Political interference in pensions raises concerns in Europe

The most blatant smash-and-grab raid occurred in Hungary, where government policy appears to herald the destruction of the country's 2.7 trillion forint ($12.8bn) private pensions system. Last month private pension fund participants were given until the end of January 2011 to transfer their pension assets to the state treasury or lose certain rights to their state pension.

The French government has already transferred €36bn assets of the pension reserve fund, the FRR, to the state's social debt-sinking fund, Cades, and the Irish government has promised to deploy the €24bn National Pensions Reserve Fund's resources "to support the exchequer's funding programme".

Such moves are not cost-free. Polish capital market players have expressed concerns that planned pension contribution cuts will have a negative impact on the local stock market, which may in turn endanger the government's privatisation campaign, undertaken to assist with the debt problem.
New measures will halt around one third of the annual 25bn zlotys ($8.3bn) inflow to the pension funds that goes to domestic equities. To put it in context, the largest Polish initial public offering, that of insurer PZU, raised 8bn zlotys.

The Polish government's move was triggered by deteriorating public finances and an election next autumn. The state deficit is approaching a politically sensitive threshold of 55% of gross domestic product.
If it hits that figure, a public finance law will require the government to increase taxes and further cut spending. It is already raising VAT. Deterioration to 60% of GDP would see the government dragged before the constitutional court. There will be longer-term costs to these pensions grabs.

They endanger two strategies designed to counter the problems caused by longevity. Under threat are the creation of pensions reserve funds in western Europe and the private pension systems established in eastern and central Europe.

The reserve funds are financed by government surpluses and designed to underpin a pay-as-you-go state pension system when it falls into deficit.
In eastern and central Europe pension reform accompanied the economic restructuring following the collapse of communism, with governments adopting a World Bank-promoted model under which a proportion of the contributions to the state pay-as-you-go pension is diverted to a participant's individual account, which is managed by a specially licensed private management company.

The system had many advantages. In addition to creating a funded pensions system it helped lay the foundations of a financial infrastructure in countries where the market had previously been officially illegal, created new globally linked and financially literate professions, and began the financial education of the population.

Hungary was the pioneer of the experiment, establishing its private pensions in 1997. Now it is the prime example of a threat to the system. Contributions to the private pension systems come from payments into the state pension systems.

But the new funds are in an accumulation phase, being too young to be paying out pensions. Consequently, although contributions are often a small proportion of relatively low salaries, the assets have grown to be substantial relative to individual countries' economies.
Just as in Hungary, governments throughout the region are tempted to claw back the contributions to the state system allocated to private pensions.

Dariusz Stanko, of the Warsaw School of Economics, said: "If governments lower the pension contribution they can use the money to finance current pension years, so reducing the deficit in the social security system, and not have to issue so many treasury bonds, which in turn means their public debt is lower.

But it is not lower in economic terms because they have assumed higher liabilities for future pension years."
This month the Polish government will unveil a cut in contributions to the private pensions sector from 7.5% of a gross salary to 5.0% and announce that for the next two years the payments will be solely in bonds dedicated to the pension funds.

Stanko said: "The idea is that the bonds will not be tradable, will be held to maturity and not have a coupon, but their face value will be indexed annually to nominal or real GDP growth. And the hope is they will not be counted as a public debt."

He said the contribution cuts were not a silver bullet: "Claims that pension funds create debt are not true, they just show the future pension debt."
There are suspicions that governments are motivated by political as well as economic factors. France's FRR was seen as vulnerable because it had been created by a left-of-centre administration but evolved under governments of the right that never warmed to it and restricted its funding.
And Hungary's death sentence on its private pensions industry was issued after a poll found only 30% of pension fund participants would voluntarily repatriate their funds to the state.
The new government reportedly felt that such a low level of support would have represented a substantial blow to its prestige.

• Summit to review controversy
The European Union will look at how it calculates the pension deficits of eastern and central European countries at the European Council summit on December 16 and 17.
The current method penalises countries that enacted fundamental pension reforms. The European Commission had made this a precondition of the countries' accession to the EU but has since undermined the reforms by adding to deficits the funds transferred from the social security budgets to the private pension companies.
Mihai Bobocea, general secretary of the Romanian pension fund association, said: "This anomaly arises because the contributions to the state are counted as revenues while the proportion transferred to private pension companies is considered expenditure.

This is not the case with implicit pension liabilities kept on the books while the resources set aside to meet future liabilities are penalised. It's utter nonsense. My hopes are high for the summit," he said.
Last month the region's pension fund associations attacked the commission in response to a green paper. The countries allege that the EC was either deliberately or accidentally failing to understand the structure and nature of their retirement schemes.