Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Pension plan stalls

The Kremlin has shifted emphasis away from encouraging growth, which is now strong, to tackling pressing social problems like pension reform. Ben Aris finds out that, although a good plan has got off to a bad start, there is hope for the future.Marina is standing outside the Valentino shop in tears. She received her monthly Rbs400 pension ($15) yesterday but lost her avoska, the occasional shopping bag that all Russians used to carry, along with her purse.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

With her husband already dead and her son killed in Afghanistan, she does not know how she will feed herself for the rest of the month. So she has come into the centre of the city, chosen an expensive shop and is begging for help for the first time in her life.

Marina’s story is typical of the older generation of Russians that have lived through the economic chaos of the past decade. As the average life expectancy of the average Russian man is only 58.5 years, while that of women is 71.9 years (Russian women drink little vodka), the bulk of pensioners are women, who have few job prospects.

Boris Yeltsin kicked off the pension reform by creating laws for mutual funds in 1996. Most people invested in the now notorious GKOs, domestic treasury bills, that were returning up to 180% until the house of cards came tumbling down in the 1998 financial crisis.

“Many funds closed but most went into hibernation,” says Elizabeth Hebert, CEO of Pallada Asset Management, which has been operating funds since 1992. “These are vehicles tested by fire – they have a seven-year track record and now are starting to pay off as people are looking for an alternative to investing into cash dollars stuffed under the mattress.”

With the Russian economy growing strongly, since the end of last year the Kremlin has shifted emphasis away from encouraging growth and towards tackling the thorny social problems of people like Marina.

Pension reforms

Currently each pensioner is supported by taxes from two workers but within 20 years the ratio will fall to one-to-one. The state pension fund (SPF) is already struggling to cope. The first stab at reforms was pushed through at the end of last year, when 55 special asset management funds were registered that can invest part of workers’ social taxes in the hope of creating more resources for tomorrow’s retirees.

Unfortunately, people like Marina will fall through the gap, as the first of the new pensions will not be paid out until five years’ time. The reforms are supposed to create a new financial market segment that could be worth billions of dollars in a few years’ time and create even more demand for the burgeoning domestic capital markets. Pension funds are allowed to invest only 15% of their assets abroad; the rest will go into Russian equities and rouble-denominated bonds.

The process began in October when 40 million Russians received a “happiness letter” informing them of how much money the SPF has put aside for their retirement. The letter included a coupon giving recipients the option of moving the “investible” part of their pension contributions – social taxes paid by employers – to one of the 55 companies in the hope of getting better returns in the intervening years and so a bigger pension when they retire.

Poor start

It was a good plan but it has begun badly. At the beginning of February, the SPF announced that only 2% of Russians had chosen to move their investible money to one of the companies. This was much less than the 10% hoped for and amounted to only about Rbs1bn ($35m), a fraction of the Rbs90bn that remains in the SPF and is managed by state-owned Vnesheconombank.

“This reform was a first step. More funds will come into the pension business but it is not likely to be a locomotive for the financial industry [any time] soon,” says Dmitri Sokolsky, head of MDM’s asset management team.

The chairman of the SPF, Mikhail Zurabov, claimed in February that the poor result was due to citizens being insufficiently informed about private management companies, either in terms of their credit quality or track records. He announced that a special agreement had been signed with ratings agency Standard & Poor’s to evaluate the credit qualities of management companies and that a special credit rating schedule had been created.

Plans backfire

“The inability of the SPF to market the reform effectively and ensure the proper administration of its technical procedures means that most of the money will stay in the state management company and make the markets more dependent on bureaucrats’ decisions, and so will slow down the development of this section of the financial markets,” says Alexei Moisseev, an economist at Renaissance Capital.

The results of how the money was distributed among the companies had not been released at the time of writing but funds in management companies controlled by the government of Tatarstan took a quarter of the total and 10 companies associated with either the big banks or the leading industrial groups took nearly all the rest.

Fund managers say that these three groups have hijacked the process; specialised funds that have been working since the early 1990s have been sidelined.

“Pension reform has got off to a disastrous start,” says Ms Hebert who heads one of the 55 specialised funds. “There was a respectable blueprint that would have qualified funds with track records and transparent structures but it was changed at the last minute.

“We ended up with 55 management companies, most of them unknown, that have no requirement to disclose their owners. Three-quarters of these companies are owned by groups and will invest into their related companies.”

Bureaucratic failings

One of the more galling examples of failure of the selection process was the authorities’ decision to disqualify Dresdner Bank, which has two years’ experience of fund management in Russia. In contrast, they accepted an application from the Management Company of Pension Funds, which was registered as a company the day before the deadline for submission of licence applications closed. The reason for the “Brand X” style name became clear the day after the results of the selection process were announced when the company, which was one of those that qualified, was advertised for sale on the internet for $1m and sold to the Tatarstan regional government.

The campaigning to attract workers to funds was further mired by some of the management companies (legally) offering company managers a $1 bounty on each worker that they persuaded to sign over their investible portion to them; an estimated 40% of applications were from employees of one of the leading financial-industrial groups.

Larry Brainard, a Russia specialist at West LB, says: “The authorities approved all the companies that applied for a special licence so it

doesn’t look like there was a serious attempt to create a new section of the financial market. This could turn into a fiasco and there is nothing there that resembles a reform.”

Hope for the future

Still, Russia’s pension reform is only just stepping off square one and the sums involved remain tiny. The launch of the reform has been mismanaged but there is growing pressure from both above and below to knock Russia’s pension system into shape.

With only a tiny pool of experienced managers to choose from, Russian companies have added a decent pension scheme to remuneration packages to attract potential employees. At the same time, the Kremlin’s arrest of Mikhail Khodorkovsky, the owner of oil company Yukos, has made managers take the president’s call for “socially responsible” business practices seriously.

“Pensions have become part of the political landscape – setting up a good corporate pension scheme has become politically correct in Russia,” says Ms Hebert.

All of Russia’s biggest pension funds are operated by the country’s biggest companies, which until recently used the assets either as a source of cheap financing, as a tax dodge or as a convenient way of owning their own stock. However, Russia’s biggest pension fund, Gazfond, which belongs to gas monopoly Gazprom, recently began to revamp its pension fund. Likewise, in January, LUKoil chairman Vagit Alekperov ordered a makeover of LUKoil’s pension fund, Russia’s second largest, saying he wanted to see his oilmen retire with “an honourable and sufficient” pension at the end of their careers.

Other industrial groups, like Interros and oil major Surgut-neftegaz, have also been shedding the bad habits of in-house pension fund abuse in the past few months, according to analysts. Maybe the most advanced of all is utilities monopoly United Energy Systems, which boasts one of the best corporate pension schemes of the government-controlled companies.

Transparency is key

Ms Hebert says that imposing more transparency on pension funds would quickly undo most of the problems and encourage more workers to move their money out of the SPF and into one of the private companies. “Next year, pensioners will be able to see what each of the funds have returned and can change company at will,” she says.

“Just increasing the transparency will create an army of 40 million people willing to fight for its old age. It just takes [President Vladimir] Putin to make it a priority for it to happen.”

In the meantime, most banks are getting in early to claim their piece of a pie that is expected to grow quickly in the coming years. “The idea is to start to participate in the process and set up a business so that in five to 10 years, when the system is flush with money, we will have our market share already established,” says MDM’s Mr Sokolsky.

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe , Russia