4. Voluntary funded pension arrangements

The Czech Republic has had a voluntary funded pension system since 1994. It covers 52% of the working-age population and the assets under management represent 9% of GDP. Section 4.1 presents briefly the changes that have led to the current system. The following sections then assess the performance of the voluntary funded pension system with respect to different criteria, such as coverage and contribution levels (Section 4.2), financial incentives (Section 4.3), assets and investments (Section 4.4), capital requirements (Section 4.5), pay-out options (Section 4.6), competition (Section 4.7) and communication (Section 4.8). Finally, Section 4.9 provides policy options to improve the design of the funded pension system.

Since its creation in 1994, the Czech funded pension system has experienced several parametrical and structural changes. Figure 4.1 presents the timeline of the main changes to the Czech funded pension system.

The Czech Republic established a voluntary funded defined contribution (DC) personal pension system in 1994, called the supplementary pension insurance scheme. Anyone over the age of 18 with permanent residence in the Czech Republic, and after the Czech Republic entered the EU also with residence in another EU country, and participating in pension insurance or public health insurance in the Czech Republic could conclude a contract with a pension fund. This has been a very popular system from the beginning, with more than 1 million participants in the first 3 months, growing steadily until reaching 4 million in 2008 and 5 million in 2012.

Since the beginning, participants with a minimum monthly contribution have received a state contribution. Initially, the monthly state contribution was determined according to the following schedule:

  • CZK 40 + 32% of the amount over CZK 100 if the participant contributes CZK 100-199

  • CZK 72 + 24% of the amount over CZK 200 if the participant contributes CZK 200-299

  • CZK 96 + 16% of the amount over CZK 300 if the participant contributes CZK 300-399

  • CZK 112 + 8% of the amount over CZK 400 if the participant contributes CZK 400-499

  • CZK 120 if the participant contributes at least CZK 500.

The supplementary pension insurance scheme required pension funds to guarantee a non-negative return on annual basis. Pension funds had to contribute 5% of profits to build a reserve fund.1 This reserve fund and other funds should be used to offset losses from negative returns, given the non-negative return guarantee. If such sources were insufficient, the loss had to be covered by a reduction of registered capital, which could not fall below a certain amount.2

In 1999, an amendment increased the attractiveness of the supplementary pension insurance scheme by raising by 25% all the parameters to define the level of state contribution and introducing tax concessions for contributions from participants and employers. At the same time, the amendment increased the minimum age for eligibility for an old-age pension from 50 to 60 years old and the minimum contribution period from three to five years. Because of the impossibility to apply the changes retroactively, the stricter eligibility conditions only applied to new participants or to the existing participants who agreed to modify their contract. As of December 2000, 172 902 participants (8% of the total number of participants by the end of 1999) had signed amendments to their original contracts to accept the new conditions.

In 2011, a main reform changed substantially the structure of the funded pension system. The main changes were implemented from 2013. Back then, the pension system comprised a mandatory pay-as-you-go public scheme (first pillar) and the supplementary pension insurance scheme described above. In December 2011, the government decided to conduct a main reform of the pension system, primarily due to the long-term unfavourable demographic development of the country’s population and the potentially unsustainable nature of a pension system based solely on the pay-as-you-go component. The main objectives of the pension reform were to ensure the sustainable development of public finances, diversify the sources of retirement income, and increase individual responsibility. In order to fulfil these objectives, the reform changed the structure of the funded pension system by:

  • Adding a new component called the retirement savings scheme (second pillar) that lasted between 2013 and 2016; and

  • Restructuring the supplementary pension system (third pillar), with the conversion (in 2012) and closure (from 2013) of the existing funds to new members and the introduction of a new supplementary scheme in 2013.

The retirement savings scheme was introduced on 1 January 2013. It consisted of transferring 3% of the employee’s gross salary that was deducted for national pension insurance (28% in total) to a private individual retirement account managed by a pension management company, under the condition that the employee contributes an additional 2% of gross salary. The scheme was voluntary, but the decision to participate, once made, was irrevocable. Entry into this system was limited to individuals up to the age of 35 in January 2013. Individuals older than 35 interested in joining this system had to decide to participate in this scheme within six months after the launch of the reform (i.e. by 1 July 2013).3

Pension management companies had to offer their clients four investment funds with varying levels of risk, a government bond fund, a conservative fund, a balanced fund and a dynamic fund. Between ten and five years before retirement, participants’ funds had to be transferred gradually into a conservative fund. For the retirement phase, a life insurance company selected by the participant provided choice between a lifelong annuity (with the possibility to add an option paying a survivor pension during three years), and a 20-year annuity.

However, the introduction of the retirement savings scheme lacked broad political consensus. In November 2014, a new government decided to end the retirement savings scheme. The reasons were that it would weaken the state pension and reduce solidarity in the pension system, while only benefitting a limited group of people given its voluntary nature. Entry of new participants ended on 1 July 2015. The retirement savings scheme was discontinued from 1 January 2016. As of 1 July 2016, retirement funds entered into liquidation and ceased to exist after they paid-out all of the participants’ funds. Participants had to inform their pension management company by the end of September 2016 how they wanted their savings to be paid out. The options were to receive the funds (in cash through a postal order or in a bank account), or to transfer the account to a supplementary pension fund.

Most of the participants received a payment to their bank account, and approximately one-fifth had their money transferred to a supplementary pension fund, according to the Association of Pension Management Companies of the Czech Republic (APS CR). At the time of closure of the retirement savings scheme, 7 943 participants (9% of the total) had failed to inform their pension management company about their decision regarding the settlement of their retirement savings. Their funds were sent to their personal tax account maintained by the Financial Administration. Individuals could request the payment of their funds from the locally competent tax office as of 2017. However, the tax office could use the funds to cover any tax arrears of the individuals. By October 2019, 2 245 participants had still not claimed their funds. Uncollected money by 2023 (currently CZK 18 million according to the APS CR) will be transferred to the state budget.

Former participants could also pay back the part of the pension insurance contributions paid into the retirement savings scheme (3% of gross salary) to the Czech Social Security Administration in order to get a full state pension. As the retirement savings scheme was funded with part of the national pension insurance contribution that initially financed solely the state pension, former participants’ state pension will be reduced for the time they participated in the retirement savings scheme. For them, the state pension accrues at 1.2% of the earnings base for the years of participation in the retirement savings scheme, instead of 1.5%. To avoid this reduction, every former participant in the retirement savings scheme could request from the Czech Social Security Administration, by 30 June 2017, information about the amount of pension insurance contributions transferred to the retirement savings scheme, and pay the calculated amount by 29 December 2017 to that institution. Only 518 participants did (0.6% of all participants), meaning that nearly every former participant will get a reduced state pension.

Overall, the take-up of the retirement savings scheme was relatively low, with 84 495 participants (1.2% of the working-age population) and CZK 3.42 billion of accumulated assets (0.1% of GDP) as of 30 June 2016. By far, the most important reason has been the threat from the CSSD party to close the scheme, since the discussions about the creation of the retirement savings scheme started. Other factors include the requirement for workers to contribute an additional 2%, their inability to withdraw their funds before retirement and the legally capped low commission that pension companies could pay to financial intermediaries.

The 2011 reform first aimed at increasing the safety of the participants’ funds. The supplementary pension system initially only consisted in the supplementary pension insurance scheme created in 1994 described earlier. The 2011 reform closed all the pension funds as of 30 November 2012 and transferred automatically the savings of the participants to new “transformed funds”. The original features of the supplementary pension insurance contracts were retained, however. Transformed funds still offer an annual non-negative return guarantee, the ability to receive an old-age pension from age 50, and the possibility to terminate the contract and receive payments. The main purpose behind this institutional change was to guarantee the safety of the participants’ funds through separating the assets of the participants from the assets of the shareholders, i.e. the fund managers.

The reform also created a new supplementary scheme for new participants. Since 1 January 2013, new participants in the supplementary pension system can only join the supplementary pension savings scheme. They are not allowed to join transformed funds but can choose to contribute into one of the “participating funds”, with different risk profiles and investment strategies. Pension management companies manage the participants’ assets in both participating and transformed funds.

Participants in the supplementary pension insurance scheme may switch to the supplementary pension savings system at any time and select the participating fund of their choice (i.e. select an investment strategy). By the end of 2019, only 3.1% of the participants in the supplementary pension insurance scheme in 2012 had switched to the supplementary pension savings scheme. The ones that switched were in particular older participants who wanted to benefit from the pre-retirement option (see Section 4.6 for more details). The main motivations to remain in the supplementary pension insurance scheme are the non-negative return guarantee and the possibility to withdraw funds without losing the state contribution from age 50 for those who joined before 1999.

The aim of introducing the supplementary pension savings scheme in 2013 was to achieve higher long-term performance. Indeed, this scheme is characterised by the absence of a return guarantee, the separation of the pension fund manager’s assets from the savings of its clients, and the implementation of a regulatory framework for the remuneration of pension management companies. Because of the return guarantee, transformed funds mainly invest into low-risk bonds with low expected rates of return. Participating funds do not have this constraint and can therefore expect to achieve higher returns.

In addition, modifications in the state incentives aimed at increasing the level of contributions paid by participants. For all participants (in transformed and participating funds), the minimum amount of monthly contributions from which the state contribution is paid increased from CZK 100 to CZK 300 in 2013. At the same time, the maximum state contribution increased from CZK 150 to CZK 230, for those contributing at least CZK 1 000 per month. In addition, the range of contributions subject to tax deductibility changed from CZK 500–1 500 to CZK 1 000–2 000 monthly, meaning that people need to contribute more in order to be able to deduct the amounts from their taxable income.

Following the abolishment of the retirement savings scheme in 2016, the government decided to increase further the attractiveness of the supplementary pension savings scheme for both individuals and pension management companies. Since 1 January 2016, workers younger than 18 are able to join the system, while parents can set up a participating fund for their children. The age at which members are able to take their retirement income was established at 60 years old, instead of being linked to the age requirement in the state pension. In order to decrease the proportion of lump-sum withdrawals and encourage a long-term drawing of benefits, pension payments taken over a period of more than ten years will be tax exempt. In order to increase contribution levels, on 1 January 2017, the tax relief on members’ contributions increased from CZK 12 000 to CZK 24 000 annually (i.e. contributions between CZK 1 000 and CZK 3 000 monthly are tax deductible), and the level of employer contributions not considered as taxable income increased by CZK 20 000 to CZK 50 000.

The 2016 amendment also makes the supplementary pension schemes more attractive for providers. This led to an increase in costs to participants. To enhance the distribution of pension products, the cap on the commission of intermediaries increased from 3.5% to 7% of the national average salary for each new contract. In the case of transformed funds, the cap on management fees increased from 0.6% to 0.8% of total assets. Meanwhile, the cap on performance fees decreased by 5 percentage points to 10% of the profit. The concern of pension management companies of not being able to meet the return guarantee in the then financial market environment justified the fee increase. In the case of participating funds, the maximum management fee increased from 0.8% to 1% of total assets, and the cap on performance fees increased by 5 percentage points to 15% of the outperformance above the initial pension unit value. There was an exception for the mandatory conservative fund, for which the management and performance fees did not increase; they are lower than for the other participating funds. Raising fee limits aimed at allowing more investment opportunities that may be more costly.

The number of participants in the supplementary pension schemes has been declining since 2012. At the end of 2019, 4.4 million individuals had a supplementary pension plan, 3.3 million (74%) in transformed funds and 1.1 million in participating funds. Overall, the system has lost 679 000 participants since a peak of 5.1 million in 2012 (Figure 4.2). This peak was due to people willing to benefit from the rules of the transformed funds, before these funds became closed to new entrants.

Since 2016, individuals under 18 years old can participate in the supplementary pension savings scheme. At the end of 2019, there were 60 584 minor participants according to the APS CR, representing 5% of all contracts in the supplementary pension savings scheme. Around two-thirds of such contracts are for children up to nine years old. An important incentive to bring children in the system is that, at the age of 18, the child can withdraw up to one-third of the savings (excluding any employer and state contributions), provided the saving period lasted for at least ten years. The contract can be cancelled at any time and the money saved can be withdrawn, but without the state contributions.

The age structure of the participating funds is skewed towards older ages. Figure 4.3 shows that, in 2018, 70% of participants in transformed funds were aged 30 to 60, with a pick of 27% aged 40 to 49. By contrast, in the participating funds, the dominating age group was the 60-69 years old (27%), followed by the 70-79 years old (17%). This is possible because there is no maximum age to join the system or to start withdrawing benefits. For these older participants, supplementary pension savings represent an interesting form of investment, as they can withdraw the funds, including the state contributions, after only five years of participation, because they have already reached the normal retirement age of the scheme. Still, the proportion of participants over the age 60 is declining and 2018 is the first year since the establishment of participating funds when they represented less than half of all participants (47%). Among new participants who entered participating funds in 2018, people aged over 60 accounted for 38%.

A majority of participants are women. At the end of 2018, women represented 53% of all participants in the supplementary pension schemes. They were slightly more represented in participating funds (54%) than in transformed funds (52%).4

The coverage of the supplementary pension schemes is quite high. In 2019, 52% of the working-age population (aged 15-64) participated in the supplementary pension system. This is in the upper range when comparing internationally across voluntary funded pension systems (Figure 4.4).

Participation in supplementary pension schemes increases with age and income. Participation is below 20% for individuals aged 20 to 24 and below 40% for those aged 25 to 29. It is the highest for individuals aged 40 to 60, at or above 60%. Participation then declines, but remains high. For example, in the 65-69 age group, around a third of seniors save. Participation also increases with income. More than 40% of individuals in the first quintile participate. It is about 70% for those in the last quintile. In addition, participation is higher for employees (61%) than for the self-employed (55%).5

Total contributions paid by participants, employers and the state have increased steadily since 2013. Overall, contributions increased from CZK 47 426 million in 2013 to CZK 57 195 million in 2019. Consistent with the evolution of the number of participants in each scheme, the volume of contributions paid in transformed funds is declining and the one in participating funds is growing. In 2019, total contributions represented 1% of GDP. This is below the levels in voluntary systems in Canada, Portugal, New Zealand and the United Kingdom (between 2% and 3% of GDP), but above those in Austria, Hungary and Poland (0.3% of GDP).

Participants pay the largest share of total contributions. In 2019, contributions from participants represented 68% of the total, employers’ 20% and the state’s 12%. In transformed funds, the composition of contributions has been similar to the overall composition since 2013. By contrast, the composition of contributions in participating funds has changed significantly between 2013 and 2019. The weight of contributions from participants declined (from 91% in 2013 to 69% in 2019), while those of employer contributions (from 6% in 2013 to 18% in 2019) and state contributions (from 3% in 2013 to 13% in 2019) increased.

The average level of contributions paid by participants remains low despite existing incentives. Around 92% of participants contribute to their individual accounts. The minimum contribution for the participant is CZK 100 per month. However, average monthly contributions in both transformed and participating funds remain below CZK 1 000 (around 3% of the national average wage in 2018), which is the maximum amount that the state matches and above which contributions are tax deductible (Figure 4.5). Participants contribute more on average in participating funds than in transformed funds. However, average contributions have increased steadily between 2013 and 2019 in transformed funds. Overall, average contributions from participants represented around 2% of the national average wage in 2018.

Accordingly, state contributions are on average well below the maximum of CZK 230 monthly. In 2019, 86% of participants in the supplementary pension system received a state contribution by contributing themselves at least CZK 300 in a month. On average in 2019, participants received a state contribution of CZK 139.

Older participants, higher income earners and self-employed workers pay higher contributions. Average contributions by participants tend to increase with age. In 2018, participants aged 18-39 contributed CZK 402 monthly on average, while participants aged 55-64 contributed CZK 1 029. Interestingly, average contributions made for minor participants were higher than those made by participants aged 18-39, at CZK 433. In addition, the average contribution made by participants who had reached retirement age (65+) was lower than that of persons aged around 60, but remained relatively high at almost CZK 900. In addition, participants in the last income quintile contribute on average above CZK 800 per month, compared to around CZK 600 for the other quintiles. Finally, despite a lower participation, the self-employed contribute more on average than employees do.

Participants’ contributions are sensitive to the design of the state contribution. As the minimum contribution required to get the minimum state contribution increased from CZK 100 to CZK 300 in 2013, the share of participants contributing below CZK 300 dropped from 30% in 2012 to 21% in 2013 (14% in 2019), while the share of those contributing CZK 300-399 increased from 18% to 22% (22% in 2019) (Figure 4.6). At the same time, the level of contribution necessary to receive the maximum state contribution increased from CZK 500 to CZK 1 000. This translated into a reduction in the share of participants contributing CZK 500-599 (from 27% in 2012 to 21% in 2013 and to 16% in 2019) and into an increase in the share of those contributing CZK 1 000-1 099 (from 8% in 2012 to 15% in 2013 and to 26% in 2019). Overall, the share of participants receiving the maximum state contribution dropped from 50% in 2012 to 21% in 2013, but increased afterwards to reach 40% in 2019, showing that people adjusted to the new rules. The 2017 tax reform had a lower impact on contribution levels. The range of contributions subject to tax deductibility changed from CZK 1 000-2 000 to CZK 1 000–3 000. However, the share of participants contributing at least CZK 2 000 has only marginally increased from 6% in 2016 to 7% in 2019.

Less than a quarter of participants receive contributions from employers, although the trend is upward since 2016. Figure 4.7 shows that the number of contracts with an employer contribution went down between 2013 and 2015 and has been increasing since 2016. This increase may be linked to the raise in 2017 in the level of employer contributions that are not considered as taxable income for employees and employers by CZK 20 000. Improving economic conditions and the growing shortage of skilled labour may also contribute to explain this trend. At the end of 2018, 22% of participants received an employer contribution. Employers’ contributions are, on average, higher than that of the participants (CZK 877 in transformed funds and CZK 973 in participating funds in 2018, around 3% of the national average wage).

State support for the supplementary pension system consists in incentives for individuals, in the form of a favourable tax treatment and direct state contributions, as well as incentives for employers, by exempting employers’ contributions from social insurance payments.

The tax treatment of supplementary pension savings can be qualified as “tEE”, as contributions are partially taxed, while returns on investment and pension payments are tax free under certain conditions.

Contributions from participants into transformed and participating funds are paid from after-tax income. Contributions of CZK 300 up to CZK 1 000 a month are matched by state contributions. Contributions above CZK 12 000 a year are tax-deductible up to CZK 24 000 a year.

Employer contributions are not considered as taxable income for the employee up to CZK 50 000 a year.

Returns on investment are not subject to income tax during participation in the system but taxed according the rules described below in out payments from the system.

If the participant wants to withdraw money but does not fulfil the conditions to receive a lump sum or a pension, this closes the contract and any state contributions are returned to the state.6 If the participant made tax-deductible contributions, the amount previously deducted must be taxed. In addition, the returns on investment and the employer contributions paid after January 2000 are taxed at 15%.

Life annuities are tax-free, including when starting up to five years before the official age of retirement. Programmed withdrawals are taxed at 15%, except if they last for more than ten years, in which case payments are tax-free. Lump sums are taxed at 15% but the tax base consists only of the returns on investment and the employer contributions payed after January 2000.

The state matches contributions from participants in the supplementary pension schemes each month as follows:

  • Nothing if the individual contributes less than CZK 300.

  • CZK 90 + 20% of the amount above CZK 300 if the individual contributes CZK 300-999.

  • CZK 230 if the individual contributes at least CZK 1 000.

The state does not match employer contributions. State contributions are not subject to income tax. The contribution thresholds and the corresponding state contributions have not been updated since 2013.

As the personal income tax system in the Czech Republic applies a fixed tax rate of 15%, state support does not vary with the income level of the participant for a given level of contribution. It does vary, however, with the amount contributed and the length of the contribution period.

State support increases in nominal terms with the level of contributions, but declines in relative terms (Figure 4.8). Monthly contributions between CZK 300-1 000 are paid from after-tax earnings and matched by the state, while those between CZK 1 000-3 000 do not get a matching but are tax deductible. The nominal value of total state support therefore increases with contributions. In relative terms, however, state support declines with the level of contribution. For someone contributing the minimum incentivised amount (CZK 300), state support is the maximum and represents 30% of the participant’s contribution. Relative state support then decreases to 20% for the part of the contribution between CZK 301-1 000 and to 15% for the part of the contribution between CZK 1 001-3 000. Overall, state support represents 18% of the participant’s contribution for someone contributing the maximum incentivised amount (CZK 3 000).

Shorter contribution periods reduce overall state support. This can be evidenced by calculating the overall tax advantage provided to an average earner when contributing to a supplementary pension scheme instead of to a traditional savings vehicle. The overall tax advantage is the difference between the present value of taxes paid over a lifetime (i.e. during accumulation and payout) with the traditional savings vehicle (with a “TTE” tax treatment) and with the supplementary pension scheme (with a “tEE” tax treatment and state contributions). The overall tax advantage declines with shorter contribution periods (e.g. by starting contributing later) because individuals save less in taxes paid on investment returns. Indeed, the longer is the investment period, the higher is the investment income that gets taxed in the traditional savings account and grows tax free in the pension account. By contrast, if the parameters to calculate the level of state contributions are not indexed over time (e.g. by inflation or wage growth), as has been the case since 2013, the advantage stemming from those state contributions declines for longer contribution periods because the value of the state contributions relative to the individual’s income declines over time.

In international comparison, the overall tax advantage provided to an average earner in the Czech Republic is in the upper range (Figure 4.9). For an average earner contributing 5% of wages between 20 and 65 years old, the overall tax advantage represents 39% of the present value of contributions. It reflects the fact that participants in the Czech Republic cumulate the advantage on contributions described above (state contributions plus tax deduction), with the non-taxation of returns on investment, without paying taxes on pension payments when assuming the individual receives a life annuity at retirement.

Overall, the design of state support is unusual when compared to other OECD countries. First, state support mixes direct contributions and tax deductions. Germany (Riester pensions) is the only other OECD country with such a mix. In addition, the calculation of the direct state contribution is different from what other countries do. As shown in Table 4.1, there are two main ways to calculate state contributions in OECD countries. Australia, Austria, Chile, Hungary, New Zealand and Turkey express the state contribution as a percentage of the individual’s own contribution, from the first unit of contribution. This allows state contributions to increase linearly as individuals contribute more, up to a maximum level to limit the budget cost. Alternatively, in Germany, Lithuania and Poland, the state contribution is a fixed nominal amount, conditioned by a minimum contribution rate in Germany and Lithuania. The key difference between the two models is that the former is income neutral up to the maximum entitlement, while the latter offers larger incentives to low-income earners, as the fixed amount represents a larger share of their income. The schedule in the Czech Republic mixes features of both models, with an initial fixed nominal amount of CZK 90 conditioned by a minimum contribution level of CZK 300 per month, and a 20% match rate for contributions between CZK 300-1 000.

Employers’ contributions to supplementary pension schemes are exempt from insurance payments. Employer contributions are not considered as taxable income for the employee up to CZK 50 000 per year. The same ceiling applies for the exemption of employer contributions from insurance payments.

Overall, state support for the supplementary pension system consists in the state contributions, the tax deductibility of participants’ contributions and the exemption of employers’ contributions from income tax and social insurance. Annual state contributions have increased from CZK 6.86 billion in 2013 to CZK 7.25 billion in 2019. The tax expenditure related to participants’ contributions can be estimated at approximately CZK 1.2 billion for 2018. The cost of employer contributions (income tax and social insurance) can be estimated at approximately CZK 6.6 billion per year. Total budget costs thus correspond to approximately CZK 15 billion per year (0.3% of GDP in 2018). Of this, almost 50% is support for employer contributions, even though employer contributions only represent 20% of all contributions paid. Given that participation and contribution levels are the highest among older and higher income individuals, they are also the ones getting the most out of this total budget cost.

Investment returns have been mostly declining in the Czech Republic over the years, both in nominal and real terms (Figure 4.10). While, in nominal terms, the average performance of pension funds was 2.0% over the last 15 years (December 2 004-December 2019), it was only 0.9% for the last five years (December 2 014-December 2019). In real terms, the average performance has been null over the last 15 years and - 0.9% over the last five years. Since 2002, real returns have been negative in seven years, from 2007 to 2009 and from 2016 to 2019. The downward trend may in part be explained by declining bond yields over the period (for example the yield from Euro area AAA 10-year government bonds went down from 3.7% in January 2005 to -0.14% in December 2019).7

In international comparison, the Czech Republic is among the OECD countries with the lowest average performance over the 5-15 years ending in 2018 (Table 4.2). In nominal terms, among countries with available data up to December 2018, pension funds in the Czech Republic recorded the lowest five-year average annual performance, and the second lowest in real terms after Turkey.

Finally, performance varies according to the type of fund. Figure 4.11 presents the average nominal returns credited into individual accounts over 2013-19 by type of fund, weighted by the total assets in each fund at the end of 2019. This return includes the part of the profit that pension management companies share with participants. Pension management companies offer members of the supplementary pension savings scheme a range of participating funds with different portfolio structures and investment risk profiles, including the mandatory conservative participating fund. They also manage transformed funds, were participants do not have investment choice but have a non-negative return guarantee. Accordingly, transformed funds always credit positive returns into individual accounts (1.1% on average over 2013-19). As there is no guarantee in participating funds, returns can be negative, as was the case in 2018 for most of them. However, since the start of the supplementary pension savings scheme, participating funds have produced positive annual returns, at 1.9% on average. Dynamic funds have recorded the highest average annual performance at 5.0%, while mandatory conservative funds only returned 0.5%.

Several factors may contribute to explaining this low overall performance. Performance is indeed the result of many factors, predominantly, the proportion of assets in guaranteed and non-guaranteed funds, asset allocation strategies, investment restrictions and fees.

Most of the assets in the supplementary pension system are in funds providing an annual non-negative return guarantee. Overall, transformed and participating funds managed assets totalling CZK 507.7 billion, or 9% of GDP, at the end of 2019. Transformed funds gathered 88% of the total (Figure 4.12).

The Czech funded pension system ranks towards the bottom when compared with other voluntary systems in the OECD. With respect to the size of the economy, assets managed by transformed and participating funds only represent 9% of GDP. This is well below the average pension assets as a percentage of GDP of other OECD countries with only voluntary funded pension systems, which was 28% in 2018 (Figure 4.13).8 Beyond the fact that some systems are older than the Czech one (e.g. the United Kingdom, the United States), low contribution levels and low performance contribute to this low ranking.

Members of the supplementary pension savings scheme have investment choice. Pension management companies are legally obliged to offer one conservative participating fund. In addition, they can offer a range of other participating funds with different portfolio structures and investment risk profiles. Participants select one or more participating funds offered by their pension management company. Participants in the supplementary pension insurance scheme do not have investment choice in transformed funds.

There is no default investment strategy in the supplementary pension savings scheme. Participants may follow the recommendation by the pension management company based on their reply to an investment questionnaire, which assesses their risk profile and investment horizon. If they do not want to reply to the questionnaire, the pension management company has to recommend the conservative fund, which in that case could be seen as the default. According to the APS CR, as at 30 September 2019, 88% of participants in the supplementary pension savings scheme aged under 50 were in a fund other than the conservative one. Participants can mix different participating funds and can change their allocation at any time. Some pension management companies also offer life-cycle investment strategies, which change the weight of different participating funds over time. Pension management companies also have to transfer automatically the assets of the participants into the conservative participating fund at the latest when participants are five years before retirement age. The transfer can be gradual over several years before, but pension funds seem to make the transfer all at once just before the cut-off age. This practice would penalise participants who have suffered investment losses just before the transfer occurs. However, the participant may ask the pension management company in writing not to apply the transfer, although this does not seem to happen in practice according to the APS CR.

At the end of 2019, 37% of the assets in participating funds were in one of the mandatory conservative funds. This is down from 62% in 2013. According to the Ministry of Finance, this is probably related to changes in the participants’ age structure, which saw an increase in the share of participants under the age of 49. These participants may prefer dynamic investment strategies due to their longer investment horizon. Assets in balanced funds represented 23% of the assets in participating funds and assets in dynamic funds 18%.

Transformed funds’ portfolios are very conservative due to the non-negative return guarantee. At the end of 2019, transformed funds had placed the bulk of their assets into bills and bonds (78.4% of total assets), while investing just 0.1% of total assets in equities, 1.3% in collective investment schemes and 19.4% in cash and deposits.

The asset structure of participating funds is generally less conservative than that of transformed funds. At the end of 2019, participating funds had 32.0% of their assets invested in bills and bonds, 48.3% in cash and deposits, 7.5% in equities and 11.5% in collective investment schemes.9 In 2018, obligatory conservative participating funds’ investments in debt securities accounted for 40.8% of their assets and investments in deposits for 59.1%. By contrast, other participating funds had higher proportions of investment in equities (10.0%) and collective investment schemes (16.3% of assets). Their investments in debt securities amounted to 36.2% and their investments in cash and deposits to 37.2% of their total assets.

Of all the OECD countries, the Czech Republic was the country with the lowest allocation to equities at the end of 2018. Figure 4.14 shows the allocation of pension assets in selected investment categories in OECD countries at the end of 2018. The Czech Republic is at the bottom of the chart with an allocation to equities of 0.7%. It is also the country with the largest allocation to bills and bonds (76.5%). This is obviously driven by the weight of transformed funds in the supplementary pension system.

Foreign investment by pension funds represented 13.9% of total investment at the end of 2018. The bulk of foreign investment was in the European Union (76%), followed by North America (11%). Foreign currency exposure stood at 8.1%. Foreign investment has increased significantly over time for participating funds, from 5.0% in 2013 to 25.3% in 2018. Over the same period, foreign investment of transformed funds has varied between 10% and 15% of total investment.

Regulation imposes certain limits on investment for transformed funds and participating funds (Table 4.3). Within participating funds, specific limits apply to the mandatory conservative funds. Equity investment is not allowed for conservative participating funds, while there is no limit for other participating funds and a ceiling of 70% for transformed funds. Conservative funds are also more restricted than the other funds on their investments in private bonds and retail investment funds (30% for both asset classes together). In addition, conservative funds cannot have the duration of the portfolio exceeding five years. Finally, the law provides for conditions for concluding transaction with financial derivatives. These are restricted only to the purpose of effective asset management.

The main fees that pension management companies charge to members are the management fee and the performance fee (Table 4.4). Additionally, if the participant asks for a change of participating fund more than once a year, the pension management company may charge a fee, up to CZK 500. Likewise, if the transfer of assets to another pension management company occurs less than five years after the conclusion of the contract, the pension management company may charge of fee, up to CZK 800. Pension management companies are also entitled to charge a fee for sending a pension benefit statement more than once a year.

The performance fee for participating funds uses a high-water mark mechanism. If the average value of the pension unit is lower than its historic maximum, the pension fund does not receive any performance fee. Otherwise, the performance fee is a percentage (10% or 15%) of the outperformance compared to the high-water mark. This mechanism was introduced to motivate pension management companies to focus on long-term performance. So far, it is difficult to appreciate an improvement in performance, but this type of measure takes time to produce results.

Pension management companies may not have an incentive to invest in certain asset classes that may require them to pay a higher investment fee to external asset managers. Investing in alternative asset classes with higher investment fees may reduce the margins of pension management companies, as they cover all the expenses of the funds they offer with the income from management and performance fees they charge to participants. However, investing in alternative asset classes may increase returns net of fees, which would allow pension management companies to receive higher performance fees and to provide better risk-adjusted, net of fees returns to participants.

Fees charged by pension management companies are middle-ranged in international comparison. Figure 4.15 compares the total amount of fees paid as a percentage of the total amount of assets under management for DC pension plans in selected OECD countries. It accounts for all fees directly paid by members, independently of the flow on which they are charged (salary, contributions, assets, performance or fixed amount). In 2018, pension management companies charged members total fees amounting to 0.8% of assets under management (0.8% for transformed funds and 0.6% for participating funds). This level lies in the middle of the range of the countries shown.

This total fee comparison may be partially misleading, however, when fees in the different countries do not cover the same cost items. Countries where fees explicitly charged to members cover a large range of costs may indeed look more expensive than countries where a smaller range of costs is covered. In the Czech Republic, fees cover all investment and administrative costs. Han and Stanko (2018[1]) analyse the extent to which various cost and fee elements are covered by fees charged to pension plan members and group jurisdictions by clusters with identical or very similar items actually covered by fees. It shows that, in many jurisdictions, explicit fees only cover costs partially, implying an under-estimation of the total charges for members.10 This nuances the middle ranking of the Czech Republic in international comparison, as countries with lower fees may not be as comprehensive.

The 2016 reform affected the fees charged for transformed funds, while fees for participating funds are catching up. As shown in Figure 4.16, the structure of the fees charged for transformed funds changed in 2016, with the share of the management fee in the total jumping from 76% to 90%. The 2016 law indeed increased the cap on management fees (from 0.6% to 0.8% of assets) and reduced the cap on performance fees (from 15% to 10% of returns). In the case of participating funds, fee caps have increased in 2016 for non-conservative funds, from 0.8% to 1% of assets for the management fee and from 10% to 15% of outperformance for the performance fee. In addition, the proportion of assets in conservative funds has declined over time (from 62% of the assets in participating funds in 2013 to 37% in 2019), explaining further the increase in fees charged for participating funds, as fee caps for conservative funds are lower than for the other funds (Table 4.4). This upward trend also suggests that pension management companies charge the maximum allowed.

Legislation requests pension management companies to hold an initial capital of CZK 50 million. A pension management company has to maintain a value of capital in line with the assets under management. The capital should be at least the sum of:

  • CZK 50 million increased by 0.05% of the value of assets in participating and transformed funds in excess of CZK 5 billion (this sum stops increasing when it reaches CZK 500 million);

  • 25% of the sum of depreciation costs of tangible and intangible assets, and administrative costs of the pension management company for the previous accounting period.11

There is also a special capital requirement to cover the risks associated with the assets and liabilities of transformed funds. The liabilities include the return guarantee, which applies to participants’, employers’ and state contributions, and the benefits to individuals choosing a lifelong retirement income. This capital requirement is 8% of the sum of risk-weighted exposure amounts. If the liabilities of the transformed fund are higher than the assets, the pension management company is obliged to transfer to the transformed fund the assets necessary to offset this difference from its own capital, no later than 30 days after the end of the quarter in which liabilities exceeded the assets.

The capital ratio of pension management companies has increased in recent years. Table 4.5 presents the ratio of the pension management companies’ capital to their cumulative capital requirements between 2013 and 2019. This ratio fell between 2013 and 2016. The Ministry of Finance saw this development as not favourable, particularly due to the possible future risk of reduction in the market price of bonds, which make up the majority of the portfolio of transformed funds managed by the pension management companies. Due to the statutory guarantee that the transformed funds cannot decrease in value, if interest rates increase from their currently low levels, and, as a result, there is an associated decrease in the price of the bonds held at market value, the pension management companies would have to make up any losses from their own equity.12 The capital ratio increased in 2017, 2018 and 2019. This increase was due to an increase in pension management companies’ capital and a reduction in the capital requirements (at least in 2017 and 2018). This reduction of capital requirements was due to a less risky profile of assets resulting from an increased allocation into deposits placed with credit institutions.

The increased of the capital ratio since 2017 may not be a sign of a better resilience of pension management companies to unfavourable developments in financial markets. The combined capital surplus can complement the assessment (last line of Table 4.5). It is the sum of the equity of the transformed funds, and the excess of capital actually held over the capital requirements applicable to pension management companies. This combined capital surplus represents the maximum possible level of losses that would result in a decline in pension management companies’ capital to the level of their capital requirements. This indicator has been divided by two between 2015 and 2018, essentially due to a reduction in the equity of transformed funds. This indicates a lower safety cushion and a reduced capacity of pension management companies to maintain their capital above the regulatory requirement in case of unfavourable market developments. This trend was reversed in 2019, but the combined capital surplus is still below the level of 2016.

One of the main challenges in the Czech pension sector continues to be a low-yield environment stemming from a large proportion of low-risk debt securities in the pension funds’ assets. Furthermore, macroeconomic developments, especially a rise of interest rates in Europe, could have possible negative impacts on pension funds’ returns. Since pension management companies cannot deliver negative returns in transformed funds, a depreciation of transformed funds’ assets would trigger the injection of additional capital, which would negatively affect the capital ratio of pension management companies.

In addition, the yearly guarantee carries a significant implicit cost. OECD (2012[2]) compares the price of different types of minimum return guarantees. While the price of a capital guarantee valid only at retirement would be equivalent to six basis points annually of the accumulated net asset value of the portfolio, it increases to 39 basis points when the capital guarantee is valid annually, like in the Czech Republic.13 This price is not charged explicitly to participants, as it is included in the total management fee of 0.8% of assets for transformed funds.

The rules differ for the pay-out options available to participants in the supplementary pension insurance scheme and in the supplementary pension savings scheme.

For transformed funds, retirement benefits can take two forms, lifelong retirement payments or a lump sum (Table 4.6). The pension management company pays the benefits in both cases, which means that there is no transfer to an insurance company in the case of lifelong payments. The lifelong retirement income (called “old-age pension”) can have a guaranteed period and a survivor option. There is no legal requirement for the mortality tables that pension management companies can use for the calculation of lifelong retirement payments. Entitlement to a retirement benefit requires a minimum saving period of five years and a minimum age of 60. In addition, 69% of participants have a service pension contract, which allows them to get a lump sum or lifelong payments at any age after 15 years of contributions.14 Unmodified contracts concluded before 2000 provide an additional pay-out option paying benefits for a predefined period of time and have looser requirements for retirement benefits (three years of contributions and age 50). These more lenient rules apply to 8% of participants in the supplementary pension insurance scheme.

For members of participating funds, retirement benefits can take the form of programmed withdrawals, an annuity, a lump sum, or a combination of the three (Table 4.7). Participants need to contribute for at least five years and reach the age of 60 before being entitled to receive retirement benefits. When choosing an annuity (lifelong or fixed-term), the pension management company transfers the assets to a life insurance company. There is no legal requirement for the mortality tables that insurance companies can use for the calculation of annuities. Programmed withdrawals can be of a specified amount (minimum CZK 500 monthly) or for a predefined period (minimum three years). In the case of death of the plan holder, the accumulated assets are assigned to a person chosen by the participant or subject to inheritance rules.

One of the new features available since 2013 is the ability to use all or part of the assets in participating funds in the form of a pre-retirement pension. This solution targets participants who are nearing retirement age, are having a difficult time finding a job and have already saved enough within the supplementary pension savings system.15 Up to 2013, the only option these individuals had was to apply for an early retirement pension from the public system. This, however, led to a permanent reduction of the public pension they received. By taking advantage of the ability to draw a pre-retirement pension from their participating fund, the individual retains the right to a higher public pension, as he/she does not begin drawing an early retirement pension. However, participants must meet certain requirements:

  • It is not possible to start drawing a pre-retirement pension more than five years prior to the time the individual reaches the pension eligibility age16

  • Participants must have saved during at least 60 calendar months (including the period of participation in the supplementary pension insurance scheme for those who switched)

  • The pre-retirement pension must be drawn for at least two years

  • The monthly amount of the pre-retirement pension must be equal to at least 30% of the average wage in the Czech Republic17

  • The pre-retirement pension must be paid out as a fixed monthly amount. Once the pre-retirement pension starts being drawn, it is not possible to interrupt or terminate the process.

Individuals drawing a pre-retirement pension get public health insurance paid by the state but do not accumulate further rights in the state pension. The benefits in the public health insurance system are valid for the period of receiving the pre-retirement pension. The individual does not have to pay health insurance contributions but has the “state insured” status. For pension insurance, however, the pre-retirement period is excluded for the calculation of the pension from the public pension system, which is paid when the individual reaches his/her pension eligibility age.18

A participant who becomes disabled and classified as fully disabled is entitled to take a pension (either for a limited period of time or lifelong) or a lump sum from the supplementary pension system (both transformed and participating funds). A minimum participation of three years is required, and the disabled individual does not have to wait until the pensionable age to receive benefits. In the contract, the required contributory period could be longer, but no more than five years.

Benefits paid to plan holders are mostly in the form of lump sums, in particular for transformed funds (Figure 4.17). The majority of the benefits paid by transformed funds in 2019 were lump sums (76.8%), followed by surrenders (13.7%). Lump sums also represented the most common form of benefits paid by participating funds (59.0%), followed by surrenders (24.3%). However, retirement income benefits (i.e. programmed withdrawals and pre-retirement pensions), were also significant, representing 15.6% of total benefits paid in 2019. One explanation is the possibility, with participating funds only, to use the pre-retirement pension or to choose the payment of the pension for a specific period of time that can be as short as three years. The number of recipients of pre-retirement pensions has steadily increased since 2013. In 2018, 1 239 pre-retirement pensions were in payment. By contrast, virtually no one purchases an annuity.

Low contribution levels, short contribution periods and low investment returns translate into low levels of assets accumulated and low retirement income. In 2019, pension management companies paid out a total of CZK 23.3 billion to plan holders (0.4% of GDP), of which 80% originated from participants in the supplementary pension insurance scheme. Overall, only 4% of pensioners’ income come from the supplementary pension schemes. The selection of the lump-sum option despite the tax penalty may be justified by the low levels of assets accumulated by the time people take their benefits. People receiving their retirement benefits as a lump sum pay a 15% tax on employer contributions and investment income, while those choosing a payment option lasting for more than ten years do not pay tax. However, the average amount of benefits received corresponds to no more than 2.5 times the national average gross monthly wage, even in the case of lump sums. With such low levels of assets, people have no incentive to take an annuity or a lifelong option.19

A pension management company (joint-stock company) entering the market must obtain a licence from the supervisory authority, the Czech National Bank (CNB). The pension management company must obtain a separate licence for each of the participating funds it offers. There are standard legal and professional requirements whose fulfilment must be met by the applicant (capital adequacy, fit and proper requirements for the management and other personnel, adequate business plan, requirements for reporting and transparency, requirements for authorisation of prospective acquisition, prudency and soundness of management). Assets of the participants in the funds are separated from the pension management company and must be kept by a custodian (bank-depositary with an adequate permission from the CNB). Investments into the pension management company or into a company from the same financial group are not allowed. These requirements seem to follow the main messages from the OECD Core Principles of Private Pension Regulation (OECD, 2016[3]).20

The Czech market of pension management companies is moderately concentrated. Since 2015, eight pension management companies are active in the supplementary pension schemes. After the 2013 reform, there were ten pension management companies in the market, of which one decided to terminate its activities (2014), and two companies merged (2015). At the end of 2019, the pension management companies were managing assets in 36 pension funds, of which 28 participating funds and eight transformed funds. In addition, the two largest companies managed 45% of the assets for 46% of the participants. The Herfindahl-Hirschman Index (HHI), which measures the market concentration of a certain industry, stood at 0.16 when calculating it based on both assets and members, indicating a moderate concentration in the market.21

Participants join the supplementary pension schemes through bank branches and regulated intermediaries. Three of the pension management companies are subsidiaries of banks and use the banks’ network for the distribution of their funds. The other pension management companies are subsidiaries of insurance companies and investment funds and rely more on intermediaries, which can charge a commission of up to 7% of the national average salary for each new contract. This commission cannot be charged to the participant and is paid by the pension management company from the total fees paid by participants. However, intermediaries have an incentive to sell other types of products, given that only pension plans have a cap on commissions. The three pension management companies that are subsidiaries of banks hold 48% of participants, suggesting that it may be easier for these companies to attract clients.

Participants can change participating funds and pension management companies at any time. The pension management company determines the composition of the portfolio based on approved fund rules. If the participant is not satisfied with the strategy, he/she may change the participating fund within the same pension management company or may transfer assets to another pension management company by terminating the contract and signing a new one. Switches are uncommon, only 0.7% of participants in the supplementary pension savings scheme changed fund or company in 2019. This may be because bank subsidiaries have an important role and participants in these pension management companies may not want to switch as they have other financial products with the bank, such as loans or savings accounts.

Participants in transformed funds can only switch to the supplementary pension savings system through their pension management company. They can later on change the pension management company if the selection of participating funds in that company does not suit their needs, but this may imply a transfer fee.

Pension management companies usually charge the maximum allowed by law with few exceptions. In particular, the management and the performance fees correspond to the statutory limits, except in the three following cases:

  • Allianz: The management fee for the balanced participating fund is 0.8% of assets instead of the 1% maximum;

  • NN: The management fee for the balanced participating fund is 0.8% of assets instead of the 1% maximum, and there is no performance fee charged for the conservative fund;

  • CS-PS: The performance fee for the ethical participating fund is 10% of annual returns instead of the 15% maximum.

Pension management companies have increasing profits due to higher fee income. They generated a net after-tax profit of CZK 1.9 billion in 2019 (around EUR 69 million). This represented 87% of operating expenses and 18% of total equity. The main income item for pension management companies is income from fees paid by participants. This income has grown constantly over the period 2013-19, and in particular in 2016 (+19%), due to the increase in the statutory limits on fees for the management and appreciation of assets. Meanwhile, fee and commission expenses (e.g. remuneration of the depositary, for portfolio management, or for contract intermediation) have declined. Especially, expenses related to the remuneration for contract intermediation declined by 34% between 2015 and 2016, despite the increase of the related cap in 2016. Finally, administrative expenses have remained broadly constant after a decline in 2014. As a result, the net profit after tax of pension management companies increased by 82% in 2016 to CZK 1.4 billion and increased again by 35% in 2019 to CZK 1.9 billion.

Participants receive a pension benefit statement free of charge once a year within one month after the end of the calendar year. Besides that, participants can also require a pension statement anytime and the pension management company has to send the statement within 15 working days. The pension management company can charge a fee for this service.

The pension benefit statement contains the following information:

  • Information about the participant’s personal pension plan (identification of the participant, saving period, the value of the plan);

  • Information about the appreciation of the participant’s funds for the period since the last statement;

  • The annual net performance of the participating fund, in which the participant’s funds have been placed over the period since the last statement;

  • The amount of fees paid to the pension management company, clearly divided into management and performance fees.

Participants receive the written statement by mail on the mailing address stated in their contract. The pension management company and the participant can arrange for different channels, such as email for example. At retirement, pension management companies inform the participants about all their pay-out options either by mail or email.

Participants have little information about the future level of pension from the supplementary pension schemes. The pension benefit statement does not obligatorily include forward-looking projections. Neither the Ministry of Finance nor the Czech National Bank offer calculators. Some pension management companies do. In order to receive an approximate calculation of the anticipated level of benefits, the participant must enter the information about the amount of estimated monthly contributions and the estimated saving period. The output is not guaranteed, it only shows the probable outcome according to the expected performance of the participating fund. Additionally, there is no dashboard system in the Czech Republic, where individuals could visualise their pension entitlements from the public and private components together.

This section presents a series of policy options to address the issues identified previously in order to improve the design of the Czech funded pension system. The options presented here are in line with the main OECD guidelines regarding funded DC pension arrangements (OECD, 2018[4]; 2018[5]; 2016[6]; 2014[7]; 2018[8]) and the OECD Roadmap for the Good Design of DC Pension Plans (OECD, 2012[9]).

The Czech authorities could consider two alternatives to strengthen the role of the funded system in the overall pension system: introducing a new, occupational pension scheme, or improving the design of the existing supplementary pension schemes. The Czech Republic is the sole OECD country where the funded pension system only consists of a voluntary personal pension scheme. All the other countries have several pension schemes, sometimes combining mandatory and voluntary, occupational and personal plans. This allows pure voluntary personal schemes to have rules that are more lenient with respect to participation, contributions and withdrawals. The Czech Republic lacks this intermediate layer between public pensions and voluntary personal pensions. One option could be to introduce a voluntary occupational pension scheme, where employers could elect to establish a plan for their employees, and employees could choose whether to join that plan. This would help increasing the role of employers in retirement income provision.

Alternatively, the Czech authorities could build on the strength of the current supplementary pension scheme and improve it. A large share of the population already participates in supplementary pension schemes. Moreover, the retirement savings scheme (second pillar) introduced in 2013 did not last long. The Czech population may thus fear that a new occupational pension system may not last long as well, especially if there is a lack of political consensus.

How to improve the design of the Czech funded pension system depends on the policy objective. The main policy objective should be to have a strong complementary pension system that helps people to build an additional source of retirement income, on top of their state pension. Whether through occupational or personal schemes, this goal requires a multipronged strategy: i) improving net performance; ii) encouraging higher contribution levels; iii) lengthening contribution periods; and iv) extending the take-up of lifelong retirement income products. The objective may only be achieved by acting on the four fronts together, as for example the take-up of lifelong pensions cannot be extended if assets accumulated at retirement are still as low as today.

The introduction of long-term investment accounts may jeopardise some of these efforts. The Ministry of Finance has recently submitted a draft act amending certain laws in connection with the development of the capital market.22 The legislative measures include the introduction of long-term investment accounts. These accounts would be subject to the same withdrawal rules as supplementary pension schemes. Tax-deductible contributions to all types of retirement savings products (i.e. supplementary pensions, private life insurance and long-term investment accounts) would be jointly limited to CZK 48 000 per year. These long-term investment accounts would not enjoy the state matching contribution, but would not be subject to the same investment restrictions and fee regulations as supplementary pension schemes. The introduction of these competing products subject to different rules could dilute the potential positive impact of the strategy to improve the design of the funded pension system and may bring confusion in people’s mind about the appropriate product to choose to save for retirement.

Before encouraging people to contribute more into the system to increase their future pension income prospects, efforts are needed to improve the net performance of pension funds. The Czech Republic could use two levers: encourage investment strategies that yield higher expected risk-adjusted returns, and better align the fees charged to participants with the costs incurred by the pension management companies.

Although the yearly non-negative return guarantee in transformed funds is attractive for participants who fear they may lose the money they put in, it is a serious impediment to investment. Investment regulation allows pension management companies to invest the money within transformed funds in various asset classes. In practice, however, these companies have an incentive to invest mostly in government bonds that provide secured flows of income and do not increase their capital requirement. In the current low interest rate environment, participants barely get more than the guarantee and their savings do not keep up with inflation. In addition, the yearly guarantee carries a significant implicit cost that pension management companies cannot charge to participants (it is included in the cap of 0.8% of assets). This reduces further the capacity of these companies to invest in more sophisticated asset classes to get better returns. A guarantee to recoup contributions at the time of retirement rather than annually would be less costly and would give more room for pension management companies to diversify their investments.

Participants in the supplementary pension insurance scheme should therefore be further encouraged to switch to the supplementary pension savings scheme, where investment returns are higher (Figure 4.11). As changing the contract of participants in transformed funds to modify the guarantee could be legally challenging, the Czech authorities should seek to increase the number of switches to participating funds. For example, pension management companies could send regularly a transfer form to all participants in transformed funds. This would remove the effect of procrastination from people who intend to switch to participating funds but have not done so yet. Alternatively, the state could differentiate the financial incentives for contributions into transformed funds and participating funds, favouring the later. A further option would be the automatic transfer to participating funds for new contributions, possibly with an opt-out option for people willing to keep the yearly guarantee for all contributions.23 In that case, each participant would have two accounts. The money already accrued in transformed funds would continue to be guaranteed in the same way, but all new contributions would flow to participating funds without guarantee. This is consistent with the recent proposal by the Ministry of Finance to allow individuals to participate simultaneously in a transformed fund and a participating fund.

The government should also promote the access to an appropriate default investment strategy to all participants. The OECD Roadmap for the Good Design of DC Pension Plans encourages the establishment of default investment strategies for people unwilling or unable to choose their own strategy. The establishment of a default is important if the funded pension system is expected to play a bigger role in retirement income provision. In addition, in case the Czech authorities decide to implement an automatic transfer from transformed to participating funds, a default investment strategy becomes essential as people are more passive and less likely to make choices. Life-cycle investment strategies can be well suited to protect people close to retirement from the impact of extreme negative shocks in financial markets, while allowing younger participants to invest more in risky assets that yield higher expected returns. In the OECD, pension providers have to offer a life-cycle investment strategy as a default in Australia, Canada, Chile, Israel, Lithuania, Mexico, Poland, Slovenia, Sweden, the United Kingdom and the United States. In the Czech Republic, some pension management companies already offer life-cycle investment strategies by mixing different participating funds. The regulatory framework could require all companies to offer such strategies as a default option.

The supervisor should monitor how pension management companies transfer the assets of the participants into the conservative participating fund before retirement. This transfer should be gradual and delays could be considered when asset values drop just before the planned transfer, to avoid that participants materialise the losses. However, it seems that pension management companies transfer the assets all at once when participants are just five years before retirement age. The CNB should monitor the situation to see whether legislative changes are necessary.

Investment restrictions could be relaxed for participating funds to allow pension management companies to offer riskier investment strategies for less risk-averse participants. Regulation forbids investment in real estate and private investment funds for participating funds. These asset classes could be allowed within certain limits and restricted to very well identified participating funds that participants willing to take more risk could select. According to the OECD Annual Survey of Investment Regulation of Pension Funds, most OECD countries allowed at least limited investment in real estate and private investment funds in 2019 (OECD, 2019[10]). The recent proposal by the Ministry of Finance would introduce a new alternative participating fund, which could invest in real estate, private equity and infrastructure investments.

The second lever to increase net performance is to ensure that fees are aligned with the costs incurred by the pension management companies to run the funds. Market mechanisms should theoretically align the costs and charges of funded private pensions and keep them at competitive levels. However, there is a number of reasons why private pension markets may fail to work (OECD, 2018[8]). If policies to increase contribution levels and periods are successful (see next sections), pension management companies will have substantially more assets under management and there may be room to reduce fees to pass on economies of scale to participants.

The Czech authorities should carefully assess the need to increase the fee cap for the new alternative participating fund using empirical evidence. They should study the cost of investing in different asset classes to check whether the current fee caps are appropriately defined for existing and planned new funds. Pension management companies claim that they cannot invest in certain asset classes that could provide better returns but at a higher cost, as they have to cover all of their costs within the fee caps. Yet, higher returns could attract more participants and larger performance fees. The regulator and supervisor should check whether the claim from pension management companies is accurate before changing the fee regulation. This requires gathering data about the fee structures of different asset managers in the Czech Republic and in the main foreign markets to better understand the costs incurred when investing in different asset classes. This data-driven analysis would allow to form a view of whether the current caps are in line with the objective of having well-diversified portfolios to reach better risk-adjusted returns.

The Czech Republic could adopt a regressive scale for management fees as assets under management grow to share economies of scale with participants. This mechanism exist in Estonia, Latvia and Lithuania for example. In Estonia, the management fee must decline by 10% after each EUR 100 million of assets under management.24 In Latvia, the fee cap is 0.6% of assets, for assets up to EUR 300 million, and 0.4% for the part of assets above EUR 300 million. In Lithuania, maximum asset management fees are going down gradually, from 1% of assets to 0.8% in 2019, 0.65% in 2020, and 0.5% from 2021. In addition, for pension management companies managing more than EUR 2.5 billion, the maximum management fee drops to 0.4% of assets for all the funds they offer. This mechanism ensures that economies of scale are passed on to plan members.

The Czech Republic could also consider structural solutions to improve cost-effectiveness. Structural solutions entail an intervention in the structure of the market by strengthening market mechanisms or imposing new organisational structures (OECD, 2018[8]). The Czech Republic could allow non-profit providers to enter the market to increase competitive pressure. For example, Italy has non-profit private providers in its occupational pension system. The introduction of a low-cost public pension management company managing a participating fund is in line with this, as long as this public provider is supervised by the CNB and is subjected to the same regulatory and supervisory rules as private providers. However, the Fair Pension Commission discussed the possibility for such a fund to guarantee at least inflation protection. This could result in the state (and therefore taxpayers) having to fill any gap and it is questionable whether public money should be used for that purpose. In addition, the arm’s length principle should apply, meaning that the public management company should be fully independent from the government in its investment decisions.

In case the Czech Republic were to implement automatic enrolment into occupational pension plans or participating funds, a default allocation of new participants to a subset of authorised private providers could be envisaged. This is implemented in Chile, Israel and New Zealand. In Chile, the pension provider offering the lowest fee receives all new entrants in the mandatory pension system for a period of two years. In Israel, all members of the mandatory pension system can join one of the four low-cost providers selected by the Ministry of Finance and the Capital Market Authority. In New Zealand, the selection of default providers for the automatic enrolment system is based on several criteria: investment capability, corporate strength, administrative capability, track record, stability, and fee levels.

There is broad consensus among all stakeholders in the Czech Republic that contributions to supplementary pension schemes are too low to help individuals complement their state pension during retirement.

Redesigning some elements of state support could improve incentives to raise contribution levels. The current system actually encourages many participants to contribute only the minimum level of CZK 300 (Figure 4.6 and Figure 4.8). In addition, only around 12% of participants make use of tax deductions. This could be due to the lack of affordability to contribute more than CZK 1 000 a month for most participants, but could also reflect a lower attractiveness of tax incentives, as opposed to matching contributions, which are paid directly in the account of the participant. This raises the question of whether the tax deductibility of contributions between CZK 1 000-3 000 a month is effective. Finally, the state contribution is defined based on the participant’s contribution level, rather than the contribution rate. As was done in 2013, increasing the minimum level of contributions necessary to get the state contribution (for example from CZK 300 to CZK 500) would probably encourage participants who can afford it to shift their contribution up. However, policy makers could envisage a more radical change of the entire state support, according to the following points:

  • First, the Czech authorities should check whether the mix of direct contributions and tax deductions actually succeeds in encouraging different income groups to contribute. This could be achieved by running a survey to assess the attractiveness of the different components of state support among the population.

  • If the current structure of state support is kept, the state contribution could be linked to the contribution rate of the individual, rather than to the contribution level. This would reinforce the link between the contributions and the earnings that these contributions will eventually substitute at retirement. For example, the full state contribution could be paid only if the participant has contributed at least say 4% of the previous year’s earnings, with a pro-rated state contribution for lower contribution rates. This would require the Ministry of Finance to adapt its monitoring system to calculate the level of the state contribution.

  • Alternatively, the structure of state support could be changed into a simple matching contribution. A matching contribution from the first crown of contribution up to the maximum incentivised amount would eliminate the decline in relative terms of the state support with the level of contributions. For example, keeping the 20% match rate, the state could pay 20 cents for every crown contributed by the participant, up to a maximum entitlement of CZK 600. This would equalise the incentive for all contribution levels up to CZK 3 000. It would reduce the incentive for lower contribution levels and increase the incentive for higher contribution levels compared to the current situation.

  • In any case, the earnings thresholds used to define the state support and the state contribution levels should be regularly updated in line with wage growth to make sure that the incentive remains relevant over time. The potentially resulting rise in the budget cost of state support could be limited by not allowing individuals aged 60 and over (the age from which participants can start withdrawing retirement benefits) to join the system.

Automatically increasing contributions could also help people to achieve their target contribution rate gradually. Studies show that many individuals would like to increase their contributions but lack the willpower to do it (OECD, 2018[5]). Automatic increases in contributions remove the effect of inertia. For example, the Save More Tomorrow™ (“SMarT”) programme in the United States allows employees participating in occupational pension plans to commit themselves in advance to increasing their contribution rate in the future up to a pre-set maximum, with increases happening each time they receive a pay raise (Thaler and Benartzi, 2004[11]). The default mechanism avoids procrastination and the link to pay rises mitigates the perceived loss aversion of a cut in take-home pay. In the Czech Republic, this could be organised more easily in the context of occupational pension plans as employers can identify pay rises.

The government could further promote employer contributions. The tax deductibility limit for employer contributions does not need to be increased further, as it already allows employers to contribute up to around 13% of the average wage. Rather, the Czech authorities could encourage social partners to arrange contractual collective agreements stipulating terms of employer and employee contributions to a pension plan. This could be organised though occupational pension plans, or continue to be channelled through supplementary pension schemes. These agreements could be mutually beneficial. Employers would be able to attract and retain good workers while receiving a tax deduction for the contributions. Employees would receive higher income in retirement. The state would reduce people’s over reliance on the state pension for their retirement.

Finally, providing information about expected benefits from the entire pension system could encourage participants to contribute more into the complementary pension schemes. Giving easy access to simulators and calculators could help achieving this (OECD, 2018[5]). By providing forward-looking information under different scenarios, these tools allow users to assess how their retirement income would change if they change some of the parameters (e.g. the age of retirement, the contribution rate in complementary plans, the investment strategy). Moreover, by combining information about the public and private pensions, they could help people realise whether their overall target retirement income can be realistically achieved given their current saving behaviour. Such calculators and simulators are available for instance in Chile, Latvia, Mexico, the Netherlands, the United Kingdom and the United States. They are more effective when based on personalised rather than general information.

The minimum saving period to withdraw assets accumulated in retirement plans is too low. Pension products are long-term savings products and participants should contribute into them for most of their career in order to produce adequate retirement income. Unfortunately, current rules are not in line with this objective, as the minimum saving period required to be able to withdraw benefits without returning the state contributions is only five years, together with reaching age 60. This minimum saving period is even lower than for “building savings” accounts, which allow people to get favourable housing loans and require six years of participation before being able to withdraw the money for any purpose.25 As a result, many participants join the supplementary pension schemes when already close to the eligibility age of 60 and participate for the minimum period.

Increasing the minimum saving period could encourage people to contribute for longer. For example, the minimum saving period for voluntary personal pension plans equals ten years in Austria, Hungary, Japan, Luxembourg, the Slovak Republic, Spain and Turkey. In occupational pension plans, there is usually no minimum saving period, only a minimum age requirement, as participation is linked to employment.

To encourage younger people to join the complementary pension system, the Czech authorities could introduce an automatic enrolment mechanism in occupational pension plans or in participating funds. Today, participation is the lowest for people aged under 30. People tend to delay enrolment in funded pension arrangements because of procrastination and inertia. Automatic enrolment takes advantage of these behavioural traits to enrol people as early as possible. It involves signing people up automatically to a pension plan while giving them the chance to opt out with specified timeframe and conditions. The Czech authorities could draw on the experience of ten OECD countries that already permit automatic enrolment (OECD, 2019[12]). Employers could be required to enrol their employees in an occupational or personal pension plan, although other arrangements could be possible to enrol automatically the self-employed as well.26 Default contribution rates could be defined for both employees and employers, and state support would help keeping the opt-out rate low. The system should also have a default investment strategy for people not willing or not able to choose their own.

If the previous measures are implemented successfully and the level of assets accumulated at retirement becomes significant, more rules should be put in place to ensure that people actually use their retirement savings as a complementary source of income during retirement. This includes further discouraging lump sum payments and increasing the attractiveness of alternative products that provide lifelong retirement income.

Once the level of assets accumulated by participants by the time they retire reaches a certain level, the Czech authorities should more strictly curtail the take-up of full lump sums. The Czech Republic already taxes lump sums and programmed withdrawals of up to ten years, while lifelong retirement income and programmed withdrawals of more than ten years are tax free. Full lump sums should be, however, even more restricted once participants have accumulated enough at retirement, to make sure that pension savings are used to produce a complementary income during retirement. Some countries do not permit full lump sums for members with accumulated assets above a certain level. For example, in Lithuania, the full lump-sum option is restricted to individuals who have accumulated less than EUR 3 000. Some countries recognise that members may value the possibility to get a lump sum to address specific needs when they retire, for example to reimburse a housing loan. In the United Kingdom for instance, individuals can have a tax-free lump sum up to 25% of the total value of assets accumulated when they take a pension or annuity. Another way to discourage lump sums would be to require pension management companies to return the state contributions in case the participant chooses a full lump sum option, as it is already done when participants leave the scheme before being entitled to a retirement benefit. For example, Austria takes back 50% of the state subsidies when the member chooses a lump sum. In Chile, the matching contribution for individuals making voluntary contributions is lost if the member withdraws the funds instead of using them to finance a retirement income.

To encourage participants to select lifelong retirement income products and protect themselves from longevity risk, the Czech authorities could consider allowing life insurance companies to offer different types of annuity products. For example, life insurance companies could advertise the possibility to combine a lifelong pension with a guaranteed period and a survivor pension option. A guaranteed period ensures that, even if the participant dies early, payments will continue during the agreed period to the beneficiary. A survivor option to protect the beneficiary over his or her remaining lifetime may also reassure participants that they are getting value for money from their annuity product. However, the higher cost of these options will reduce the income people would get in retirement. In addition, some annuity products allow insurance companies to share profits with individuals, who can therefore get bonuses on top of the guaranteed payments in well performing years. OECD (2016[6]) provides an overview of annuity products and the guarantees they provide in order to optimise the role that these products can play in financing retirement.

Finally, the Czech authorities should establish clear rules to build appropriate mortality tables including future improvements in mortality and life expectancy, and check that providers of retirement income products apply these rules properly. As lifelong retirement income products and annuities become more widespread, the Czech authorities should strengthen the supervision of pension management companies and insurance companies regarding the mortality tables used for reserving. Today, there is no minimum requirement for mortality tables. As discussed in OECD (2014[7]), the regulatory framework should ensure that pension management companies and insurance companies use appropriate mortality tables. In particular, mortality tables should include expected future improvements in mortality; be regularly updated to accurately reflect the most recent experience; and be based on the mortality experience of the relevant population.


[1] Han, T. and D. Stanko (2018), “2018 Update on IOPS work on fees and charges”, IOPS Working Papers on Effective Pensions Supervision 32.

[10] OECD (2019), Annual Survey of Investment Regulation of Pension Funds, http://www.oecd.org/daf/fin/private-pensions/2019-Survey-Investment-Regulation-Pension-Funds.pdf.

[14] OECD (2019), Pension Markets in Focus, http://www.oecd.org/daf/fin/private-pensions/Pension-Markets-in-Focus-2019.pdf.

[12] OECD (2019), “The role of automatic enrolment schemes in enhancing funded pension systems’ inclusiveness and retirement income adequacy”, in Inclusiveness and Finance, https://www.oecd.org/finance/Financial-markets-insurance-pensions-inclusiveness-and-finance.pdf.

[4] OECD (2018), Financial Incentives and Retirement Savings, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264306929-en.

[5] OECD (2018), “Improving retirement incomes considering behavioural biases and limited financial knowledge”, in OECD Pensions Outlook 2018, OECD Publishing, Paris, https://dx.doi.org/10.1787/pens_outlook-2018-8-en.

[8] OECD (2018), “Pension costs in the accumulation phase: Policy options to improve outcomes in funded private pensions”, in OECD Pensions Outlook 2018, OECD Publishing, Paris, https://dx.doi.org/10.1787/pens_outlook-2018-6-en.

[6] OECD (2016), Life Annuity Products and Their Guarantees, OECD Publishing, Paris, https://doi.org/10.1787/9789264265318-en.

[3] OECD (2016), OECD Core Principles of Private Pension Regulation, https://www.oecd.org/daf/fin/private-pensions/Core-Principles-Private-Pension-Regulation.pdf.

[13] OECD (2016), OECD/INFE International survey of adult financial literacy competencies, http://www.oecd.org/finance/OECD-INFE-International-Survey-of-Adult-Financial-Literacy-Competencies.pdf.

[7] OECD (2014), Mortality Assumptions and Longevity Risk: Implications for pension funds and annuity providers, OECD Publishing, Paris, https://doi.org/10.1787/9789264222748-en.

[9] OECD (2012), “A Policy Roadmap for Defined Contribution Pensions”, in OECD Pensions Outlook 2012, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264169401-9-en.

[2] OECD (2012), “The Role of Guarantees in Retirement Savings Plans”, in OECD Pensions Outlook 2012, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264169401-8-en.

[11] Thaler, R. and S. Benartzi (2004), “Save More Tomorrow: Using Behavioural Economics to Increase Employee Saving”, Journal of Political Economy, Vol. 112/1.


← 1. A pension fund could distribute its profit as follows: minimum 5% into a reserve fund, maximum 10% distributed to shareholders, and the rest used for the benefit of the participants.

← 2. The pension management company would have had to contribute with its own capital to keep registered capital at least at the minimum level.

← 3. For the unemployed or economically inactive persons, the six-month period started from the time when they became contributors to the pension insurance system following the launch of the reform.

← 4. Source: OECD Global Pension Statistics.

← 5. Source: Fair Pension Commission, Introduction to the third pillar, 24 May 2019. EU-SILC data.

← 6. It is not possible to withdraw a lump sum before the age of 60. Early withdrawal is possible as an annuity or programmed withdrawal up to five years before the official retirement age.

← 7. Source: ECB, http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=165.YC.B.U2.EUR.4F.G_N_A.SV_C_YM.SR_10Y

← 8. Source: OECD (2019), Pension Markets in Focus. Simple average of assets as a percentage of GDP for OECD countries with only voluntary funded pension systems, including the Czech Republic.

← 9. The large allocation to cash and deposits stems from the fact that, recently, bank deposits have provided a better return than government bonds.

← 10. In Han and Stanko (2018[1]), the Czech Republic should actually be classified in cluster A, the group of countries with the most comprehensive fees and charges.

← 11. If a pension management company has entered the market less than a year ago, it shall use 25% of the value of depreciation costs of tangible and intangible assets and administrative costs stated in the business plan for the calculation.

← 12. There is currently a limit of 35% to the proportion of bonds valued at maturity. This limit will disappear following the application of the IFRS 9 accounting standard, which allows each company to decide which asset to held to maturity and value it accordingly.

← 13. The calculations rely on a stochastic financial market model using 10 000 Monte-Carlo simulations of different asset returns and inflation. This model assumes that a representative individual contributes 10% of wages each year during 40 years and invests in a life-cycle investment strategy with an initial equity exposure of 80%.

← 14. The service pension is a separated contract. The funds for determining the level of benefits under the service pension have to be kept separately and the contributions for this contract shall not exceed contributions intended for retirement pension.

← 15. A pre-retirement pension is also compatible with people working, or receiving unemployment or sickness benefits.

← 16. In 2020, the pension eligibility age is 63.5 years for men, gradually rising by two months per birth cohort until reaching age 65. For women without children, it is 63 years and two months, gradually rising by six months per birth cohort until equalising the retirement age for men and then evolving at the same pace until age 65. Women with children can retire up to four years earlier depending on the number of children raised. In assessing women’s entitlement for a pre-retirement pension, however, they are assumed to have the same pension eligibility age as men born the same year, regardless of the number of children.

← 17. In 2019, this meant that at least CZK 224 820 had to be saved in the supplementary pension savings system in order to be able to receive a pre-retirement pension for the minimum period of two years.

← 18. The pre-retirement period is not considered as insured unless the recipient engages in gainful activity.

← 19. Similarly, insurance companies are not interested to offer annuity products.

← 20. A thorough study of Czech pension management companies’ compliance with the OECD Core Principles could be conducted in the next stage of this project.

← 21. An HHI below 0.01 indicates a highly competitive industry; an HHI below 0.15 indicates an un-concentrated industry; an HHI between 0.15 and 0.25 indicates moderate concentration; and an HHI above 0.25 indicates high concentration.

← 22. https://www.mfcr.cz/en/themes/capital-market/capital-market-in-the-czech-republic/initiation-of-an-inter-ministerial-comme-38422.

← 23. The automatic transfer to participating funds may be legally challenging to implement, as changes cannot be applied retroactively to already established contracts in the Czech Republic.

← 24. For example, if a management company charges 1% of assets and manages EUR 220 million, the actual fee will be 1% on the first EUR 100 million, 0.9% on the second EUR 100 million and 0.81% on the last EUR 20 million, thus an overall fee rate of 0.937% (=(100×1%+100×0.9%+20×0.81%)/220).

← 25. Building savings accounts allow people to save at a higher interest rate than in current accounts and to obtain a favourable loan to buy, build or reconstruct a property after two years of participation. The state contributes up to CZK 2 000 per year if the individual contributes at least CZK 20 000 in the previous year.

← 26. For example, in Lithuania, the State Social Insurance Fund Board enrols all types of workers.

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