funds, the Hungarian ones are a few steps behind on the road to recovery, because of heavy legislative changes that will most definitely have adverse effects. Multifunds have started being implemented in 2008, on a voluntary basis, by most 2nd pillar pension companies – this means that the raging storm in global equity markets rocked the young aggressive funds put together by the Hungarian pension market. And because the law was initially very brave and risk-permitting, forcing dynamic funds to invest at least 40% in the stock market, the depreciation came accordingly. The aggressive (dynamic), higher risk funds lost almost a third of their assets’ value during 2008, while the conservative funds (low risk ones) lost about 10%. Fund managers on the Hungarian pension market blame the reform’s timing for these poor results: had th reform been mandatory for the whole market starting 2009, this mayhem could have been avoided, with funds now in theoretical double digit positive territory. But legislation allowed pension companies to offer multifunds starting in 2008. While the larger public was asking for more investment options, the fund managers hastened to provide such products, and only a few pension companies waited for 2009 to implement their 3 funds instead of a single one.

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So with this bad timing, the whole market was caught on the wrong foot, with too much equity in their portfolios, and the returns matched those holdings, brutally shaving off assets’ values. But instead of supporting the 2nd pillar on the road to recovery, politicians further worsened the situation: they allowed the opening of the system (removal of mandatory feature) for participants over 52, allowing and encouraging then to switch back to the state system and thus realize (mark) the losses in their personal retirement accounts. Also, management fees were reduced, but the funds’ contributions were increased towards the Guarantee Fund.

Voluntary pension funds on the Hungarian market (3rd pillar) suffered similar losses in 2008, because of the falls in equity markets – but are now recovering by posting strong positive returns. In the meantime, the Budapest based government was forced to reduce the state pensions in order to avoid a potential default on its payment obligations.

CZECH REPUBLIC

Voluntary pension funds (3rd pillar) in Czech Republic are among the few less affected by he current crisis, mainly because their traditional conservative investment approach, but also the guarantee requests embedded in the legislation. The voluntary pensions market in the Czech Republic is the largest in the CEE region, the 10 active funds managing net assets of about EUR 7.4bn, slightly larger than a year ago. While the voluntary pension market is relatively developed (now being in its 16th year of operation), the Czech Republic is among the few Easter markets without a mandatory 2nd pillar in place.

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The bond rich Czech funds closed 2008 by posting a slightly above zero nominal net return for the year, thus respecting the guarantee request in the legislation, that obliges them to provide a 0% per year nominal return. The result, although respectable for a year such as 2008, comes at the long-term cost of average-rated performance. Traditionally, Czech pension funds have very low exposures towards equity markets, under 5%-10%, and this led to several opportunity costs for the funds’ 15 year history. During the first 6 months of 2009, the funds also managed to post positive returns, although the market weighted average return stood at only 0.5% for this first semester.

During the summer of 2009, the voluntary pension funds have been a subject for stress-testing by the Czech National Bank, the supervisory authority of the market, and managed to pass the test without any serious problems. This also helped to regain the participants’ trust into the system, even in times of crisis. However, in this last year, the CNB increased capital and solvency requirements for the pension funds, as part of the anti-crisis package to help safeguard the Czech financial markets.

The Czech workers’ membership in the voluntary pension system is more than generous in numbers – the 10 funds on the market manage the retirement savings of over 4.4mn plan members, which means that 86% of Czech Republic’s active population is enrolled in the system and makes active contributions to the funds. But the system’s problem is another one – the low level of contributions, only representing about 2%-4% of participants’ gross wages. To help address that problem, Czech authorities now contemplate the possibility to implement a voluntary 2nd pillar with contributions of at least 6%. Also, there have been extensive talks about a second version of the current voluntary 3rd pillar, but without any guarantee (to allow more consistent equity investments) and with multifunds (lifecycling portfolios).

CROATIA

Croatia is another private pension market whose growth has only been slightly hindered by the financial and economic crisis. At the end oh Q2 2009, the funds’ net assets under management passed the EUR 3.6bn mark, which puts Croatia among the middle-sized pension markets of CEE. Mandatory pension funds (2nd pillar) posted net returns of -12.5% for 2008, helped by the limited equity exposure and less dramatic market crash of the local stock exchange.

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Now, they are also on the straight road to recovery, posting 4.5% net returns for the first 8 months of 2009. The reason for their slower recovery comes from bond markets – because in 2008 Croatian pension funds not only lost on equity, but also on fixed income instruments – that is why the stocks’ rally this year only brought moderate gains to the pension funds.

Also, the political climate only marginally affected the market’s development. After the Croatian prime minister publicly called the private pension system a “disaster” on late night TV, he proposed of an opening of the 2nd pillar, meaning the removal of the mandatory feature. After heavy lobbying from the pension funds, their managers and also mainstream media, such a decision was not adopted, and the market was left unaffected. Surprisingly, a bit later, the same PM came to better feelings toward the private pension system and promised the contributions directed to the 2nd pillar would increase in the medium term.

At the same time, Croatian voluntary pension funds, much less developed than the mandatory ones, also began a quick recovery process after the losses posted for 2008. Currently, they only have 140,000 plan members.

SLOVAKIA

The private pension market of Slovakia, especially its 2nd pillar, is by far the most agitated in the whole CEE region, and that happens in spite of the losses of only 7% posted by the market last year, which puts Slovakia among the countries less affected by the crisis. In Slovakia, the socialistic government has been at open war with the private pension fund management companies for 2-3 years now, and the results start to show and affect the efficiency and profitability of the system for its participants.

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After two periods of opening the 2nd pillar, by removing its mandatory feature, both of them imposed by the authorities, came other malevolent decisions: a dramatic cut in management fees, which were reduced by two thirds. Also, authorities forced pension funds, by law, to guarantee, positive returns on a 6 month basis, and at the same time forced them to realize losses on depreciated equity portfolios. Actually, that was the reason for which pension funds in Slovakia had in 2009 the worst period since inception, without being able to take advantage of the recovering financial markets.

But the worst news is that it all came against a background of heavy campaigning by the Slovak authorities against private pension funds – the prime minister of Slovakia was the main voice in this manipulation campaign, meant to reduce public trust in the 2nd pillar pension system and to convince the workers to switch back to the state system, helping to fill up its massive deficit. The Slovak PM publicly declared himself the biggest enemy of the 2nd pillar of private pensions and takes every opportunity to badmouth pension funds and to advise citizens to switch back to the state system. But in spite of all those desperate measures by the authorities, only 10%-12% of the 2nd pillar’s participants made this move. But the guerilla war against the private pension system is set to continue, as the Slovak PM now eyes a possible reduction in contribution levels directed to the 2nd pillar, to hasten the choking of the system.

The combined assets of the 2nd and 3rd pillar funds in Slovakia is now in excess of EUR 3.6bn, but the Government only sees in this a short-term pot of cash to bailout the public pension system.

THE BALTICS

The Baltic states (Estonia, Latvia, Lithuania) currently run the smallest private pension systems in the region, with net combined assets (2nd and 3rd pillar funds, all 3 countries) of only EUR 2.6bn. The Baltics have also been the European countries most affected by the financial and economic crisis, and that is why pension funds also posted among the largest depreciations in asset value in the region. On the other hand though, the recovery is also quick, the pension funds in these countries now posting double digit growth figures for 2009, which will soon fill up the gaps opened by last year’s falls in equity markets.

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In ESTONIA, the government decided to cut the contributions directed to the 2nd pillar from 6% to 2%. The 2nd pillar mandatory funds now manage assets of about EUR 800mn on behalf of 590,000 participants. Contributions are set to rise again to 4% in 2011 and 6% in 2012, with the Government promising for compensations for the participants most affected by the measure. After the depreciations in 2008, 2nd pillar funds posted net returns of 13.8% for the first 6 months of 2009, and most of the funds are now in positive territory for the last 12 months. The less developed 3rd pillar could also be reformed in the near future, with payout legislation and taxing benefits to be changed.

Also, in LITHUANIA, the contributions directed to the 2nd pillar were reduced by the Government from 5.5% to 3%, during 2009 and 2010. The 2nd pillar funds now manage EUR 740mn and, after last year’s losses, posted a solid 13% return for the first 8 months of the year 2009, starting a consistent recovery of assets. Furthermore, Lithuanian authorities decided to cut public pensions by at least 10%, in order to reduce public expenses and avoid the possibility of default.

In LATVIA, the Government also decided to reduce contributions directed to the 2nd pillar from 8% to 2%, although they should have gone up to 10% in 2010. Meanwhile, it will be 2% in 2010, 4% in 2011 and 6% in 2012. The measure was also accompanied by a cut in public pensions, to reduce the massive pressures on the state budget. Also, Lithuania is, like the rest of the Baltics, in the process to reform its public pension system, under the guidance of the International Monetary Fund and the other international financial institutions.

BULGARIA

The private pension market of Bulgaria, one of the smallest in the region, also began recovering from last year’s losses. In 2008, for the first time since its inception in 1994, the combined (2nd and 3rd pillar) market posted a net fall in assets under management. After depreciations of about 20% for 2nd pillar funds and slightly more for 3rd pillar funds in 2008, pension funds came back to positive territory this year. Also in Bulgaria, like other countries in the CEE region, the authorities took at some point into consideration a reduction in the contribution level directed to the 2nd pillar, to save some budget money, but in the end such a measure has not been adopted.

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For the 3rd pillar, year 2010 could bring the introduction of multifunds, after several years of discussion on this issue. Currently, both the supervisory authority and the market players are preparing the technical details to implement such a reform. Combined assets of all the private pension funds in Bulgaria now stand at EUR 1.36bn. .

ROMANIA

Romanian pension funds are the only ones in the CEE region and among the few in Europe and the world which can boast excellent investment results for the last two and a half years, since the inception of the Romanian 3rd pillar funds. Launched in the troubled waters of the financial and economic crisis, the funds took a very conservative approach to investments and it apparently paid off. At the end of the first 9 months of 2009, the mandatory 2nd pillar managed EUR 475mn on behalf of 4.4mn active members. The funds posted an average annualized performance (return) of 15% since their inception, which is three times higher than the corresponding period’s inflation rate. Unfortunately, the system’s development was hindered at the beginning of 2009, when contributions were frozen at 2%, instead of 2.5%, which was the projected level for 2009.

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Afterwards, the signing of Romania’s arrangements with the international financial institutions (IMF, the World Bank and the European Commission) reaffirmed the Romanian Government’s intention to resume contribution increases as initially envisaged. This is a conditionality that the IMF and the other financial institutions impose to Romania, in order to make future disbursements.

In the meantime, voluntary pension funds, which manage over EUR 41mn worth of assets on behalf of almost 180,000 participants, also posted consistent positive returns – 7% in average, annualized, since their inception in May 2007.

In the short and medium term, the priorities for the Romanian private pension system are the setting up of the Guarantee Fund, an overhaul of primary legislation, possible introduction of multifunds, and also adopting payout phase legislation for the pension funds. Also, the 2nd pillar awaits, perhaps for 2011, the recovery to the initial calendar of contribution, after the much uninspired decision of 2009. While Romanian authorities continuously state that Romania does not yet afford a stronger 2nd pillar, the government increased public pensions by 5% this year, in spite of a 15% deficit in the public pension system, translated into a EUT 1.5bn deficit estimated for the year 2009.