The Pension Test

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The Pension Test

By Ekaterina Shokhina, Gateway Russia

September 19, 2003

Forty million Russian citizens now have the right to choose who will manage their pension savings: the state Vneshekonombank (VEB) or one of over fifty private companies. The VEB promises complete reliability but at yields lower than inflation, while private companies offer actual yield of 3-4% but with unknown risks.

In addition to the Vneshekonombank, now 55 private administration companies (Rus. UK) will take charge of forty million Russians’ retirement savings. This was announced by the Ministry of Finance September 5^th, as it released the results of the competition between 59 companies for the privilege to invest the savings component of pensions. However in the coming year, the overwhelming majority of retirement savings will go to the state-authorized company, Vneshekonombank. According to Pension Fund of Russia (PFR) estimates, private administration companies can only count on about 5-7% of pension savings, due to the late public announcement of the program and delays in the competition.
Weeks earlier it was decided who would be responsible for overseeing what went into all those pension portfolios. The United Deposit Company (Rus. ODK), affiliated with VEB, won the special depositors competition. Representatives of the private UKs argue that the government “pulled a fast one on them” by making the conditions of the competition for selecting companies so liberal that a large number of companies won. This means that limited resources will be carved up between them and pension portfolio management will be accompanied by high costs. On the other hand, for those choosing a private company a wider selection is a clear advantage.

The slow boat to reform

A month ago it seemed that real pension reform would not start this year. Only an insignificant portion of Russia’s 40 million future retirees received information about the state of their pension accounts and the forms for selecting an administration company by the planned deadline. The International Confederation of Consumer Associations (KonfOP) succeeded in rousing the PFR from its stupor. It went to the government with a request “to examine the issue of postponing the deadline for selecting administrative companies based on the actual date of notification.”

The silent unwilling

Experts all confirm that at present no more than 5-7% of Russians are likely to opt for private companies. First of all, no one knows anything about them, with the exception of Trioka Dialog, which started advertising ahead of time. “The government is not planning a full-scale public information campaign about the new pension program changes. The government has only budgeted $500,000 for publicizing the reforms,” says Sergei Stukalov, General Director of Montes Auri UK, part of the Guta Group. There are tons of companies, but almost no information about them. “The public will be completely confused. It’s a hard task to pick one company out of fifty five, and many will forego their right to chose,” says Pavel Teplukhin, president of Trioka Dialog UK.
Secondly, none of the UKs have ever managed the investment of the saving component of workers’ pensions. As a result, it is impossible to evaluate their success in this sphere of activity. “Our predictions for the first year are extremely pessimistic. It’s bad enough that the government has not explained the essence of the reforms but it also won’t let private administration companies do it, either. We still don’t have the right to advertise as we have yet to conclude our contract with the PFR,” says Anatoly Miliukov, General Director at Alfa-Kapital UK.
The fact that filling out the UK choice forms and getting them to the PFR requires both time and money is another factor complicating Russians’ choices.

The cost of the issue

It is at the same time completely clear that Russians who have less than ten years to go before retirement would make any choice at all. They have nothing in particular to gain from handing over their savings to a commercial organization. For someone earning 5,000 rubles a month, the amount of savings (no more than 1,500 rubles a year) is too small to make the difference in earnings from a conservative state UK versus a higher yielding private UK very substantial.
The situation is different for young Russians with thirty years until retirement and much higher salaries. It’s important to note that only limited funds go into the pension savings program. The maximum withholdings are established each year. At the same time, Natalia Plugar, Director of the Legal Department at NIKoil UK, feels confident that these limitations should not upset Russians, “as investment yields will increase the amount of their savings every year.”

Plotting yields

A conservative approach to pensions is common not only among future pensioners, but also among administrative companies.
The majority of these companies state that they will not chase after high yields in the first year and will avoid taking big risks in order to keep the trust of the few citizens that come to them.
“We are offering a conservative portfolio with a large number of corporate bonds. Our main goal is to reach yields that outpace inflation by a few percentage points. Today that means 3-4% net yield,” say Miliukov. “As time passes, we will give our clients the option to choose among several investment portfolios with different levels of yield and risk.” Similar portfolios are being offered by other UKs. In structure, they will resemble the companies’ mutual funds. First of all, these have already been tried and tested, and the companies are able to tell clients what they are likely to yield. Secondly, the UKs are only permitted by law to use tested financial instruments.
According to law, the VEB, which according to all predictions will get around a billion dollars in retirement savings, will invest in state securities and bank accounts at an interest rate lower than inflation. Mortgage securities remain outside the scope of retirement investment, as they still lack a legal basis.
Natalia Plugar at NIKoil believes that most pension money at the VEB will be used to fund further government bond issues, which will in turn lower their yield.

Start-up costs

Private administration companies view the new investment opportunity with restrained optimism and assume that they will have to tighten their belts at first. Their losses could exceed earnings. Economists predict that over the next year, the number of UKs will fall from 55 to 10-15, as managing a small amount of money (on average $2 million per company) without a large capital base will prove difficult. As Elena Lukovkina and Anton Kovalev, experts at KonFOP, explained, the securities under the management of ill-fated UKs will be sold by the special depositor for the best price possible and the proceeds will return to the PFR. The clients will go to the state UK and will have the opportunity to choose a new UK the following year.