Crisis poses threat to pension benefits and
the pension reform alike
A Risk Forecast of Political Capital
22 April, 2009
Summary
The financial crisis and the economic recession threaten all three pillars of the
Hungarian pension system. The next government(s) under pressure would have to
simultaneously meet the expectations/needs of the population, financial players,
international organisations (IMF, ECB) as well as the state-run pension system. As
rising protectionism in the region indicate that decision-makers show little concern for
the needs of private insurers, in the coming period these may have to face increased
risk. At the same time, the drastic impairment of private pension funds may slow
pension reforms in general and undermine popular support towards them in CentralEastern Europe. Populist campaigns can focus on the goal of “saving the pensions”,
which can hamper further reform steps.
Effects of the crisis on Hungary's pension system
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
Losses suffered by private pension funds
The drastic losses suffered by pension funds (in the past few months the total value of
invested assets decreased by 15 percent in Hungary) intensify the population’s distrust
of the financial system. This is only exacerbated by banks’ unilateral loan-agreement
modifications that, at a time of strong forint devaluation, have led to significantly higher
loan payments.

Another setback for self-reliance
Following disappointing experiences with private pension funds the population’s
already lackadaisical interest in self-reliance is further weakened. While due to the
crisis the population's appetite for savings has recently improved, unhappy experiences
with investments may slow the process.

Rising unemployment
A rapid rise in unemployment reduces the revenues of state-run and private pension
funds alike1. In the case of the former this poses a financing, in the latter a yield risk.
Rising unemployment increases the risk as, continuing a strategy consistently applied
since the systemic change, the forthcoming governments can hope to remove some of
the jobless from the labour market by offering enticing retirement options. And this will
only put additional pressure on pension funds.

Raising the retirement age: double pain
The forming government plans speeding up the introduction of the statutory retirement
age at 65 to the earliest date allowed by the Constitution and a further increase by six
months annual from then on. With raising the retirement age (incidentally, a needed
and welcome development) the percentage of those withdrawing their assets from the
The advocacy group representing private pension funds projects a 5 revenue loss for 2009.
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second pillar in one lump sum will increase, for the expected years spent in retirement
will decrease. On the one hand, this will put further pressure on funds and, on the
other, due to depleted savings after caring for children and repaying debts, the
proportion of low-income pensioners will rise, placing additional burdens on the social
welfare system.

Growing government intervention
Government regulation of the second pillar is expected to increase (in the form of
additional yield-guarantees and provisions related to investment structures). However,
for this funds have to switch from the current self-government basis to a share
company model. As a result they could generate assets providing the basis for a yield
guarantee.
Due to a wave of popular disaffection, decisions detrimental to the pension system
could be made (we have seen examples for this in Slovakia): reduced employeecontributions, options to return to the state-run system promoted by effective
communication and the elimination of mandatory membership.
The drastic impairment of pension savings may increase popular dissatisfaction with
private pension funds and indirectly this could stall the pension-reform process
throughout the region.
Expected governmental measures concerning the pension system
in Hungary
The Bajnai-government’s planned anti-crisis measures concern the pension
expenditure more radically which consist of elements as follows:

Postponing the 2009 pension adjustment to 1 January 2010;

Cancelling the reduced pension correction in 2010;

Withdrawing the second part of the 13th-month pension of 2009;

Abolishing the 13th-month pension entirely as of 2010, to be replaced by an
optional pension allowance conditional on expected GDP growth;

Changing the pension indexation method;

Implementing stricter regulations on early retirement;

Raising of the retirement age (by 2012, to 65 ages)

It is still questioned whether the whole socialist faction will vote for these measures,
which are necessary for maintaining the low budget deficit, but extremely
unfavourable for the pensioners and for those who are close to the retirement age
(see the “Pensioner Dilemma” below). An extensive pension reform is unlikely in this
term, as the remaining one year is not enough for a structural transformation of the
system.

In the medium term the extremely unpopular pension reform may be helped by the
fact that the majority of Fidesz supporters come from the active segment of the
population, i.e., once in power, the party may embark on painful restructuring and
face less political backlash.
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The “Pensioner Dilemma”
In respect to the state-run pension system stability is a top requirement; yet recently
this has come under increased threat. Demographic and labour-market trends
simultaneously undermine the pay-as-you-go system on two fronts: young people spend
more time in the educational system and become active contributors at an increasingly later
age, while more people reach retirement age and spend more years in retirement.
Of all major systems, the pension system carries the largest political risk for
governments (the so called “Pensioner Dilemma”). As pensioners may decide elections
(close to half of all active voters are pensioners) past campaigns had focused primarily on
currying political favour with that segment of the population. However, the new government is
also under pressure to cut the expenses in the pension system. As international investors are
clearly losing patience with the Hungarian welfare system on the verge of collapse, the
government is forced to implement measures adversely affecting pensioners. While some
government measures that were undertaken a few months earlier (e.g., the reduction of the
13th month pension and its termination for future retirees) already challenged long-held
taboos, the new government’s planned anti-crisis measures go even further (see above).
However, major reforms needed for long-term sustainability are unlikely to be implemented in
the following one year.
In other words, for a credible long-term pension reform there is a need for political
consensus, or at least the cooperation of the two major parties. However, the coming
election season is not conducive for the development of such consensus as the parties wage
a fiercest struggle for precisely that one-third of the electorate made up of pensioners most
active in elections.
Between 2010 and 2015 Hungary's baby-boomer “Ratkó” generation (born in the early
1950s during a period of banned abortion) will reach 60; from then on, following the
voter-grabbing logic politicians are expected to pass decisions favouring the older generation
and delay urgently needed reforms. Consequently, this increases political risk in the
short and medium term alike.
Rates of the optional portfolios of OTP Private Pension Fund in 2008-2009
1,1
Classic portfolio
Balanced portfolio
Growth portfolio
1
0,9
0,8
0,7
0,6
3
11-Mar-2009
9-Feb-2009
24-Feb-2009
25-Jan-2009
10-Jan-2009
26-Dec-2008
26-Nov-2008
11-Dec-2008
11-Nov-2008
27-Oct-2008
12-Oct-2008
27-Sep-2008
28-Aug-2008
12-Sep-2008
29-Jul-2008
13-Aug-2008
14-Jul-2008
29-Jun-2008
14-Jun-2008
30-May-2008
30-Apr-2008
15-May-2008
15-Apr-2008
31-Mar-2008
16-Mar-2008
1-Mar-2008
31-Jan-2008
15-Feb-2008
1-Jan-2008
16-Jan-2008
0,5
Private pension funds
In 2008 private pension fund assets in Hungary suffered major losses of between 10 to
20 percent. Simultaneously, almost without exception membership yields turned
negative. In 2008 the asset-weighted average yield in the second pillar came to -15.82
percent, the first negative yield in the ten-year history of these funds. Through
mandatory annual statements all members learn of the depreciation of their savings, which
could trigger a strong panic reaction among the population. To prevent such an eventuality,
pension funds have already launched campaigns advising the population against
withdrawing assets or encouraging moving assets to safer portfolios, as to avoid realising
losses.
Pension funds have lost assets worldwide as well as in the region. Romanian funds
represent the only exception; they actually managed to produce positive yields.
Fund members can monitor the performance of their assets in real time, which also
means that an increasingly large percentage of the population becomes aware of huge
losses.
Periods of poor performance provide politicians the opportunity to criticise private
pension funds, further damaging the public's perception of the system and, once in
power, the same politicians can easily justify political decisions detrimental to funds.
Here is a Hungarian example: the administration in office between 1998 and 2002
temporarily suspended mandatory membership for newly hired employees and neglected to
implement previously established contribution increases. As a result, the financial position of
private pension funds seriously deteriorated.
Private pension fund net yield rate, and average
Central Bank base rate and consumer price index
Source: PSZÁF, MNB, Stabilitás
25
20
15
10
5
0
-5
Average Central Bank base rate
-10
Consumer price index
-15
Yield
-20
1999
2000
2001
2002
2003
2004
4
2005
2006
2007
2008
Private pension fund - misery: Slovakia and Romania
The most blatant attempt at “disciplining” the private pension system was seen in Slovakia.
The second pillar, introduced in 2005 by the Dzurinda-cabinet, was regularly attacked by Robert Fico,
claiming that the revenue loss caused by these funds to the state-run pension system creates huge
costs for the state. After gaining office, the campaign waged against private pension funds led to
concrete measures: referring to poor performance, on two occasions in 2008 the government
provided fund members the option of returning to the state-run system. Lately, the Slovak
government tried to score points with voters and hamstring the operation of private pension funds
with promises of a drastic reduction of fixed fees charged by pension funds.
Romania also implemented measures to weaken the market position of private pension funds.
In Romania members can enter the second pillar since 2008. Under effective regulation fees paid into
private pension funds are to be raised by an annual rate of 0.5 percent until it reaches 6 percent by
2016. However, the raise for 2009 has been suspended by the government for political reasons, a
decision pensions funds plan to challenge at international legal forums.
For further information, please contact: Krisztián Szabados, director, Political Capital
szabados@politicalcapital.hu
+36 1 437 6787
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