Opening the door: Government-driven changes are set to make pensions more attractive

The concept of private pensions is relatively new in Turkey, with the first private scheme having been introduced only in 2003. Since then, the system has grown rapidly, although it is still small relative to the size of the economy. Furthermore, it is expected to expand in the coming years, as the government has introduced legal changes to make pensions a more attractive form of savings for retirement.

THE BASICS: Turkey’s private pension plan is a voluntary, defined contribution system that has been designed to supplement the state’s social security system. Plan participants make regular contributions (typically monthly) to a pension fund. The retirement savings that accrue are a function of contributions, investment returns and administrative expenses charged by the pension fund.

Various investment alternatives are typically offered by the funds, allowing participants to choose a level of risk that suits his or her preferences. Because Turkish pension customers are generally conservative in their savings preferences, government debt instruments account for 58% of assests under management by pension funds. This is followed by time deposits (20%), equity (14%), foreign debt instruments (5%) and corporate bonds (3%).

CURRENT UPTAKE: At the end of 2011, total assets under management by pension funds stood at TL14.3bn (€6.1bn), representing 2.7m policyholders. While this represents tremendous growth in just nine years, this number still equates to only 3.5% of the population. Moreover, for the targeted group – people aged between 25 and 45 – the figure is not much higher, standing at just 7.7%. In terms of assets under management as a percentage of GDP, Turkey is also well behind not only the global average but also its peers. According to a report from the OECD, as of 2009, (the latest figures available at time of press) the value of Turkey’s pension funds was equivalent to 2.3% of GDP, far below the global weighted average of 67.1% and less than the rates found in some markets to which Turkey is sometimes compared (Poland at 13.5%, Mexico at 7.5%).

MAJOR PLAYERS: As measured by assets under management, the two largest players in this market are Anadolu Hayat ve Emeklilik (21%) and AvivaSA (21%), followed by Garanti Emeklilik (16%), Yapı Kredi Hayat ve Emeklilik (16%) and Vakıf Hayat ve Emeklilik (6%). These firms are all part of larger financial holding companies that represent some of the largest banks in Turkey. Anadolu is a unit of the same group as ş bank, the largest bank in the country as measured by assets, while AvivaSA is 49.83% owned by Aksigorta, the insurance division of Akbank.

Having an established relationship with a bank is an important competitive advantage, as more than 55% of pension contracts are sold either directly through banks or result from leads provided by lenders. As Meral Eredenk, the general manager of AvivaSA, told OBG, “The market has seen seven new entrants in the past four years, going from 10 to 17 players. However, the market itself has not seen 70% growth, so it is unlikely that all these players will remain. In particular, those without a bancassurance partner will face great difficulty, as the return on direct channels often takes a decade.”

ROOM FOR IMPROVEMENT: While the system has grown significantly during its nine years, the sector has faced some barriers to expansion. According to Burak Sayın, the group manager for research and development at Yapı Kredi Emeklilik, persistence is the greatest challenge for pension funds because people can enter and exit the system at any time.

While this flexibility may make the system more attractive for contributors, some 1.6m of the 4.6m contracts issued since 2003 have lapsed.

This figure is consistent with research by AvivaSA, which shows that customers contribute to their pension plans for seven years on average, despite the fact that contributions withdrawn before 10 years are subject to a 15% withholding tax on cash value.

Convincing people to stay in the system can be difficult, but pension funds also face hurdles when it comes to persuading potential customers to open an account in the first place. While tax incentives exist – for example, contributions of up to 10% of annual income are not subject to income tax at the time of contribution – only around 35% of account holders benefit from these rules, according to Sayın.

This is in part because the process is cumbersome for individuals. They are required to provide documentation of contributions to their payroll department, which can take time and effort. In addition, because Turkey has a sizeable grey economy, a large number of workers do not pay taxes, so a tax break may well be less meaningful for many citizens.

CULTURAL DIFFERENCES: Finally, pension funds are facing some cultural barriers when in it comes to investment preferences. As the World Bank wrote in a March 2012 report on domestic savings in Turkey, 73% of household assets were accounted for by bank deposits as of 2010. Lenders have historically offered competitive rates at a low level of risk, making time deposits a more attractive vehicle for savings than equities, which are perceived to be risky, particularly given the volatility in the performance of the Istanbul Stock Exchange over the last several years. While government bonds are less risky, they are generally of a longer term than time deposits and some government instruments, such as inflation-linked bonds, can be difficult to fully understand.

Moreover, stepping beyond the realm of liquid assets, another popular form of retirement savings in Turkey is real estate, according to Eredenk. “There remains a preference for real estate among investors. There are 2.7m pension clients compared to 10m real estate investors. The history of inflation and economic uncertainty has made consumers uncomfortable with liquid assets, but I am confident that this will change with the new tax regime and continued economic stability,” she told OBG.

PROPOSED AMENDMENTS: Indeed, as Eredenk has indicated, to help make the pension scheme more attractive, in 2011 the industry collectively proposed a set of changes that could encourage higher levels of participation. The main proposal from the industry involved a shift away from tax incentives towards state contributions.

In this model, the state would supplement an individual’s pension contribution with a deposit of some percentage of the amount an individual invested. Access to this state credit would only be available to those who contribute for a minimum of 10 years and start withdrawing after the age of 56.

Moreover, because income taxes would be paid on contributions at the time they are made, only the investment return would be taxed.

In April 2012 the government announced that it would indeed modify the private pension system, largely along the lines of the proposal made by industry participants. The primary change was a switch from tax breaks to government matching, with the state promising to supplement pension plan payments by 25%, just as suggested by industry, according to a presentation by Ali Babacan, the deputy prime minister responsible for the economy. However, this amount would be subject to a maximum of 25% of the national gross minimum wage. Taxes would be paid only on returns, which again is sensible given that individual contributions would be taxed during the investment period.

One final new feature introduced by the government was that this state contribution will not be accessible until at least three years had passed. After this initial period, 15% of the government supplement will be available, rising to 35% after six years and 60% after 10 years. The full state contribution will not be available until retirement.

MOTIVATION: While most governments aim to encourage private savings, it is particularly important in Turkey, where authorities are struggling to rein in a current account deficit that is being financed by foreign capital inflows and is equivalent to 10% of GDP. While it is unclear how quickly the new pension scheme could have an effect, it is a positive change, according to Özlem Derici, the chief economist at Erste Securities. “These announcements are important and positive, as the current account deficit is effectively a savings gap,” she told Dow Jones in April 2012, “But it is not likely to help reduce the current account gap this year, and it will probably have an impact on the gap in two or three years.”

The reaction from industry participants was unsurprisingly positive, with some sector representatives saying publicly that they expect the new incentives to raise the number of participants by 50%. Indeed, the stock price of the only publicly traded company that sells pension plans – Anadolu Hayat ve Emeklilik – rose sharply in the days following the announcement, strongly suggesting that at least the market believes that the new policy will have a positive impact on the country’s pension plan providers.