Future pension systems must rely on multiple elements, which is in a simplistic wording the three pillar system

Tibor A. Parniczky, an IOPS regional coordinator

What is the system of pension insurance in Hungary and which are the specific pension insurance practices?
I. First Pillar Provision
All employed Hungarian citizens are obliged to participate in the social security system. There are now two parallel mandatory pension systems: a reformed state pension system and a mandatory private pension fund system. The reformed state pension system is financed on a pay-as-you-go basis. The reformed state system comprises 75% of the the mandatory private pension funds expected provide 25% of pensions on defined contribution basis. Employees were assigned, or could choose, their social security pension structure based on their age at 30 June 1998. All new entrants to the labour force must participate in the mandatory pension fund system.
Under the mandatory pension fund system, employees contribute to one of the approved mandatory private pension funds. Assets accumulate in individual accounts.
The normal retirement age is age 62 for males and 58 for females in 2005. A minimum of 20 years of service is generally necessary for the full retirement pension.
The pension from the reformed system is based on the employee’s average net income earned after January 1, 1988. The income, in the calendar years prior to the third year before retirement, are indexed according to the annual increase in average national net wages. Monthly average indexed earnings are then counted up to a ceiling to establish a pension base. A pension formula, scaled by years of employment from ten to 40 years, is then applied to the pension base. The formula is regressive, allocating more pension to the lower parts of the pension base. Pensions are increased according to the average of wage and consumer price inflation. A thirteenth month pension is also provided, and given other ad hoc increases the resulting pensions are around 60% of covered earnings.
Earlier retirement is possible with a corresponding reduction in the pension payable.
II. Funded pension provisions
What are the public feelings about the private occupational pension schemes in your country?
Private pension funds has become integral part of the pension system, institutional investors in the capital market, and customers of the financial intermediary institutions. At individual level, pension fund membership is a usual item of the employee benefit package for about 1/3rd of the employees. However, the coverage should be higher, and the average contribution will not ensure adequate benefits. Recent changes in the tax allowances even reduced the tax preferences of employee contributions.
In Hungary voluntary employer-sponsored pension plans are offered as follows:
Supplementary contributions to mandatory pension funds;
Voluntary mutual pension funds; or
Life insurance with a savings element.
Mandatory pension funds (MPFs) may be established by financial institutions, local governments, employers, and labour or professional organisations. An MPF must be licensed and must have a prescribed minimum of members in order to remain in operation. The pension funds are regulated by the Hungarian Financial Supervisory Authority.
Supplemental voluntary contributions are permitted which can be paid either by the employee and/or employer up to a certain limit to an MPF. Benefits are paid out as an annuity or under certain conditions as a lump sum.
Voluntary Pension Funds (VPFs) are independent from the state social security system and function as a fully funded system. The VPFs are usually administered by the employers’ insurance companies or financial institutions. The regulation of the investment structure allowable by VPFs is in full compliance with the EU and OECD norms.
The voluntary pension contribution can be paid either by the employer or the employee or both. The benefit can be received as a lump sum after ten years of membership (regardless of age) or an annuity.
Taxation
Mandatory Pension Funds
Employees receive tax credits of 25% on contributions to MPFs. Investment returns for the mandatory pension funds accumulate on a tax-exempt basis. Employer contributions are considered as tax deductible.
Voluntary Pension Funds
Employees receive a tax refund of 30% on the total contributions to a VPF, with a maximum tax credit of HUF 100,000. The Tax Authority transfers the amount of the tax refund to the employee’s pension fund account. Employer contributions to a VPF are tax exempt to employees on the portion up to 50% of the minimum wage.
Investment Issues
The mandatory and voluntary pension funds managed assets of HUF 995 billion at the end of 2003. The voluntary mutual benefits funds have less than 0.1% of the assets of the mandatory and voluntary pension funds together.
Banks and insurance companies own 10 of 18 mandatory pension funds and 11 of 70 voluntary pension funds. Employer-owned pension funds must appoint a trustee to manage their assets. There are 15 large companies (mainly backed by banks, insurers) in the VPF sector, which account for around 80% of members and for 86% of asset size. Six large financial groups dominate the MPF market. However, in both sectors there are about one-third of the pension fund define themselves as non-retail, employer based pension fund.
Mandatory and voluntary pension funds invest above 70% of their assets in government securities, 5% in corporate bonds 9% in shares and 7% in investment funds. Investing in real estate and foreign assets is not dominant in Hungary. There are some restrictions on investment, for example, a maximum of 70% of assets can be held in government securities or a maximum of 30% of assets can be held in currencies which differ from the member’s claim.
According to a prediction of the Financial Supervisory Authority, the assets to GDP ratio could reach 30% in 2020. The assets of the pension funds are likely to rise by 20% or more yearly in the next few years. Pension funds will be more dominant on the stock exchange and government security market.
III. Outlook
Which, in your opinion, are the major challenges facing the European pension systems in the context of the modern realities?
The major challenge of European pension systems is of course the foreseeable increase in life expectancy, and its consequences. It is a real threat to adequacy of future pensions if we also take into account the increase in health care expenditure in broad sense to ensure better quality of life.

In what aspect must the reforms be carried out?
Future pension systems must rely on multiple elements, which is in a simplistic wording the three pillar system. From institutional point of view there are more than three solutions for retirement savings. Another challenge is to really convert savings into real pensions.

Which are the major challenges facing the pension insurance systems of the EU acceding countries, among which is also Bulgaria?
Our pension systems provide the opportunity for a basic pension solution. Even the recent pension reforms and proposals point to different solutions than the CEE pension reforms, and make use of developed financial markets. At the same time the EU level regulation emphasize the rights of migrant workers, portability of pension rights, cross border services. But these suppose the availability of at least similar institutions. Otherwise our countries will be only targets of cross border services, and not providers.

Hungary

Tibor A. Párniczky:
Holding a university degree in software design and mathematics participated in the Actuarial Training Program organized by the UK Government Actuary and the City University of London in 1992-1993. From 1989 to 1993 worked as a senior expert for Human Risk Management Ltd. covering private and public pension programs. Became an Advisor to the Ministry of Finance in 1993. Since 1994 served as General Vice President to the State Private Funds Supervision of Hungary, and after the establishment of the consolidated financial supervisory agency in 2000, he became the Chief Pension Supervisory Councellor of the new Financial Supervisory Authority of Hungary. He was the Director of pension reform programs at the East-West Management Institute. During this assignment he organised pension R&D and training projects in Central and East Europe, and the CEE INPRS Regional Seminars on Private Pension in cooperation with the OECD. The seminars and the connected research projects focused on management, governance, supervision and regulation. He has been the speaker on various meetings and conferences and author of publications on such topics. Before joining Hewitt Associates, based on his international experience, Mr Parniczky, has conducted independent consultant in private pensions and pensions regulation and supervision. At the Hewitt Associates Tibor is responsible for the Retirement and Employees Benefit Financial Management practice since 2006. He also participating in regional RFM projects.

In 1999 he has been elected as chairman of the Outreach Taskforce of the OECD Working Party on Private Pensions. He is one of the founder and coordinator of the Regional Coordinator of the International Network of Pension Supervisors and Regulators (INPRS). INPRS/IOPS is the organization initiated by the OECD and has been formally established as International Organisation of Pension Supervisors (IOPS) in 2004. In the period of the pension reforms, Hungary implemented the private pension funds and Mr. Párniczky participated in this endeavor as one of the major architects of the new system. He is also a member of the Hungarian Society of Actuaries, and frequent speaker of conferences and training programs, as well as government consultant on private pensions regulation and supervision, especially on Central and Eastern European private pension systems.