Experts weigh in on pension reform

Pension fund managers and some analysts warn that proposed pension reforms won't motivate participation of workers or financial institutions in the new savings scheme, but will add to the appeal of existing supplementary private pension funds outside the government sphere.

In a region where the population is aging faster than new workers are joining the work force, the traditional pay-as-you-go (PAYG) system is becoming less and less viable as governments struggle to make pension payments with the amount of social security taxes being paid in.

The reforms, which are set to be finalized in the coming months, would transfer part of the state pension burden to privately managed funds under a system of voluntary contributions from workers. However, some say that not enough workers will volunteer to switch to the private funds and that companies will have little incentive to create those funds.

Under the proposal, starting in 2013, workers would have the option of putting 3 percent of the 28 percent of their income paid for social security into private pension funds. The catch is, workers who choose to divert money to the private funds would only be able to do so if they supplement that 3 percent with their own additional 2 percent, for a total of 5 percent of their income going into the private pension funds.

"You basically have to voluntarily increase your own taxes to 30 percent," said Jiří Rusnok, director of ING's pension fund. "This part of the new system should be dedicated to younger people because they are the ones that will face this pension problem in the future. But younger people don't have money. They have to solve their housing problems and that type of thing, so thinking about having some money 40 years ahead? They don't think about that."

Only higher-income individuals will be interested in putting part of their social security payments into private funds, analysts and fund managers say, and ultimately only up to 20 percent to 25 percent of the working population will participate.

Such a small amount of participation not only compromises the stability of the pension system, those in the industry say, but will likely result in very few new private actors entering the market to manage those funds. Presently, there are 10 entities that manage supplementary pension funds in the country.

"The conditions are tough, and it will not be easy," Petr Poncar, chairman of the management board of Allianz's pension fund of the reforms, said of the management of voluntary contributions to funds.

Proposed legislation requires managing entities to have 300 million Kč ($17.5 million) in capital, which is first fronted by the company and should then, in theory, be replaced by money from workers paying into the system.

"The optional nature of the fund scheme ... means additional cost for companies in terms of marketing. Participation will be lower than in a compulsory scheme, so the accumulation of assets will be slower," said Martin Holub, a researcher at the Research Institute of Labor and Social Affairs. He, along with colleague Milan Šlapák, wrote that it will take a long time for companies to see any profit. Also, heavy regulation, like caps on customer fees from which managers profit at less than 1 percent, will make entering the market less attractive.

In a country report released in April, the International Monetary Fund (IMF) said the move away from the PAYG system was a good one, but that state plans to carry it out were problematic. In addition to being discouraging for investment in new private funds, the IMF said other features of the proposed reform, like a voluntary redirection of 1 percent of social security payments to parents' pensions and lowering the social security payment cap to four times the average wage, would contribute to the PAYG system's deficit.

"I rather doubt new investors [to manage the new pension funds] will come, because of the instability regarding the political situation, and these are investments where the breaking even point is rather far away, like 10 years or more," Rusnok said.

The Czech Republic has high participation in supplementary pension funds - around 70 percent of workers voluntarily contribute to privately managed funds to supplement their state pension - but current participation levels cannot serve as a gauge for future interest in the government's proposal for voluntarily diverting social security taxes to the funds, since the system would operate much differently from the private funds available now.

Currently, all pension funds must provide a "0 + guarantee," which means they promise their investors will receive at least as much money as they invested. That makes fund managers extremely conservative in their investments, which in turn lowers yields. In addition, government incentives for supplementary pension funds are structured in a way that users have found it more profitable to invest small and use existing pension funds as five-year savings instruments rather than career-long retirement insurance.

Despite doubts about the viability of the proposal for shifting some social security taxes to funds, fund managers say the existing supplementary system will actually benefit greatly from the reform. Investors would be able to choose from two categories of funds with lower or higher risk profiles, meaning a chance for higher yields, but fees would remain low, and government incentives would continue.

"It will be the best open investment fund on the market," Poncar said. "Young people have not been so interested in this type of product, but now they will be able to choose an investment strategy, and transformed pension funds will allow participants a chance to have higher profits."

Cat Contiguglia can be reached at
ccontiguglia@praguepost.com