Time to diversify
The Czech pensions system is distinguished by a complete rejection of a compulsory second-pillar system and one of the earliest private systems. Private pension funds have been operating since 1994, a time of colourful financial scandals caused by a flawed privatisation programme that spawned infamous investment funds and massive losses at the major banks. For that reason they were tightly regulated from the start – by the Ministry of Finance initially and since 2000 by the dedicated State Supervision of Insurance and Pension Funds – and have remained one of the sounder pillars of the financial market.
From the beginning the state added a contribution. The initial growth was fitful, with the market stagnating by the mid-1990s. There was no tax relief, but the state provided an escalating scale of contributions up to CZK150 (e5) a month depending on the individual’s contribution, with an upper participant limit of CZK500. As a result clients rarely contributed more than the upper limit. Furthermore, with no early exit penalties and only a five-year minimum contribution period which was waived for those wishing to ‘retire’ at age 50, it soon became evident that private pensions were being used as a state-subsidised short-term investment for older clients rather than a long-term retirement policy. By 1999 50% of pension fund members were over the age of 50.
The critical change came with new legislation in 2000. It closed the obvious loopholes by increasing the minimum contribution period to 12 years and raising the full pension withdrawal age to 60 (although as an incentive to younger workers, members could withdraw half their accumulated sum after 15 years’ of contributions). Those who do withdraw early, except in exceptional circumstances, forfeit the state contribution. In addition the law introduced tax relief for contributions up to CZK12,000 a year, and for the first time encouraged employer participation, by allowing corporate tax and social security contribution relief of up to 3% of an employee’s gross salary.
The tax breaks have given pensions a massive advantage over building society savings and life insurance. Pension assets have grown from some CZK44bn in 1999 to CZK56.8bn by mid-2002, while the number of participants has grown from 2.24m to 2.54m. “We expect room for another 500,000 new clients, probably most through employee benefits schemes,” says Jiri Plisek, chairman of the board of directors and CEO at Ceske Sporitelny Pension Fund (PF). The addition of an employer’s contribution has been the most important element in fuelling growth, explains Plisek: “Before, we could only market to individual clients, but now we can talk to employers and unions.” Plisek estimates that 600,000 of the pension fund clients have come directly though employer schemes.
At the same time the industry has undergone a massive consolidation, from 44 in 1995–96 to 13 as of early November, largely as a result of mergers and acquisitions. The funds now segment into about eight large banks and insurance companies, all either foreign or owned by foreign financial groups with the exception of Ceske Pojistovny, the former state-owned insurer.
This September, Credit Suisse PF merged with the Vojensky Otevreny fund – a fund initially set up for armed forces and police members, acquired in 2000 by Winterthur Life and Pensions, a business unit of Credit Suisse, and as of mid-2002 the largest by asset size and third in terms of members. The new fund, operating as Credit Suisse, has some CZ18bn in assets and 600,000 participants, and a 26% market share. Ceske Pojistovny PF is close to taking over Commercial Union PF. “The merger will give us almost 20% market share,” says Tomas Matousek, vice-chairman of the board of Ceske Pojistovny PF.
Most funds market through branches rather than self-employed commission-based sales people. ING PF, for instance, gets its clients through bank branches, those of GE Capital with which it has a co-operation agreement, brokers, adviser and employee benefits packages which combine pensions and life insurance, and are targeted at large companies. The products offered tend to be a simple savings account that at maturity offers a lump sum or is used to purchase an annuity
The existing investment regulations preclude any scope for differing risk profiles. The pension funds can invest in bonds issued or guaranteed by the state, as well as bonds from the Czech National Bank (central bank), other Czech banks, corporate bonds trading on the Prague Stock Exchange (PSE) primary or secondary market, local municipal bonds and those issued by OECD member states or their central banks. Pension funds can also purchase certain real estate and other tangible and intangible assets, and hold assets on bank deposit, up to a maximum 10% of the total. Equity investment is limited to shares and participation certificates trading on the PSE, which the funds find particularly restrictive as only some seven companies are big and liquid enough to warrant investment. Typically equity makes up 5% of portfolios.
All the funds stress their conservative approach and invest the majority of the assets in Czech state bonds. This strategy has inevitably produced similar yields across the funds, and not very high ones given the Czech Republic’s falling inflation rates – for 2002 the central bank’s target is an annual average of 2% – and thus lower interest rates. “We are also concerned with overheating in the Czech bond market this year and next, which will be a problem for the performance of the pension funds as bonds make up 70% of their portfolio,” adds Pavel Rudis, analyst at CRA Rating Agency in Prague.
A few have diversified into higher yielding OECD issues. Ceske Sporitelny PF, part of the Austrian Erste Bank group, has bought some Polish and Hungarian government bonds, utilising the regional expertise of its parent’s asset management company.
Most funds would welcome a broader selection, especially in overseas investment. “Considering the narrow spread of the Czech financial market, an enlargement of investment opportunities would certainly be beneficial,” says Matousek. “The possibility to invest in foreign securities would enable us to better diversify our portfolio, which in turn would enhance the security of our fund in the inevitable event of fluctuations in the Czech capital markets. One essential component of expanded investment possibilities is derivatives, which are a crucial instrument for hedging against market risk.”
Regardless of what the Czech authorities decide, the European Union, which this October accepted the Czech Republic along with seven other central and east European countries for membership in 2004, will change the picture dramatically, and not a minute too soon. As Jiri Plisek puts it, “the conditions on the Czech market are horrible”.