Pension reform in Pension reform in Czech RepublicCzech RepublicWhy the Czechs go gainst the stream?Why the Czechs go gainst the stream?

Jiri Rusnok, ING Czech and Slovak RepublicsPresident, Association of Pension funds of the Czech R.

21. November, 2011

CONFERENCE of STABILITÁS, Budapest

ING 2

Content:

• A bit of history

• Key reasons why the Czechs didn't reformed according the WB 90´s pattern

• Current structure and some key parameters of pension system

• The new architecture of pensions

• Reasons why the paradigmatic change is coming right now

• Some speculation about an uncertain future

ING 3

History

• October 1918 – the new independent state – Czechoslovakia.

• October 1924 – act about employees' insurance against sickness, disability and age (peasants and craftsmen/tradesmen not covered).

• Retirement age – 65 years for both men and women.• Contributions paid in proportion 50 : 50 by employee and employer.• At 1930 in CS with almost 15 mio inhabitants only 167 ths. pension benefits paid

out.• 2011 almost 3 mio old-age and disability pension benefits in 10,5mio CZ.

ING 4

History

• 1948 – 1990 Soviet type of general social security, financed by general tax revenues – some features nevertheless still partially based on the pre-war traditions;

• 1993 – The split of Czecho-Slovakia, the former occupational privileges were abolished, specific payments to the social security – including health insurance introduced;

• 1996 – The first big parametric changes – retirement age started to grow

• for men: from 60 to 63

• for women: from 53-57 to 56,5-61,5

• 2003 – 2011 - further legislative changes consisting mainly of parametric changes to other extension of retirement age

ING 5

Retirement age - timetable

After the last amendment of the law in 2011

20312041

ING 6ING 6

Structure of Czech Pension System - today

I.pillar

PAYG

State admin.(ČSSZ)

Contr.Rate 28%

Exependiture cca 350 bn.CZK ≈ 9,2% GDP

(of which about 80 % old age benefits)

III.Pilar Supplementary Pension Insurance with State SupportFF (DC) Private Admin.

(PF ,a.s.)AuM ≈ 250 bn. CZK <

5% of GDP

III.PillarLife

InsuranceFF

Private Admin.

(LI compan

ies)

General = mandatory Supplementary = voluntary

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I.Pillar - replacment rate: average out-paid old-age pension to average gross/net salary

40

45

50

55

60

65

70

75

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

%net salary gross salary Linear (net salary)

Source:MLSA of the Czech R.

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Almost flat rate – newly granted old-age pension to pre-retirement wages

Gross salary

Net salary

Source:MLSA of the Czech R.

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Cumulative distribution of persons according to the gross wage in %

Source: MLSA of the Czech R.

Fold of the average wage

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Key reasons why the Czechs didn't reformed according the Worl Bank 90´s pattern

• The Czech Republic was a front-runner in parametric changes in pension system

• Labor market equilibrium was not harmed so seriously during the transformation period (late 90´s)

Average Employment and Unemployment Rates, The Czech Republic, 1993 - 2003, in %

0

1

2

3

4

5

6

7

8

9

10

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

64,5

65,5

66,5

67,5

68,5

69,5

70,5

Unemployment Rate Employment Ratewww.CZSO.cz

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Key reasons why the Czechs didn't reformed according the World Bank 90´s pattern (2)

• Most pensioners was basically satisfied with their benefits – they get 60% and more of their previous net wage,

• Czech Republic was not dependent on WB/IMF financial support not strong pressure from them to implement WB style pension reform,

• Vaclav Klaus - clear leader of the Czech liberal/right wing part of political spectrum was always against the mandatory saving's pension pillar,

• From early 90´s hot debate about the future of pension system, strong and skilled opposition (mainly the Trade unions confederation and later the social-democrats party),

• Monetary and macroeconomic crises in late 90´s so the issue of transitional costs very sensitive one. Particularly with the quite mature PAYG pillar.

ING 12ING 12

Structure of Czech Pension System – since 2013

III.Pilar Supplementar

y Pension Insurance with State Support

FF (DC) Private Admin.

(PF ,a.s.)

AuM ≈ 250 bn. CZK < 5% of GDP

General = mandatory Supplementary = voluntary

II.Pillar

Pensions´Savings

Contr.rate

2%+3%

FF(DC)

Admin = Private Pension

Company

Start:

January 2013

I.pillar

PAYG

State admin.(ČSSZ)

Contr.Rate 28%

Exependiture cca 350 bn.CZK ≈ 9,2% GDP

(of which about 80 % old age benefits)

III.PillarLife

InsuranceFF

Private Admin.

(LI compan

ies)

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Expected New Architecture of Private Pensions

Current PF New Investor

Pension Management Company (PC)

Transformed Fund

Conservative F.

Other F.I

Other F.II

Conservative F.

Balanced F.

Growth F.

Gov. Bonds

F.

III. pillar II. pillar

Must be established:

___ manadatory

----- voluntary2%+3%

Clients contributions + State contr.+

Employers contr.

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III.Pillar - Current Legislation Background

• Pension system currently consists only of I.pillar (PAYG DB) and III.pillar (FF DC);

• III.pillar is voluntary, individually based; provided by commercial financial services providers (10 players of 8 international financial group)

• Total market = 4,5 mio planholders and 9,3 bn € AuM (approx. 4,8 % of GDP);

• State supports individuals and also employers to participate by direct state subsidy to individual contribution and also both individuals and employers by tax incentives;

• Current economic structure of PF is a mono-fund and profit-sharing principle similar like in traditional life insurance.

• Costs of providers are not regulated (2010 total expenses from 64 b.p. of AuM to 211 b.p. of AuM;),

• The net profit is created as a gross return (yields) of total assets minus total costs. The distribution of profit is stipulated by the law as follows:

• Min. 5 % of net profit to reserve fund

• Max 10 % of net profit to shareholders

• Min. 85 % of net profit to planholders;

• The provider has to guarantee a positive „0+“ return for client for each year

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Comming Legislation

• Current III.pillar will be transformed and the new II.pillar will be introduced;• Both pension products should be provided by one type of pension administration

(managing) company (hereinafter PC);;• The PC will be established either by the transformation of current PF or from the

scratch; • Transformation of current PF will be done such that the balance sheet of mono-fund

PF will be split into two balance sheets:• The new PC• And the so called Transformed Fund (hereinafter TF);

• The PC will cover its cost only by a combination of management fee (% of NAV, in TF % of AuM) and performance fee.

• Fee level proposed for III.pillar funds:• Performance fee for funds: in TF 15% of achieved net profit (gross yields –minus

0,6 % of AuM managing fee); in other funds 10 % of NAV increase within a year however the principle of high water mark will be applied.

• Management fees:• transformation f. - 0,6 % of average AuM• conservative f. - 0,4 % of average NAV• other funds – 0,8 % of average NAV

A high water mark fee calculation specifies that the performance fee

percentage only applies to amounts in excess of the previous high in net

asset value.

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II. Pillar – legislation background

• The new II.Pillar will be based on opt-out (voluntary) principle however once the person will join the II. Pillar it will be mandatory for them till the retirement

• All persons up to 35 will have the option to opt out partially from PAYG mandatory social security I.Pillar

• Those who will take part in II.Pillar can redirect (divert) 3 % of their pay-a-roll tax (social security contribution) in to their individual account in II. FDC Pillar.

• Those who will opt-out partially from I. Pillar will be obliged at the same time to put into their individual account in II. FDC Pillar also their own contribution (from their net disposable income) in amount of 2 % of their pay-a-roll/gross salary/.

• So in fact; since this moment those persons will pay the social security tax at the level of 30 % of pay-a-roll in place of current 28% .

• This social security tax will be collected by employers from the salaries of their employees, like today.

• Persons above 35 (any age ceiling) will get a half a year period (2nd half of 2012 or more probably 1st half of 2013 or all 2013) in which they can also join the II.Pillar under the same conditions as above mentioned for those below 35.

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17

New architecture in II. pillar

3%+2% = 5%

of a gross salary

AuM fees and Performance fess

No Performance Fee Performance Fee

Gov.Bonds F.

Conservative

F.

Balanced F.

Growth F.

AuM Fee % 0,3 0,4 0,5 0,6

Perf.Fee % NO 10 10 10

Current PF Pension Management Company (PC)

New Investor

management fee + performance fee

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18

New architecture in III. pillar

Current PF,a.s. New investorPension Management Company (PC)

Transformed.

F.

Conservativ F.

Other F.1

Other F.2

Other F.3

Contribution of planholders+ state contr. + employers

´contribution

AuM fee + Performance fee

AuM Fee % 0,6 0,4 0,8 0,8 0,8

Perf.Fee % 15 10 10 10 10

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III. Pillar Project – The change of state contributions level

• All other tax incentives – both for individuals and employers remain in force

0

50

100

150

200

250

participant´s contribution

sta

te c

on

trib

uti

on

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Reasons why the paradigmatic change is comming rigth now

• Reform oriented government with extraordinary majority in parliament: 118 of 200 votes,

• Younger generation (born in baby boom of 70´s) is expecting more individual responsibility in old-age security than previous generations. They has also created certain push towards politics to moderate the consequences of demographic changes in an intergeneration solidarity,

• In the year 2010 there has been serious discussion within the two expert groups called by the government: II.Bezdeks´commision (May 2010), National Economic Council of the Government (December 2010). Both this groups supported the idea to introduce II.pilar of mandatory pension savings,

• PM Nečas in role of Minister of labour and Social Affairs was responsible of pension reform already in government of PM Topolanek (2006 -2009),

• The financing of transition costs is solved by introducing a single rate of VAT in two steps:

• 2011 - base rate 20%, reduced rate 10%• 2012 - base rate 20, reduced rate increase from 10% to 14%, • 2013 – one rate 17,5%

• If the coming phase of economic crises will hit more seriously fiscal revenues, I would expect that finally the unified rate will be increased already during the next year to 19%.

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Some speculation about an uncertain future

• Unfortunately the no political consensus was reached about the origin of II. pillar with current opposition (social democrats),

• Social democrats therefore use the pension topic in their partially populist political agenda,

• Since it is quite likely that they will win next election; the probability of significant changes in current set up of II. Pillar is also quite high,

• This creates very complex environment for both potential clients and the pension providers.

• Nevertheless the worst case scenario for clients is that they will have to transfer they money collected in the meantime the 2nd pillar to their accounts in III. Pillar – which is fully supported by all political spectrum.

• Fortunately the additional investment needed for opening the II.pillar operations will be for existing providers in III. Pillar very limited (lot of synergies under the umbrella of one pension managing company).

Thank you for your attention

Contacts:jiri.rusnok@ing.cz