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Competition and costs in the Hungary 2 nd pillar

Competition and costs in the Hungary 2 nd pillar. Gregorio Impavido (gimpavido@worldbank.org). Content. FSAP update 2005 TN Impavido Rocha (2006) Structure, growth, investments (5 – 15) Performance and cost comparisons (16 – 24) Decumulation phase (25 - 26) Concluding remarks (27 - 33).

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Competition and costs in the Hungary 2 nd pillar

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  1. Competition and costs in the Hungary 2nd pillar Gregorio Impavido (gimpavido@worldbank.org)

  2. Content • FSAP update 2005 TN • Impavido Rocha (2006) • Structure, growth, investments (5 – 15) • Performance and cost comparisons (16 – 24) • Decumulation phase (25 - 26) • Concluding remarks (27 - 33)

  3. Not covered in this presentation (1/2) • Description of 1997 pension reform • Palacios Rocha (1998) • Rocha Vittas (2002) • Gedeon (2001) • Gál Tarcali (2003) • Simonovits (1999), Müller (1999), Marin, Stefanits and Tarcali (2001), Augusztinovics et al (2002) and Orbán Palotai (2005) • …

  4. Not covered in this presentation (2/2) • Impact on financial market development • Impavido, Musalem, Tressel (2001 – 2003) • Vittas (1998, 2000) • Shah (1997) • Davis Hu (2004) • Blake Orszag (1998), Davis (1999) • …

  5. Few MPFs are still in operation • Decreasing number of funds with little impact on concentration • Immature system covering 50% of labor force • Low-ish asset growth

  6. The MPF market is concentrated • Market is concentrated with 6 largest MPFs representing around 85% of relevant measure

  7. Three types of sponsors can be identified • On average MPFs sponsored by FIN are the largest

  8. The growth of the system has been mixed • Low asset growth due to stagnating contributions and membership in 2000 – 2002 (2nd Q. 2003)

  9. Determinants of low contribution growth • Contributions represent the largest component of growth in initial years after reform • Low membership growth and possible evasion compressed covered wage bill • Stagnant contribution rates and decreasing contribution ceiling compressed contribution base

  10. High share of Government bonds • Investment portfolio concentrated in Government securities

  11. Why such high share of Government bonds? • Liberal investment regulation • Unsupportive fiscal policy • Low supply of alternative investment vehicles • Low performance of equity market (0% between 12/97 – 8/03) • Conservative asset management culture of subsidiaries of continental Europe mother companies

  12. Low investment performance • Av. Real Gross RR = 4.85% (weighted) • Av. Real Wage Growth = 5.27% • Possible reasons: low (but higher than equity) performance of Govt securities due to high credit rating and possible unrealized capital losses due to recent hike in interest rates

  13. Is the number of MPFs low? • Hungary is not unique.

  14. Is the asset growth low? • Maybe, but….

  15. Is investment performance low? • Yes, maybe due to high sovereign credit rating for Hungary • CORR with S&P ratings 2000 = 0.18 • CORR with S&P ratings 2004 = 0.33

  16. Lack of investment performance comparability limits competition • Comparisons of investment performance across MPFs are impaired due to: • No true time rate of return calculations • RR calculations ignores operational costs • No rules on benchmark rebalancing • Brokerage fees not necessarily charged against asset base

  17. Costs cannot be readily compared • OP Fees (admin 66%, guarantee 6%, supervision 5%, marketing 2%,…) out of the operational reserve similar to all funds • AM Fees on top of operational reserve and different by type of sponsor

  18. Contributions fees across countries • Hungary fares better than most countries in terms of total fees over contributions at their 7th year of operation

  19. AM fees across countries • Hungary fares worse than most countries in terms of total fees over assets at their 7th year of operation

  20. Are current fees high or low? • Mixed structure of fees and recent dominance of AM fee implies quickly rising (doubled in first 7 years) fees over contributions (fees are high) • Average assets for Hungary inflates total fees over assets (fees are low) • The FSAP TN concludes that fees are not particularly high today but they will be if fee structure is maintained in the long run • Today fees are 2.9% of Av. Assets for managing a buy and hold laddered portfolio of government bonds with an inefficient contribution collection system, poor information disclosure, a low guarantee fee that is justified only because MPFs have no capital.

  21. Maybe LR fees are better than current fees • Current fees appear high due to the current small asset base (4% of GDP) • Current total fees are not relevant because it ignores the fixed/variable fee mix and therefore, how quickly fees over assets are likely to fall over time (high fix fee -> fast decay) • Then let’s project current fee structure over time

  22. LR total fees over Av. Assets • LR fee of 1.2% is still high • Especially since this projection ignores maturation of system and likely lower growth of assets starting with 2014

  23. Segmentation of costs is still present in the LR • LR fee of 1.2% for average MPF, 1.7% for highest cost MPF, 0.5% for lowest cost MPF. • Segmentation is still present: some MPFs are extracting a rent due to lack of readily comparable information on performance and costs

  24. What are the LR costs for an individual? • 1% AM fee over 40 years of contributions amount to 20% of contribution fees or final cash balance fee (25% compensation fee on contributions - APPENDIX B) • Charge Ratios for average MPF in Hungary are worse than CR for most LAC countries (Whitehouse 2000) and Australia (Mitchell Bateman 2003) Mexico and Argentina are exceptions • Important Caveat: exercise is mechanistic.

  25. Decumulation phase (1/2) • Pension funds can sell annuities • Single, joint, term level annuities with Swiss indexation in 4 possible combinations • No gender discrimination • Weak reserving (no reserving for investment risk) and investment rules

  26. Decumulation phase (2/2) • Limit on discount rate for valuing liabilities inconsistent with fixed income AAA nature of such liabilities • Operating reserve can be used to replenish technical reserves (explicit intergenerational redistribution inconsistent with DC nature of MPFs (Feldstein 2001)) • Lack of retirement products with varying longevity and investment risk sharing properties between providers and retirees

  27. Concluding remarks: growth • Mixed performance can be attributed to elements of reform reversal (contribution rates and switching) that have caused contributions not to grow as expected • Mixed performance can be attributed to undiversified portfolios and relative low investment performance.

  28. Concluding remarks: fees • Comparing fees across countries is problematic due to the different design of different second pillars (coverage, target replacement rates, contribution rates) • Total fees over contributions compare favorably with other countries but total fees over assets do not • Long run fees appear high if assets do not grow more quickly and the current cost structure is unchanged (lower current average AM fees). This probably would suggest that short run fees are high too

  29. Concluding remarks: cost segmentation • While MPFs charge similar fees over contributions, MPFs sponsored by financial groups tend to charge AM fees that are on average 275% and 98% higher than fees charged by MPFs sponsored by large employers and MPFs considered independent. Nevertheless, they manage the same type of portfolio and are not associated with higher performance.

  30. Concluding remarks: disclosure • The segmentation in fees is due to the lack of readily available comparable information on cost structure. This has impaired competition. • Comparability of investment performance also limits competition but not as severely as the lack of costs comparability.

  31. Concluding remarks: prow low cost fund policies • Further to increasing comparability, incentives for lowering costs could be introduced by changing the rules for the default fund for undecided members. Mexico is a good example. • Similarly, switching in general can be facilitate through the use of internet based solutions. Mexico again.

  32. Concluding remarks: retirement • Only life insurance companies should sell annuities as they can partially hedge longevity with mortality systematic risk • Given the presence of a 1st pillar with 45% replacement rate a richer menu of retirement products with varying degrees of longevity and investment risk sharing properties should be allowed • MPFs should be allowed to provide lump sums or income drawdowns only to avoid undesired intergeneration redistribution. AM versus ALM.

  33. Concluding remarks: retirement • Swiss indexation is difficult to match and should be eliminated. Price indexation is easier to match provided you have a liquid mkt. of long duration CPI indexed bonds

  34. End

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