In today’s overview, we’re bringing you a detailed overview of the Croatian pension system, the trends facing it, as well as what are the short and long-term changes that should be made to make the system work better.
Starting with the numbers for the mandatory pension funds, they reported an NAV of EUR 22.2bn as of the end of August 2024, which represents the highest value for the funds in history. This also represents an increase of 0.4% MoM, 9.7% YTD, and an even more significant 15.2% growth YoY.
Based on this, one would say that the system is working efficiently, but let’s take a closer look at the numbers. First of all, the net inflows. For pension funds, the net inflows refer only to Pillar 2 inflows, which include a total of 2.3m workers (Pillar 1 includes only 1.7m, as based on the 2002 pension reform, people under 40 at the time had to join Pillar 2, and people over for 40 could choose if they wanted to participate or not). A lot of people chose to do so, and younger people automatically joined the system after they started working.
Pillar 2 net inflows refer to the 5% of the gross salary and in 8M 2024, the average net inflows into the pension funds amounted to EUR 123m. If we account for the discrepancy between the Pillars, the net inflows into Pillar 1 amounted to a rough average of EUR 275m during the period. Combined, this would mean that there were net inflows of EUR 400m monthly into the Croatian pension system.
While Pillar 1 is called the pillar of generational solidarity, meaning the inflow from this is used to pay the pensions to current retirees directly, Pillar 2 is invested through the pension funds. In absolute terms, the NAV of these pension funds grew by EUR 85m on a MoM basis, and EUR 2.9bn on a YoY basis, while net inflows amounted to EUR 131m MoM and EUR 1.43bn YoY. In other words, a decrease in the value of assets was recorded on a MoM basis that had to be covered with net inflows, while on a YoY basis, app. 50% of the increase in NAV came from net inflows.
Net contributions into the Croatian pension funds (January 2019 – August 2024, EURm)
Source: HANFA, InterCapital Research
Given Croatia’s shrinking population (app. 3.9m according to 2021 consensus), it isn’t clear how sustainable this model is, especially in its current form. To detail why, let’s look at some facts, starting off with the ones referring to foreign third-country workers.
In 2024 up until the end of September, app. 159k new working permits for third-country workers were issued, of which 102k were new working permits, 40.4k were renewals, and 16.6k were seasonal workers. The number is probably higher, as this statistic does not include people who will have to renew their permit but still haven’t, as well as illegal workers. On an annualized basis, this would imply app. 211.8k working permits issued this year, an increase of 22% compared to 2023.
Why does this matter? It matters due to the fact that 15 years of active employment is required in Croatia to be eligible for pensions. It is unlikely that many of the workers will fulfill those conditions. The 159k permit number would imply app. 6.9% of employed persons in Croatia are foreigners. Given that many of them are paid the minimum gross salary of EUR 840, a rough calculation gives us that they pay EUR 130 each month into the Croatian pension system. This would mean that app. 5% of all net inflows into the pension system are coming from foreigners, and again, it is unlikely that they will ever benefit from this.
Thus far, we have a system that is largely supported by net inflows and isn’t as such self-sustainable, and it’s getting a (free) boost from foreigners. So what could be done differently to optimize the system? One could go for radical reforms such as the ones suggesting that the State pays a certain amount of money, for example, EUR 10k for each newborn child into a certain investment fund, with all the earnings and proceeds from this being used to finance that person’s pension. This is unlikely to occur, as the Croatian political and bureaucratic system is unfortunately short-sighted and unlikely to make changes that might affect their ratings, especially among pensioners.
As such, some other changes could be made. The changes referred to here are only for Pillar 2, as Pillar 1 would require a complete reform before it could work more efficiently. For Pillar 2, a larger focus should be made on the A category, which is considered the riskiest with 30% of assets invested into equity, but it also is the one with the best returns. Besides, investments are made into a diversified portfolio of stocks, investment funds, ETFs, etc., which over the long term will, for the most part, minimize risks while providing above-average returns.
Breakdown of the A, B, and C categories of the pension funds, by sex, as of August 2024 (% of the total)
Source: HANFA, InterCapital Research
As we can see, the majority of people in Pillar 2 are in the B category, which has a medium risk profile, with a maximum of 15% of investments into equity. The B Category in fact has a total of 1.8m people inside of it, making up app. 79% of all insured persons in Croatia. While this category does give solid returns (since inception, an average of 5.4%), it is still behind the A category’s return of 6.9% on average. Both of these are of course, ahead of the C category, with a 5.1% return since inception.
Gross returns of A, B, and C category pension funds since 2015 (2015 – 2024 YTD, %)
Source: HANFA, InterCapital Research
It should be noted that the returns described above are gross returns, which after reduction for various fees and costs, would end up app. 0.4% – 0.65% lower than what is represented in the graph. To demonstrate the potential returns, let’s say what a 20-year period would look like. To do this, we can do a rough calculation, with the variables below:
Period: 20 years
Base gross salary: EUR 1,821 (latest average for July 2024, adjusted for inflation growth each year)
Returns: A category: 6.91% average, B category: 5.41% average, C category: 5.13% average.
Total potential returns of A, B, and C categories over a 20-year investment case (EUR)*
Source: InterCapital Research
*Gross returns, returns are reduced by app. 0.4% – 0.65% each year due to various fees and costs.
Based on this, if one chooses to invest in the A category, they would over the 20 year period accumulate app. EUR 8.7k higher amount of assets on their pension accounts than category B, and EUR 10.1k higher assets than category C. In relative terms, the A category “gave” 18% and 22% higher returns than the B and C categories, respectively. However, it has to be noted here that the assets from the pension account are not paid out as a financial annuity after retirement, but are paid out according to calculations made with the mortality tables. Therefore, the returns seen here would not be the ones paid out to retirees and are not as high as if they invested the money themselves. The main point still remains though, as the base would be by far the highest in the A category, leading to overall higher pensions.
In other words, A category is by far the best one, even with higher risks involved. Unfortunately, app. 87% of the employees in Croatia who invested in the B category are those aged between 19 and 54, and by investing their pension in the B category they are missing out on higher returns. In absolute terms, this represents 1.58m people who invested in the B category aged between 19 and 54, and there is no impediment for them to switch to the A-category and increase their potential return. The good news is, that a switch towards the A category can be done quite easily, including online through the Government’s E-Građani system.
Several other things have to be pointed out. People who are within 10 years of retirement, will automatically be moved from the A category to the B category. However, a request could be made that allows one to switch back to the A category. This, in turn, is only available until 5 years from retirement. Furthermore, according to the new law implemented on 1 April 2024, people in the C category can switch back to the B category if they have more than 6 months until retirement from that date.
One other way that the pension system could be boosted is by allowing all the categories to invest more in equity, especially the A category. Historical returns over a longer time period, in most cases show that equity values keep rising, especially when invested in stable and growing companies and economies.
These are just a few general changes that could be made to the pension system, which aren’t going to affect any people negatively, thus making it more likely that they could be pushed through on the political level. In the longer term, however, changes will have to be made, no matter how painful. The State cannot depend on the influx of foreign workers which brings almost free inflows into the pension system. Delaying the inevitable by doing this will only make the changes even harder to implement later on. Until then, the pension system will keep chugging along like a train, and while many foreigners might get onto it, it is unlikely that they will reach the final destination.
