Six years after the pension reform was implemented, the Estonian government is finally set to make some further adjustments to the mandatory second pillar system. The Estonian pension reform, which has largely been regarded as a great success, is now moving into its second phase. Not only is the government preparing how to organise the first pension payouts from the system, but it is also planning to review the investment regulations for pension funds and increase the cap of equity investments from 50 per cent to 70 per cent of assets. The government is further attempting to reduce the management fees for second pillar funds.

Robert Kitt, chairman of the management board of Hansa Investment Funds and board member of the Estonian Association of Fund Managers, is keen to take advantage of the new investment regulations. The firm, which offers three second pillar pension funds with different risk levels, already has plans to boost its equity allocation in two of its three pension funds.

Mr Kitt, who expects the new investment regulations to be in place by January 1 2010, believes a higher equity allocation will appeal to its members.

“Our system is so young and immature. Our clients have, on average, 35 years to go before they will retire, so the high equity options have been very popular,” he says.

Indeed, about two-thirds of Hansa’s pension clients have signed up for the fund with the highest amount of equities, the third mandatory pension fund (K3) with 50 per cent invested in equities. With the new regulations in place, K3’s equity exposure will be raised to 70 per cent and the equity allocation in its second pension fund (K2) will increase from 25 per cent to 35 per cent of assets.

Despite less rigid investment restrictions than most of its central and eastern European peers, Estonian pension funds are required to have 70 per cent of their assets invested in liquid assets. There is also a cap of 10 per cent of investments in real estate, which since 2005 may also include indirect property investments. In addition, funds are banned from investing in commodities.

“But my belief is that we must have some non-liquid assets to be able to diversify, since we have such a long investment horizon,” says Mr Kitt. Compared to their former communist peers, Estonian funds still have a great deal freedom to invest abroad or in alternative asset classes.

In 2007, returns from second pillar funds ranged from 1 per cent to 11 per cent. Like most of its international and domestic peers, Hansa’s funds struggled to pull in positive returns in the first quarter of 2008, with the exception of one fund that has a 100 per cent bond allocation.

“The volatile market has certainly left a footprint in our returns. But unlike some other central and eastern European countries, where a decline in the market has sparked criticism among pension fund members, that has not happened in Estonia and there has been no criticism from our clients,” says Mr Kitt.

According to Pensionikeskus, the Estonian pension information centre, pension funds have, over the past year, reduced their allocation to direct equities and bonds. The overall share of indirect investments has increased from 37 per cent to 51 per cent.

Another issue facing the second pillar funds is the government’s plan to force a reduction in pension fund fees; a matter that has been under discussion for years. Politicians claim the management fees, which generally are higher than 1 per cent, are far too much.

“In comparison with other countries, our fees seem very high. But on the other hand, fund management companies have made large investments to set up the funds and build up the system,” says Mr Kitt, who also emphasises that there is a good dialogue about the issue between all concerned parties. With the continuous growth of assets, pension fund fees are also expected to gradually come down.

The second pillar consists of 15 mandatory pension funds offered by five providers, but each firm’s market share differs significantly. Hansa, for example, is managing more than half of the assets in the system, which Mr Kitt admits is “ridiculously too much” compared to western standards. The system has had a very high take-up and about 95 per cent of those eligible have joined the system.

The beginning of next year will also bring some significant changes to the second pillar system. On January 1 2009, members will for the first time be permitted to take money out of the second pillar. Since the implementation of the pension reform in 2002, assets have been frozen in the system and anyone set to retire before 2009 is not eligible to join. This second phase of the reform is not yet organised and the government will need to set up a system for how to arrange the payouts. However, a majority of second pillar members are young and far from retirement, so it is unlikely it will lead to any major payouts from the system.

Printer friendly version

Email this article to a friend