Russia: the time is right

The pensions landscape in Russia is changing for the better.
Michael Brough explains why

Whilst occupational pensions remain the exception rather than the rule in Russia today, with perhaps only 5 to 10 per cent of the population currently expecting an additional benefit to the available provision from the State, this is expected to rise dramatically over the next 20 years. This rapid increase is likely to be driven by companies changing HR benefit policies and practices to address local and regional skill shortages, using creative benefit design.

This in turn is likely to be encouraged by the growing numbers of global (and local) insurance and pension providers carrying out their business in Russia. In addition, Government reforms to encourage and incentivise private pension provision is expected largely in an attempt to combat the effects of the ageing population.

Skill shortages in a wide number of industries across Russia (predominantly in Moscow and St Petersburg) mean that there is a war for talent. This has led companies increasingly to use benefits (and therefore pension arrangements) as part of their reward strategy to attract and retain key talent.

How Russian and multinational companies are choosing to address this skill shortage can often be dramatic and rather short-sighted. They largely focus on the “cash is king” mentality, which is evident in Russia (driven by a 13 per cent flat rate of income tax).

A case in point is the limited although growing practice by companies of simply attempting to buy out a key employee’s rival’s contract through paying up to two or even three times salary. Counter to this, there are companies setting aside a defensive “war chest” of up to two or three times a key employee’s annual salary, so that should a rival seek to attract them away, the company already has the resources set aside to retain that employee. This is clearly an unsustainable practice as future salary levels and growth mean companies must consider the much wider talent market as a whole, where such practices remain exceptional.

How companies deal with skill shortages remains company specific, but there are increasing numbers of alternative strategies being considered both by Western multinationals operating in Russia as well as Russian corporations. A few examples include:

Introducing a new pension scheme: This would typically be defined contribution (DC) in nature and would come with company contributions and usually an employee contribution requirement to aid appreciation of the benefit. A vesting schedule is also popular to encourage longer-term saving. Such pensions are relatively unsophisticated, but do come with a requirement to guarantee investment returns. This largely constrains creative asset allocation strategies and in recent times, with the significant growth in the Russian equity market, has meant existing DC pension plan members have not enjoyed the returns that could have been available to them had these guarantee requirements not been in place.

Introducing a basic “flexible benefits” programme: This is where companies seek to offer key workers benefits from a menu to specifically suit them and their dependants.

Key workers in Russia are commonly provided with private medical healthcare, life and disability insurances, critical illness cover, luncheon benefits and other perquisites, such as club memberships and so on. DC pension plans are exceptional but sit well within a flex programme. A more targeted approach around offering flexibility is therefore growing in popularity as companies seek to retain key talent. One difficulty here though has been around the abilities of providers to effectively administer a flex programme.

Targeted and focused benefit planning at recruitment stage followed by regular ongoing review: This is a strategy growing in popularity. Understanding benefit needs at the pre-employment stage and then monitoring this over time is vital. Many key executives, for example, are currently keen to develop Western skills and affording them opportunities to work outside of Russia for periods, to become involved in foreign learning via training courses and conferences, is now extremely popular.

Grasping opportunities
Over the last few years (and particularly since the 2001/02 pension reforms), there has been an increase in the number of pension providers – insurance groups principally – entering the Russian market, particularly those with strong European parent groups. This clearly indicates that the provider markets are gearing up to respond to anticipated increased levels of new pensions business.

Many of these providers have been entering other Eastern European markets over the last ten years or so and have enjoyed significant business. By entering the Russian market early and in their numbers (AIG, AVIVA, ING, Raiffeissen and ERGO, for example) indicates clearly that they see the Russian DC pensions market as being important and that future significant business opportunity and market advantages are here now.

Russia, like much of the rest of the world, is facing the same problems associated with too few workers being required to support increasing numbers of pensioners. In Russia, this is combined with the tragic demographic trend of a decline in male life expectancy. This mortality trend is unusual and has seen male life expectancy fall to under age 60, which is lower than Russia’s pre-1950s levels. A demand for some 20 million immigrants will be required to sustain economic growth over the next two decades.

Russia recognises that it must act to contain its public pension liabilities in an ageing society and by introducing pension reforms it is clearly acting sensibly to encourage second pillar and third pillar pension provision.

Tackling the problems of falling male life expectancy, as well as filling skills shortages by acknowledging and encouraging widespread immigration, means there is a need for Russia to go much further. Perhaps offering improved tax incentives to encourage pension savings and liberalising investment rules will provide some of the necessary triggers to more rapid growth in private and occupational provision.

The Russian government is also keen to support the growth and development of occupational and voluntary individual pension programmes for a wider proportion of the Russian population. It has also indicated recently the need to have a robust system of indexed state pensions, as well as sufficient tax incentives to encourage pension savings in the third pillar.

All in all, this is an important time for pensions in Russia and the government has a real opportunity to transform its system to meet the challenges that lay ahead.

Written by Michael Brough, senior consultant at Watson Wyatt