Tuesday, 7 December 2010

The On-going Crisis in Private Pensions

In a previous post I wrote about the scandal surrounding Poland's private pension schemes. This had been caused by the growing realisation that these private funds were not delivering on their promises. Rather than managing to valourise Polish pensions they have proved to be an elaborate method of passing public money to private companies. The new pensions being paid by the private funds are miserly, even compared to the state-pension, whilst the profits of these companies have been huge. Furthermore, with the government coming under increasing internal and external pressure to bring down its public debt, attention has begun to focus on how passing huge sums of taxpayers money to the private pension schemes is contributing to this burgeoning debt. The defenders of this system are of course now coming out in force to predict Armageddon if anyone dares to interfere with these schemes.

The privatisation of part of the pension system in Poland was introduced by the then Finance Minister Leszek Balcerowicz. According to his adviser, Ryszard Petru (who had responsibility for drawing up the reform), it was brought in with two main purposes in mind:

1. To change the manner in which pensions are counted. Instead of offering a pension at a guaranteed level, it was now to be dependent upon payments and how investments fared on the stock-market. This was introduced in order to encourage people to work longer and harder.

2. To break the monopoly of the state in organising these pensions and create new financial bodies with a steady source of funding. These could then act as long-term investors in the Polish stock-market and be participants in future privatisations.

As an aside, Petru also argues that in the mid-1990s they estimated that the worth of state property that could be privatised would be enough to pay for the debt caused by payments to the pension funds. He then bemoans the fact that the funds from privatisations (which rapidly speeded up during the term of the government he served) were wasted on other things. Now, there is a case against the short-sighted policy of successive governments to sell off state assets to cover their deficits (the present administration is one such culprit.) However, to suggest that such public property could have been sold in order to cover payments to private companies is breathtaking in its cheek.

You will notice that no attention was paid to improving future pensions, despite the huge propaganda of how these would grow on the stock-market. To be honest it would not surprise me if people such as Petru were so blinded by their own ideology (that was particularly prevalent in the 1990s) that they believed this propaganda themselves. Private good, Public Bad - Four Legs Good, Two Legs Bad.

The model for the pension reform in Poland, which was emulated in a number of post-communist countries in CEE, came out of Latin America a few years before those in CEE. Pensions were privatised first in Chile and then in a number of other Latin American countries, including Argentina and Bolivia. The failure of this privatisation to improve pensions and its negative impact on public finances meant that some Latin American governments have returned to a state system.

The first such example was in Argentina, when in 2001 the government confiscated around $3.2bn of pensions' savings before the country stopped servicing its debt (an action that saved the country from economic ruin.) Then in 2008 the government fully nationalised the private pension system (which carried around $25bn in funds) in an attempt to protect retirement investments from the international financial crisis. The government then promised to pay out a set amount to pensioners, with the state social security agency pledging to protect the value of people's investments.

Also, earlier this month, the Bolivian parliament agreed to nationalise the country's pension-fund system that had been created in 1996. The private pension system was declared a failure, by the Bolivian President Eva Morales who signed the bill. Simultaneously a law to lower the retirement age to 58 for men and women (life expectancy in Bolivia is just 65 for men and 69 for women) was also passed, alongside a plan to raise social benefits.

The crisis in the private pension system is now leading governments in CEE to reconsider these schemes. Last year Lithuania reduced contributions to its private funds; in April 2009 Estonia declared that it would freeze pension-fund contributions until the end of the year and in Bulgaria 20% of private vocational pension funds will put their assets under state control until 2014. For weeks now in Poland there has been an ongoing debate (within the government and the media) over the future of the private pension funds. This was sparked by comments made by the Minister of Labour, and supported by the Finance Minister, that part of the payments made to the private pension funds should be taken back and given to the state social insurance scheme. It was also suggested that individuals should be allowed to resign from the private system and pay fully into the state system. This led to divisions and uncertainty within the government, with some vehemently defending the private pension funds. The latest unconfirmed proposal to come out of the government is to reduce payments to pension funds from 7.3% to 5% (i.e. from ZL24bn to ZL16m) and that these payments would not be paid in cash but in long-term pension bonds, which would eventually be bought back by the government.

More drastic measures are being taken by the Hungarian government. Last month it announced that individuals must decide whether they want to invest in the state or the private pension system. Around 3 million workers in Hungary invest some of their pension contributions in private schemes. Those that choose to remain with the private pension system will lose their right to draw their future state system. This will almost inevitably result in the vast majority of people moving back to the state system, leading to the collapse of the private pension funds. Commentators have declared a de-facto nationalisation of the private pension’s schemes, that are worth $14.6bn.

It is not difficult to see that the issue of public debt, swelled by the financial crisis, is the immediate cause of these measures. As much as anything, this is being driven by external pressure from the EU on countries such as Hungary and Poland to rapidly bring down their budget deficits and public debt. However, the EU rebuffed a request last month, from 9 EU members (including Hungary, Poland and Sweden) to discount from deficit figures the amount given to these private funds. Pressure has come from the EU for member states not to move away from the private pension system, with the EU commissioner for economic policy and finance saying: 'it is key that those countries that have introduced pension reform do not withdraw from it.' Whether the EU will decide to compromise on its position not to discount the transfers to the private pension funds from the deficit - in an attempt to save the system - is to be seen.

The potential collapse of the private pension systems in countries such as Poland and Hungary (as well as Argentina and Bolivia) is a sign of how the private sector is no longer able to deliver on the promises it made during the heady days of the 1990s. However, a question-mark remains over what will happen to the large amount of sums that had been transferred to these funds if they are to return to the government. As noted above, the governments of Argentina and Bolivia are using these to guarantee future pensions. However, in Hungary and Poland the impetus is to fill budget gaps and meet the obligations being set down by international institutions such as the IMF and EU. The primary concern for any government, when considering pension reforms, should be how to best provide pensions for its citizens. The private pension funds have failed in this and it is right to change this system and bring money back into government hands. However this should be done in order to more efficiently and safely use people's money so as to guarantee a decent pension in the future.

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