Hungary: striving for sustainabilty

 

Hungary has been badly affected by the current economic turmoil and became the first European Union member to request a stand-by loan from the International Monetary Fund late last year. The move demonstrated that the Hungarian economy is not weathering the current financial turmoil well and this is having a huge effect on both a financial and social scale. Pensions have not remained unscathed and will need to undergo further change to make it a truly sustainable system.

Hungary last amended its system in 1998 after the last recession brought about a period of double digit inflation. Up until this point the system was a one-pillar, mandatory unfunded, public pay as you go pension system. The current system consists of three pillars: 

• State-run pay as you go system – a mandatory tax financed public pension; 

• Mandatory funded private pension funds; 

• Voluntary pension funds.

“The original idea of the Hungarian pension reform was to introduce a mandatory private pillar providing such a good private pension for the joiners that the burden for the public system would be significantly diminished. According to the World Bank (1994), the public pillar with all its alleged pitfalls is only needed as a safety net,” explained András Simonovits from the Institute of Economics, Hungarian Academy of Sciences in Budapest. 

 

Pension reform

From 2009 pension funds are required to select their members’ investment portfolios according to their age category. “In the mandatory fund market, there are three lifestyle portfolios”, said Hungarian Supervisory Authority (HSA) deputy director general Mihály Erdös. “We have a so-called dynamic portfolio for people with more than 15 years to retirement age, a balanced portfolio for people who are five-15 years off retirement, then a classical portfolio designed for members with less than five years to go.” For the voluntary market, however, there is no legal requirement for categorisation. 

The largest portfolio is the dynamic portfolio, with a membership base of more than 80% of the 2.9 million people-strong workforce currently enrolled in the multi-pillar system. 

Between 1999 and 2007 mandatory pension funds achieved annually an average net return of around +5.7%. Nevertheless the net nominal return in 2008 was -20%. “It was an exceptional year,” stated Erdös, “the annual performance of the Hungarian stock exchange was -53.3%. The Central History European Stock Index (CETOP), another benchmark for the annual performance of pension fund investment published an annual return of -51% last year. This is the [challenging] environment where pension funds currently invest their money.”

The third pillar of the Hungarian pension system has experienced a similar situation. Erdös continues: “Regarding the voluntary pension fund market, the average net return was 

-10.3% in 2008, but for the period of 1999 to 2007 it amounted to +6.9%.” Nevertheless, it is important to note that this is a nominal rate, and inflation was still quite high.

There is a general consensus that even though the loss of the average net return in 2008 might be of concern to members, the impact on pension funds however should be smaller, due to their long-term investment perspective. Nonetheless, the low rates of net real return in the Hungarian pension fund sector raises concerns about the sustainability of the system and the increasing need for financial support. Simonovits suspected if “the benefits from the mandatory private funds are much lower than the corresponding benefits from the unfunded public funds, then there will be [national] pressure to make up the difference. Private gains, public losses.” The government however opened the door of return for those above 52.

Refinancing the system however implies further burdens. Simonovits added: “Our basic problem now is that a lot of firms and private pensions have taken up foreign currency loans. Until the collapse of Lehman Brothers et al, the Western banks almost encouraged the people to take out these loans and Hungary’s over exposure to them has been a major cause of its current troubles.” 

So what can Hungary do to rebuild its pension system? Opportunities for international financial support are limited so what other options are there?

 

Further changes ahead 

The former Hungarian Prime Minister Ferenc Gyurcsány set up a national roundtable in 2007 to discuss and analyse the national pension system. Different ideas of making paradigmatic changes within the system have been voiced. Gyurcsány resigned at the end of March 2009 but the new Prime Minister Gordon Bajnai – whose mandate will cease in 2010 – continues his plans to cut pension benefits to reduce the state deficit and mitigate the impact of the financial crisis to the Hungarian economy. 

Erdös said: “The [former] government has already decided on measurements to make the pension system sustainable, for example increasing the retirement age from 62 to 65.” Since 2006 continuing restrictions on early retirement rules and incentives for late retirement have been implemented. These rules passed parliament in May 2009 and stated the retirement age will reach 65 in 2018 for males and in 2020 for females. 

This governmental change is in response to Hungary’s reputation of being the country with the world record of youngest pensioners, with an average age of 53 years. Zaupper reveals: “A high proportion of pensioners, about 709,000 people, equivalent to 23% of all pensioners, have not reached the normal retirement age of 62 years yet. Nevertheless about 432,000 people [61%] of those are ill health pensioners.”

The number of disabled and ill health pensioners is another issue the Hungarian government has to address. Disability and ill health pensions were seen as a popular income generator for citizens losing employment especially during the recession in the early 1990s. “The number of new ill health pensioners per annum has decreased significantly since 2001 due to restrictions on eligibility,” declared Zaupper optimistically.

Since 2001 pension benefits increase every year according to the “Swiss Formula”, projecting equally the rise of wages and inflation (50%/50%). In order to review government spending, the Hungarian roundtable suggested determining the pension increase on Gross Domestic Product (GDP) growth instead. Zaupper explained: “If GDP lies below 2%, any pension increase will be 100% inflation-linked; if indexation rises between 2% to 3% then the formula will be made up of 80% consumer price index and 20% net salary growth. In case GDP lies between 3% to 4% this mixed indexation will include 60% inflation and 40% net wage growth. If GDP growth is above 4% then we will have the traditional 50%/50% indexation.” The new government implemented this change which parliament passed in May 2009.

The 13th month pension, which was paid twice a year in May and November, represents another financial burden for the Hungarian government. The former government announced in February 2009 that the 13th month pension will be capped by HUF 80,000 per month (£247.75) for current pensioners. Additionally, it was planned that the provision will be built into the normal pension for current pensioners and new pensioners from 2010 will not receive the benefit any more. However, due to the deepening of the financial crisis, the new government went even further – they abolished the 13th month pension completely. However, the issue remains on the political radar and is likely to become an issue during the next general election in 2010.

Despite this, a growth dependant “pension premium” has been introduced – the condition of the payment is that GDP increases by at least 3.5% in a given year. The full amount – one monthly pension – will be paid out if the GDP growth reaches 7.5% and a proportionate amount if it lies between 3.5% and 7.5%, capped by HUF 80,000. Thus, a growth dependant version of the 13th month pension survives. However, slow growth forecasts mean it is unlikely to become an issue at any point soon. The new rules provide the system with additional stability as both the pension increases and the premium are in correlation with economic growth.

With all this change it can be hoped that an exciting and promising time lies ahead for Hungarian pensions. By implementing all the changes above, the government estimates to reduce pension expenditures by 3.5% by 2050. The increase in normal retirement age will add to a reduction of 1%, the flexible model of the Swiss indexation rules with 1.5%, and ceasing the 13th month pension will reduce the expenditure by another 1%. 

Nevertheless time flies and the increasing pressure of providing a sustainable pension system becomes increasingly prominent and Simonovits sees the real problems creeping up: “People don’t get private pension benefits as yet. It will be a problem in 2013 when the system starts to operate, and pensions will be paid out. People will realise that they only get half or two-thirds of their private benefit than they had originally planned for. This will cause real problems.”