FUNDED PENSIONS IN CENTRAL AND EASTERN EUROPEDesign and Experience

Agnieszka Chlon-DominczakGeneva, October 9th, 2003

Countries implementing mandatory funded pension schemes

0

2

4

6

8

10

12

1997 1998 1999 2000 2001 2002 2003 ...

num

ber o

f cou

ntrie

s

HungaryKazakhstan

PolandLatvia

CroatiaEstoniaBulgaria

Macedonia

LithuaniaSlovakiaUkraine

Dependency rate(65+/15-64)

Population ageing

0

10

20

30

40

50

60

Bulg

aria

Croa

tia

Latv

ia

Esto

nia

Hung

ary

Pola

nd

Mac

edon

ia

Kaza

khst

an

num

ber o

f per

sons

old

er th

an 6

5 pe

r 100

per

sons

age

d 15

-64

2002

2050

Pension expendiutre

0

2

4

6

8

10

12

14

Croa

tia

Pola

nd

Mac

edon

ia

Hung

ary

Bulg

aria

Latv

ia

Esto

nia

Kaza

khst

an

% o

f GDP

Reasons for the multi-pillar reform

• to make the pension system sustainable in long run to reduce implicit pension debt to diversify risk

• to achieve better balance between collective and individual responsibility in the pension system

• to encourage additional savings• to develop and strengthen financial markets

Design

Minimum pensionsCountry Minimum pension

level(% of averagewage in 2002)

Qualifying period(women/men)

Structure of the guarantee

Hungary 17% 20/20 Financed from the state budget

Kazakhstan 20% 20/25 Financed from the state budget, topping-up pensionsreceived from the funded pillar

Poland 30% 20/25 Financed from the state budget, topping-up pensionsreceived from the first and second pillars.

Latvia 17% 10/10 In the first tier, financed from social securitycontributions.

Croatia 10,5%2 15/15 In the first tier, financed from social securitycontributions.

Bulgaria3 19% 15/15 In the first tier, financed from social securitycontributions.

Estonia 13% 5/5 In the first tier, financed from the state budget

Macedonia 41%

38%

35%

Over 30/35 years

Over 20/25 years

Over 15 years

Financed from social security contributions, topping-up pensions received from the first and secondpillars.

Changes in the PAYG

• to balance public pension expenditures

• to create room for financing the transition costs

Strategy Countryexamples

Going towards defined contribution

Poland

Latvia

Croatia

Reducing existing defined benefit

Hungary

Bulgaria

Estonia

Macedonia

Flat rate minimum benefit Kazakhstan

Contributions

• Tax treatment: usually EET• Size of contributions to funded component depends on capacity to finance transitions costs

0%

5%

10%

15%

20%

25%

30%

35%

Poland Latvia Bulgaria Hungary Macedonia Croatia Estonia Kazakhstan

non old-age first pillar second pillar not a funded scheme member

0%

5%

10%

15%

20%

25%

30%

35%

Poland Latvia Bulgaria Hungary Macedonia Croatia Estonia Kazakhstan

non old-age first pillar second pillar not a funded scheme member

Participation in the funded pillar

18 24 30 36 42 48 54 60

Hungary

Macedonia

Estonia

Latvia

Poland

Croatia

Bulgaria

Kazakhstan

mandatory

voluntary not allowed

Transition costs• Size depends on:

policy choices contributions members of funded system

individual choices• Examples:

Poland: 1.6% of GDP Hungary: 0.6% of GDP

• Financing: current tax revenues savings on pensions future revenues (debt)

Contribution collection

K azakh stan

C roa tia

S ep ara te in s t itu tion

P o lan d

B u lg aria (u n til 2 0 0 3 )

M ac ed on ia

S oc ia l S ec u rity A d m in is tra to r

L a tv ia

E s to n ia

B u lg aria (from 2 0 0 4 )

U n ified co llec tion w ith tax

C en tra lised

Hu ng ary

D e-c en tra lised

C on trib u tion c o llec tion

Supervision

C roa tia

M aced on ia

S ep ara ted

K azakh s tan

P o lan d

P artia lly con so lid a ted

H u n g ary

B u lg aria

L a tvia

E s ton ia

F u lly con so lid a ted

S u p ervis ion

Licensing• financial requirements:

minimum shareholder capital,• legal provisions and quality check:

presenting draft articles of association for the approval of the supervision

business plan information on the quality of the managers

0% 20% 40% 60% 80% 100% 120% 140% 160%

Kazakhstan

Poland

Croatia

Macedonia

Hungary

% of assets

Corporate bonds, equity and investment fundsMunicipal bondsshort-term bank depositsreal estate

Investment limits

Min 50% in state bonds

Min 50% in state bonds

Foreign investment

• In Estonia: only investment in specified categories of foreign investment, no quantitative limit

0%

5%

10%

15%

20%

25%

30%

35%

Hun

gary

Latv

ia

Mac

edon

ia

Cro

atia

Kaz

akhs

tan

Pol

and

Bul

garia

Guarantees• Rate of return guarantees:

Relative to pension sector Kazakhstan Poland Croatia

Relative to benchmark: Hungary

• No rate of return guarantee: Latvia Bulgaria Estonia Macedonia

• Financing of guarantees: Mandatory reserves

Hungary Kazakhstan Poland Bulgaria Estonia

Guarantee funds Hungary Poland Estonia

Payouts• Mandatory annuity:

Hungary (pension fund or insurance company) Poland (providers not decided yet) Croatia (specialised companies) Bulgaria (licensed companies) Estonia (licensed insurance companies)

• Several options: Latvia (various annuity types - joint, variable, deferrals) Macedonia (annuity or scheduled withdrawal) Kazakhstan (once the system matures - annuities, currently

lump-sums are allowed)

Transparency and accountability

• Annual statements financial statements investment structure shareholders structure

• Valuation of assets• Information for participants

individual accounts (by mail, also by Internet or telephone)• Web site• Publishing investment results

Experience

Members

Funded system participants (ths) % of all contributors

Kazakhstan 5 141 100%Poland 10 990 76,4%Hungary 2 253 49,6%Bulgaria 1 115 48,40%Croatia 938 67,50%Estonia 210 35% (of choice group)Latvia 325 32%

Membersage distribution

• Similar age pattern in Poland and Hungary, despite different switching policies

• Other countries: in Estonia: 45% in the age group 20-25 and 32-34% in age group 26-60,

fairly equal distribution

0%

20%

40%

60%

80%

100%

Hungary Poland

above 55

40-5530-40

up to 30

Number of funds

Initial year 2002Kazakhstan 10+1 13+1Hungary 38 18Poland 21 17Bulgaria 8Croatia 7Estonia 6 15 fundsLatvia 6 11 plans

Concentration

0%

20%

40%

60%

80%

100%

1 2 3 4 5 6 7 8 9 10

% o

f tot

al m

embe

rs

Bulgaria

Estonia

Croatia

LatviaKazakshtan

PolandHungary

• Significant share of state funds in Latvia (76%) and Kazakhstan (46%)

Average size

0100200300400500600700

Pol

and

Kaz

akhs

tan

Bul

garia

Cro

atia

Hun

gary

Latv

ia

Est

onia

thou

sand

per

sons

Market structureTRANSFERS BETWEEN FUNDS

• Fewer transfers among funds than expected: in Hungary around 1% of members changed funds In Poland the number of changes is growing:

1.4% in 2000 1.7% in 2001 3.1% in 2002

in Kazakhstan: mostly transfers from state to non-state pension funds share of state pension fund decreased from 82% in 1998 to 46% in 2001 smaller movements between private funds

in Latvia: in 2003 c. 12% participants changed from state to private pension funds

Assets(USD MLN)

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

1998 1999 2000 2001 2002

mill

ion

USD

Hungary Kazakhstan Poland

Assets• Role of pension funds as institutional

investors:

stock market capitalisation

pension funds' equity

% of stock market in pension funds:

Hungary 6,28 0,16 2,6%Poland 6,19 2,13 34,4%

Investments

0%

20%

40%

60%

80%

100%

Pola

nd

Kaza

khst

an

Hun

gary

Bulg

aria

Cro

atia

GDS Equity Others

c

Design of funded systems:• Countries tend to limit:

types of charges contribution based asset based performance based transfer fee

levels of charges for all or for selected charge types

• Charges deducted only by managers• In few cases: specific charges can be paid directly

from pension fund assets

Charge design in the region

Types of chargesCountry Limits on charge

structure admission fee contribution-based fee

assetmanagement fee

performance fee

Hungary Kazakhstan Poland Latvia Croatia Bulgaria Estonia Macedonia

Source: Agnieszka Chlon-Dominczak, Funded Pensions in Eastern Europe and Central Asia: Design and ExperiencePaper prepared for the World Bank in co-operation with FIAP (2003)

Impact of fees in selected countries

Poland2001

Polandnew law

2004

Kazakhstan2001

Kazakhstannew law

2002

Croatia2002

Croatia –draft law

Up-front fee(% contribution) 8.5* from 7.0 to

3.5 1 0 0.8 0.8

Management fee(% assets) 0.6 Up to 0.54 None 0.6

(0.28) None 1.2

Rate of return fee/‘performance fee’ (%return)

None Up to 0.06 10 15 25 None

Reduction in assets 17.4 14.4 10.3 16.5 29.3 26.4Reduction in yield 0.82 0.65 0.37 1.13 1.61 1.19

Source: World Bank (2003)

Charges - actual performance:

• Charge levels are different across countries

• They reflect the legal design, supervision practices and competition

• Economies of scale are hardly observed

Charges vs. size of pension funds

Kazakhstan and Poland:y = -0.1209Ln(x) + 2.926

R2 = 0.0389

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

0 150 000 300 000 450 000 600 000 750 000 900 000

number of members

aver

age

char

ge p

er m

embe

r (in

ths

teng

e)

y = 10.502Ln(x) - 71.521R2 = 0.1763

30

50

70

90

110

130

150

170

190

0 500 000 1 000 000 1 500 000 2 000 000 2 500 000 3 000 000

number of members

aver

age

char

ge p

er m

embe

r (in

PLN

)

• Charge level does not depend on the pension fund size• Some economies can be seen in Kazakhstan• In Poland - bigger funds charges are higher

Kazakhstan 2001 Poland 2002

Early experience with costs

• Costs of initial year high: driven by sales and advertising

• Reductions in following years• Some costs imposed by the law

costs of guarantees and mandatory reserves costs of reporting costs of supervision

y = -0.8075Ln(x) + 10.638R2 = 0.6997

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

0 150 000 300 000 450 000 600 000 750 000 900 000

number of members

aver

age

cost

per

mem

ber

(in th

s te

nge)

y = -18.783Ln(x) + 336.7R2 = 0.185

30

50

70

90

110

130

150

170

190

0 500 000 1 000 000 1 500 000 2 000 000 2 500 000 3 000 000

number of members

aver

age

cost

per

mem

ber

(in P

LN)

Charges vs. size of pension funds

Kazakhstan and Poland:

• More economies of scale than in the case of charges• In Kazakhstan - stronger than in Poland

Kazakhstan 2001 Poland 2002

Rates of return• Kazakhstan:

relatively high real returns, little disparity between funds

significantly better performance of state fund - different asset allocation

• Poland lower, but still above zero real

returns large differences between funds

• Hungary lack of comparable data in 2001 net fund returns at 6.1%

KAZAKHSTAN June 2000June 2001

October 2001October 2002

June 2002June 2003

Weighted average 6.81/% 6.50% 4.12%Non-state Accumulation Funds:standard deviation 1.01% 0.51% 1.96%Minimum 5.44% 5.33% -1.07%Maximum 8.70% 7.07% 5.41%State Accumulation Fund 5.14% 9.04% 5.19%

2000 2001 2002Inflation rate 13.2% 8.4% 5.9%Real wage growth 5.7% 9.5% 10.0%Bank deposit rate (nominal) 14.7% 12.8%% 11.0%

POLAND December 1999December 2000

December 2000December 2001

December 2001December 2002

Weighted average 4.5% 2.1% 14.5%Standard deviation 3.5% 3.5% 2.7%Minimum -0.9% -5.4% 6.3%Maximum 12.5% 6.3% 16.6% 2000 2001 2002Inflation rate 8.5% 3.6% 0.8%Real wage growth 4.2% 3.6% 2.7%Real bank deposit rate 6.5% 4.4% 3.8%

Administrative costsPOLAND

0

200

400

600

800

1 000

1 200

1 400

1 600

1 800

2000 2001 2002

PLN

bn

sales and marketing

other costs

reserves and guarantees

ConclusionsMEMBERS AND MARKET STRUCTURE

• Overswitching or underestimation? distrust to the public system belief in private savings?

• Large concentration: biggest funds: bank or insurance backing

more efficient sales? earlier presence on the market?

• Little changes between funds design worked? outflow from public managers

ConclusionsASSETS AND INVESTMENT

• Assets will be growing at a fast pace• Increased investment in equity would be

desirable to diversify risk within pension system, not

only within funded pillar• Necessity to increase foreign

investment limits

ConclusionsCOSTS AND CHARGES

• Costs still relatively high

• Necessity to work on the cost reduction:eliminating excessive guarantees increasing client’s awareness

Conclusions• Trend towards multi-pillar schemes:

Implemented in 8 countries Considered in Slovakia

• Experiences up to now: high participation fast increase of pension savings concerns regarding transition financing

Issues for the future• Elements of success:

prudent supervisionprudent investments

equity foreign investments

transparency and accountabilitykeeping costs low re-thinking guarantees