Pensions In Central & Eastern Europe: A closing chapter
Pension fund reforms launched in 2013 by the government of Petr Nečas have fallen flat. The voluntary second pillar is to be abolished as of January 2016, while many of the third pillar funds will have to be merged to meet capital requirements.
The second pillar’s demise came as no surprise. Prime Minister Bohuslav Sobotka, when in opposition, warned that his Czech Social Democratic Party (ČSSD) would abolish the system if it won the October 2013 election. The ČSSD-led coalition government that took power in 2014 has kept its promise.
“Cancellation of the second pillar is certainly a mistake. It is evident that the negative campaign led by the opposition in 2011-13 discouraged many potential clients,” said Vladimir Bezděk, CEO of Penzijní společnost České pojišťovny.
The opposition’s warning deterred a number of companies active in the third pillar from participating: AXA, ING, Aegon and its subsequent fund acquirer Conseq Investment Management.
“Though we considered the second pillar to be a good solution for both clients and the sustainability of the Czech pension system, the risk/return ratio of such a business was very unfavourable,” explained Richard Siuda, head of retail sales, and a board member of Conseq Investment Management.
Few workers ended up enrolling – 83,067 as of the end of September 2013 – while assets amounted to only CZK1.4bn (€51.5m, figure 1). Other factors deterred take-up. Although membership was voluntary, it was irrevocable. Furthermore, members had to personally contribute an additional 2% on top of the 3% diverted from the 28% social contribution rate, making the system unattractive for the low paid.
At a glance
• The second pillar is to close in January 2016.
• Political opposition blamed for low enrolment.
• Natural wastage has shrunk ‘transformed’ third pillar pension funds.
• There are too many ‘participation’ funds and too little capital.
Despite the ČSSD’s antipathy to the second pillar, the government avoided the full-scale nationalisation that Hungary enacted in 2011. Following recommendations from a committee led by Prof Martin Potůček of Prague’s Charles University, fund members will have the choice of transferring the assets to their existing third pillar, keeping them, or transferring them to their first pillar accounts to maintain their ultimate state pension value.
Changes to the third pillar supplementary pension funds – in existence since 1995 – have also proved less popular than envisaged. The old system, with its rebranded ‘transformed’ funds, was closed to new entrants during November 2012, while the threshold for the additional state subsidy was raised to increase the contribution rate. It was replaced with ‘participation’ funds with different risk profiles. Unlike the transformed funds, they did not carry a no-loss guarantee.
According to the Association of Pension Funds of the Czech Republic (APS ČR), the number of individual transformed plans fell from a peak of around 5m in late 2013, equivalent to around 80% of the working population, to 4.6m by September 2014. Assets fell by 6% year-on-year to CZK322.6bn as members cashed out.
Participation fund growth has accelerated, but does not compensate for the shrinkage in transformed funds. In September 2014, membership was up by 211% to 192,985, and assets by 322% to CZK3.4bn (figure 2).
Movement from the transformed funds to participation funds has been negligible, despite the former’s lower returns (figure 3). Siuda cites return rates (from inception in February 2013 to October 2014) ranging from 34.3% for Conseq’s Global Equity participation fund to 5.46% for the 2023 government bond fund. In contrast, Conseq’s transformed fund generated 2.17% in 2013 and an expected 1% in 2014.
The no-loss guarantee of the transformed funds has resulted in an overwhelmingly bond-weighted asset allocation, with Czech sovereign bonds accounting for 71% share of the aggregated portfolio as of the third quarter 2014, and other bonds a further 17%, compared with less than 1% in equities. The Czech National Bank, in its 2014 Financial Stability Report, expressed concern about the transformed funds’ vulnerability to interest rate shocks, although these are addressed by accounting methodology.
“By law, transformed funds are able to classify government bonds into a held-to-maturity (HTM) accounting category, which is accounted by amortised cost with no interest risk,” explains Bezděk. “The portion of HTM segment is able to be up to 30% of portfolio. Additionally, we can hedge interest risk via interest rate swaps.”
One of the purposes of the third pillar law was to initiate plans with different asset profiles, depending on age and risk appetite. Each provider must offer one conservative, government-bond based fund, and any number of higher risk profile plans.
One of the consequences of the low interest in the new system is that many of the 32 funds offered by the market’s eight providers will fail to reach the minimum CZK50m capitalisation and will merge in 2015.
For example, Conseq has a bond fund, two target-date government bond funds and a global equity plan. “Unfortunately, we do not have enough capital for all bond funds so we plan to merge the target-date funds into the bond one,” says Siuda. “The funds will merge in January 2015. The merger ratio will be based on the NAV per share, as is usual for fund mergers.”