A historic change in pension funds in Israel is now underway. For the first time in decades, the state will not issue designated bonds as a safety net for pension fund savers, and a new mechanism will come into operation.
Up to now, the state has issued to the pension funds designated bonds giving a guaranteed return of 4.86% and linked to the CPI. These bonds were issued monthly, and 30% of the funds’ assets were invested in them. This is the safety net that the state gave to savers, and it ensured that monthly pension payments would be stable.
The cost of subsidizing this benefit, however, has grown. The main reason is the fact that the pension funds have become the exclusive savings instrument, and have grown rapidly, while the cost of raising public debt through instruments other than the designated bonds has fallen.
Under the reform now underway, the pension fund cash that was earmarked for the special bonds will be invested in the capital market. At the same time, the safety-net mechanism will be replaced by a new one guaranteeing pension savers an index-linked return of 5.15% on 30% of their pension savings.
How will it work? The funds will allocate 30% of their assets to be managed as determined by the Ministry of Finance, and the return will be measured. If, after five years, the annual return does not reach 5.15%, the fund will receive a top-up to this amount from the state. This mechanism will considerably reduce the state’s commitment, in comparison with the designated bonds mechanism. A state-managed fund will be set up into which returns exceeding 5.15% achieved by the pension funds will be paid.
An accounting will take place on a rolling monthly basis. That is, on money invested in the capital market in October 2022, there will be an accounting in October 2027. On money invested in November 2022, an accounting will take place in November 2027, and so forth. At each accounting date, either top-up money will be paid to the pension funds, or excess returns will be transferred to the state, to be managed conservatively by the accountant general.
The reform also affects switching between pension funds. To make this easier, the top-up will be paid for the whole period in which the return was below par by the saver’s original fund into the new fund, and the original fund will make an accounting vis-à-vis the state after five years.
Annual deposits into the new pension funds total some NIS 40 billion. 30% of this amount, that is, about NIS 12 billion, will now be channeled to the capital market. According to a study by the Bank of Israel, most the money will be invested overseas, raising the proportion of foreign assets in the funds’ portfolios. In 2021, that proportion was about 30%.
The reform is getting underway at a time of turbulence in the markets. The past year has seen falls on the markets and an outbreak of inflation, making the target of a 5.15% index-linked return challenging. But it should be borne in mind that the starting point is October 2022, and if the Bank of Israel manages to rein in inflation through interest rate hikes, then the inflationary challenge will be smaller. Still, the volatility on the markets and the fear of a recession will make the next few years challenging enough.
Published by Globes, Israel business news – en.globes.co.il – on October 2, 2022.
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