Russia's pensions system: Economies of scale dominate

Russia’s mandatory non-state pension fund (NPF) assets grew by 18.6% year-on-year in rouble terms to RUB2,034bn (€29.6bn), according to Central Bank of Russia (CBR) data for mid-2016. At the same time, the number of pension providers continued to shrink. 

As of late November, there were 43 NPFs signed up to the guarantee scheme of the Deposit Insurance Agency (DIA), an ultimate condition of second-pillar provision. This meant that 10 firms had left the industry or folded into existing DIA signatories.

This reduction has been driven by consolidation, which accelerated in 2016. Seven financial groups now control 90% of assets, with several individual NPFs merging into single platforms, including Future Financial Group, Safmar (see panels) and Gazfond.

In 2015, Future Financial Group, which consolidates the pension fund assets of Boris Mint’s O1 Group, started mergering of two of its funds, NPF Blagosostoyanie and NPF Stalfond into Future NPF. This process was completed in 2016.

“Both funds focus on mandatory pension insurance, so the merger enabled us to get rid of redundant departments while sustaining best business practice in customer care and corporate governance,” says Nikolay Sidorov, CEO of Future NPF. 

The merger pushed Future into third place for pension assets (RUB232.7bn) and second in terms of membership (3.72m) according to CBR’s mid-2016 data. Half of the remaining four funds – Our Future (formerly Russian Standard) and Uralsib – are set to be integrated by the end of 2016.

Consolidation is one way that individual NPFs can grow, given the continuing pressures on the whole pensions system. The federal budget remains in deficit, leading to a moratorium on contributions for 2017-19, following on from a policy of freezes since 2014.

Previously 6% of the 22% social tax went towards the mandatory funds, the remainder went to the Pension Fund of the Russian Federation (PFR). Such has been the squeeze on the state system that in 2016 pensioners did not get their regular indexed increase, and have had to make do with a one-off payment of RUB5,000 planned for January 2017.

Within the government there has been pressure to remove the privately run compulsory second pillar from the so-called ‘social bloc’. This opposition has come from the Ministry of Labour and Social Protection and deputy prime minister Olga Golodets.

In response, the Ministry of Finance and CBR have put together an alternative pensions proposal, described as a “modernisation”. 

One of the rationales of the plan, unveiled at September’s Moscow Financial Forum, was that the existing system fails to provide adequate pensions for the middle classes. 

While the current 22% social tax is entirely employer funded, the new plan proposes rising contributions from employees incrementally. They start at nothing in the first year increasing to a maximum 6% of salary. These monies will be accumulated in newly created Individual Pension Capital (IPC) accounts. The new system would be mandatory, but allow for five-year contributions breaks, and use existing savings in the NPFs as the first contribution.

Evgeny Yakushev, executive director of NPF Safmar, says that given six years of frozen contributions, the finance ministry and CBR are looking at opportunities to provide new streams of income for the pensions industry.

The government’s co-authors are discussing their proposal with the pensions industry, social partners, and the relevant ministries, with CBR aiming to draft a law at the beginning of 2017.

One of the elements under discussion is how the tax deduction that would apply, either to personal payments or concurrent social tax contributions, the latter is opposed by the ‘social bloc’. Other issues include how to make it mandatory, and whether it should cover the self-employed.

Yakushev is sceptical. “We have had a difficult economic situation where incomes have decreased, so it’s very difficult to see how the system could cover a large part of the population,” he says.

An alternative has been proposed by the Non-State Pension Fund Association (ANPF) – a self-regulatory organisation in the Russian pensions market – that would maintain contributions, but at about 1% rather than the frozen 6%. Yakushev, a board member of the ANPF, adds: “After the economy recovers, we could rethink the second pillar.”

Another issue is that most second-pillar members have opted for NPFs rather than the fund run by state-owned Vnesheconombank (VEB). This figure now exceeds 30m, about half of the economically active population. As Sidorov points out: “They have consciously chosen second-pillar pension savings as a financial instrument. Changing the system after 13 years of operation means questioning the trust of those people.”

In a further sign of popularity, as of the beginning of November 2016, there were 5.7m new applications in the mandatory system compared with 3.7m in the same period of 2015. Yakushev expects that number to rise to 7m by the end of 2016, with about 70% involving workers moving from VEB-managed accounts to the private system, and the remainder transferring between NPFs.

Increasing investment income in the private system has accounted for the interest, with the funds generating an average year-to-date return of 9.5% as of mid-2016, compared to inflation of 6.7%. The main trend has been a continuing shift into corporate bonds, alongside the CBR reducing the maximum exposure to bank deposits. The limit was cut from 65% to 40% in 2016. 

The CBR envisages further reductions, with its first deputy chairman recently stating that the level should fall to 5-10% in order to free up assets to invest in the capital markets.

One of the main changes to investment regulations occured in June 2016, this allowed NPFs to participate directly in privatisations. This enabled pension funds to buy into the following month’s 10.9% share offering in Alrosa, Russia’s biggest diamond mining company. “With Alrosa growing at 40% for the time being, it’s been a fantastic investment,” says Yakushev.

Various alternative assets have also been suggested by the regulator, including high-tech start-ups, investment into small and medium-sized companies, securitisations and infrastructure bonds. The last would offer improved returns than those generated by municipal and regional bonds. But, they would need a good credit rating and guarantees from the administrative authorities to make them viable investments.

At the same time, the Russian finance ministry has initiated a proposal whereby the funds, as of 2017, would have to generate “an economically viable rate of return”, at amortised rather than market value. The risk premiums would be priced into each deal with the CBR as the final arbiter. NPFs would have to compensate for any losses or profit reduction out of their own resources. While the idea is to stamp out abuses such as funds investing in beneficiaries, the pensions industry has warned of the risk of pushing them into low-yielding investments.

On the regulatory front, the CBR has introduced risk management procedures that include shifting the evaluation of each transaction from the asset management companies to the NPFs themselves. “As a part of this process, we expect stress testing to be introduced in 2017,” says Yakushev.

With the funds gaining in experience, the finance ministry has proposed that they can manage the pensions assets directly rather than having to use asset management companies.