II pillar

This year has been full of surprises and major changes in our daily lives and in the financial world, which should reflect the economic side of real life. Even in their wildest dreams, school children could not have imagined at the beginning of the year that almost all the schools in the world would be closed for months.

The financial world has been verging on the surreal for years. But only recently have there been so many absurd situations and decisions that the line between the real and the surreal is beginning to blur.

Who could have predicted that a company’s shares could go up by more than 100% after filing for bankruptcy? The global car rental company Hertz filed for bankruptcy in June after running into difficulties but then began to prepare a public share offering due to growing investor interest. The authorities ruled out this plan, as the money from the share issue would have simply gone to creditors.

While anything can be rationalised, there is a line beyond which reason starts to resist. For me, that line was crossed a while ago, in 2014. That was when the European Central Bank lowered its key interest rate to –0.1%, which meant that interest would be paid by the lender rather than the borrower. But maybe I’m just too old-fashioned.

The ECB has now further lowered its interest rate on the deposit facility to –0.5%. As a result, almost all German government bonds will carry a definite loss if held to maturity, and even the very highly indebted Italian government can enjoy the luxury of negative interest rates.

In 2020, however, events have moved towards the surreal at an entirely new pace. From a half-century low of 3.5% in February, US unemployment surged to a historical peak of 14.7% by April. On the other hand, although the S&P500 Index, which follows the performance of the largest US companies, initially fell by 34%, the US stock market was close to its previous peak by the end of July.

Protection against the absurd

LHV’s pension funds have for a long time increasingly focused on real assets, including real estate. We have also kept an eye on the commodities sector, but as long as the global economy shows no signs of recovery, there is no reason to expect an increase in the demand for industrial commodities.

There is one mineral resource that stands out from the rest in our current absurd and unreal world: more and more investors are starting to see gold again as a yardstick against which to measure the value of other assets. Gold is shining ever brighter in an environment where countries have abandoned all budgetary discipline and central banks are unashamedly financing public spending without even trying to find justifications.

While investing in the low-risk government bonds guarantees a loss due to negative interest rates, there is at least some hope of earning from gold. Investing in gold is encouraged by the growing tensions between the world’s two largest economies, deepening social inequality and the resulting dissatisfaction.

When power overrides the common good

Flipping through an analysis, entitled “Where to put money amid the bear market in trust”, by Citigroup strategist Matt King last September, one slide stuck in my mind. It described how the nature of democracy can change when power becomes more important to politicians than values.

Trust in politicians has not waned overnight; it has happened gradually over a long period almost everywhere in the world. It’s impossible to pinpoint a particular moment and say that trust ended there, but some events and periods should be noted.

In spring 2019, I registered for the first time the phrase “parliamentary mathematics” being used in Estonia. Politics should be based on values; mathematics is value-free. The new coalition agreement, however, was described by the participants as a trade-off: they weighed and bargained who would have the biggest slice of the pie. With the agreement signed and the pie divided, the abolition of the mandatory funded pension was already decided by summer 2019.

At a pensions seminar organised by the International Monetary Fund and Bank of Estonia on 30 September last year, the Estonian finance minister announced in his typically forthright manner that the matter had been decided: mandatory pension would be terminated (i.e. replaced by a voluntary scheme) and any further discussions would have to be held without the minister. He then left the seminar. The stakeholders were left with no other choice but to look on as the decision was written into law.

I was somewhat surprised to see the otherwise outspoken finance minister give slightly vague answers before a full sitting of the Supreme Court at the beginning of August this year regarding the preparation of the new Funded Pensions Act. However, during a recess, the minister was once again straightforward with the press. He declared that failing a favourable decision by the Supreme Court, the government would abolish the second pension pillar completely.

Liberty, responsibility and self-determination are precious values for society, but it would be absurd to make every mandatory element voluntary. For example, I hope the abolition of compulsory basic education will never be demanded on the grounds that parents, who know their children best and care about them the most, can provide them with the best and most personalised education. It is probably clear to everyone that it would be demagogic to say that without compulsory education, schools would compete and provide better education.

Disservice rather than service

It would be naïve, or downright malevolent, to claim that the proposed pension reform will boost competition and productivity. The government’s reform aims to turn the existing pension funds with their very long-term horizons into short-term (about 12 months) funds. This would significantly restrict their ability to choose investment opportunities and make the different funds even more similar to one another.

There is no doubt, then, that the law pushed by the government would hamper the performance of pension funds and restrain competition, putting those that continue to invest at a disadvantage. This is because the volume of pension funds would shrink, service fees would go up, and the share of bonds with negative yields in the funds would increase.

The draft act doesn’t contain a single provision that would expand the investment opportunities of pension funds. Then again, this is not important for the government, given that the main goal and political decision is to abolish the mandatory funded pension, leaving the public with a choice between fast or slow liquidation.

The pension reform proposed by the government would (initially) retain the current pension funds but would destroy the three-pillar pension system where each pillar has a distinct function (the voluntary second pillar would lose its distinct function).

It is natural for a pension system to evolve and change with the values of society. But it is absurd that the development and improvement of the pension system should be treated in the same way as political bargaining and pie slicing to be handled in the space of a few months.

If we were to learn anything from the pension reform completed in 2002, it is that haste does not bring success. The collection phase turned out more or less well because it received at least some attention. By contrast, the disbursement phase, the discussion of which was postponed arguing that it could wait, is still not working today, 18 years later. This does not mean that pension insurance is necessarily a bad or useless product.

While fine tuning its plan to abolish the second pillar, the current coalition has failed to take the time to examine what it is abolishing. If anything, it is a lack of interest and time that could explain the justice minister’s answer to the Supreme Court that the coalition’s reform plan would reduce discrimination, enabling people to join a pension fund at any age.

Unlike now, there were politicians in the Pro Patria party at the time of the creation of the funded pension system who realised that small contributions over a short time would only make a small amount, and if paid out over a long period, the disbursements would be extremely small. A short collection period would be impractical and lead to disappointment, which is why the 2002 reform, now labelled “discriminatory”, aimed to protect the people who did not have enough time to collect a proper pension.

In retrospect, it is pension insurance contracts that should have been restricted 18 years ago, not making them available for benefits below 10,000 euros or until 2030, by which time the market will be large enough for a viable product. At present, there is a risk that the Funded Pensions Act will be amended so that pension insurance will never be available in Estonia.

I hope that Estonia is (and will remain) a country that is guided by the principle “with power comes responsibility” and will not embrace the increasingly common cut-throat morality of “might makes right”.

As long as trust in the state and the currency it issues is on a downward trend in the world, the price of gold is likely to move up, or rather, the value of money relative to gold will decline. Rationality is out and absurdity in.