The Eurasian Connection Organised by Kring Internationaal Johan de - - PowerPoint PPT Presentation

The Eurasian Connection

Organised by Kring Internationaal Johan de Witthuis, Utrecht, 14 April 2016

W elkom

W elcom e Wilkommen Bienvenida Bienvenu Bem-vindo Velkommen Benvenuto

Välkommen

Tervetuloa Dobrodošli Witaj

Program

16.30 Doors open 16.45 Welcome and introduction of the guests by Caroline Tuin, Chairperson Kring I nternationaal 17.05 Rob van Leeuwen will take us to the world of pensions in the countries that were the former Soviet Union 17.45 I ain Batty, laywer at CMS Cameron McKenna. As one of the founders

• f the pension system in Poland, I ain will talk to us about the

developments in the pension system in Eastern European countries that are now member of the EU. 18.25 Q&A 18.35 Closing drinks and networking opportunity 19.30 Doors close

Welcome and introduction of the speakers

Caroline Tuin

Agenda

• Welcome
• I ntroduction of our guests

Welcome

to the 4th meeting of the Kring Internationaal

Introduction of our guests

• Rob van Leeuwen (1964):

– Graduated in 1989 from Groningen University with a Masters degree in mathematics; – Became a full member of the Royal Actuarial Association of the Netherlands in 1995; – Working since 2001 in successor states to the former Soviet-Union (predominantly in Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, the Russian Federation, Tajikistan and Ukraine); – Before 2001, Rob worked for several Consulting firms in the Netherlands as well as in Russia and as a technical director and member of the management board at a mid-sized insurance company in the Netherlands; – Since 2001, Rob has been working on a combination of international donor projects and assignments for private sector clients in the CIS.

Introduction of our guests (2)

• I ain Batty:
• Has been practising as an English solicitor for 25 years
• Is a partner at the leading international law firm, CMS, and is responsible for the

co-ordination of the Commercial Practice in Central and Eastern Europe;

• Has a wealth of experience in the CEE region having worked there since 1991

and having lived there since 1997. He is based in Poland but travels extensively through the region;

• Has been involved in drafting pension fund legislation for a large number of

countries in the region including Poland, Bulgaria, Romania, Croatia, Slovakia and Macedonia. He has also worked in Russia, China and Kenya;

• Iain has a particular focus on advising insurance companies and pension fund
• perators on a variety of commercial, regulatory and contractual issues across

the region;

• Iain regularly speaks at conferences and appears in the press.

Pension reform in the former Soviet Union - out in the desert

Rob van Leeuwen

The Washington consensus

• Or: roll-out of the Chilean model
• I n the early 1980-ies Chile has reformed its pension system, to include a

mandatory, funded, Defined Contribution, privately managed component

• This was part of a wider reform effort, to set the Chilean economy on a

market-oriented (or: “capitalist”) path

• I t fitted well with the general “zeitgeist” (Reagan, Thatcher, Milton

Friedman),promoting self-reliance instead of dependency of the State

• These reforms were copied widely in Latin America (Argentina, Bolivia,

Colombia, Mexico, Peru etc.)

• Success factor: 35 years of continually declining interest rates
• Problem: high marketing, administration, asset management costs
• Reforms were picked up by the World Bank, I MF, USAI D, EU
• When former socialist economies started to transfer to market economies

in the 1990-ies, this opened a new field for the introduction of the “three pillar” model

The three pillars (of wisdom?)

• Pillar I : mandatory, PAYG financed, can include a basic pension, often

includes a Notional Defined Contribution (NDC) component

• Pillar I I : mandatory, funded, Defined Contribution (DC)
• Pillar I I I : voluntary, includes both occupational pensions and private

arrangements This is the World Bank classification, which is most widely used in practice Problems:

• The “double burden” or “transition burden”

– no extra cost: implicit liabilities are made explicit; or should we say: – liabilities (to citizens) that can be reneged upon become “harder” (to bondholders)

• Risk of high marketing, administration, asset management costs
• Citizens fail to make informed choices

Advantage: citizens have their nest eggs in two baskets:

• The demographic, domestic, labor share of GDP-dependent basket
• The potentially international, capital share of GDP-dependent basket

Kazakhstan

• I ntroduced in 1998
• Pillar I mostly concerns legacy pensions, a basic pension and a minimum

guarantee

• Pillar I I is dominant

– Funded by an employee contribution of 10% of wages – From 2018 the employer will contribute an additional 5% of wages

• Pillar I I I is virtually non-existent
• The State took the transition burden upon itself
• I mpeccable technical implementation:

– A legal and supervisory infrastructure creating a wide array of potential investment vehicles – After initial hick-ups the contribution collection mechanism was sophisticated and automated

• Problem: lack of investment opportunities, resulting in low nominal returns

and negative real returns

• The State guaranteed a 0% real return
• 2013 reform:

– all pillar II pension funds were brought under State Control – The strict DC system is to attain DB elements – details remain hazy

Russian Federation

Russian Federation

• I ntroduced in 2002
• All contributions paid by the employer
• Pillar I : a basic pension + an NDC component (contribution 22% for those

born before 1967, 16% for those born thereafter)

• Pillar I I : based on a contribution of 6% for those born in or after 1967

– since 2014 also these are diverted to Pillar I; this moratorium will extend at least into 2017 – since 2015 participation in Pillar II is voluntary

• Pillar I I I is mostly limited to industry-wide DC plans and DC plans of some

foreign employers

• The system is hugely in deficit: about 50% of pension payments comes

from general taxes

• Recently the NDC system moved to a “points” system, which allows the

government to better control costs in times of high inflation

• Pension age 55 (female) respectively 60 (male) – still a “sacred cow”

Other countries

Ukraine:

• Has been contemplating the introduction of a second pillar for 15 years – it

was supposed to happen when several macro-economic parameters (e.g. inflation) would meet certain criteria

• What actually happened was that only the minimum pension was

somewhat indexed and as a result over time all pensioners are squeezed to the minimum Azerbaijan:

• Did a good job implementing Pillar I : a basic pension + an NDC component
• I s implementing a funded pillar in a very cautious way (and rightly so!)

Tajikistan:

• I mplemented a funded pillar in 1999, but it remains underdeveloped
• Only in 2013 crossed over from the Soviet DB system to an NDC system,

but also this reform is far from complete, mainly due to lack of human resources

Conclusions former SU

• As Leo Tolstoy said: “All happy families are alike; each unhappy family is

unhappy in its own way.”

• I n Russia and Kazakhstan pension reform has been partly reversed
• I n Azerbaijan, Tajikistan and Ukraine it hasn’t really taken off yet

Problems:

• The transitional “double burden” was underestimated

– “Petrostates” coped with this more easily – until recently

• Real investment returns were overestimated
• Lack of knowledge and indifference on the part of the population

– Great scope for “nudging” people into one or the other choice by making it the default option

• Lack of investment opportunities

– Notwithstanding rhetoric about pension systems providing a “stable base of long-term investors”

• Wider economic instability not conducive to stable retirement saving

– Inflation, currency depreciation, corruption, civil war, political risk

• The State can be a good arbiter between private parties

– However, as a contributor, having the State as your counterpart is something different…

Pensions in Eastern Europe

• a hasty retreat?

Iain Batty

Wave of reform to create three pillar pension systems

• Reform spread across the region with new laws implemented between 1998

and 2005

• Wide-ranging reforms in Poland, Hungary, Romania, Bulgaria, Croatia,

Macedonia and Slovakia

• The Czech Republic was a straggler, introducing its reforms in 2013

Pensions Terminology in CEE

• Differs from existing EU terminology
• First Pillar – state social security
• Second Pillar – mandatory, funded, privately managed
• Third Pillar – voluntary, funded, privately managed, whether employer

sponsored or individual

Overview of Pension Reform in the Region

• Until mid 1990s virtually no funded provision
• State was monopoly provider
• After that many countries in the region underwent radical reform
• Reform justified by need to avert a demographic crisis and also the need to

create domestic institutional investors

• Reform heavily influenced by World Bank

Moves to Three Pillar System

• Move to a three pillar system inspired by the World Bank
• I n Pillar I individual benefits are more closely linked to contributions
• Many people are (or were) able to contribute to privately managed Pillar I I

funds

• return for making contributions to Pillar I I funds people pay lower

contributions to Pillar I

Legal Model - Segregation of Management Company and Fund

• Standard model in CEE countries
• I ncreases transparency of ownership
• Lessens opportunity for fraud
• Provides clearer charging structures
• Assets deemed to be owned by state
• Eurostat decisions and court cases
• Caused problems for fund sponsors later on

Charging structures

• Fee on positive investment return
• Fee on contributions
• Fee on assets
• Switching/ withdrawal fee
• Varying fees depending on relative performance

Guarantees

• I mprove confidence
• But at a cost – ultimately members will pay
• Relative rate of return guarantee
• Central fund to be used in event of fraud – paid by pension funds
• Taxpayer funded resource – used for under-performance and fraud

Reversals of Reform

The middle of the last decade was the highpoint for CEE pensions. Concerns started to be raised because:

• little competition re charges
• uniform investment policies
• high proportions of investment in government paper
• switching between funds

The financial crash of 2008 had a decisive impact

Case studies Poland and Hungary

Poland – Legal Framework – Second Pillar

• I ndividual chooses fund
• Employer should not know identity of chosen fund
• Employer channels money to social security agency – ZUS
• Pension fund company controls pension fund
• Company is dedicated single purpose entity capitalised to minimum € 4

million

• Pension fund is purely pool of assets
• Regulation by interventionist supervisory body

Poland – Tax and Investment – Second Pillar

• Tax treatment of 2nd pillar is same as for social security contributions i.e.

EET

• Originally only 5% of pension assets could be invested abroad
• Quantitive restrictions on investment
• Funds did not take advantage of ceilings on equity investment
• Little in the way of corporate bonds
• Much went into government paper

Poland – death by a thousand cuts

• 2011 – reduction in rate of contribution from 7.3% to 2.3%
• Reduction in charges
• Modifications to guarantee system
• Restrictions on advertising

Poland - Further drastic cuts in 2014

• Transfer of 51% of assets to state social security
• Ban on investment into sovereign bonds
• ”Safety zip” mechanism
• Ban on advertising (reversed by Constitutional Court)
• Further participation in Pillar I I pension assets was made voluntary (default
• ption = only Pillar I )
• Fear now that new interventionist government will abolish system
• I f so, questions over what will happen to fund assets

Poland – Foreign Investment

• Originally capped at 5%
• Questioned by ECJ
• Now at 30%
• Currently ≈ 8% of assets invested abroad

Poland – Top Pension Funds

Fund 1) Nationale Nederlanden 2) Aviva 3) PZU 4) Met Life 5) AXA Total AUM – EUR 28 Billion approx. Number of members 3.0 million 2.6 million 2.2 million 1.6 million 1.1 million

Hungary – Pillar II

• Pillar I I went live on 1 January 1998
• Mandatory for those entering labour market for first time
• Voluntary for other groups
• Take-up rate was much higher than government expected
• Many Pillar I I funds but market was dominated by five players
• Consolidation subsequently took place
• Employer channeled contributions to funds and therefore had some

influence on decision

Hungary – Flawed legal regime – Second Pillar

• Legal form of MPF was unsatisfactory
• Strongly influenced by form of Hungarian voluntary mutual benefit funds
• I n theory banks and insurers could not establish funds
• I n practice they did
• Single legal entity – non transparent
• Governed by consolidated Hungarian financial supervisory authority

Hungary - devastation in 2011

• Populist nationalist goverment almost eliminated pillar
• Justified on basis that defecit needed eliminating
• I nitially categoried a suspension but then declared permanent
• I n theory members could remain as such
• I n practice this proved bureaucratic and difficult
• There are now around 60 000 members compared with one million plus prior

to 2011

• Sponsoring FI s took a haircut

Plundering of pension assets in

• Romania
• Slovakia
• Estonia

The Czech Republic implemented a new second pillar in 2013 and eliminated it in 2016

Lessons to be learnt

• Approach of CEE states should have been foreseen
• Biggest problem was that assets in funds were deemed to have been state

social security assets

• States had good reasons for doing this but this increased risks of

expropriation

• FI s have had their fingers burned. None are likely to want to re-enter the

mandatory pensions market in coming decades

• Many states struggle with troublesome demographics and state pensions

which provide little more than a subsistence income

• Will there be the emergence of viable voluntary pillars in the future?

Lessons for the Netherlands?

• We have around 50% in PAYG, around 50% funded

– That’s good (… is it?)

• We are an island of DB in a sea of DC.

– (High) time to change?

• The “second pillar” was actively pushed by international donors for developing

countries and countries in transition.

– Don’t try this at home! – It is not a panacea for aging of the population due to low birthrates and increased longevity

• I t shows however that the link between “employer” and “pension” is an accident
• f history rather than a natural phenomenon

– Compare with the link between “employer” and “health insurance” in the US, which we find strange

• Pension is the business of the individual, aided by the State
• The individual should – up to certain limits – be compelled to participate in

pension arrangements

• Competition between funds does not work very well, however the State should

not manage assets (is the Swedish model the answer?)

• Pensions should be based on a mix of PAYG promises and funded arrangements

QUESTIONS??

Next event

13 October 2016 The African Connection

Please join us for drinks and talks