The Opportunity Of a Lifetime

For each 1,000 rubles a company pays its employees, it has to pay 356 rubles to the government in the form of social tax, 280 rubles of which goes to the State Pension Fund to doll out as retirement benefits. The fund will receive nearly $14 billion this way this year and the figure is expected to grow dramatically over the next decade, yet there is currently no investment mechanism the government likes to make money on that money. But that is about to change -- and private pension funds can't wait.

President Vladimir Putin's government has sent the final and most crucial bill in its pension reform package -- the long-awaited legislation on investing pension funds -- to the State Duma, which looks likely to approve it by the end of the year. The reform, which Putin pledged to undertake shortly after he was elected, is designed to transform Russia's pension system by creating Western-style retirement savings accounts to hold a portion of each worker's salary until it can be paid back in the form of a pension.

The government has rushed to implement the plan because the current distribution system, where the working population directly funds present pension payments, has been endangered by rapid demographic changes: The number of working-age adults is declining and the number of elderly is increasing. At the same time, life expectancy is expected to grow, adding further to the burden on the fund.

The investment bill has been the only part of the government's reform package that has been subject to serious debate. Other draft laws constituting the package cleared the Duma relatively easily in mid-July despite protests from leftists backed by demonstrators outside the Duma.

One such bill was on state pension provision, which does not change the existing legislation except for raising the base pension to 450 rubles from 180 rubles. It also introduces a long-service pension and reduces the length of employment requirement. Another bill, which was amended this month, split retirement and disability pension funds into three parts.

Slicing Up the Pie

Opening the door for the investment bill's approval, the Duma last month passed a major amendment to the Tax Code that gives the Pension Fund the authority to directly collect a part of the 35.6 percent unified social tax levied on payrolls, which had been collected by the Tax Ministry.

The Pension Fund can now directly collect half of the roughly 79 percent of the total social tax that is earmarked for pensions, with the Tax Ministry collecting the other half. Thus, the 35.6 percent breaks down into 14 percent collected by the Pension Fund, 14 percent collected by the Tax Ministry for the Pension Fund, and 7.6 percent collected by the Tax Ministry for other social services.

The 14 percent collected directly by the Pension Fund, more than 200 billion rubles ($6.9 billion) this year, is divided into the mandatory state pension insurance and "accumulation" parts of the pension funds. Individuals will be able to invest the funds in these accounts in a few years using their own judgment. The percentage of workers' contributions put in individual accounts is calculated in inverse proportion to the worker's age. This part will reach 2 percent of the total social tax earmarked for pensions only by 2010, as older workers retire, according to investment bank Troika Dialog,

Thus, under the government plan, an individual's pension would be divided into three parts guaranteed, respectively, by the state, the Pension Fund and by the individual's investment decisions.

The government expects the accumulation part of the pension funds to amount to 30 billion rubles ($1 billion) in 2002, 43 billion rubles in 2003 and 60 billion rubles in 2004. Troika research predicts that combined accumulation units may grow to $30 billion -- probably more, assuming returns on investments -- by 2010, a half of it expected to go to the private sector.

While it is trying to push through a law that would allow investment of some pension funds to generate more money, the government is battling both the private sector, which is pushing for a more radical reform, and the left-wingers, who are stalling.

Pension Fund Monopoly

The business community -- including insurers, nongovernmental pension funds and asset management companies -- is struggling for a piece of the lucrative business, saying that under the government draft, the Pension Fund will receive excessive control over investments.

The fund will oversee all investments in the medium term and heavily advocates channeling funds into state securities. The government is expected to appoint a single investment manager in 2002. In 2003, individuals will have a choice between several companies selected by the government through a tender. The field might then open to include any private sector company in 2004.

The initial draft prepared by the Economic Development and Trade Ministry was considerably more innovative in terms of private companies' involvement in pension schemes and in diversifying investments, businessmen have said.

According to Troika data, the draft also provided for an investment component of up to 6 percent of the 28 percent levied on payrolls, as opposed to a maximum of 2 percent under the current draft.

The Pension Fund, however, has stubbornly defended its monopoly on investments, sending back the draft to the ministry several times for amendment.

The influential Russian Union of Industrialists and Entrepreneurs, or RSPP, which includes the heads of nearly every large business in the country, continues to lobby for a larger role for private companies.

"Under different forecasts, by 2010, the accumulated portion of pension contributions will reach $50 billion; therefore, it is very important to have insurance companies represented in this sector of the pension system," said Igor Yurgens, president of the All-Russian Insurance Association and vice president of the RSPP.

Insurance companies see their place in the government pension system first of all in paying out annuities on labor and professional pensions and also in forming, together with nongovernmental pension funds, a system of nongovernmental or professional pensions, said Nikolai Nikolenko, vice president of Industrial-Insurance Co., or PSK.

Entrepreneurs warned last month they were going to propose an alternative bill on investment to the Duma if the government sticks to its conservative line. Yurgens, however, said later the alternative plan is likely to be shelved.

Under the government draft, insurers will participate in Pension Fund investment schemes in the initial stage, but only by insuring professional risks of asset-management companies and depositories selected by the Pension Fund.

Private Funds to Get a Slice

Another interested party, nongovernmental pension funds, or NGPFs, will have to wait to invest pension money along with the rest of the market until 2004.

However, NGPFs are the only members of the investment community that will play a distinct role in investing pension funds under the current plan, albeit farther down the road. Private funds now control a tiny fraction of the market, some $ 1 billion, but could easily double their strength when the professional pension system, a part of the pension package, is introduced.

And more money may pour into NGPFs as companies' employees decide to invest in them rather than the Pension Fund.

The fund has endorsed the scheme and is especially keen to hand over to the NGPFs the special benefits component on pensions -- money paid on top of the regular pension, usually to compensate for dangerous or harsh working conditions. Currently, these benefits are a huge burden on the Pension Fund. Workers in 1,861 professions -- about 20 percent of the country's workforce -- are currently entitled to such benefits, which suck up 30 billion rubles a year and are paid out at the expense of regular pensioners.

Under the proposed new system, companies will pay for each individual's benefits separately from the rest of the pension contributions and will have a choice between the Pension Fund and an NGPF.

The government also has said it is planning tax breaks for NGPFs, which would attract more investors and further irritate insurers. Taxation of insurance fees would remain unchanged.

Bill Likely to Pass Unchanged

Despite disagreements over the investment bill, there is a fairly broad consensus that it will pass through parliament relatively unchanged.

"I don't think the draft approved by the government, whether the Duma passes it this year or not, will be axed or changed dramatically. It was discussed widely, and the opinions of all the sides, including the deputies, are incorporated into it," said Yevgeny Gontmakher, head of the government social development department, which is in charge of preparing the reform plan.

"Of course, some amendments will be made by the Duma. Insurers would like to make some clauses of the law 'stronger,' just as the left-wingers would like to see them 'weaker,' but we think we have come to a reasonable compromise," he said. "But if insurers want to have even more than they are getting now, they may end up with nothing at all -- you have to be realistic."

The "right-wingers" will try to speed implementation without trying to change the essence of the bill, said Gontmakher.

"They will push for an earlier inclusion of nongovernmental pension funds in the system and giving individuals a broader choice for investing the pension money. This is all already in the bill, the argument is only about the time frame," said Gontmakher.

However, Andrei Jvirblis, a spokesman for the All-Russian Insurers' Union, said the RSPP's alternative bill will remain entrepreneurs' "hidden weapon."

"Businessmen are ready to discuss the government's bill if the same version we have already seen is submitted to parliament," he said. "However, there are suspicions that it may come to the Duma sterilized, that essential innovations may be lost along the way."

If this is the case, the entrepreneurs may draw their swords again, said Jvirblis. They don't expect the alternative bill to be adopted instead of the government version, but its introduction would give them more leverage as the debate moves to a conciliatory commission or another such collective body.

One of the bones of contention is the structure of investment. Under the current government draft, up to 20 percent of the funds may be invested in foreign assets. However, Pension Fund chief Mikhail Zurabov said that, at least in the short term, the pension money will be invested only in state securities, a provision businessmen will not accept, said Jvirblis.

Government paper is a risky asset that by definition cannot constitute a large part of a pension fund portfolio. Entrepreneurs have urged the Pension Fund instead to invest more money in corporate bonds to boost companies' capital.

The government bill also will face opposition from left-wingers defending the current distribution system. They are likely to simply vote against the investment bill rather than propose amendments, said Gontmakher.

However, even the opponents of the government pension reform plan don't expect any obstacles to its passage. Duma Deputy Martin Shakkum of the Russia's Regions faction, for example, said that the bill will probably make it through the Duma as is, even though disagreement over the investment component remains.

"I am not an advocate of the accumulation system. In principle, this may be a good idea, but in the present situation, its introduction would be premature," he said.

At the moment, pension money is being immediately reinvested in the economy because pensioners spend it on staples straight away, so the system is beneficial for the economy, said Shakkum.

"The main thing is that no one can guarantee that the money that is accumulated will retain its value over time, it's even less probable that the value of the savings will grow. Especially, given the fact that we might be on the brink of major financial turmoil" with the price of oil and world markets plummeting, he said.

The accumulation system would only work when people are able to make their own choice and invest in NGPFs, but not when the Pension Fund is put in charge of managing individuals' money, he said.

Even so, "the passage of the law is very likely because the presidential administration and the president have been convinced that this is advisable, although the arguments were not always clear and correct," he said.

"This is extremely profitable for those who will manage and distribute this money. There are so many rich people who are waiting for this law to be passed so they can have another party. Pension money is a gold mine -- that's why so much lobbying is going on -- but not for the owners of the money. They will have no guarantees they won't get just a tiny portion of their money in the end," said Shakkum.

Delegating the Pension Fund the authority to distribute the money means putting it in the hands of an institution that is rather opaque, relative to non-state funds, which are closely watched by regulatory authorities. At the moment, the fund is only subject to annual routine checks by the Audit Chamber, the Duma's budget watchdog, but is often slow providing the data. The government bill provides for the creation of a special government body that would supervise the Pension Fund's actions, but so far its structure has not been clarified.

Some analysts are skeptical that the new accumulation system will take off soon after the restrictions on investment are lifted. Troika Dialog predicts that for the first few years most Russians will leave their savings with the state fund, much like the 68 percent of households that still keep their savings parked at the state savings bank Sberbank, but not for lack of options.

It probably won't be until 2005 that the private sector will be able to attract significant funds from the state sector and not until 2007 will they take a market share from the state fund, said Troika.

There are more issues to be addressed. To make up for the funds that would be diverted to the accumulation funds, the Pension Fund is going to draw on its reserves, which Zurabov put at $3 billion.

Speaking at a seminar on pension reform recently, Zurabov said the reserves will be used through 2003 to compensate for an estimated annual shortfall under the new system at 35 billion rubles to 37 billion rubles, or a 2.2 percent drop from the current level. Thus, the Pension Fund will simply be using its own reserves, some critics say.

The fund has been building up reserves by paying out less than the estimated 37 billion rubles to 42 billion rubles it has been collecting over the past few months.

As of 2004, the fund expects to receive about 50 billion rubles a year from the state to bridge the gap, said Zurabov.

Staff Writer Torrey Clark contributed to this report.