Pension reform: objectives and experience

Veiko Tali

07. 12. 2012

Multipillar pension system to reach

social sustainability – ensure adequate level of pension income fiscal sustainability – mitigate pressure to state budget and dependence on tax revenue economic objectives - positive feedback to long-term economic growth

Main pension reform objectives

Unfavourable demographics

I+II pillar to sustain the replacement rates for new pensioners

0%

5%

10%

15%

20%

25%

30%

35%

40%

2002 2007 2012 2017 2022 2027 2032 2037 2042 2047

II pillar RR of II pillar member I pillar RR of II pillar member

I pillar RR of II pillar non-member

o (long-term) investments into local economy (with positive effect to growth, productivity, restructuring and competitivness)

o development of capital markets (stock exchange), especially corporate bonds market

o more diversified financial sector e.g development of asset management sector

Pension reform economic objectives

Market-based approach (reliance on private sector

providers and competition as driving force)

UCITS based pension funds

Clear division of roles between participants

Integrated supervision / domestic providers

From quantitative restrictions to prudent man rule

Not protecting domestic market (EU free movement

of capital rules, attractiveness of converging and

growing economy, risk of bubbles)

Main regulatory assumptions

Underperfomance of long-term target rate of 2.5 % of real investment return of mandatory pension funds - erosion of public trust

Financial crisis : collapse of returns

90

110

130

150

170

190

210

07

.20

02

01.

20

03

07

.20

03

01.

20

04

07

.20

04

01.

20

05

07

.20

05

01.

20

06

07

.20

06

01.

20

07

07

.20

07

01.

20

08

07

.20…

01.

20

09

07

.20

09

01.

20

10

07

.20

10

01.

20

11

07

.20

11

01.

20

12

EPI

EPI-00

EPI-25

EPI-50

EPI-75

CPI

Target

But results are different ….

0,000

50,000

100,000

150,000

200,000

250,000

1.08.2002 1.04.2004 1.12.2005 1.08.2007 1.04.2009 1.12.2010 1.08.2012

ERGO 2P1 ERGO 2P2 ERGO 2P3 Sampo 25

Sampo 50 Sampo Intress LHV L LHV M

LHV S LHV XL LHV XS Nordea A

Nordea A Pluss Nordea B Nordea C SEB Energ

SEB Kons SEB Opt SEB Prog Swedbank K1

Swedbank K2 Swedbank K3 Swedbank K4 Target

Temporary suspension of II pillar contributions (2009-11) Higher contributions in 2014-17 (choice of participant)

Fiscal pressure : impact of crisis

0%

1%

2%

3%

4%

5%

6%

2 0

02

2 0

03

2 0

04

2 0

05

2 0

06

2 0

07

2 0

08

2009 I

-IIQ

2009 I

II-I

VQ

2 0

10

2 0

11

2 0

12

2 0

13

2 0

14

2 0

15

2 0

16

2 0

17

2 0

18

Employer contribution Employee contribution

0%

1%

2%

3%

4%

5%

6%

2 0

02

2 0

03

2 0

04

2 0

05

2 0

06

2 0

07

2 0

08

2009 I

-IIQ

2009 I

II-I

VQ

2 0

10

2 0

11

2 0

12

2 0

13

2 0

14

2 0

15

2 0

16

2 0

17

2 0

18

Employer contribution Employee contribution

Reverse effect to capital market

0

0,5

1

1,5

2

2,5

3

3,5

4

4,5

5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Stock market capitalisation

Pension funds assets

Hegemony of banking finance

0%

20%

40%

60%

80%

100%

120%

140%

160%

banking sector assets debt securities market capitalisation

stock market capitalisation

% o

f G

DP

Banking sector assets vs securities market

2004 2005 2006 2007 2008 2009 2010 2011 30.09.2012

20% of II pillar assets are in Estonia, but less than 1/3 of it in real economy Mai issue: structure of investments (long-term vs short-term, etc)

Domestic investments

0%

20%

40%

60%

80%

100%

2004 2005 2006 2007 2008 2009 2010 2011 2012

Estonia Latvia/Lithuania

Finland/Sweden/Denmark France/Germany/UK

Luxembourg/Belgium/Netherlands USA

Others

Domestic allocation of pension funds

13

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Average

OMX vs S&P500, DJ, Nasdaq

14

more than 50% of II pillar assets are actually managed outside dominance of II pillar pension funds with no catalyst effect ?

Domestic fund management industry

0

500

1 000

1 500

2 000

2 500

2004 2 005 2 006 2 007 2008 2 009 2 010 2 011 2 012

Debt funds Equity funds

Mandatory pension funds Voluntary pension funds

Other funds (property + hedge)

Tendency to passive investment Fees don’t follow scale effect and investment structure

Passive or active investment

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006 2007 2008 2009 2010 2011 2012

Equity Equity funds Other funds Money market

Bonds Deposit Other

PASSIVE

No correlation between fees and investment return

II pillar fees

0%

4%

8%

12%

0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

ER

GO

2P

3

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SE

B E

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GO

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2

LH

V X

L

LH

V S

No

rde

a C

SE

B O

pt

LH

V L

No

rde

a B

No

rde

a A

Management fee Investment return

Management fees don’t follow scale effect and investment structure

Management fees and assets

0,0%

0,5%

1,0%

1,5%

2,0%

0

500

1000

1500

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

II pillar assets Average II pillar management fees

Review of pension fund’s fees (simplification, limits) Amendments in investment regulation of conservative funds More strict regulation on conflict of interest Monthly disclosure of investment portfolio More frequent switching possibilities (from annual to 3 times per year + contionous for redirection of new contributions)

Regulatory changes in 2011

UCITS-based investment regulation market value (fair value accounting) daily NAV for entry and exit 10 % limit for non-traded securities

Day to day performance pressure Impact of switching to returns - too frequent ?

Chains of short-termism ?

Switching activity: impact to investments ?

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

20 000

40 000

60 000

80 000

100 000

120 000

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Contributions to new fund Change of units

% of IIP members % of IIP members

How to break the vicious circle?

Lack of instruments, liquidity

Pension fund’s investment channeled outside Estonia

Shrinkage of local capital markets

Not only increasing life expectany and small birth rates cause the demographic pressure, but also migration of working population is eroding sustainability of pension system / Census figures 2000-2011

Additional negative effect of migration

Estonia

-5,5%

Latvia

-13%

Lithuania

-12,3%

High level of foreign support dependency

8.5 10.6

14.6 16.2 16.8 18.8 17.3

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2007 2008 2009 2010 2011 2012 2013 draft

total cost (m euros) incl foreign financing and CO2 (m euros) foreign financing and CO2, % total volume

Half of public investments from foreign sources

20.3

31.3

55.9

46.4 41.6

48.8

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

0

200

400

600

800

1,000

1,200

Total investments (m euros)

incl foreign financing and CO2 (m euros)

investments from foreign financing, % total volume

Demography, growth and foreign financing % of GDP, % y-o-y

1.2

1.3

1.4

1.5

1.6

1.7

1.8

-15

-10

-5

0

5

10

15

2001 2005 2009 2013 2017 2021 2025 2029

Foreign financing in GDP, %

Growth of Estonian GDP, %

Labour force 18-63 / dependants (ps)

Demographics and support prospects % EU27 average

1.2

1.3

1.4

1.5

1.6

1.7

1.8

40

50

60

70

80

90

100

2001 2005 2009 2013 2017 2021 2025 2029

SKP per capita PPS (% EL27st)

Abikünnis (% EL27st)

Tööealised 18-63 / ülalpeetavad (ps)

2007-2011 EU budget average net position % of GNI

-1%

0%

1%

2%

3%

4%

5%

Lith

uan

ia

Luxe

mb

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rg

Esto

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Latv

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Hu

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Po

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Gre

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Bu

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Po

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Slo

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Ro

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Cze

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Mal

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Slo

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Be

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and

Spai

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Cyp

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Au

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Fin

lan

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Fran

ce UK

Ital

y

Den

mar

k

Swe

de

n

Ge

rman

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Ne

ther

lan

ds

How to break the vicious circle?

Lack of instruments, liquidity

Pension fund’s investment channeled outside Estonia

Shrinkage of local capital markets

Revision of investment restrictions door open for alternatives (PE, infrastructure, forestry, renewables, green investment)? prudent man rule (reliability of managers, ability of supervisor , public trust ?)

Specialized funds with certain investment structure (as compulsory, designated or favoured?) /domestic, long-term, active etc/ Fee structures linked to performance and/or investment structure ? Publicly managed (default) pension funds ??

Some possible directions to consider ?

Thank You for attention!