Taking
CEEC pensions seriously
Second pillar pension provision in Central and
Eastern Europe has been
developing at a rapid rate, and the potential for growth in this area
must not be
underestimated. Francesca Fabrizi explains
Central and Eastern European (CEE) countries
are gearing up for a pensions boom. While some might argue that these
countries are, compared to their Western European counterparts, still
in the early stages of pension development, the experts say otherwise.
Indeed, the likelihood is that as and when more employers set up offices
in this part of the world, and awareness rises of the need for individuals
to save for their own retirement, levels of contributions into 2nd and
3rd pillar pensions will increase dramatically.
One common feature of these countries is that they have all relatively
recently introduced three pillar pension systems. This includes a 1st
pillar which is a minimum level state pension, normally Pay As You Go;
a 2nd pillar typically funded by the employer and employee; and a 3rd
pillar which is voluntary.
With the general foundations now laid, this is a market that is set to
experience an awful lot of pensions activity in the coming years. In fact,
says Michael Brough, senior international consultant at Watson Wyatt,
over the next five to ten years, there is likely to be a high volume of
contributions coming in from this side of the world as both salaries and
levels of interest in pensions increase.
But realistically how much growth is actually expected? Last year, Allianz
Global Investors produced a report on the pension systems in 11 Central
and Eastern European countries which revealed deep structural reforms
fuelling
a projected 19% per annum increase in private pensions assets until 2015.
Brigitte Miksa, head of international pensions at Allianz Global Investors,
explains: “There were four major findings of the report that I would
like to highlight. The first is that old-age dependency ratios in CEE
countries will worsen considerably, similar to Western Europe and in some
cases get even worse.
“Second, as a whole, the region has experienced fundamental pension
reform and this has been marked by the introduction of capital funded
accounts; there has been a very courageous approach to the introduction
of DC and this on a mandatory basis and this is fairly remarkable compared
to the traditional pension Western European markets.
“Third, the size of the financial assets in the region lag far behind
Western Europe – general household investment behaviour is much
more conservative than in more developed capital markets with a very strong
focus on
currency deposits.
“Fourth, we expect the pension markets in Central and Eastern Europe
to grow considerably – we expect a 19% yearly growth rate in pension
assets with an increase from €51bn to €245bn in about eight
years.”
One country not covered in the report was Romania as its development happened
too late for the report. Alexander Börsch, the project manager for
the report, explains: “Romania was the last country in Eastern Europe
to introduce the three pillar pensions system late last year, but it has
since experienced a very rapid asset growth with about 2.2 million of
the 3.8 million eligible having already joined; and while the whole regulatory
framework has not yet been finalised, this is definitely a country to
keep an eye on.”
Poland
One country which is seeing particularly high levels of pensions activity
is Poland. Watson Wyatt, for example, is working on a variety of different
projects in the region, says Brough, helping clients design schemes. “Very
often we are working with organisations that are setting up a new business
– for example a multinational re-locating from Western Europe to
the East and choosing Poland – and they need to know which benefits
they should offer their workers; what the appropriate levels of pay and
benefits for these job roles are; which providers they should be using,
and so on.”
In terms of scheme design, only a DC structure exists in Poland –
there is no defined benefit per se, even when it comes to state benefits
– and there are currently only around 20-25% of multinationals providing
some kind of supplementary pensions arrangement. “So”, reiterates
Brough, “there is huge potential here. A lot of employees are spending
time, for example, in the UK and becoming members of a UK plan and then
going back and seeing they don’t have the equivalent arrangement
in Poland, so they are creating a demand for it. Pensions are also seen
as being such a useful recruitment and retention tool that more and more
employers are looking to introduce them and in particular at the executive
level.”
In Poland there are two routes employers can go as far as their pension
vehicle is concerned – the qualified or the non-qualified route.
The qualified route – which is marginally more tax efficient –
has a restrictive set of rules, so employers don’t have the creativity
they might like. The non qualified route, on the other hand, is more flexible
and almost anything is possible – the company can be as creative
as it wants to be.
At the moment, says Brough, it is a fairly even split between those that
go the qualified route and those that go the non-qualified. “For
those employers that want to provide a simple design for everyone, the
first route works well; those that want to be a bit more financially creative
will go for the second.”
Another feature of pensions in Poland is that there are typically very
few options available when it comes to the fund range. Brough explains:
“Most have four fund options to pick from and they follow the extremes,
so you have a cash fund, a bond fund, a balanced fund and a stock fund
– employees are left to choose between these four.”
Added to this, not many people receive investment advice so employees
are at risk of either reckless conservatism with young people investing
in cash all their lives or at the other extreme older people closer to
retirement investing in a high risk fund. It is fairly unlikely, however,
that better financial education is going to be at the top of the government’s
agenda in the immediate future, argues Brough: “There was a fairly
recent change of government in Poland, and while the new president has
made a few appointments within the Ministry that covers pensions, pensions
are still not high up enough on the political agenda as healthcare is
much more of a focus. But given the qualified route doesn’t work
very well, that the tax system doesn’t fit well with the rest of
Europe and that there is a growing desire in Europe for pan European pensions,
there is a real need for pensions in Poland to be given some further attention.”
Czech Republic and Slovakia
Two other countries that have been on the pension radar in recent times
are the Czech Republic and Slovakia, which are fairly similar when it
comes to their pensions offerings. Brough explains: “The tax rules
in both these countries tend
to drive design – a company tends to get a 3% deduction for its
contributions, so about 90% of companies offering plans have a 3% contribution
rate as it is tax efficient. This is, however, a very low level of contribution
which is likely to be an issue in the long-term as 3% doesn’t buy
you much in pension terms, so there is a need for reform to make tax incentives
a bit more generous so people will contribute more.”
In the Czech Republic, however, employees do get tax deductions on contributions
at pretty low levels of limit and there can be State enhancements to encourage
contributions. Brough explains: “It works very much like a personal
pension plan type environment – people have individual arrangements
which are transferable and portable – you can move around from employer
to employer and take these pension pots with you. Also, in the Czech Republic
there are no penalties for transferring which is different to Slovakia
where there can be fees that apply when you transfer, so it not as open
and transparent.”
In addition, there is a much higher take-up and a larger number of employers
offering pension plans
in the Czech Republic and Slovakia compared to neighbouring countries
driven by, says Brough, the tax rules and the tax benefits in these countries.
Also, the fact that these products are simple to set up has meant that
the providers are much sharper and better at selling them which has boosted
their take-up. “Providers tend to offer all sorts of discounts across
other products.”
Looking briefly at some other countries in the region, in Russia, there
is still very much a “cash is king” mentality – people
are looking for more pay, while benefits are less of a focus. Brough explains:
“There is pretty much full employment in Moscow so people are regularly
being poached by employers who are prepared to pay a lot to tempt workers
away. In particular, the big Russian national organisations are paying
as much as 100% pay rises to attract staff away from the multi-nationals.”
In response, some employers have been looking within the benefits framework
to help with the recruitment and retention of staff, so there is a definite
move towards offering benefits here, says Brough*.
Kazakhstan, Uzbekistan and Ukraine are all a little bit behind Russia
as far as their pension structures are concerned, continues Brough, but
they are beginning to have similar employment problems in that people
with the right skills are becoming harder to find, particularly qualified
engineers, senior executives and administrators with good English skills.
As a result, good employer incentives such as pensions and benefits are
likely to move further into the spotlight.”
Going forward
But while there is considerable potential for 2nd pillar pension growth
in the CEE region, more needs to be done in the meantime as State benefits
are far too low to cover the shortfalls until contributions are at sustainable
levels. The incentives to top up the low levels of state benefits in some
of these countries – especially Poland – are not very good,
so there is a demographic time bomb waiting to happen. All of these countries
have ageing populations, people are living longer and so how are they
going to support themselves in retirement if the levels of state benefit
are low and there is little incentive to encourage topping up?
So while the CEE region has great potential, it does need the support
of the governments and the sooner these governments embrace the issue
the better. “Hopefully the various governments in this area will
look to simplify and reform the tax structures to make them more attractive
so that more and more pensions are paid in,” says Brough.
The CEEC Forum
To help ensure Central & Eastern Europe pensions development is not
left out of the general European debate, the European Federation for Retirement
Provision (EFRP) recently set up the CEEC Forum, bringing together representatives
from private pension institutions – operating both mandatory and
voluntary schemes – from new
EU Members that over the past decade have introduced multi-pillar pension
reform.
The Forum provides an opportunity for these representatives to: discuss
issues common to Central & Eastern European pension systems; exchange
views on experiences in pension systems and promote common European values
in pension systems.
Csaba Nagy, chairman of the Hungarian Association of Pension and Health
Funds, Stabilitàs, was appointed Chair of the CEEC Forum last year.
Nagy comments: “We are still in the early stages of development
with the CEEC Forum, but the last meeting we held was a great success
– it was very well attended with representatives from Bulgaria,
the Baltic countries, the Czech Republic, Romania and Hungary, to name
a few, and the main topics of discussion
were the implementation problems of the IORP directive and the restrictions
of DC pensions – we had an excellent presentation from Oxera on
this topic.”
Commenting from a more local perspective, the pension system in Hungary,
he says, is developing nicely. “The hottest news for us at the moment
is that two new members have joined Stabilitàs – the pension
fund of the Hungarian Army and the pension fund of Electricity Companies,
which is excellent news for us.”
On the regulatory side, however, Nagy has also been busy. “At the
beginning of last year new legislation was brought in which included provision
for the centralisation of collection of current contributions and payments
in arrears – which became the duty of the Hungarian Tax Authority.
And while there have been some teething problems with the transformation,
we are on the right track and we will be working actively with the Authority
in order to finalise this transformation period.”
The main aim of the legislation is to push down the costs of pensions
in Hungary. Nagy continues: “There are two main drivers of cost
in this industry – from the asset management side and the administration
side. Costs have already been limited on the asset management side by
legislation, and the administration costs should in the long run be reduced
by
this centralised collection and centralised administration set-up.
“We also recently launched a multi portfolio system for the mandatory
and voluntary pension funds which includes three portfolios: conservative,
balanced and dynamic; and so our pension fund members are classified into
these portfolios.” The investment portfolios are designed to take
into consideration the age and lifestyle of the member.”
Overall, he adds, these legislative changes are very significant and will
enable domestic pension funds to adopt practices which will enhance the
overall operation of the funds.
“It is vital to improve performance and meet the competitive challenges
of the domestic pensions industry as well as those in the dynamically
growing European Union pensions market.”
*For a more detailed account of pensions in Russia (written by Michael Brough) please click here.
