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Czech: Government Finally Opens a Door to Pension Reform Debate


Milan Kantor of Penzijni Fond Komercni BankyCzech - Less than a year ago, pension reform was almost unmentionable in the Czech Republic, pension fund managers say. One government after another had shied away from a problem widely expected to worsen dramatically as the country's population ages, and pleas to do something—anything—about it fell on deaf ears.

So it came as a great surprise to many in the pension fund business when the current coalition government recently opened the door for a debate on the issue by announcing a reform proposal. The Czech Pension Fund Association (APF) attempted to push that door further open further last week with its own reform proposal that pension fund representatives say will work better and benefit more of society.

The APF's proposal—compiled by the country's largest pension fund, Credit Suisse Life & Pensions—would give employees the option of saving a portion of their social security taxes in pension funds, or the system proposed by the government. At first glance, the system is similar to reforms introduced in Slovakia, Hungary and Poland. But a major difference lies in a related proposal that would let clients move their savings into the state system (in the other three countries the system is mandatory).

With this two-way option and increased willingness on the part of the government to listen to alternative solutions, pension fund managers are hopeful their proposal will be adopted.

Under the current Pay-As-You-Go pension system, employees pay the pensions of those who have retired. The PAYG system ran at a deficit of Kc 16 billion ($582 million) in 2002, and with the ratio of workers to retirees set to plummet from 3:1 to 1:1 in the coming decades, the system is unsustainable in the long term.

As part of its public finance reform package, the government has proposed introducing a Notional Defined Contribution system (NDC). Under this system, employees would pay into a "virtual" pension account that would pay them upon retirement an amount that better reflects their contributions, the government says. Working people would be able to access their accounts electronically to see how much they have saved toward their own pensions.

The problem with the proposed system, pension fund managers and observers say, is that a state-run NDC system will not bring the kind of returns that private pension plans can. It may also, they warn, be vulnerable to political tampering.

"[This proposal] does not resolve the fact that future governments will not necessarily feel obliged to adhere to this government's decisions" and could propose changing the system based on "the future budgetary situation of the country," said Ivo Foltyn, chairman of the board of Penzijni Fond Ceske Pojistovny.

Pension fund managers also point out that as the individual NDC accounts would be virtual and not actual deposits, there's no guarantee that higher-paid, higher-contributing employees would actually get back what they paid into the system. Fund managers cite government materials stating that the NDC system will guarantee a pension of 40 percent of the wage of those receiving the national average wage or less.

"Around 60 percent of the population is on or below the average wage, which leaves a big question mark as to what the remaining 40 percent of the population will receive," said Katerina Susakova, head of PR and marketing at Credit Suisse Life & Pensions.

Compromise solution

The APF says its proposal addresses this imbalance. Dubbed the Principle of Voluntarily Motivated Diversification (PVMD), it would let employees allocate a portion of their social security taxes to the pension fund of their choice rather than to the NDC system. Social security is paid jointly by employees and employers and equals 26 percent of an employee's salary.

In order to ease the impact of a loss of payments to the NDC system, the APF proposes that as of 2005 those over 36 be allowed to allocate 6 percent of their social security taxes to pension funds. In 2006, those over 26 would be allowed to allocate 5 percent and as of 2007 the remainder would be able to allocate 4 percent. The PVMD system is based loosely on reforms in Hungary, Poland and Slovakia, where employees are obliged to pay a fixed percentage of social security taxes into pension funds.

"This system is unique because it would be totally voluntary—employees would be under no obligation to have their social security taxes paid into pension funds," said Petr Zaluda, country CEO of Credit Suisse Life & Pensions. "Employees would also not be obliged to remain in this system. If they decided they didn't like it, they would be allowed to return this money to the NDC system."

The APF also proposes raising the retirement age to 65; the government has proposed 63.

The government has made it clear that pension reform will not include obligatory payments into privately owned pension funds. Many leading Social Democrats (CSSD), the dominant party in the governing coalition, have expressed the fear that private pension funds could go bankrupt, leaving the state holding the bag.

"This is a compromise solution between the two systems that we think addresses the government's fears by giving people the option of private savings rather than making it obligatory," said Milan Kantor, APF president, and board chairman and executive director of Penzijni Fond Komercni Banky.

Pension fund managers are optimistic about their chances of success. They say that by pushing pension reform to the front burner, the government has given private funds a unique opportunity to make their case.

"Successive governments have balked at the idea of even discussing pension reform, but this government has opened the debate," Zaluda said. "A year ago no one imagined the government would go this far, and we've found an unprecedented willingness from different ministries to listen to us. It's early days yet, but we hope we'll get our message across."

The fact that 2.6 million people have already opted voluntarily to invest some Kc 70 billion in pension funds, Susakova said, has been a strong argument in discussions with government ministers. "It demonstrates that people are willing to think about their own future and are more responsible than the government gives them credit for," she said.

The problem with the current system, some pension fund managers complain, is that there is insufficient motivation for people to invest significant sums in pension funds. The government offers annual tax breaks of Kc 12,000 for people investing in pension funds and provides a Kc 150 subsidy for those investing Kc 500 per month. The problem with this, said Petr Benes, CEO and board chairman of Ceskomoravsky Penzijni Fond, is that more than 90 percent of people invest Kc 12,000 and no more.

"It's extremely difficult to get people to invest voluntarily—you have to motivate them," he said. "And when you motivate them with tax breaks, they will only invest the absolute minimum required. The Czech Republic's neighbors have the right idea in obliging people to pay into private funds rather than leaving it to individual choice."

"Our proposal is not ideal, but it has a better chance of passing than an obligatory payment scheme and is definitely a step in the right direction," he added.

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