Accumulative pensions what the system should be like

Oleksandr Panchenko, Commissioner of the National Securities and Stock Market Commission

Principles of creation of the second pillar of the pension system in Ukraine – compulsory funded pensions.

 What to plan for?

On the eve of New Year’s holidays, a draft law on compulsory retirement pension was registered in the Verkhovna Rada. The initiator of submitting was made by the MP Galina Tretyakova and a group of her colleagues.

Still, pensions have been paid to Ukrainians by the goverment. State-level pensions at the solidarity level of the pension system were intended to meet the basic needs of pensioners. However, unfortunately, the size of state pensions is far from covering even the minimal needs of Ukrainian pensioners. And let’s be honest with each other – any increase in the near future under the current economic conditions is hardly possible.

Since 2004, the third level of the pension system – voluntary accumulation funds – has started to develop in our country. But over the past 15 years, the voluntary retirement savings system has had little development. At present, only 6.6% of working-ability Ukrainians have accounts in non-state pension funds, and their average savings are just under 3,500 UAH.

Because of the lack of pension payments and the inability of the state to significantly increase them, Ukraine has long been talking about the need to create a second pillar of the system – mandatory savings pensions. The main task of the second pillar is the formation of the employee’s basic retirement capital throughout the entire length of service. For each employee’s salary, a certain percentage is deducted, which goes not to the state but goes to a personal retirement account.

But despite several approaches to creating this system, no progress has been made so far. And finally, we have in the Verkhovna Rada a draft law that describes in what form a system of funded pensions should be created.

Four second pillar whales

What does the draft law offer? It proposes the creation of a centralized system of funded pensions, based on four key entities: the State Fiscal Service (will exercise the function of controlling the payment of pension contributions), the Pension Fund of Ukraine (since it is now responsible for the collection and administration of the SSCs, it is quite logical to add a PFU pension contributions), the Central Administrator (will administer pension accounts, manage retirement benefits and calculate the value of retirement assets) and the Treasury (as the entity that accumulates contributions and determines relationships with service companies). This model makes it possible to achieve the greatest cost savings through economies of scale.

Suppose we have a decentralized system and there are two dozen retirement account administrators on the market. They all need to keep their own records of customers, which means at least keeping an office, paying staff, developing and maintaining an accounting system, backing up information on a duplicate server (which is a common standard for data security), etc. These are all costs.

Expenditure is the factor that most significantly influences the choice of a model for creating a funded pension system. The higher the costs, the lower will be the income on retirement assets and, accordingly, the amount of payments to retirees. At the same time, when we talk about pension account accounting functions, we assume purely an IT function. And it would be logical to put it on one central subject of the system.

Regarding costs, the draft law fixes a maximum commission rate of 0.5% to avoid cost inflating by individual companies. But even half a percent of it can be quite a lot. It all depends on the state of the market, the size of the assets involved. According to the draft law, under a centralized system, the Central Administrator Council will be able to flexibly respond to the situation and reduce the cost bar. Who in the case of a decentralized system will promptly respond to and reduce the marginal cost of all participants? Will self-managed asset management companies reduce their retirement fund fees?

The situation is similar with the efficiency of companies. The system must have financial control over the effectiveness of money management. And this is not about regulatory oversight. From this situation, another problem arises – the redistribution of retirement accounts, which are managed by a failing company and transfer to other companies in the market. Who will hold the competition among the companies? It is also a non-regulatory issue, but an extremely economic one.

It is important to understand that a centralized model does not eliminate competition. At the second pillar, asset management companies can compete for clients, but they will only do so at the expense of their performance, which will be reflected in the return on investment, not through aggressive advertising.

Besides the cost factor, the choice of a centralized model is dictated by such an important characteristic as the simplicity and ease of use of the system. Consider this situation in a decentralized system – an employee wants to move from one pension fund to another. What should he do if there is no single Treasury? You must first come to Fund 1 and apply to open an account, then to Fund 2 and also apply for termination of the contract. Then monitor the execution of both applications. Minimum, a person is drawn to two “windows” and then has to check their request. Instead, it can resolve the issue in a single window by applying to the Treasury, either physically or online, to monitor its execution online.

Another advantage is to avoid the risk of any forced choice of the management company by the employer. There is a sad experience in other countries where some businesses “trade” their employees’ accounts – forcing companies to service their retirement savings. In the case of a decentralized model, the employer will receive this resource and, through collusion with the administrator of the private pension fund, will be able to influence the choice of employees. This risk can only be avoided in the case of a centralized system.

It is the centralized system of private retirement savings that answers all these questions. It is the basis of  the draft law 2683 on Compulsory Retirement Pension.

Countries that have recently launched their retirement savings systems are moving towards the centralization of the systems – Armenia, Hong Kong, Georgia, Lithuania, India and several others. Why not go the same way for Ukraine?

This text reflects the author’s personal view of the issue and is not an official position of the National Securities and Stock Market Commission.

Source: НВ.Бізнес