WARSAW - Pension reform in the economies of Central and Eastern Europe is a very different ball game from in the European Union countries.
Hyperinflation during the early 1990s significantly eroded the already limited state pension systems of many countries east of the EU. The economic institutions necessary to support funded pensions, such as liquid and transparent domestic equity and bond markets, are at best relatively new and at worst non-existent in this region.
"The problems in the European Union are nothing compared with those of Central and Eastern Europe," said Kees van Rees, chairman of the European Federation for Retirement Provision.
Passing responsibility for investment decisions to individuals is a common feature of many attempts at reform. Many governments in the region are keen to follow the example of governments in Latin America, particularly Chile, and encourage citizens and local employers to take on the management of pension savings.
That will be good news for money managers and insurers looking for new markets. But progress has been slow, even in countries such as Poland and Hungary where new pension systems that combine public and private features have been put in place.
EU membership carrot
There is no doubt the prospect of joining the European Union is the carrot that has been encouraging Poland and Hungary in particular to reduce state spending. Pension issues will be key in future discussions on enlarging the European Union, said Mr. van Rees.
Regulators in Poland are certainly keeping a close eye on events in Brussels. Pawel Pelc, deputy director of UNFE, the domestic pensions regulator, said Polish pension law likely will be brought in line with EU law once it is clear what the draft directive on cross-border pension arrangements will look like.
Poland is at the forefront of reform in the region, and has introduced a broad restructuring of its pension system. Around 10 million Poles are estimated to be covered by the new system, which channels employers' social security contributions into a state-backed pay-as-you-go arrangement for people who were older than 30 at the beginning of 1999 and compulsory defined contribution funds for those younger than 30. Commercial insurers and money managers handle the defined contribution plans and citizens can choose from among 21 plan providers.
Iain Batty, a partner at the London law firm of CMS Cameroon McKenna, estimated assets in the new system to be around $1.3 billion at the end of June, the most recent data available. Assets are expected to grow to $76 billion by 2010. But the system is not without its flaws, and critics say its introduction was hurried and the state institutions that were to have administered it were not properly prepared. (See story on page 18.)
With Hungary's reformed second-pillar pension system, in which citizens invest part of their social security contributions into mutual funds, more people have joined the system than was anticipated. The participation mainly is due to generous tax incentives and some level of compulsion. Assets in the second pillar at the end of last year were estimated around $500 million. Assets in the country's third-pillar, or employer-backed, plans are very small. By 2009, assets in both second- and third-pillar, pensions are expected to be worth around $40 billion.
Moving too fast
The relatively rapid takeoff in Hungary's second pillar caused problems for the government as well. Too much money flowing into the mutual funds meant that not enough money was available for payment of current pensions through the pay-as-you-go state system. As a result, the Hungarian government has frozen contributions to the second-pillar scheme to 6% of employers' social security contributions, said Mr. Batty.
From 2002, Hungary's second-pillar mutual funds will be able to invest 30% of assets in non-domestic assets. In Poland, however, funds can invest only up to 5% outside of the home market. Reasons for that difference include that Hungary has a relatively small pension market and it is dominated by five mutual fund providers with established links to international insurance groups such as Allianz and AIG.
Russia is a market to watch and although progress has been slow, the political commitment is obvious, Mr. Batty said. President Vladimir Putin last month called for the establishment of a funded second-pillar pension system. "There is huge pent-up demand for pensions but the major thing holding the system back is where the assets would be invested," said Mr. Batty. Russian government debt has not had a particularly good credit record over the past few years. Corporate governance and transparency are key concerns in the country's equity market. "A foreign provider entering this market would clean up, but they would face enormous problems" during the initial years, he added.
Pension provision in the Czech Republic is confined mainly to the third pillar, where individuals have had to make private arrangements to build up retirement savings. However, at the beginning of last year, limited tax relief was introduced on group savings contracts with employers and this market is expected to grow rapidly in the next few years, according to research published by consultants William M. Mercer in Geneva.
In Kazakhstan, the state has allowed for the private sector to manage individual pension funds in addition to a state-run central accumulation fund to meet future pension liabilities. As assets in the private sector funds accumulate, the state's reserve fund is likely to be privatized. "This marks a very pronounced shift of responsibility to the private sector," said Mr. Batty. The central fund is thought to account for just more than half of the country's combined first- and second-pillar assets; private funds make up the balance of the savings. No figures were available on the size of the reserve fund.
Croatia is expected to follow Poland's example with a mandatory, funded, privately managed defined contribution system running alongside the state's pay-as-you-go system. A pension supervisory body has been put in place and, after some delay, the system is expected to launch at the beginning of 2002.
Latvia plans to introduce during the next year an arrangement where social security contributions would be channeled into pools of assets run either by the state or private-sector money managers. It is unclear how much will be managed by the state, Mr. Batty said. Confidence in the private sector's ability to look after savings is limited.
Pension provision, let alone pension reform, is almost non-existent in Romania at the moment. Pensioners reliant on the state system can barely afford to feed themselves, said Mr. Batty. Funded pension provision is only one of a number of solutions necessary for economic reform in the country. The Romanian government has been working on reforming its state pension system since 1997, but domestic political problems have scuppered parliamentary-level attempts to introduce a funded system similar to that of Poland. Mr. Batty hopes new legislation will be passed this year. A number of international insurers such as American International Group Inc., New York; Allianz AG, Munich and CGNU PLC, London, have set up shop in Romania and hope to get a slice of what is expected to be a large private pension market.