Recent developments in the Slovak pension system

Peter PenzesWorld Bank International Insurance Symposium

15 – 16 October 2012

Overview

1. General characteristics of the Slovak pension system

2. Major changes in the design3. Underlying reasons4. Challenges and lessons

2

Slovak pension system

1st pillarsince 1907

coverage: 100%

public PAYG

mandatory

DB

Social Insurance Agency

Supervision: Ministry of Labour

Repl.rate: 45% average salary

2nd pillar(1st pillar bis)

since 2005

coverage: 62%

Private, individual accounts

voluntary

DC

Private managers

Supervision: NBS

Supervision: NBS

3rd pillarsince 1996

coverage: 35%

Private, individual accounts

voluntary

DC

Private managers

Supervision: NBS

Supervision: NBS

3

Pension reform in the CEE region

4

Hungary 1998

Poland 1999

Latvia 2001

Estonia 2002

Lithuania 2004

Slovakia 2005

Romania 2007

Overview

1. General characteristics of the Slovak pensionsystem

2. Major changes in the design3. Underlying reasons4. Challenges and lessons

5

Fees in 20051. administration fee (for Social Insurance Agency, central collection

system) 0,5%

2. entry fee (for PAMC) 1%

3. management fee (for PAMC) 0,78% p.a. NAV

6

7

Changes in feesMajor fee alterations

as of July 2009 /April 2012

Success fee (2009)- calculated every month (about 5,6% of average return)+ deduction of other expenses (costs of transactions, taxes, etc.) from pension

funds assets

Management fee (2012)- decreased from 0,78% p.a. to 0,3% p.a. of NAV-----------------------------------------------------------------------------------------------------------Reasons2009 – positive incentive - reward good performance (tool: success fee)2012 – expensive system with low performance

Portfolios2005 – 31/3/2012 conservative pension fund (no equity)balanced pension fund (max. 50% of equity)growth pension fund (max. 80% of equity)

1/4/2012added index fund – passively managed

Since 1/9/2012Bonds fundShares fundOther funds designed by providers

8

2005: Guarantees• Internal benchmarks (relative

guarantee): comparison of yields of the same type portfolios with an obligation of the management company to pay money to the fund fromits own pockets

• Market response• Herding• Low-risk portfolios

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-20%

0%

20%

40%

60%

80%

100%

conservative balanced growth

Structure of portfolios (as of March 2008 )

bank deposits bonds+T-bills shares other assets liabilities

Reg. limits 0% 50% 70%

Reality 0% 14% 20%

10

2009: changes of the guaranteesExternal benchmarks:a) conservative portfolio

Average yield to remain stable over 6 months period Underperfomance: Management company to transfer money

from its own pockets to the pension fund Sanctions

b) balanced and growth portfolio The asset structure to match the benchmark compiled by

management companies and disclosed in prospectus No sanctions

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Structure of assets in retirement pension savings (2009)

0

200

400

600

800

1 000

1 200

1 400

1 600

31.12

.2008

31.1.

2009

28.2.

2009

31.3.

2009

30.4.

2009

31.5.

2009

30.6.

2009

31.7.

2009

31.8.

2009

30.9.

2009

31.10

.2009

30.11

.2009

31.12

.2009

mil. o

f €

bank accounts bonds treasury bills shares other

2009 guarantees – market response

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2009 Guarantees - Market response

-20%

0%

20%

40%

60%

80%

100%

conservative balanced growth

Structure of portfolios (as of June 2011 )

bank deposits bonds treasury bills

shares other assets liabilities

• Market response

• Sale of shares

• Duration of portfolio<1 y

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2012: further changes of theguarantees

• Guarentees to remain only in bonds portfolios• Comparing the average yields over the 5 years period• Underporformance: Management company to transfer

money from its own pockets to the pension fund

Contribution rate1/1/2005 – 31/8/2012 - 9%

Since 31/8/2012• Mandatory contribution rate 4%• Voluntary add-on contribution 2%• Since 2017 onward yearly increase of 0,25 pp until 6% (2024)

Country perspectiveEstonia - 2% -> 0% (2009,2010) -> 2% (2011) -> 4% (2012)Latvia - 8% -> 2%(2009)Lithuania - 5.5% -> 2%(2009)Poland 7.3% -> 2.3% (2011)Hungary – nationalisation (2010-2011)Romania – 2% - 6% (2016) frozen in 2009 at 2%

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Entry&ExitOpt-in and opt-out window (01/09/2012 – 31/1/2013)Opt- in for first time labour market entrants (until 35 years of age)

Previous arrangements• Automatic enrollment for the first time labour market entrants

1/1/2005 – 15/11/2008 1/4/2012 – 31/08/2012

• Opt- in for the first time labour market entrants (6 months) 16/11/2008 – 31/3/2012

• Opt-in 1/1/2005 – 30/6/2006 1/1/2008 – 30/6/2008 (23 000 entered) 15/11/2008 – 30/6/2009 (14 500 entered)

• Opt-out 1/1/2008 – 30/6/2008 (106 000 exited) 15/11/2008 – 30/6/2009 (66 000 exited)

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Overview

1. General characteristics of the Slovak pensionsystem

2. Major changes in the design3. Underlying reasons4. Challenges and lessons

16

Reasons: First pillar financing gap

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Source: Égert, B. (2012), “The Impact of Changes in Second Pension Pillars on Public Finances in Central and EasternEurope”, OECD Economics Department Working Papers No. 942, OECD Publishing. http://dx.doi.org/10.1787/5k9fltdtxbr6-en

Reasons: Underestimations

• Expected No of 2nd pillar entrants: around800.000

• Real No of 2nd pillar entrants: 1,5 mil.

• No upper age limit for entry

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Reasons: Adverse macroeconomicdevelopment

• Conditions for entryand stay in theeurozone:– General government

debt < 60% GDP– Budget deficit < 3%

• Fiscal Stability Treaty– Budget deficit < 3%

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0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

-10%

-5%

0%

5%

10%

15%

2004 2005 2006 2007 2008 2009 2010 2011

Real GDP growth rate Budget deficit

General government gross debt

Reasons: Poor performance of 2nd pillar funds

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-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

01/01/2006

01/07/2006

01/01/2007

01/07/2007

01/01/2008

01/07/2008

01/01/2009

01/07/2009

01/01/2010

01/07/2010

01/01/2011

01/07/2011

01/01/2012

Growth Balanced Conservative Inflation

Growth funds 1,21 % p.a

Balanced funds 1,52 % p.a

Conservative funds 2,60 % p.a.

Inflation 2,8 % p.a.

Overview

1. General characteristics of the Slovak pensionsystem

2. Major changes in the design3. Underlying reasons4. Challenges and lessons

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Challenges in the design

• Low returns • Financing gaps in public pension pillar (pressure

on fiscal deficits) – fiscal affordability needed in the short run

• Huge inception costs (agents)• No economy of scale (dedicated pension

managers too costly)• Public and political consensus needed• Not immune from political influence

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Lessons

Not easy to completely reverse the reform• Bilateral investment treaties (protection of

foreign pension providers)• Ownership rights of savers• Endowment

Further alternatives for pension saving

23

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Thank you for your attention

Peter PenzesSenior Regulatory ExpertSecurities Market and Pension Savings Regulation SectionNational Bank of Slovakia

t: +421 2 5787 3374e: peter.penzes@nbs.sk