Written by: Petr Vykoukal (www.penize.cz)
Photo by: Vladimír Weiss
A sharp drop in income is something that those with high earnings must deal with when they retire. If they don’t want to live on “bread and water”, they must begin arranging for old age decades in advance.
During the final twenty years of the last century there was a growing global effort to rid nations of the obligation to financially support retirees. The reason: the existing system was built mainly on the “pay-as-you-go” principle – retirees were paid out of contributions made by current workers – but over the long term this is unsustainable. In many countries, including the Czech Republic, huge deficits have begun to appear – the country cannot afford its existing retirees, and if your retirement is still years away, you can be sure that not much will be left for you. Additionally, the current Czech system relies too heavily on solidarity. If your income is small (e.g., about CZK 10,000 a month), you will receive a pension that is close to your current income (about CZK 6,500, depending on many conditions), but if your earnings are now far above the average (e.g., CZK 50,000 a month), your state pension will be only slightly higher than the average pensions of current retirees, in this case about CZK 8,200. The world is backing off from state involvement in pension systems, and greater emphasis is being placed on personal savings,” says Austin Kimm, general director of AVIVA life insurance, describing the direction many countries have chosen. Under the influence of growing problems with so-called current retirement systems, rather radical reforms have been made. For example, Poland recently introduced mandatory savings in private pension funds. Slovakia is preparing extensive changes in its existing system too, going so far as to freeze a portion of its privatization revenues for this purpose. No such effort is being made in this country yet, and unless changes are made, when today’s 30- and 40-year-olds retire, there won’t be any money left for their pensions.
There are many options with the best-known instruments for savings being pension funds and life insurance. However, financial consultants believe that it’s a good idea to save money in other ways as well. Zdeněk Sluka, the executive director of Sophia Finance, a company that focuses on personal finance consulting, recommends many other products for saving for retirement. His first choice is arranging your own housing for your retirement. This will allow you to save on rent, and you can spend the money on something else. If you have any money left over after paying off your mortgage installments, he advises that you set up a building savings account, which is probably the most advantageous personal finance product at this time (thanks to state contributions, the yield is over 12%), and its great advantage is that you can take the money out after five years. But you certainly shouldn’t spend this money, you should use it for further investments. Sluka recommends investing in mutual funds, from which you can assemble a portfolio that corresponds to the risk profile and timetable of nearly anyone who is interested in investing, thanks to the enormous variability of such funds. Besides funds, Sluka also sees real estate as an interesting long-term investment.
Pension funds are here
Following years of rapid growth and a huge wave of mergers, pension funds are going through a calmer period. The number of clients changed only slightly last year – in the first three quarters only about 50,000 new clients appeared, which translates to only 2% growth. “The entire market is slowly becoming saturated. We can expect a limit of about three million clients, but even the current 2.5 million represents a great success in the voluntary sphere,” says Petr Žaluda, general director of Credit Suisse Life and Pensions, the largest pension fund on the Czech market. He says that new clients can go into the supplementary pension insurance system from firms that contribute to their employees’ insurance, but as yet they are just deciding on closing contracts. It is expected that other employers will try to improve their social programs in an effort to increase employee loyalty and cut costs.
However, the chances for growth are very small. This was also probably one of the reasons the British financial group AVIVA sold the Commercial Union pension fund, which it bought from Mostecká uhelná just two years ago. True, the fund was relatively large in local terms (160,000 clients), but in an essentially divided pension market it didn’t have much of a chance to achieve a significant position, so its owner sold it to the Česká pojišťovna pension fund. There are currently only the funds of large, global asset managers on the market, such as Credit Suisse, ING, ABN Amro, as well as funds of large domestic banking institutions, and two very small “corporate” funds (Hornický, which is owned by the OKD mining company, and Zemský, which belongs to Mostecká uhelná). Further conglomeration can occur only in the event that funds’ parent companies on the international level merge.
Nevertheless, pension fund administrators have reason to be happy – the volume of managed property is rising quickly. While at the beginning of last year pension funds recorded CZK 50.4 billion accrued by clients, at the end of September (no more recent data are available) this figure was up to CZK 59.5 billion. However, if clients saved more, which would help supplementary pension insurance become another pillar of retirement assurance, the growth of managed property will be even sharper. Žaluda sees 10% of one’s salary as the optimal limit. With an average wage of CZK 15,000, this would mean CZK 1,500 per month, but the current average is lower. For example, Credit Suisse Life and Pensions fund clients save an average of CZK 677 per month.
Insurance is still rising
Life insurance is a product that is a traditional method of saving for retirement around the world. In order to make this retirement savings tool more attractive for the citizenry, the state has made it possible since 2001 to deduct a portion of paid premiums from the tax base each year. This was a powerful development stimulus. In 2001 alone, prescribed policies grew by 25% to CZK 28 billion, and this growth continued last year, with CZK 24 billion in prescribed policies in the first nine months, i.e., a year-on-year increase of 15%.
Investment life insurance, which is one of the best sellers abroad, will probably be a future insurance hit. In the meantime, this trend has yet to appear on the Czech market. With investment life insurance you don’t put your savings into the insurer’s so-called technical reserve (over which you have no control), instead you invest in a mutual fund of your choice, depending on your investment profile. So you don’t have to invest your money conservatively (as is the case with classic life insurance), you can invest in stocks, for example, and your decision is not permanent, as you can move your savings around as you wish. The reason this product dominates the life insurance field abroad is that it is more transparent than classic insurance, and it allows you far more freedom in adjusting the savings part of the policy to the particular client’s needs.
There is every reason to expect that the Czech life insurance market will develop similarly. “I expect the investment life insurance sector will grow at an annual rate of 20%, as compared to the 10% growth of the life insurance sector as a whole,” says Kimm, whose AVIVA (originally Commercial Union life insurance) was a pioneer in investment life insurance on the Czech market. In 2002 the entire investment life insurance market in the Czech Republic reached CZK 3.7 billion, which accounted for 11-12% of all life insurance policies. In 1998, when investment life insurance was launched in this country, it accounted for only 2%.