Russian Federation: Russian Pension Reform Is Not Doing Well

Last Updated: 15 May 2008
Article by Leonid Zubarev

Russian pension reform has started in 2002 when the government divided the state labour pension into three parts.  The basic part is a guaranteed minimum equal to all participants.  The amount of contributions to the insurance part depends on the length of service and the salary of an individual participant.  Contributions attributable to these parts are recorded on notional individual accounts and are still used to finance the pay-as-you-go element of the state pension system.  The third funded part of the labour pension represents a savings element and can be invested according to guidelines set force by the government and can be managed by the state (Vnesheconombank), private asset managers or non-state pension funds. 

According to the Russian press, the reform has apparently failed.  The state owned Vnesheconombank still manages over about 98% of the pension money contributed to the funded part of the labour pension. The tender mechanism designed to give an individual participant a choice between the state owned bank, a private asset manager or a non-state pension fund has not been promoted enough. Most of the participants have simply ignored the opportunity. One of the reasons is believed to be poor advertising campaign.  According to the Russian Centre of Public Opinion Studies, in 2006 60% of respondents "have heard something" about the reform while 22% have admitted that they "have never heard of it" before the poll.  Half of the Russian population has no idea what is the aim of the pension reform and what issues it has to resolve. 

Private asset managers do not see reasons why they should spend their own money to promote the reform.  Last year the tender turned into a simple qualification exercise and 55 out of 56 bidders were allowed to advertise their services to future pensioners.  However, last year results discouraged private asset managers and earlier this year the tender has failed as there have been no bidders.

The government is concerned that concentration of the pension money in the hands of one state owned asset manager. About 140 bln roubles have landed at the accounts of Vnesheconombank simply because the employees have not made their choice and by default the money has been transferred to Vnesheconombank.  According to the Ministry of Economic Development, a draft law has been developed to introduce a completely different and to some extent a revolutionary approach.  The idea is to make private asset managers a default option.  If an employee does not expressly allow Vnesheconombank to manage his pension money, the State Pension Fund would transfer the funds to private asset managers and distribute the amount among qualified asset managers.  Investment income would also be proportionally distributed among all of the participants who do not opt for Vnesheconombank. 

From the financing point of view, the new system is also far from being a success.  The government has already taken an unpopular step and excluded the most active population (those who was born before 1967) from participation in the funded part of the labour pension.  However, according to the State Audit Chamber, this was not enough.  By 2020 there will be only 116 employees to 100 pensioners while today there are 135 employees to 100 pensioners.  The State Pension Fund deficit will amount to about 1.5% of GDP.  One of the possible ways for curing the situation may be a further reduction of the number of employees eligible to the funded part of the labour pension.  Their contributions can instead be routed to finance the basic and the insurance part of the state pension.  However, this could simply bury the remains of the trust in the reform and would mean a complete return to the pay-as-you-go mechanism.

Another measure that is being discussed is also far from being popular.  At present, Russian men generally retire at 60 and women at 55.  After a year or so of silence on this sensitive issue the government sources have again started a discussion about potential increase of the pension age by 5 years.  As a result, given the life expectancy for Russian men of 59 years the financial position of the State Pension Fund is bound to improve!  However, in view of the parliamentary and presidential elections in 2007-2008 and the fact that, according to the polls, over 88% of the Russians do not support the increase of the pension age, it is likely that neither of the unpopular steps will be taken before the election campaign comes to an end.

Additional burden on the state pension system is early retirement.  In Russia about 27% of the employees are entitled to early retirement and can become pensioners 5-10 or even 15 years earlier than the pension age.  So, a 40 year old pensioner is not an extravagant millionaire but, perhaps, a former military officer.  In response to this challenge the government has developed a law on professional pension systems.  The first draft appeared some three years ago but was heavily criticized.  The main point of disagreement was the list of professions that are subject to early retirement.  However, according to the State Pension Fund, controversial issues have apparently been resolved and the law can come into force in 2007.  The draft provides that employers in dangerous industries will be required to contribute another 3%-7% to fund early pensions for their employees until they reach the pension age and switch to the general system.

The business also does not remain disinterested.  The Russian Union of Entrepreneurs has developed proposals to amend the Tax Code and cancel the unified social tax completely.  It is proposed that the basic part of the labour pension should be funded through the state budget.  An individual employee would then have a choice to make a 4% contribution from its own income to which the state would add further 4%.  As an additional incentive it is proposed to exempt contributions from personal income tax while pension benefits would remain subject to tax.  However, it seems that given the current deficit of the State Pension Fund the government would not be willing to accept such radical approach.

On the front of the private pension provision there have been some recent developments that would hopefully make this sector more transparent and attractive to business.  The government decree No 432 dated 14 July 2006 introduced new procedure for licensing of non-state pension funds that came into force on 1 August 2006.  Having superseded previously enacted licensing regulations, the licensing procedure has for the first time introduced a definition of a "material breach of licensing conditions".  A material breach includes

  • non-compliance with minimum capitalization requirements;

  • non-compliance with qualification requirements for the management of the non-state pension fund;

  • breach of pension rules;

  • non-compliance with guidelines for investment of pension reserves;

  • non-compliance with reporting requirements.

Having discovered at least one of the above material breaches the Federal Service for Financial Markets may file a claim for revocation of the licence with the court.  In respect of existing non-state pension funds the Federal Services will first of all check the compliance with reporting requirements. 

Another area which causes concerns for the regulator is investment of pension reserves.  According to the Federal Service for Financial Markets, new guidelines for investment of pension reserves may soon be promulgated by the government.  The draft follows the model of allowing non-state pension funds to invest pension reserves in certain assets without using asset management companies.  In addition to state bonds and bank deposits the new regulations will allow non-state pension funds to invest directly into mutual investment funds (PIFs) including mutual funds investing into real estate.  Otherwise investment into real estate would not be allowed.

The new guidelines would allow investment of pension reserves by asset managers into shares and bonds of Russian listed companies, mortgage certificates and other assets. It would also be possible to invest into foreign securities that fall under certain conditions.  The regulations tend to limit a possibility of re-investment and do not allow investing more than 5% into shares and bonds issued by companies that are contributors (except where such contributors are also listed companies).

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 21/02/2007.

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