The crisis for Central Europe's pension funds

By bne IntelliNews July 7, 2009

Nicholas Watson in Prague -

The global economic crisis affected pensions everywhere, but less so in Central Europe. However, there is still a danger that governments in the region could use the financial disaster as an excuse to backtrack on urgent reforms.

According to recent data from the Organisation for Economic Co-operation and Development (OECD), private pension funds lost 23% of their value in 2008, or some $5.4 trillion. What started as a financial crisis with the collapse in stock markets, escalated into an economic crisis, bringing a second wave of trouble for pension funds from falling earnings and rising unemployment, thus reducing private pension fund contributions. For public pension funds, the accompanying rise in unemployment benefits and the massive fiscal stimulus packages is putting a strain on public finances; budget deficits in OECD countries are expected to reach nearly 9% of national income in 2010.

Looking at private pension funds in particular, the largest losses of 37.5% were recorded in Ireland. At the other end of the scale, losses were just over 10% in the Slovak Republic and lower still in the Czech Republic. Polish losses were somewhere in the middle, down by 17.7%.

Given that stock markets plummeted across the world after Lehman Brothers collapsed, the wide difference in private pension falls can't be explained solely by the relative performance of markets. Rather, it seems that how the pension funds were invested is the key criteria. "These huge differences in investment returns are explained by differences in the way pension funds are invested," says Edward Whitehouse of the OECD's social policy division. "Stock markets in OECD countries all fell by around 45% in 2008. Government bonds tended to rise, with the international index up by over 7% in 2008. These assets, along with deposits and property, are the main ones in which pension funds invest."

Therefore, those countries whose pension funds invested more in bonds than stocks like the Czech Republic and Slovakia tended to do better than the English-speaking countries where pension funds were mostly invested in equities.

Poland lost more than the other Central European countries because of a peculiarity in the law that was meant to help the Polish stock market but has ended up - as these laws so often do - making things worse. Open Pension Funds (OPFs), a pillar of the decade-old reformed pension system, are limited to investing only 5% of their assets outside of Poland. This has indeed helped make the Warsaw Stock Exchange the largest bourse in the region, but the heavy presence of the funds on the market drove the over-valuation of Polish stocks and led to the huge falls when the crisis finally arrived on Polish shores.

Age-old problems

The relatively smaller role that private pensions play in Central Europe has meant the effect of their collapse on the general population was limited somewhat. For current retirees, private financial sources make up more than 40% of retirement incomes in Australia, Canada, the Netherlands, the UK and the US, whereas they contribute less than 5% of incomes in Austria, the Czech Republic, Slovakia, Hungary and Poland.

That, however, is an unsustainable position and so for today's younger workers, private pensions are expected to provide around a third of retirement incomes in Hungary, half in Poland and 60% in the Slovak Republic. "Although the impact of the current crisis in these countries will be relatively minor, it highlights the need for resilience to a future crisis," says Whitehouse.

Worryingly, Whitehouse notes growing evidence of a reversal of pension reforms. Slovakia, for example, has encouraged people to opt back into the state pension scheme rather than diverting part of their contributions to private, defined-contribution plans. When this was first offered, only 6% of members of the private plans chose to switch back. However, it is no longer compulsory for labour-market entrants to join the private funds and the public scheme is the default option. "This is an irreversible, once-in-a-lifetime decision which will have long-term effects on the retirement incomes of new labour market entrants," he says.

The motivation for this change is short-term fiscal problems, he argues. Some 60% of workers actively chose to join the new private pensions at the time of reform. This was many more than expected, and the diversion of contributions from the public to the private scheme has left a hole in the government's finances. A more sensible way of alleviating short-term fiscal problems, he argues, is temporarily to reduce the contribution going into private pensions. Although no OECD country has adopted this strategy, it is likely to be used in Estonia, Latvia and Lithuania.

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