Modernization of the pension system of Kazakhstan

Apr 05. Kazpravda

By Rahman Alshanov, Rector of the University “Turan”, Doctor of economic sciences, professor

Criteria – reliability and efficiency

Modernization of the pension system of KazakhstanAs known, pension accumulations have specific investment quality. First of all, this is “long” money, which will be claimed only after 45 years of retirement. Therefore these funds can be used in large infrastructure projects, such as the construction of railroads, highways, pipelines, ports, etc. Pension savings have a unique, attractive investment potential.

The world has accumulated considerable experience in the use of pension savings. There are three main types of pension scheme. Individual -funded system, when pension fees paid by the employees or employers are accumulated in individual accounts; the solidarity (unfunded) scheme, organized on the principle of “intergenerational solidarity”, when pension contributions are not saved, but paid to pensioners; and the distribution system, when pensions are paid from general tax revenues. This type usually is used for payments to vulnerable citizens, the disabled, survivors’ benefits, etc.

Many states seek to provide not only the reliability of pension savings, but also their efficiency. These funds, in fact, must work, and their idle accumulation would be unreasonable. At the same time, creating a reliable, guaranteed protection of pension savings is one of the basic principles for those who decided to use them as investment. It is an axiom. As a rule, these savings are protected by the state.

Taking into account different nature of business, ethic principles, the states either trust the business to mange pension funds, or to do it themselves. The second category includes many leading countries of the world. Such practice is satisfactory for the public. At low inflation and in the conditions of stable economy, the priority is rather reliability of retirement savings, than investing in business. The developed nations in their history experienced many bitter times when eminent companies, whose shares were invested in pension savings overnight collapsed, burying the hopes and future incomes of pensioners. That’s why “reliability is higher than profitability” is the guiding principle of pension policy in many countries.

At the same time, there are countries that skillfully use investment potential of pension funds. For example Chilean experience. In the initial period of domestic market relations, romantic mood prevailed in economic policies. We rightly thought that being active pioneers in the introduction of market relations, we would achieve substantial results on the use of advanced methods of retirement savings. We created private funds that accumulated the bulk of pension funds in the country: as of 01.01.2013, the number of contributors (recipients) of pension funds increased to 8,422,512 and their accumulations grew to 3 183.2 billion tenge. Annual payments to pensioners reached 323.0 billion. Currently, there are 11 pension funds in the republic. Of these, four funds have the largest amount of retirement savings (75.1%): the People’s Bank of Kazakhstan – 33.3%, SAPF – 19.6%, “Ular Umit” – 12.6%, “Grantum” – 9.6%.

The main problems

The role of pension sector is growing in the economy of the country. Retirement savings’ ratio to the GDP as of 01.01.2013 grew to 10.1%, and pension contributions – up to 7.8%. The structure of total assets and capital pension funds reached 107.3 billion tenge.

But during 20 years of their existence major problems in their functioning have come to light. Some successful companies, especially raw, placed their shares abroad, where they could attract relatively cheap money and subsequently painlessly repay it. Other successful companies do not intend to place shares on the domestic stock exchange. In the result the market has shrunk.

And the government, taking into account the situation in the young developing market, tried to limit the scope of application of pension savings, protecting them from excessive risks. Thereby the market of application of retirement savings was left without high-income areas. The main part of pension savings is invested in government securities (50.5%), including securities of the Finance Ministry (49.1%). Then come corporate securities of RK issuers (25.9%), mainly bonds (20.5%). And this figure is reducing. The share of other financial instruments is 23.6%.

The current situation can be interpreted in two ways. The growth of deposits in only two directions – in government securities and in the second tier banks, confirms that the emphasis of the pension funds’ investment policy is on the conservative scenario and on reliability of tools. On the other hand, the support of the private sector, which is in the second place, is no less meaningful. We can say that there is no monopoly on the use of considerable resources of pension funds by the state alone. The non-state sector in 2013 received investment funds in the amount of 812.1 billion tenge or by 87.9bln more than in 2012.

High inflation is one of the characteristics of the emerging market. Logically and historically, it should be relatively low in our country, but it is artificially maintained at a high level because of the deformation of market relations, lack of business competition and excessive speculation in the trade and financial sector. Inflation destroys at the grassroots the return of investments of pension funds. Inflation is higher than the yield. Thus, from November 2009 to November 2010 the nominal income ratio was 16.95% at the inflation rate in this period of 26.82%. From November 2009 to November 2010 the figures respectively were 4.17% with an inflation rate of 7.70%. A similar picture is in 2012-2013.

Analysis shows that in the short term, the cumulative inflation rate significantly exceeds an average ratio of pension funds’ nominal income on both moderate and conservative investment portfolios.

Under such circumstances there is no sense to motivate the existence of private pension funds. The limited market forces the individual pension funds to participate in high-risk investments, to acquire shares of not reliable and sometimes dubious companies and banks. As a result, a number of pension funds suffered significant damage. Thus as of January 1, 2013 the loss of pension funds for the default of issuers on securities amounted to 16.9 billion tenge. The market, in fact, was not ready for the adoption and use of pension savings. The inflation brought to naught the quality of “long” money- the main advantage of retirement savings.

According to the National Bank, the cumulative return in the period of 1998-2012 years on the moderate investment portfolio was 366.15%, on the conservative portfolio – 356.07, and the accumulated value of inflation reached 236.31%.

The weak link

The weakest link is the activity of pension funds. The effectiveness of their work is seen in the data for 2010, when 7 funds gained profit, and 6 funds incurred a loss of 2.8 billion tenge. The following data also show a significant decline in quality indicators: in 2005-2007 annual growth of retirement savings made up on average from 30 to 40%, and “pure” investment income – up to 65%; in 2010 these indicators already accounted for respectively 21 and 16%.

Among other things, there is such a fact as mentality. A number of managers in the pension funds have a desire to live in grand style. Initially the pension funds had a 0.5% commission from the activities on pension assets, and management companies of pension assets had commissions as high as 15%. In an early stage, when savings’ rate was low, this remuneration was an incentive. But now, when these assets exceeded 3.3 trillion tenge, each percent of interest has grown considerably. At that, the value of the commission is not attached to the performance, and is increasingly dependent on the value of pension savings. This negative situation where the material welfare of pension funds’ workers depended on the amount of deductions only benefited all employees of the system.

Unfortunately, this anachronism, when the funds lost profitability, and the incomes of their employees grew, was discovered very late. Money of retirees, present and future, to put it mildly, was used wrongly: expensive offices, jeeps, high wages, and holidays in prestigious resorts – all that was afforded on the money of pensioners. Excessive and avoidable costs have become a norm. Thus every year 600 million tenge is spent on notification of investors about the state of individual retirement accounts. Expenditures on maintenance of the automated information system for technical support, renewal of licenses, and so on, reached 500 million tenge. All these and other costs are covered at the account of pension assets, through the establishment of high rates of fees for management and investment activities.

Moreover, there were elements of criminal acts and creation of theft schemes. Thus, according to the National Bank, some of the funds acquired securities of affiliated companies that fell into default and the shareholders of the funds were associated with these artificial defaulted, loss-making companies.

When mechanism does not work

According to the National Bank, in the period from 2004-2012, two pension saving funds were eliminated – JSC “NP” Valut-Transit Fund “and” JSC “Korgau.” For the same period the National Bank issued a permit for the reorganization to five NPFs: JSC “Industrial Kazakhstan” in the form of merger with JSC “SAPF”; JSC “Amanat Kazakhstan” in the form of merger with JSC “Eurasian NPF”, later the JSC “Eurasian NPF” was renamed to JSC “NSP Astana”; JSC “BTA Kazakhstan” in the form of merger with JSC “Ular Umit”, the JSC “KNPF” Philip Morris Kazakhstan and JSC “NONPF” Kurmet” in the form of merger to other pension funds.

Of course, there are shortcomings, but the main thing is that the market mechanism of pension contributions does not work. Ultimately, the state would suffer the scope of defects of this segment of the financial market. Even now, as the yield of the funds is guaranteed by the state, over 8 billion was spent to cover the losses. But the main problem, due to the low yields and losses in some pension funds, is the risk that starting from 2032 the budget for compensation of losses and current payment of guaranteed pensions will use the money of the National Fund. According to estimates, in near decade about 1.5 million people will retire, annually from 100 thousand in 2011 to 200 thousand in 2021 with an average annual increase of pensions by 39%.

In addition, for this category of investors of NPF, who are in the system from 14 to 23 years, the amount of pension payments by 2022 could reach from 500 to 600 billion tenge.

The main contradiction of the pension system is the increasing gap between the growth in the number of contributors who reached retirement age, and average figure of mandatory pension incomes in the country.

According to the estimates of the National Bank, its head G. Marchenko believes that taking into account the growth of pension payments, the budget by 2042 will deplete the NF resources received from the oil windfall.

The weakness of the national pension system lies in the fact that of 8.5 million of employed population, 3.5 million people, or 41% regularly deduct pension contributions. Furthermore, of 2.7 million of the self-employed, these contributions are made by only 932 thousand, or 34.5%. As a result, the average saving on one pension account made up less than 400 thousand tenge at a relative rate of 1 800 thousand tenge, or 4.5 times less than it is required.

As known, eventually getting a small pension, this category of pensioners requires low rates, low prices, and increase in social support.

Another problem is in fact that in 2012, over 17% of women, according to the Minister of Labor and Social Protection Serik Abdenov did not have the necessary record of work and could not claim to the joint portion of pension payments. According to calculations of the Minister, by 2015, the number of these women will reach 50%, and by 2018 – 100%.

The way out

What is the solution? The Government in the name of Deputy Prime Minister Kairat Kelimbetov defends the need for the creation of a Single National Pension Fund (SNPF). It is clear that the yield will not essentially change due to the lack of spheres for the retirement savings’ application. But the main thing here is the reliability and guarantees of pension savings’ safety.

On this stage, the government measures seem like a step back from the market principles in the direction of methods of paternalism, state capitalism and dirigisme. In fact the essence of the matter is that the state is unsatisfied with the pension funds’ activities and is seeking to optimize their performance. The state itself is going through the market methods to “conduct” savings, fully introducing the tools of public-private partnership.

What measures are proposed to rescue the pension system then? Obviously, the decision did not come overnight. There are concerns about what is offered in return. The SNPF will be created on the base of the SAPF. The rest pension funds are offered three options: liquidation and sale of assets at a decent price; merge into SNPF, or transformation into a managing company. The new pension system, according to President Nursultan Nazarbayev, “will allow more effectively and safely disposing the savings of our citizens.”

First of all in 2013, all individual retirement accounts will be transferred to the SNPF. This transference will be carried out in full. At that, this act, according to K. Kelimbetov, is not nationalization of pension savings, which remain in the property of citizens.

According to G. Marchenko, it is necessary in a long term to create reliable protection mechanisms against possible encroachments of the Government to close any gap in the budget, since such temptations have been observed.

Another challengeable proposal is to unify the retirement age. The initiative of Minister S. Abdenov is quite understandable: there is a threat of a hole in the budget. Gaining time is possible through the increase of women’s pension age. At the same time we cannot say that these are our “domestic” problems. In one form or another they are present in many countries of the world, even in Chile, which we followed, and which after 17 years of use of the modernized pension system had to retreat under the pressure of emerging problems.

To keep within means

The main weak points of national pension systems are known. Outpacing inflation over the yield, volatility of individual markets, where money is invested, decline in fertility with increasing life expectancy, income disparity in national budgets and growth in pension payments, etc. Some of them are aggravating.

Indeed, one of the causes of the debt crisis in European countries was the lack of resources to maintain a high level of social standards, including pensions. This is particularly noticeable in the Southern European countries, where labor productivity lags behind the same Germany, and pension in Spain is almost equal to German (1200 and $ 1190 USD respectively). And of course, the desire to raise the retirement age to 67 years in France, Germany, Italy and to 68 years in the UK, causes understandable resentment and fierce resistance of the population.

It is not easy to recognize the weakening competitiveness of the national economy, falling tax revenues and pensions and a high level of unemployment. Among unpopular measures there is also a decision of the Cyprus Parliament to nationalize pension funds to fight the crisis. Many countries are concerned about the aging of the population. At the same time the life expectancy is increasing. However, the growth of pension payments requires considerable efforts and comes upon the budget of a country.

This contradiction is solved at the account of increasing the retirement age. In Japan, for instance at the average life duration of 82.1 years there is a uniform retirement age for men and women – 70 years, in Denmark, Norway, Germany it is 67, in the USA, Canada, Sweden – 65.

It should be noted that in different countries, the role of non-state pension funds is different. In the U.S., Canada, UK, Australia, they account for more than 40%, and in the Czech Republic, Poland, Hungary, Slovakia -for less than 5%.

By all accounts, the world’s pension system is going through the most difficult stage of its development, and long-term forecasts are not optimistic. The pension system of Kazakhstan is “ill” with the same disease. The desire to minimize the risks to achieve efficiency of the modernized national pension system is a general challenge. There is no perfect solution in the world. We should think how to better and maximally protect old age – there is no alternative to this goal.

At the same time it is obvious that we must live within our means. It’s not difficult to distribute all that we have gained, but much more difficult to maintain at a proper level our accumulations. The main guarantee of social welfare was and is the rise of the national economy on the basis of productive diversification, the scale introduction of innovations and rapid growth in labor productivity.