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Pension reform in the Czech Republic

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pavel jirak

Pension reform in the Czech Republic. The responsibility for the standard of living in the retirement age is being passed from the state onto the citizens.

Pavel Jirák Chairman of the Board of Directors and CEO of the Penzijní fond Komerční banky (PF KB) which won the 2012 Czech Pension Fund Award provides some details about the situation of the reform.

pavel jirak

The Czech Republic’s crucial problem stems from the relatively unique combination of a rapidly aging population and the fact that the state provides for virtually 100% of pensions. This system is unsustainable in the long run and is unfavorable to all of the country’s population under 40 men and women alike. Unless we commence a reform our pension system would collapse in a short time. The state would have to consume increasing parts of the country’s GDP to fund pensions and would gradually find itself in the middle of a severe intergenerational conflict. The main aim of the reform is to make the population use multiple diverse sources for their pensions and stop relying on a single source, i.e. the state.

The Czech Republic’s state pensions are on average equal to approximately one half of the money earned whereas pensions in Austria, Denmark or Hungary reach three quarters.

The average salary in the Czech Republic reached approximately €973 before taxation, or €760 after taxation at the end of last year. Roughly one third of the population reached the average wage. The average pension reached €422. Men received on average €468 and women €383. Unlike pensioners in other countries an overwhelming majority of Czech pensioners rely solely on the state pension.
graphgbfr

The chart shows that regarding the relation between pension and salary Iceland and Greece whose population enjoy nearly 97% of the average earnings are at the top. However Greece found itself on the brink of bankruptcy and has to make drastic cuts that will affect the standard of living. Italy and other countries have also come up with strict saving measures.

On the other hand Great Britain has the lowest average state pension in relation to average earnings. Most of the pensioners’ income is provided by its optional part – the state pensions by the pay and many different insurance schemes. In this way the basic pension which is determined according to prices and which is equal to roughly €512 per individual rises to the average of some €1,241 per month.

2012 and Czech pension reforms

“The small pension reform” that came into effect on 1 October 2011 contains a significant change of the retirement age. People born after 1965 will be allowed to retire after they reach the age of 65. The pace at which the retirement age increases will also accelerate to six months per year in the case of women and two months per year with men.

“The grand pension reform” is different from the small one in that it will allow people to take some of the money from the current pension system to newly formed pension companies and save money in private pension funds. The Czech Republic’s pension system will newly feature 3 pillars. The key changes will become effective on 1 January 2013. The PF KB has been preparing for the reform for several months.

All nine domestic pension funds view the reform as a challenge and most are planning to participate in pillars II and III of the new pension system: i.e. to set up pension companies and to transform existing funds.

We have already contacted the Czech National Bank with our request for a licence enabling the PF KB to operate in both pillars of the pension system as well as an application for permission to provide supplementary pension insurance through our transformed fund, stated Pavel Jirák. We have detailed each step required to carry on the necessary changes in pension funds as well as the commercial offer for participants who newly enter the system.

The pension savings system will newly consist of three pillars. What will become of the existing pension funds and how do they fit into the new system?

The existing state pension system is the pillar I; the pillar II includes the newly formed  pension saving in pension companies while the pillar III represents additional pension insurance with state contribution created by transforming the existing one.

The pillar II of the pension system will have the form of opt-out. By entering the pillar II participants grant their consent to transfer three per cent of the existing social insurance payment from the pillar I to a pension company on condition that they also add two per cent of their gross salary. It means that the employer will remit five per cent to pension companies on behalf of the employee. The pension company will invest these resources in order to create another source which will be used for funding a lifelong pension or twenty years’ pension after the employee retires. The decision to enter the pillar II will be optional and will be suitable especially for young people whose earnings exceed the average. People over 35 years of age have to make this decision within the first 6 months of 2013. Entering the pillar II will mainly favour self-employed persons and entrepreneurs, who will be allowed to remit nearly half of their pension insurance to private accounts. Self-employed persons remit 6.5 per cent of their income to pension insurance now.

The participants of the pillar III will enjoy an increase of the state’s allowance while the tax deductions and the possibility to claim a contribution from the employer will remain as they are now. Other benefits such as one-off payment when one reaches the retirement age will also remain in place. This is why I consider the pillar III to be one of the most attractive financial products on the market.

The transformation will especially mean a separation of the participants’ property from the shareholders’ property and hence more transparent management also. The PF KB will become a pension company which will manage 4 funds for the pillar II and 5 funds for the pillar III. The funds will differ in the height of the risk. The riskier the investment the higher the expected profit but also the higher volatility or the less certainty of the fund’s profitability in the given year. As the participants’ retirement approaches the savings are automatically transferred to less risky and finally to safe funds. The reform will bring several advantages to current participants in pension funds as well as to those who will enter the system by the end of November this year. The transformed funds will retain their current guarantee of non-negative profit each year. At the same time they will be allowed to decide to opt for the new funds of the pillar III at any time.

What makes the PF KB attractive for clients?
PF KB informed the public about the pension reform openly and its parameters in the course of last year and continues in this effort. I dare say that all our participants have been offered a chance to become familiar with the reform if they wished to do so. We have also published a number of articles and interviews for the country’s broader public; we provide information on special phone lines and at the offices of subsidiaries comprising the Komerční banka Group. Our website (www.pfkb.cz) contains a special section dealing with the pension reform with some practical sample questions and answers. Our intensive information campaign will continue this year so information about the pension reform can reach each responsible citizen who does not wish to make light of their provisions for retirement. We believe that the fact that there is sufficient information and maximum openness on our part is our existing and future participants’ crucial advantage. Other benefits include advantageous offers of recreational and spa stays in the Czech Republic for our clients. I should not forget to mention the foreign awards that we have won. In addition to the prize awarded by the GBAF, the World Finance magazine announced the PF KB the “Best pension fund of the year in the Czech Republic” also. We´ve got both these prizes for the second year in a row, says Pavel Jirák happily. Repeated awards from expert juries prove that the PF KB is the right partner for entering the system of additional pension savings.

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The benefits of automated pension plans

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The benefits of automated pension plans 1

While many people will prefer to speak to fellow human beings when discussing their investments, automation is already part of everyday life. Over the last few years we have seen introduction of robo-advisors, with many pension investment companies placing these new platforms front and centre of their future strategies. So, what are the benefits of automated pension plans and robo-advisors?

No-nonsense information gathering

KYC, or Know Your Client, is an integral part of the investment world. The wider your knowledge base on a particular client the more personalised the service you can offer. Failure to gather the correct information, and use it accordingly, is a breach of investment regulations in many countries. Therefore, the use of robo-advisors allows a no-nonsense and clear approach to information gathering.

These systems use an algorithm to choose the most appropriate investment strategy for your pension fund. The algorithm is based upon issues such as:-

  • Your attitude to risk
  • Your investment term
  • Your current investment goals

It is worth noting the variable “your current investment goals”. Due to the way that the system is set up, you can update your investment goals on a regular basis. This means that your portfolio would be automatically adapted to your new goals.

As pension-fund regulations continue to be tightened, information gathering is becoming even more important. This initial data gathering exercise will also incorporate a degree of guidance and thought provoking comments. For example, this could highlight the risk/return ratio and the suitability for pension fund investment. The concept of the robo-advisors platform is simple; participants have time to think about the consequences of their attitude to risk for example. The majority of platforms use a concept known as modern portfolio theory.

Source: Unsplash

What is modern portfolio theory?

As a sidenote, you will find that many robo-advisor platforms will mention the concept of modern portfolio theory. This is a Nobel Prize winning economic theory based on the use of data points to create a personalised portfolio of investments. Modern portfolio theory presumes that the majority of investors are risk averse. This means that those looking to take additional risk will expect additional rewards. As a consequence, their pension-fund portfolio would need to reflect this.

Using ETFs to create a personalised portfolio

Automated pension investment platforms (also known as robo investing) tend to use Exchange Traded Funds (ETFs) to create personalised investment portfolios. ETFs have been around for many years and they are an integral part of the investment scene. There are numerous benefits to using ETFs such as:-

Focus on a particular market/type of investment

ETFs are basically funds which are structured to mirror the make-up of a particular market, sector or type of investment such as a commodity or index. For example, the S&P/TSX Composite Index is recognised as the benchmark Canadian index. As a consequence, for those pension fund investors looking at a balanced risk/return, an ETF mirroring this index would be ideal for their portfolio. The funds are created by replicating components/weightings of a particular index with some ETFs also using futures and options

Continuous adjustments

Just as indices are rebalanced from time to time, it is important that your pension fund investments undertake the same process. Say for example the robo-advisor system created a personalised portfolio consisting of two index ETFs. If one index was to perform much better than the other, at some point this would need to be reweighted. The strategy behind this is simple; if the balance of your portfolio was tilted towards one particular ETF index then your future performance would also be tilted towards that index. This could lead to increased volatility and impact the balanced approach to investment.

Price visibility and trading

While many people view ETFs and mutual index tracking funds as one and the same, there are a number of differences. The main difference is liquidity, with ETFs constantly traded throughout the day and mutual fund prices set at the end of each trading day. As a consequence, robo-advisors can react to intra-day news flow, while those holding mutual funds will need to wait until the daily price has been set. You’ll often find that transaction costs associated with ETFs can be significantly less than mutual funds.

Risk profile criteria set by human experts

While the majority of the processes associated with automated pension plans have little or no human input, there is significant input with regard to risk profiles. This means that investment experts will allocate particular ETFs, and other exchange traded instruments such as futures, to various risk/reward profiles. When we talk of risk/reward in the context of pension investments, this does not indicate extreme risk – this isn’t advisable for long-term pension investments. Indeed, those pension advisors allocating funds to ETFs offering extreme risk/reward ratios may find themselves answering questions from the regulators.

In the modern era, there is nothing to stop the process of opening a pension fund, right through to management of investments, from being fully automated. Whether we move closer to this alignment in the future remains to be seen. However, in the meantime the vast majority of investors prefer an element of human expert involvement, even if just to oversee any potential discrepancies.

Low-costs improve long-term returns

The cost of any service or product comes down to the components. Traditional active pension fund investment will involve an array of different people with different skill sets. The combined cost of these teams can be significant and is reflected in the fund’s management and ongoing charges. Therefore, the more elements of the system which can be automated the lower the management fees and ongoing charges. When you also consider that many robo-advisors will use ETFs, which simply track various assets or indices, the cost element is yet another competitive edge.

While there is certainly a place for active investment management, using expert investment advisors, very often automated pension plans will complement this alternative approach. Many people now choose to maintain a core element of their pension fund under a robo-advisor platform, as their pension-fund backbone. Allocating an element to a more active investment approach offers the opportunity to enhance returns, although there is an obvious element of risk.

Source: Unsplash

Easy-to-use investment platforms

The subject of pension investment can be complicated at the best of times. Therefore, the introduction of robo-advisor platforms, offering regulatory updates and guidance, has been extremely useful for many people. A growing number of people seem to prefer this plain talking approach to pension fund investment. You could argue that this removes any potential conflict-of-interest, the volatility of human nature making way for cold hard facts. Obviously, there will be advice and guidance available, as and when required, but this would likely come at an additional cost.

It is worth noting that before any robo-advisors platform is released to the market it will undergo stringent testing. This testing will take in both in-person testing and remote user testing which is unmoderated. As a consequence, those creating these platforms can help and assist those testing the systems in person. On the flipside, remote user testing is akin to releasing the platform into the mass market. These users are guided by the instructions and design of the platforms, giving invaluable feedback on any tweaks and changes required.

Removing human emotion

The removal of human emotion from investment decisions can be considered something of a double-edged sword. However, robo-advisors provide a no nonsense approach to pension fund investment. A relatively swift in-depth questionnaire will gather all of the information required, allowing algorithms to calculate the appropriate risk/reward ratio. The use of EFTs takes away day-to-day management of investments, in favour of index tracking funds. Auto rebalancing and opportunities to adjust your risk/reward ratio going forward creates a very flexible environment.

Those looking for a passive investment strategy will be attracted to robo-advisors. Those looking for a more active approach still have plenty of choice in the wider market. Then there are those looking for a mix of the two. In recent years we have seen huge advances in artificial intelligence, which already play a role in wider investment trading strategies. Will this technology become more commonplace in the future?

Summary

Robo-advisors have been around, in some shape or form, for some time. In many ways they do the time-consuming legwork that human advisors did in the past. This allows pension advice companies to focus their funding on areas where they can enhance their business. There is a general misconception that robo-advisors have total control over pension fund investments. This is wrong. There are human advisors and investment experts in the background tweaking the system, allocating EFTs to specific risk profiles and constantly enhancing their offering. 

While the current raft of robo-advisors make little or no use of artificial intelligence, the ability to learn, this must surely be an aspiration for the future. This is an area of the market which is constantly developing and changing. We already accept artificial intelligence in many areas of our life, so why not the world of investment? Would you trust an advisor who was able to learn from human mistakes?

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The Viral Return On Investment

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The Viral Return On Investment 2

By Sabine Saadeh Author of Trading Love

Investment Pitch

It was around August 2018 when a friend of mine approached me with an investment scheme that was remarkably enticing.  At first I hesitated because going into business with close friends is never a good idea for me, let alone have your money pooled into an investment fund. The business model was exceptionally thought through and I knew for a fact that it will generate value. Nonetheless, I declined the investment offer. A year later, the fund was generating income long before it had planned to, and I thought I had missed out. The return on investment from that fund in relation to the cost of the investment was outstanding.

A year later, I watched from afar as my friends began to squeeze each other out given their greedy excitement after the success of their fund. As more time went by, I watched them make the biggest mistake of their lives, and that was letting go of the creative element in that fund. Return on investment is the value created by the said investment that is closely tied to economic, financial, psychological and societal factors. However, creativity is their cornerstone.

Covid-19

Come 2020 and Covid-19 reshuffled the classic value mantras. The whole world experienced complete disruption. The path of the virus and the length of time the global economy will remain shuttered is still very much unknown. So what does this mean? This means that investment value will change. The risk of the investment does not have to do anymore with the amount of capital available for resiliency but with the amount of creativity available in the business.

Sabine Saadeh

The viral return on investment should change people’s economic narrative. Businesses should focus on liquidity, contingency plans, multiple supply chains and CREATIVITY. After all a business’ local resilience will be highly priced in the value of the investment rather than what the market views as efficient. Taking my friends’ fund as an example, if they had retained their creative element, their business would have proved to be resilient, despite the high debt incurred by the fund to continue operating during lockdown. This high debt increased the risk of their business collapsing and in turn weighed in on their capacity for growth.

The Investor

After all, an investor is looking for an investment that will preserve his/her purchasing power without undermining their wealth. If I had invested in that fund, I would have lost the capital invested and spent the income generated during the lockdown period. So what was the point of the capital without the talent in that fund? Covid-19 is not the only threat; climate change is even a bigger threat. It is therefore imperative for us to respect and nourish interdependence, and especially in business environments.

Sabine Saadeh

Sabine Saadeh

We cannot act like the virus anymore, latch on to a person with creativity and sup them dry just because we invested in them. We need the creative more than the creative needs us, it is their talent that is going to generate income for us. Our capital opens the path for the creative to generate income for us. The smart people of the world already set their bets on that, through ESG investment schemes, which is the most sustainable form of investing. ESG which means environmental, social and governance investing; seeks positive return on investment while taking into consideration the long-term impact of the said investment on society, environment and the performance of the business.

ESG

The year 2020, is when the world went up in flames and ESG established itself as the mainstream way for investors to make profits. Although the investment preference had already began to change over the last five years, the inflow was still very mediocre in ESG.

It was after the wildfires and the social issues erupting everywhere in the world and the corruption stories of the businesses that are too big to fail, that it became a no brainer that the inflow in ESG would increase massively. Then The DWS Group’s ESG funds according to CNBC began to outpace the S&P 500 this year, and Blackrock highlighted ESG as the most sustainable form of investing.

Businesses that are taking into consideration empathy and creativity while operating are better equipped for future sustainability, even though they are sacrificing return on investment in this present time.

What are we waiting for then? If Covid-19 didn’t help us see clearly that we all intertwined in nature for our future’s sustainability, then what will?

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European market responds to second wave of infections

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European market responds to second wave of infections 3

By Rupert Thompson, Chief Investment Officer at Kingswood

Global equities ended last week on a negative note and were down around 4.5% from their all-time high in early September. This morning, European markets have fallen back a further 3%.

The initial catalyst for the correction was a sharp run-up in the mega cap tech names which had left them looking extended and ripe for some profit taking. The FAANGs are now down over 10% from their highs and the froth looks like it has been blown off. While they may well remain volatile, there is no obvious reason for them to be at the forefront of any further sell-off. The fundamentals behind the tech sector remain strong and valuations are once again looking more reasonable.

However, the correction also clearly had its roots in the sheer scale of the rebound from March with global equities up some 50% from their low. This inevitably left markets vulnerable to a set-back, particularly with valuations at twenty-year highs.

The rebound in turn was in good part a result of the massive policy stimulus. The weakness late last week was triggered by disappointment that the US Fed had not extended its QE program. Even so, the Fed is still buying $120bn of bonds a month and remains a major support for equities. Indeed, it made it clear that it has no intention of raising rates for at least another three years.

The Bank of England also decided to leave policy unchanged last week. However, it kept open the possibility of cutting rates into negative territory next year if it should be necessary. An extension of its QE program later this year also remains quite possible.

All the same, the fact of the matter is that central banks have now spent most of their ammunition. Going forward, changes to fiscal policy will be much more important than any tweaks to monetary policy in shaping the economic recovery. And on this front, the news is not particularly encouraging as the markets may now be appreciating.

The US has failed to agree on an extension of the fiscal stimulus measures which expired in July and may now not be able to before the November elections. As for the UK, Rishi Sunak is still resisting calls to extend the furlough scheme beyond October.

Just as important for markets will of course be Covid-related developments. This morning’s declines are a response to the second wave of infections now being seen in the UK and across much of Europe and fears that renewed social distancing measures/localised lockdowns could disrupt the economic recovery.

While the latest wave of infections is clearly a major cause for concern near term, it shouldn’t be forgotten that the longer term outlook regarding Covid is not all bad. Several late stage vaccine trials are now underway and a vaccine could quite possibly become available within a few months.  Some countries, most notably China, also seem to have avoided a major secondary spike despite the reopening of their economies.

In short, the outlook remains quite uncertain. We believe it remains prudent at this juncture to maintain a broadly neutral stance on equities until some of these unknowns are cleared up – one way or another.

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