Pension reform plan already reveals 10 pitfalls

Individual points of the long-planned pension reform are finally being revealed to the public. They give rise to many questions and ambiguities that neither the government nor the respective ministers have yet been able to give satisfactory answers to. Whether this is an effort not to frighten citizens or stems from uncertainty about what final form the new system will have, it is worth pointing out a few pitfalls and unresolved aspects.

1. Lack of courage

The proposed “reform” is unnecessarily cautious and essentially won’t resolve anything. Taking out 3 percent from people’s wages doesn’t create a sufficiently large investment cushion and by no means will make a significant contribution to their pensions. Yes, admittedly, the additional approximately Kč 2,000 for the pension that an average client will receive from the state is not that bad. But it is not enough to radically improve the funding gap.

A more courageous future government will either have to increase payments or tell the truth and motivate people to really meaningful save for their pensions — both in terms of the amount of savings and reasonably selected tools.

2. One-way trap

It will be possible to enter the system yet never get out of it, even if it is inefficient and people could more sensibly save for their retirement elsewhere. Owing to this setup, there will be little motivation for the pension funds to take care of the clients they have already won.

3. Costs

If there is a single aspect that will decide about the long-term benefit, it is the funds’ management costs. On one hand, the funds will obtain a convenient supply of money every month; on the other hand, they will have no obligations regarding the payment. This means that in the case of conservative funds the annual charge should be a few tenths of a percentage point. When it comes to dynamic funds, the charge should amount to a maximum of 0.6 – 0.8 percent of the value of the asset.

The visions of some potential managers about a 2 percent charge from the money managed would mean that the funds will be considerably disadvantageous for the clients. The great unknown is the other fees that the funds will be able to charge and which should be part of the calculation of the fund’s total maximum costs.

4.   Investment strategy

There is talk about four compulsory strategies, ranging from the very conservative to the very bold. But how will people be able to pass between the strategies? Will the transfers be anyhow limited or subject to charges? And who will advise people on what strategy to choose?

5. False promises of certainty

A big topic is the question of a state guarantee, an idea the government rejects, saying that if people want “certainty” they should invest in the funds formed by Czech government bonds. While it is an interesting option for the state — which can gain a cheap and stable commercial outlet for the bonds — for young clients in particular it is the road to hell. With a 30-year investment horizon, young people’s money should not be tied up in bonds. If the state’s rhetoric motivates people to make unnecessarily conservative investments, it deprives them of potential revenue. Should they obey the state’s recommendation pertaining to secure investment, they will get nothing in return but a 100-percent guarantee of a low yield.

6. A badly chosen product

Given the Czech population’s poor level of financial literacy, the option of several investment strategies is rather bad and many people will most likely choose to be either too cautious or too daring. Why hasn’t the state set out on the path that is increasingly popular worldwide, the path of life-cycle funds? These funds buy for young clients dynamic investments and as people get old increase the share of conservative investments in the portfolio that are aimed at maintaining the attained value. Today, among retail products it is the most reasonable instrument of managing the possible yield and risk according to the client’s age. At the same time, it is an ideal tool for people who don’t know how to decide.

7. Creation of an oligopoly

Today, the state is striving to change the conditions of building savings and instead of compulsory establishment of special institutions merely define the product’s conditions with the aim to increase competition. Why doesn’t it then proceed in the same manner within pension reform, merely defining the conditions for how the respective product should look?

Should just a handful of providers originate, we can expect two possible scenarios:

• the murky Czech pond, in which all of them will set very similar price terms and no one will exert pressure to lower costs;
• or a completely unfettered one, as in Slovakia, where all of them, striving to gain clients, will inflate the acquisition costs to the maximum irrespective of economic advisability.

One way or another, the result will be the same:  unnecessarily high costs that the client will have no chance to avoid.

8. The uncertain fate of today’s pension funds

Great questions are raised by the declarations pertaining to the reform of the current pension funds. If they are also to manage the second-pillar funds, why should they offer the same product in the third pillar too, with state support to boot? They should either come up with other offers or someone will sooner or later open the question of the sense of state support which would be a death sentence for today’s pension funds.