Czech plans for a second pillar go against current CEE trends, writes Krystyna Krzyzak. But the reforms still have every chance of being overturned

Bucking the trend, the Czech Republic pushed through a second pillar, privately funded system in November 2012. This was at considerable political risk. Unlike most other CEE EU states – which earlier introduced second-pillar systems, then clawed contributions back into the first pillar to offset budget deficits inflated by the financial crisis – the centre-right, Civic Democrat-led coalition of prime minister Petr Nečas instigated reforms in 2011 that overhauled the existing third pillar (see panel) and introduced a second-pillar system. This was set to start in 2013.

The new second pillar is funded by diverting three percentage points of the 28% gross wage social security contribution, with workers adding a further two percentage points. All workers have the choice to opt in during the first half of 2013, after which only those aged under 35 years can do so. The decision is irreversible. The transitional costs of losses to the first pillar are to be partly covered by value-added tax (VAT) increases announced in the 2013 budget.

While the reforms took the long view – the first pillar covers some 95% of pension benefits, but with an increasingly ageing population and a falling ratio of active workers is fast becoming unsustainable – they failed to convince large sections of Czech society. Opposition came from the Social Democrats, the largest single party in the Lower Chamber of Deputies (lower house of parliament), trade unions, left-wing parties and NGOs.

In October 2011, the left-wing dominated Senate (upper house) rejected the bill. The following year, with the economy in recession, pension reforms looked like a luxury that could only be sustained by unpopular austerity measures such as tax rises. Meanwhile, the government’s once comfortable majority eroded as coalition members, including the Civic Democrats defected or rebelled. In September 2012, President Vaclav Klaus, the Civic Democratic Party founder, vetoed the pensions bills on grounds of a lack of consensus. In November, Nečas succeeded in garnering a slim majority to push through both the 2013 budget, which he tied to a confidence vote, and a vote overturning the presidential veto. The government’s chances of surviving its term until the next elections in 2014 remain highly uncertain. Meanwhile the Social Democrats, currently the most popular party in opinion polls, advised asset managers in November not to bother with the second pillar as the party had every intention of repealing the legislation if elected.

The pension reforms involve newly created pension companies licensed by the Czech National Bank (CNB) for managing second and third pillar funds. The CNB also approves each individual fund. As of mid-November, the CNB had licensed 11 companies – the nine firms in the existing third-pillar, and two newcomers to Czech pensions, Conseq Investment Management and Raiffeisen. “Raiffeisenbank in the Czech Republic focuses its products and services mainly on a target group, which we call premium clients – clients with above-standard income,” says Martin Kolouch, board member of Raiffeisen pension company. “These are mostly people who have quite a good living standard, know some basic financial planning and long term investing and able and want to invest their money.
Therefore, the pension reform is a reasonable chance for us to offer pension products to these clients and we see a good potential to service these people also with pension products.”

Each company must offer four funds – state bond, conservative, balanced and dynamic.
They will derive their income from asset management fees, where the caps range from 30bps for state bond funds to 80bps for dynamic ones, as well as a high water mark performance fee of up to 10% on all, but the state bond funds. Additionally, each second pillar company must have acquired 50,000 members within two years, which may prove tricky given the increasingly pessimistic forecasts of the take-up.

The estimated size of the second pillar market has been scaled down from more than a million, to as low as 500,000 – just 10% of the workforce. According to a recent study published by Institute for Democracy & Economic Analysis, the think-tank of the Czech educational institution CERGE-EI, entering the second pillar would only be beneficial for 50% of men and 30% of women.

Using annual wage and second pillar growth rates of 3%, the study found that for men there is no advantage in subscribing in the lowest two wage deciles, none in the third lowest if entering when older than 24 years, and likewise in the fourth if above age 29. For women, it is only advantageous for those in the seventh decile and above. The computed wage replacement rates are not encouraging: 55% for top-earning men who started contributing at age 24, and 29% for women in the same wage bracket and age group. Co-author Jiří Šatava attributes the big gender discrepancy primarily to women’s higher life expectancy, and time taken off for maternity leave, during which time second-pillar, but not first-pillar contributions would be suspended. (The study did not factor in women’s lower wages and higher unemployment rate).

Uncertainties about the second pillar’s political and economic viability have divided the pensions industry itself. AXA announced that it would not participate in the second pillar – although it will be acting as a distributor for Penzijní fond Komerční banky – as did ING in November. Jiří Rusnok, director of ING Pension Fund, Czech Republic, cites the lack of backing across the political spectrum, the risks posed by the opposition and the lack of understanding among workers about the proposed changes for ING’s decision. “I am personally in favour of increasing the weight of pensions savings, and even of an opt-out, but the reforms should have been handled in a more professional way, with all the necessary support,” he told IPE.

Raiffeisen’s Martin Kolouch is more optimistic. “The pension reform is more than needed; its main disadvantage is that for a lot of people it simply comes too late,” he notes. “We are ready to enter second pillar at the beginning of next year and believe it will survive.”