Jun 9, 2017
Who needs pension reform?

Author: Marina Rudneva

The government works on pension reform, the key initiative of which will be the Individual Pension Capital (IPC). The main idea of the innovation is that citizens will have to collect money for their own pensions, saving up to 6% of their salaries on the accounts in the chosen NPFs

The government works on pension reform, the key initiative of which will be the Individual Pension Capital (IPC). The main idea of the innovation is that citizens will have to collect money for their own pensions, saving up to 6% of their salaries on the accounts in the chosen NPFs

The idea in question is not bad, but to implement it we face a lot of challenges. First of all it is motivation and involvement: how to motivate citizens to give up a certain amount of "live" money from their current income, even in favor of a future pension? It is possible that the IPC will be treated as an additional tax, as previously it was the employer who paid the mandatory contributions and now this burden would fall upon the workers themselves. Income reduction can entail a wave of discontent among citizens as well as the workers' demands to raise wages by the amount of IPC deductions. According to the Federal State Statistics Service, the current average monthly salary in the country comprises RUB 36.7 thousand, and 6% of the salary is a significant amount for many Russians. It is possible that in such a situation many citizens will find ways to optimize this as a cost.

It can be concluded that the middle class makes the target audience for the new pension system. It is assumed that this segment of the population can and should think about the future. But even here there are certain obstacles that can hamper the IPC popularization. The first and fundamental one is that the majority of Russian citizens is not used to taking care of their own pension. This has always been done by the state through contributions made by the employer. And the issue is about the state and the loss of confidence in it. Over the past 15 years, the government has already carried out a third pension reform. Lack of trust in the pension system forces citizens who have savings to invest them in alternative instruments. Upon the launch of IPC, the government, together with non-state pension funds, will have to perform large-scale work to gain back the confidence of citizens so that the pension contributions will be a more profitable and reliable type of investment, rather than deposits or real estate.

Auto-subscription is another point of particular attention, when discussing the new pension reform. Initially, it was proposed to include in the IPC only those who are already forming their savings in NPFs, and leave the "silent" ones inactive in this pension plan. Later this issue was revised and a decision was made to automatically include "silent" ones in the IPC. And consequently the auto-subscription option was developed and offered. This is due to the fact that, according to the Ministry of Finance, the refusal of "silent" ones to enter the new system can lead to a reduction in the value of a single retirement point. This initiative is also supported by the Bank of Russia: they call the auto-subscription a key IPC element, without which the new pension system would not work. In turn, the Ministry of Labor is totally against the auto-subscription to the IPC.

While the officials of the financial and social sectors are arguing, the concept of new pension reform continues to be worked out. It is planned that the IPC will start working in 2019, and will be mandatory for the employer to connect all employees to it. After that, the cumulative component of the mandatory pension system will be completely transferred to the "portfolio" of individual pension capital. Savings of the "silent" pensioners will either be converted into pension points, or transferred to NPF. In the next five years, voluntary contributions will be made in the amount of 0% and with each year will increase by 1 point, until they reach 6%. The criteria for distributing the "silent" pensioners between the NPF and the PFR still remain unclear. I would like the developers of the new concept to clearly define these criteria and consequently clarify the business process, aimed at the "silent" ones.

Despite the fact that participation in the IPC will be quasi-voluntary, it is safe to say that the citizens, even those who think about their future pension, will not rush to change the existing pension model. The Russians mentality makes them look first at how the innovation works before using it. And this fact gives Russians a reason to think that the use of "retirement vacation" will be massive and, quite possibly, repetitive, in the hope that upon the time allotted for the given vacation everything will settle down, become transparent and understandable. From this point of view, in the first five years, the IPC will be economically inefficient in the business model of non-state pension funds, since the funds will be able to receive the savings of citizens who decided to change NPFs, CCs or transfer savings from the PFR, after five years. Before that, you can only invest new income, which may not be available if citizens use the notorious five-year vacation.

In addition to the "dead souls" with zero payments, the central administrator (CA) will also affect the investment profits of the NPF and, consequently, the amount of pension payments, since the costs for its creation will be incurred by non-state pension funds. The central administrator is a new commercial structure designed to regulate NPF activities, account IPC receipts and keep the client database. It is understood that CA will be a tool to reduce the costs of pension funds and the administration of the entire system and will undertake the functions currently performed by the funds, PFR and the tax service, i.e., it will perform the functions of a conventional outsourcer. This work is to be paid. So we have another acute question: what are the tariffs for the CA services for NPFs and who will set them? The lack of details in this aspect of the reform raises serious concerns and questions among industry representatives.

The conclusion is obvious: if the initiators of pension reform want the new system to work and not cause any rejection of either the society or the business, the IPC concept should be thoroughly refined.