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PROBLEMS IN KAZAKHSTAN PENSION SYSTEM

May 2017 - Finance. Legal Developments by Synergy Partners Law Firm LLC.

More articles by this firm.

Mr. Alzhan Stamkulov, partner

Synergy Partners Law Firm

State Pension Fund. Kazakhstan made a state monopoly on managing pension assets in 2013. Prior that reform about dozens of private pension funds in Kazakhstan that had been a major driver for a local stock market and finance. Nowadays JSC United Pension Fund accumulates all pension contributions and manages all pension assets; however, its revenues are negative. JSC United Pension Fund (JSC UPF) is fully owned state company.

WTO and Kazakhstan. Kazakhstan recently joined the WTO and opened its market for assets management companies. In other words, the Kazakh legislator should remove the state monopoly on pension assets management. It is more likely that the National Bank of Kazakhstan is considering reforms to come back to prior pension system with private pension funds.

The prior pension system had its own pros and cons. It is necessary to make a number of improvements to eliminate the previous mistakes. Let's consider in details.

United Pension Fund. In early 2016, the National Bank of Kazakhstan made the suggestions that private asset management companies may take a part of UPF assets for management. This assumption contradicts the WTO requirements. The asset management companies should have access to its own pension funds rather than to be subcontracted by JSC UPF with all possible legal risks tainted by possible corruption in a state procurement. In pursuit of free market competition, asset management companies shall compete for customers by services. Customers will choose and prefer to whom they trust their savings and on what terms and conditions.

Conflict of interests: asset management companies and their shareholders. The major concern for the past decade was the conflict of interests between owners of asset management companies and customers. To get low-yielding finance, the financial industrial group bought an asset management company with its private pension fund. Then, an affiliated subsidiary, that required finance, issued its corporate bonds so that this private pension fund purchased it. The management company acted for the benefit of shareholders and its affiliated company, while it shall do in the best interests of private pension fund clients.

As a suggestion, the securities laws should prohibit the private pension fund to acquire any securities of affiliated or related entities. The laws also shall prohibit the cross-swap purchase of securities of another asset management company that has the same conflict of interest.

In addition, the law should also prohibit banks from owning asset management companies with its private pension assets, as there will be a conflict of interest by depositing these pension savings in these banks or by the acquisition of securities of these banks to maintain necessary market capitalization and comply with prudential standards.

Conflict of interests: governmental spending and asset management companies. The Same concern is the conflict of interests between state and pension fund consumers. This conflict of interest is perhaps the biggest concern in Kazakhstan history. Let us explain. Everything was established in such a way as to oblige pension funds to buy low-yielding Kazakhstani treasury securities, securities of national companies and Kazakhstani banks. Previous private pension funds, and nowadays JSC UPF have no other choice.

In practice, it turned out that the state borrowed money from pension funds to finance its own various governmental programs, such as Expo 2017 and other lavish projects.

The government indirectly finances its national companies through savings from pension funds under very low remuneration. As a result, pension funds had income below the inflation. National companies could get financing less than 5% per annum in Tenge, a Kazakh national currency. SMEs could receive financing from banks at 15-20% per annum in Tenge.

With the fall in oil prices in 2015, the situation has become very clear. SME sector in the economy reduced in a size, while national companies expanded and reached more than 70% of the economy. Of course, employment and tax revenues did not increase. As evidence, anyone can cite the fact that most regions and cities do not have SMEs as the major group of taxpayers. This is some sort of unfair competition between the national companies and SME. It has a concern on the national companies their procurement policies and spending.

The question arises, why should then JSC UPF provide finance to the state at very low-interest rates for unclear governmental purposes? If the government wants to borrow, then it should borrower on competitive market terms and upon the decision of the asset management company. Probably, it is already more than obvious that it is necessary to eliminate such a conflict of interests.

Investment opportunities of funds. Investment abilities for asset management companies are vital matter. Asset management companies should be able to trade solely in the interests of their clients, not for the state. This means the ability to keep savings in foreign currency, in foreign financial institutions with a high investment rating, buy shares of companies from S&P500, or buy highly-reliable fixed income instruments. The asset management company should also be able to invest medium risk securities. The essence of investment abilities is to be protected from various risks while making a profit.

Partial withdrawal from pension savings. In early 2017, the representatives of the JSC UPF informed that they were considering the possibility of a partial withdrawal from the pension savings by a consumer for its specific needs, for example, a mortgage.

To answer this question, let's consider one example. For example, a man, 45 years old, must make a complex surgery operation to remove a benign tumour. So, the person shall die without this treatment. Let’s assume he does not have enough money for the surgery. The compulsory medical insurance for Kazakhstan citizens operates from January 1, 2017 on the principle of a joint model and this system cannot provide a customer with insurance coverage for inpatient treatment and surgical operations, while are some quota for expensive treatment that usually is not available. The only option is his pension savings. If he has retirement savings, then does this individual have a right to withdraw its savings to save his life by an expensive surgical operation?

The answer is obvious. We suggest that Kazakhstan citizens should be able to (1) partially withdraw their pension savings for vital medical treatment that are not covered by compulsory health insurance, (2) purchase extended medical insurance or health-care package from pension investment income in order to obtain a broader or more universal medical care as an alternative to compulsory health insurance. This can be on an annual basis or on a semi-annual basis.

We consider that, unlike UPF, private pension funds will help to increase competition between medical clinics for the funding and increase the number of employed people. The funding would be more competitive, which would lead to an improvement in the quality of medical services through competition. The employee himself chooses the medical insurance company that suits him or chooses his subscription service in a private clinic with his insurance package and service. A part of loss adjustment, the insurance companies will verify and control unnecessary medical treatment, fraud and quality of services.

Payments from pension funds will go to medical insurance companies and clinics directly. What will happen? There will be competition, the market will choose a more economical and efficient player in the medical services market. Conversely, people will choose these asset management companies that can increase investment income in order to buy more expensive medical insurance with a greater coverage or service.