Private Pension Funds in Hungary: Early Performance and Regulatory Issues

August 1996 The early performance of Hungary's voluntary private pension funds suggests that concerns about Hungary's ability to implement successful pension reform may be exaggerated. Despite the limited scope resulting from the high payroll taxes for the compulsory, unfunded public pillar in Hungary's pension system, the early performance of the voluntary private pension funds has been encouraging and in many respects better than expected. Investment returns have been well above the rate of inflation and participation has expanded rapidly. But, Vittas argues, the sector is highly fragmented and there are several regulatory weaknesses (although action is already under way to remedy some of them): ° No compulsory use of custodian and licensed asset managers. ° Use of book values and cashflow accounting rather than market values. Market valuation on mutual fund principles would allow more meaningful rates of return to be reported and would avoid penalizing workers who transfer their accounts. ° Costly tax treatment that benefits high income earners but provides no incentives to nontaxpayers. ° Infrequent statements and inadequate information disclosure on fund performance. ° No guarantees for minimum levels of relative profitability, and a need for strengthened and more effective supervision. The potential of the private pension funds will clearly remain limited without systemic reform. Hungary's pension system suffers from the same problems that afflict most pay-as-you-go (PAYG) systems in Eastern Europe: high system dependency ratios, low retirement ages, lax criteria for disability pensions, increasing evasion, heavy pension costs, and large deficits. In May 1996, Hungarian authorities decided to create a mixed system with two mandatory pillars and one or more additional voluntary pillars. The first pillar will offer a basic pension to all eligible Hungar...