In the seven years following the Yugoslav war, Kosovo has been engaged in a programme of social and economic reform and reconstruction. A significant part of this programme has been the development of a contributory pension system which people can trust
Before the war, Kosovo, like the rest of Yugoslavia, had a pay-as-you-go (PAYG) pension system which was administered by Serbia. This system, along with every other economic structure, collapsed in 1999.
Kosovo, now an autonomous UN protectorate within Serbia and Montenegro, and the UN Interim Administration Mission in Kosovo (UNMIK), has since set up a reformed pension system based on the World Bank's three tier model, with a first tier universal basic benefit paid to everyone over the age of 65, and a third tier regulatory regime for voluntary supplementary pension funds.
The second tier is represented by the Kosovo Pension Savings Trust (KPST), a mandatory scheme which was set up in 2001 to administer and manage the pensions savings of Kosovo employees.
Membership of the KPST applies to anyone working in Kosovo who was born after January 1946. Full coverage was introduced in two stages: from 1 August 2002, employees of public sector, socially and publicly owned companies and large enterprises became eligible; a year later, coverage was extended to small and medium businesses and the self employed. KPST currently has 200,000 members, about 10% of the total population, and €170m assets under administration.
Arieta Koshutova, a Kosovar with professional experience of international pensions consultancy and UK pensions schemes, was appointed director of the KPST in early 2003. She believes that pensions reform is an important step for Kosovo because it has created institutions that give people a financial stake in their future.
The key to this is the system of individual pensions savings accounts. "The policymakers felt that, to achieve financial sustainability, it was important to introduce individual pension savings," she says.
"Giving individual retirement accounts a central role means that the bulk of retirement income in the future will be based on savings and investments, rather than the tax and transfer systems that predominate in the old systems in Europe."
The KPST is a not-for-profit entity, so there is no tax on profits. Taxation for pension fund members follows the EET principle, where both returns and contributions are exempt from tax.
Mandatory contributions to individual pensions savings accounts are currently 5% for employers and 5% for employees. Employers must deduct 5% from employees' salaries and and another 5%. They can voluntarily contribute additional amounts up to 10% of salary, with a total maximum of 15% of salary.
Contributions to KPST are mandatory for people born after January 1946, although older people may contribute if they wish. As a result most KPST contributors are aged between 40 and 60.
"The reason this date was chosen was to get a sort of 10-year window of opportunity for investment, so that contributors could get some investment return out of their money," Koshutova explains.
In theory, there should be no pensions in payment. In practice there are. This is because when the scheme was launched employers in the public sector failed to screen their employees by age and made contributions on behalf of all employees, rather than those born after January 1946.
This has meant that from August 2004, KPST started to pay out pension savings benefits. Currently it is making around 150 payments a month.
Yet since liabilities are only for contributions received after 1 August 2002, the start date of the scheme, and since contributions are a small percentage of a low average wage, the amounts are trivial and are being paid as lump sums.
One of the early objectives of KPST was to ensure its independence and thus reassure members that their pension savings were protected from political interference. The governance structure of the fund has been designed to ensure that KPST operates at arm's length from government.
KPST is constituted as a legal entity, separate from government and its assets are the legal property of employees. This is an important message to get across, Koshutova says .
"At public meetings in Kosovo, people will talk about pension assets as KPST money or United Nations' money. It is not KPST's or UNMIK's or the government's money. It is contributors' money.
"Contributors are the stakeholders of this fund. They own their share of the assets, like they own a house. Nobody can take that away from them. Wherever they are, whatever they do, it's their own stake."
KPST is run by an independent governing board, which defines investment policy within investment limits prescribed by UN legislation rather than government. The board is made up of seven members, including ‘professional' members - people with international professional experience of pension investments and pension plan design - and ‘representative' members, who are people representing the interests of Kosovar employers and employees.
Board members are chosen by a nominating committee chaired by the head of the Banking and Payments Authority of Kosovo (BPK), the regulator and supervisor, inter alia, for second and third tier pensions in Kosovo.
With independence comes responsibility. The KPST board members and its director are charged with a fiduciary responsibility towards the fund and have the same fiduciary responsibilities as a trustee in the UK.
"The governing board's responsibility is to work solely for the benefit of the contributors, and contributors alone," she says. "For that reason we have fiduciary insurance for all board members, and myself, who implement the board's decisions."
Initially, fiduciary insurance was not easy to obtain, she says. "Fiduciary insurance was a challenge to start with because Kosovo was a new place for insurers, and the risks were high. "The insurance is costly but I think it is worth it, because it sends a clear message that the board's job is to invest money for the benefit of contributors only. It shows that their money is well taken care of."
The KPST works closely with Tax Administration, Kosovo's revenue service, to administer the scheme. Contributions are made though the payroll, in the same way that income tax is deducted. The organisational arrangements involve the employers, Tax Administration, commercial banks, the central bank and BPK, the central bank, and create two flows - of money and of information.
On the money side, banks collect and process monthly pension contributions from employers, and transfer them to the BPK, the central bank, The BPK accumulates these transfers and sends them to the individual pensions savings accounts at the KPST
On the information side, employers report details of pensions contributions they have made to Tax Administration, which reconciles the information about the money and who the money belongs to and passes this information on to the KPST.
The KPST then feeds this data into its record of contributions. Employees' contributions are unitised, which makes it easier to track individual entitlement to the specific share of total assets.
Finally, information is sent to the employee. The KPST is legally obliged to provide individual account statements to each member every year. "The statement enables each contributor to check the balance to see how much they have contributed and how much their employer has contributed. They can also see the return of investments, and the cost of managing this money," says Koshutova.
The decision to involve Tax Administration in the reporting and reconciliation process was taken on the grounds of cost, she says.
"At the beginning the policymakers were faced with the choice of a unified collection scheme through tax administration, where the costs are low, and a system where KPST would handle everything itself but where the costs would be high.
"This approach allows the KPST to develop as a centralised institution with only one office in Pristina and a small staff of just over 20. It generally helps us to maintain a low administrative base."
The UNMIK regulations are explicit about how the contributions are to be invested. They say that KPST assets "shall only be invested… to maximise returns on investment solely for the benefit of participants and beneficiaries".
The investment goals, according to the regulations, are protecting pension assets, diversifying investments, earning the maximum return consistent with the security of pensions assets, and maintaining adequate liquidity.
The first goal - the security of pensions assets - was of paramount importance in the early days of the fund, says Neil McPherson, the chairman of the governing board and the head of European business development and money market funds at Standard Life Investments in the UK.
"Given the history of pensions in Kosovo we thought it was extremely important to build credibility and confidence in the system, and we couldn't afford in the early stages to have any diminution in the value of the balances," he says. "So our initial strategy was to protect the value of the funds. Kosovo was also a zero inflation environment at that time, so we were providing a true real return."
The governing board started with a low-risk strategy of investing in money markets within the Euro-zone. This was done through ABN Amro's AAA-rated money market funds. ABN Amro was chosen after a full tender process, which KPST is obliged to do under UN tendering regulations, McPherson says.
"This provided a relatively low money market base yield which gave us, while not guaranteed security, the best security we could get."
However, the 10-year accumulation period before pensions had to be paid has given the KPST an opportunity to broaden its investment, first into equities and then into fixed income.
"We didn't want to lose the advantage that the 10-year accumulation period gave us. We wanted to diversify and so we diversified into equities," says McPherson. The KPST board chose Vanguard's global stock index fund to provide exposure to a wide range of equities.
Diversification into fixed income was achieved earlier this year when, with bfinance as consultants, the KPST board appointed two more external managers, Schroders and ECM. "We decided to go for some absolute return fixed income," says McPherson.
The KPST gave Schroders and ECM roughly 40% of the asset allocation split equally between them. It placed 20.6% in the Schroders SISF euro-hedged strategic bond and divided a further 20.6% equally between ECM's diversified European credit and European credit funds.
"These changes to the asset allocation are funded by reducing our cash weighting and then directing new flow, " says McPherson. The flow of new money is significant, he says. "One of the characteristics of the fund is very much the flow, with €3-4m coming through every month As a result we are growing from a low percentage base quite rapidly"
The KPST board reviews asset allocation continually and if necessary modifies it to reflect market conditions. Last year, it increased the allocation of assets invested in equities through the Vanguard fund from 30% to 50%,
At the same time it moved the highly liquid portion of assets placed with the ABN Amro global liquidity fund into the ABN Amro interest growth fund to benefit from longer duration and greater return. As a result of these changes the KPST unit price increased by 8.73% over the year.
From the start, the KPST has chosen to invest in passive rather than active management through pooled investments and mutual funds, which provide it with a diversified pool of assets at low cost.
"We charge a 1% management fee which pays for all costs and we need to be very cognisant that higher charges can easily eat up members' contributions," says McPherson.
"The balance between the costs of asset management and the costs of running the operation are constantly under review in order to keep them as low as possible and within this 1%. Passive investment is obviously one way of achieving that."
The other advantage of passive management is that it is communicable, he says "It's very transparent and easy to communicate to the workforce."
One future development is investment choice by members, McPherson says. "Currently there is no member choice in Kosovo, and that is one of the things that is under consideration. As that develops I could foresee a broader range of investment, either via bundled investment opportunities or individual funds according to people's risk tolerance. But this is some way off yet. We are still a very young fund."
Another longer-term development is the emergence of a domestic capital market in Kosovo. Currently the KPST fund can invest anywhere geographically. It must, however, limit itself to publicly traded securities to ensure liquidity and price transparency.
The lack of listed securities in Kosovo, and the bar on investing in private equities, disqualifies the KPST from investing in Kosovo. This situation has been criticised by some Kosovar politicians. "There is more and more political pressure in favour of domestic investments versus international investments, but I don't see that, in the very short term, that can happen," says Koshutova.
"The KPST board has reviewed its investment strategy to see if there is any way it can invest inside Kosovo . But at this point in time, given the absence of any appropriate domestic investment vehicles, the board has adopted a strategy of 100% investment abroad."
Koshutova suggests that the best defence the KPST can mount against criticism of its role within the larger Kosovo economy is the support of its members. "We think that the contributors are the best ammunition. If our contributors have the trust and the confidence that we are doing the right thing, we feel their voice should be heard," she says.
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