New government faces reform challenge
After its predecessor’s failure to push through a package of pensions reforms, the new government that took power in June will be trying again. The June elections once again returned a centre-left Czech Social Democratic Party (CSSD)-dominated government. Unlike its predecessor, a minority administration that relied on the tacit support of the opposition Civic Democratic Party (ODS), the CSSD with its two centre-right partners, the Christian Democratic Union and Freedom Union-Democratic Union, has a majority, albeit of one.
“All the politicians agree that the reforms must be complex, and that all pillars must be agreed on and reformed together,” says Martin Maha, managing director of Mercer Human Resource Consulting in Prague. The previous draft amendment, which covered the separation of shareholder and member assets in the private system, and the introduction of voluntary occupational schemes, was a complicated package that met stiff resistance from, among others, the Association of Pension Funds of the Czech Republic, the industry body which has all the private pension funds as members.
Ron van Oijen, chairman of ING’s Czech and Slovak Republics management committee, points out that the funds have to transfer at least 85% of the profits to policyholders, expenses are limited and the current risks low because most of the funds are owned by strong international financial groups. “Many of the companies won’t have the expertise or economies of scale,” he explains. “If they outsource, they’ll come to us anyway, and if they go bankrupt, so will the pension fund.”
According to Jiri Kral, director of the Social Insurance Department at the Ministry of Labour and Social Affairs, the current government plans to continue pension reforms, including separating pensions benefits from the state budget, the transformation of the State Social Insurance Department into a public body, and some adjustments to the first pillar, which is suffering the strains of unfavourable demography. Five workers are now required to support two pensioners; by 2030 this rises to eight. The Czech republic, like other former communist states, had a low retirement age by west European standards, 50 years for women and 55. In 1995 these started to be raised progressively, to 60 years for men and 53 to 57 years for women by 2007. Although there is a general agreement that the retirement age should continue rising thereafter, to 65 for both sexes, Kral says that this subject is off the agenda. This leaves the government two options: either lower existing benefits, or convert from a defined benefit (DB) system to a notionally defined contribution (NDC) scheme.
Whichever choice the government makes, it intends to start by making some non-controversial but essential technological improvements. Neighbouring Poland, which launched into its pension reforms in 1999 with a social security system unable to handle the transfer of contributions from the state system to the second pillar, has provided a salutary warning for other countries in the region. According to Kral, the government first has to set up a database that centralises all the earnings records of an employee, and mandate employers to send in annual statements. At present records are updated only when an employee changes jobs or finally applies for a pension. The administrative groundwork should be in place by 2005, at which point more fundamental reforms such as discussions about DB versus DC can start.
In the meantime the government will try again to change the accounting system of the third-pillar funds, although Kral is not optimistic about its success, and re-present the law on occupational schemes with some slight modifications. The occupational schemes face opposition not only from the pension funds, which argue that companies lack the expertise, but by the large neo-liberal ODS opposition which viewed them as a corporatist encroachment on individual life. The occupation schemes would be non-profit-making closed end funds run by employers and employees, with professionals managing the assets, possibly with legal minimum sizes or ability for smaller companies to join forces, and most likely, given the state support for existing private pensions, have additional tax benefits. They would expressly be forbidden from investing the assets in the sponsor company. “The idea is to enlarge choice for individuals,” explains Kral.
The one thing that has virtually disappeared off the political agenda is a compulsory second-pillar scheme. “The typical World Bank model won’t be adopted in the Czech Republic,” notes Maha. “We may follow Sweden or Italy and start with a cautious privatisation of the first pillar.” The Czechs shied away from a mandatory system as adopted in Hungary and Poland for many reasons, including the lack of resources to finance the transition cost, the shortfall in the state system as a portion of contributions gets diverted to the second pillar. While Hungary and Poland used privatisation proceeds, the Czechs had earlier on sold off many of its companies through a voucher system.
Many Czechs have also questioned whether a second-pillar scheme is strictly necessary, given that nearly 40% of the workforce has joined a private scheme, while the state system provides a reasonable replacement rate and strong income and inter-generational solidarity. For lower-income groups, which usually cannot afford additional contributions to private pensions or other savings schemes, the replacement rate is around 65% of net income, the average 58%, while higher earners will receive 25–30%. “Higher earners usually use other financial tools such as third-pillar funds, life insurance or endowments, which also carry tax advantages,” adds Maha.
For the pensions industry, nevertheless, the lack of enthusiasm for a compulsory system is a great disappointment. As ING’s van Oijen points out, one evident drawback of exclusively voluntary private pensions or other savings systems is that they fail to capture younger workers, especially in the former communist states, where people are making up for decades of poor consumer goods availability. The average age of Czech pension fund members is still a relatively elderly 45.