1. Presenter: Dariusz Stańko Ministry of Labour and Social Policy
POLISH PENSION REFORM
Presenter: Dariusz Stańko
Ministry of Labour and Social Policy

2. Strengthening the link between contributions and benefits: Polish NDC (first) pillar

3. Why NDC in Poland ? High pension expenditure due to:
Relatively generous pension formula
on average 80% replacemet rate
little link between earnings history and pension level
Early retirement
wide-spread early retirement privileges
average retirement age: 55 for women, 59 for men
virtually no incentives to postpone retirement
Public preferences:
pension should be linked to paid contributions
Long-term outlook:
population ageing, thus need to prolong working lives and increase retirement age

4. New system Architecture
NDC
PAYG
mandatory, administered by the
public institution, individual accounts
First Tier
Open
Pension
Funds
Funded
mandatory, administered by private
institutions, individual accounts
Second Tier
Savings and
additional insurance
Funded
voluntary, administered privately, individual accounts
Third Tier
Mandatory Social Security System

5. Design of the new pension system in Poland (1)
New Polish pension system is:
defined contribution
with two accounts: non-financial and financial
The old-age contribution was divided into:
NDC % of wage
FDC 7.3% of wage
Rates of return:
In the NDC are linked to the wage fund growth
In the FDC depend on the financial market returns
Persons below 30 (in 1999) have both NDC and FDC accounts
Persons aged 30 to 50 had a choice of one (NDC) or two (NDC+FDC) accounts
53% of them chose to have two accounts
Persons over 50 years of age stay in the old system
Source: Polish Chamber of Pension Funds

6. Design of the new pension system in Poland:
Close link between contributions and pensions:
Shorter working lives
Lower wages
Result in lower pension savings
Promotes:
Longer working lives
Higher earnings 6

7. First Tier NDC Pensions
Employment
Self-employment
Notional Capital
Unemployment
Maternity and child-care
Pension
Army service =
Average Life Expectancy at the retirement age
unisex life tables

8. First Tier Initial Capital
For people who were working before the introduction of reform, an initial capital is calculated according to the following rule:
Initial
Capital (NDC)
Hypothetical
old-age pension calculated according to the old system rules as of December 31, 1998
Average Life Expectancy
Unisex at age 62
(209 months) = *

9. First Tier Demographic Reserve Fund
Created in Year 2009 – an extension?
Funded part of the public tier (currently 0,4% of NDC pension contributions)
Accumulates surplus in order to finance upcoming deficit
Allows to adjust to demographic fluctuations
Reduces dependency on the state budget
Since recently – equity part; passive investment

10. FRD (Demographic Reserve Fund): Investment limits
Asset class
Restriction
Securities issued by the state treasury (government bonds)
Max. 100%
Securities issued by the City of Warsaw or other local administration communities (municipal bonds)
Max. 20%
Debt securities guaranteed by the state treasury
Max. 80%
Public listed equity1
Max. 30%
Secured listed bonds1
Bonds issued by public companies1
Max. 5%
Note: 1 Combined maximum of 40%.
Source: Ordinance of the Minister of Economy, Labour and Social Policy concerning the investment of DRF resources (January 24th 2003).

11. Asset allocation of FRD
Year
Stocks
Bonds
Treasury Bills
Deposits
Dec 04
2,1%
97,9%
0,0%
Dec 05
20,1%
79,8%
0,1%
Sep 06
28,8%
58,7%
5,7%
6,8%

12. FRD: Investment strategy
Passive investment for stock portfolio
Replication of WIG, monthly purchases
low investment costs (0,06% of average assets)
reduction of systematic risk
List of stocks kept changing each month:
weights of companies in WIG index are variable,
structure of WIG subject to periodic modifications,
turnover for some companies comprising first 30 companies with the biggest shares in WIG were not sufficient for investing in them resources of FRD.

13. Performance of FRD 1 Jan 2005 – 30 Sep 2006, stock portfolio
Source: ZUS.

14. Performance of FRD 1 Jan 2005 – 30 Sep 2006, bond portfolio
Source: ZUS.

15. Treatment of special privileges for certain occupations

16. Earlier retirement (I) Only in the old pension system (but miners are exception):
Jobs with unhealthy or special conditions or requiring special abilities. Applicable to workers born before 1 Jan 1949 and workers who fulfil those conditions before the end 2008: - 55 yrs old – 30 contributory and non-contributory years 55 yrs old – 20 years of contributions and unfit to work - 60 yrs old – 25 years of contributions and unfit to work Also, those born before 1 Jan 1949 can retire earlier – before 60 years old (women) and 65 (men) if their rights come from separate regulations: war disabled, war heroes, civil workers, forced mine workers during the II WW, disabled due to work accidents, working in special conditions etc.

17. Earlier retirement (II) Only in the old pension system (but miners are exception):
Early retirement despite of age:
teachers born before 1 Jan 1949 with 30 yrs work experience, 20 years must be in special conditions etc.
railway workers (f55, m60)
parliament and upper house members, who till the end of 31 Dec 1997 had met conditions for earlier retirement, i.e. 30 years’ contribution period for women and 40 – for men,
Carers of children with special needs

18. Early retirement and labour market outcomes80
200
400
600
800
1000
1200
1400
1600
1800
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
w tys. osób 20 22 24 26 28 30 32 34 36
w proc.
Pre-retirement benefits
Pre-retirement allowances
Pensions below retirement age
Employment rate 55-64 70 60 50 40 30 20 10
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Employmetr rate (15-24)
Inactivity rate(55-64)
Increase in early retirement provision is accompanied with drop in employment rate of older workers
Rising inactivity rate of people 55+ does not correspond to rising employment of younger workers

19. Separation of social assistance from social insurance

20. Minimum pension guarantee
Topping up pensions to the level defined by the law:
Due to the indexation mechanism, relation between minimum pension and average wage is likely to fall
Since it adds to joined benefits from the first and the second pillar, possible solutions in the funded pillar affect the probability and value of potential payout (option): - minimal required rate of return - investment limits - payout options (programmed withdrawal) etc...

21. Minimal benefits from social insurance as of 1 March 2006
Requirements:
m : 65 yrs old and 25 years of contributory and non-contributory periods
f: 60 yrs old and 20 years of contributory and non-contributory periods
Current value of benefits (from March 2008):
minimal pension, minimal total disability pension, minimal survivor pension 636,29 PLN
minimal partial disability pension 459,57 PLN
Exchange rates: 1 PLN = approx. 2,4 USD; approx. 3,6 euro

22. Impact of reforms on labor costs

23. New system Contributions
Contribution is paid by employee and employer:
old-age: 50% employee, 50% employer
disability: 50% employee, 50% employer
sickness: 100% employee
work injury: 100% employer (0,67% - 3,6% according to risk level)

24. Pension system Projections for the future - no reform
Pension expenditure would increase:
from 11% of GDP in 2000
to 17.3% in 2050
By the same time, the number of pensioners would double
from 7 million in 2000 to almost 15 million in 2050, of which:
more than 10 million old-age pensioners
Total pension deficit would exceed 7% of GDP
Based on Social Budget Model, the Gdansk Institute for Market Economics

25. Population structure in Poland
2002
2030
100+
Kobiety
100+ 90 90
Mężczyźni
Mężczyźni
Kobiety 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10
400
300
200
100
100
200
300
400
400
300
200
100
100
200
300
400
Source: GUS
ths
ths

26. Types of financial consequences of pension reform
Long-term:
reduction of long-term pension system liabilities (implicit debt)
Short and medium-term:
increase or decrease in the public finance deficit due to pension related expenditures (explicit debt)

27. Transition costs In multi-pillar pension systems
a part or the entire contribution is transferred to pension funds
current pension payments require financing
a transition deficit occurs
Options to finance the deficit:
current revenue from tax or other sources
for example privatisation in Poland
pension savings or public expenditure savings
changes in pension formula
changes in retirement age
changes in pension indexation
future revenues - increased explicit debt
Examples:
Poland: 1.6% of GDP
Hungary: 0.6% of GDP

28. Misunderstandings regarding reform costs
Transfer of a portion of contribution to funded pension scheme is not a cost (but strains on liquidity)
it reveals a portion of the implicit debt and
it reduces future public finance obligations
Increased funding requirements can be offset by higher debt, purchased by pension funds
Pension funds assets invested into equities stimulate investment and economic growth
It is better to turn a portion of pension liabilities into savings now than to have much greater problems with redeeming such obligations in the future

29. On macroeconomic level....
Pension expenditure
State budget subsidies
Pension expenditure exceeding 10% of GDP
Unbalanced pension system requiring state budget subsidies
Between the overall level of subsidies increased mailny due to inbalances in the pension system – transition costs accounted for less than a half of total subsidy

30. Long-term projections
Main ways of expenditure reduction:
increase in retirement age
actuarially balanced pension benefits
Rate of return on NDC accounts equal to the wage bill growth
Takes into account both changes in wage level and number of covered workers
Benefit indexation – below wage growth level
several amendments up to date, but
revenues grow faster than expenditures 0% 2% 4% 6% 8%
10%
12%
14%
16%
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
% GDP
PAYG (old system and NDC)
Farmers pensions
Uniformed forces
FDC
Pre-retirement benefits

31. Pension expenditure (% of GDP)
Changes in the PAYG systems
Pension expenditure (% of GDP)
Level in
Change from 2004
2004
2030
2050 EE
6.7
-1.9
-2.5 HU
10.4
3.1 LT
1.2
1.8 LV
6.8
-1.2 PL
13.9
-4.7
-5.9 SK
7.2
0.5 SI
11.0
3.4
7.3
EU25
10.6
1.3
2.2
EU15
1.5
2.3
EU12
11.5
1.6
2.6
EU10
10.9
-1.0
0.3
EU9
(EU10-PL)
8.8
4.8
Change in pension expenditure level is not correlated with multi-pillar system implementation
Design of the PAYG system matters more in that respect

32. Impact on adequacy? Value of individual accounts – ZUS and OFE
Compared to the value of contributions paid:
Value of pension accounts in OFE are much higher than in ZUS
Relatively low wage growth
Good returns on financial markets
If the current developments are continued, expected pensions could be higher
Value of individual accounts – ZUS and OFE

33. Future pension level Source: OECD, Pensions at a Glance, 2005 Spain
100 90 80 70 60 50 40 30 20 10
Spain
Austria
Ireland
Denmark
Belgium
Germany
Norway
France
Poland
Italy
Hungary
Switzerland
Sweden
Netherlands
Greece
United States
Czech Rep.
/Slovak Rep.
Finland
Portugal
Luxembourg
United Kingdom
Source: OECD, Pensions at a Glance, 2005

34. Summary
Transition costs in Poland include most importantly the coverage of increased deficit in PAYG scheme:
pensions are paid according to the old system rules
part of contributions is invested by pension funds
level of transition financing: 1.5 per cent of GDP
The adequacy of future benefits does not depend on the financing, rather on the type of pension system (DB vs DC)

35. Introduction of the second pillar and readiness conditions

36. Pension funds in Poland
Source: Own calculations based on data from KNF.

37. Size of the Polish mandatory pension savings industry (Nov 2007)
Source: KNF ( ) and own calculations based on the former.
Note: Exchange rate of National Bank of Poland as of 30 Nov 2007: 1 USD = PLN 2,4589, 1 euro = 3,6267 PLN

38. Members and average premiums as of end of November 2007
Source: KNF ( and own calculations based on the former.
Note: Exchange rate of National Bank of Poland as of 30 Nov 2007: 1 USD = PLN 2,4589, 1 euro = 3,6267 PLN

39. Second pillar in Poland (I)
Act of 28 August 1997 on organisation and operation of pension funds (Ustawa o organizacji i funkcjonowaniu funduszy emerytalnych z dnia 28 sierpnia 1997 r.) (Dz.U nr 139 poz. 934)
OFE - open pension fund (art. 9-26), the fund's Articles of Association (art.13, changes: art )
A depositary (art ), paid by OFEs: 2006 – 17,38 m zł (3,21% of operational costs)
PTE – a general pension society (art ): The governing bodies of the society:
the Management Board,
the Supervisory Board,
the General Meeting
the Audit Commission

40. Safety mechanisms
legal and physical separation of pension fund from managing company
legal requirements for PTE and its staff
depositary (custodian)
investment limits
supervision and control by KNF
mandatory minimum rate of return
so-called cascade of guarantees (Guarantee Fund)
minimum pension
Treasury as the last resort

41. Guarantee Fund (art. 184 and next ones)
fixed part (primary) – up to 0,1% of net assets The National Securities Deposit
variable part (additional) – 0,3-0,4% of net assets PTE – accounting units, assets of OFE
total 0,5% of net assets
Does the value of the GF influence the value of the PTE?

42. Reality of the protection of the whole system?
„The guarantee granted by the State for solvency of the pension system as the whole is a fiction. Such a guarantee, even though being an element of public pension systems, is socially pernicious. It is so because it creates, a fallacious feeling of safety, which in turn impedes an adjustment [process] of the system that can really guarantee this safety.” (Góra, 2003 : 89).

43. Average industry rate of return
industry average return (AR) weighted by market shares of OFEs is calculated twice a year (end of March and September) over 3-years horizon; since April 2003: market share of a pension fund cannot exceed 15%
The average is calculated as the weighted average of returns of individual OFEs (ri) and their market shares (xi)

44. Mandatory minimum rate of return
mandatory minimum rate of return (MRR) is calculated as the smallest of two values: the average reduced by four percentage points and the average multiplied by half:
An example: A) industry average was 16% B) industry average was 4% C) industry average was – 5%
Mandatory minimum rate of return is equal to: A) min [ 16%-4%; ½* 16%] = min [12%; 8%] = 8% B) min [ 4%-4%; ½* 4%] = min [0%; 2%] = 0% C) min [ -5%-4%; ½* -5%] = min [-9%; -2½%] = -9%

45. OFEs’ rates of return for the period: 30-09-04 and 28-09-07
Name of OFE
Rate of return during the period
Deficit
OFE Polsat
59,22% X
Pekao OFE
56,93%
AIG OFE
54,73%
ING Nationale-Nederlanden Polska OFE
54,50%
Commercial Union OFE BPH CU WBK
54,30%
Generali OFE
53,10%
OFE PZU „Złota Jesień”
52,66%
OFE Pocztylion
52,22%
OFE Skarbiec-Emerytura
51,60%
OFE „Dom”
51,19%
AXA OFE
51,15%
AEGON OFE
49,97%
Nordea OFE
48,81%
Allianz Polska OFE
46,38%
Bankowy OFE
43,81%
Average weighted rate of return
52,50% x
Minimum required rate of return
26,25%
Source: KNF.

46. Deficit in the open pension fund
In case a particular fund achieves a return below the mandatory minimum rate of return, its managing company (PTE) must cover the deficit.
Its amount is defined as a sum which, after the payment of a PTE into its OFE – will increase the investment return to the level of the mandatory minimum rate of return.
Increasing option leverage.
Penalties paid by the PTE Bankowy: - end of June 2001: 3,68 mln zł - end of September 2001: 35,38 mln zł - end of December 2001: 16,40 mln zł

47. System of return guarantees
The deficit is covered from assets put aside in the reserve account of an OFE by liquidating of accounting units.
In the case there is not enough assets, the deficit is then covered by amounts allocated in the additional part of the Guarantee Fund (liquidation of accounting units).
If there is still a deficit, it is paid against own assets of a PTE.
The last two layers of guarantees are: resources of other PTEs deposited in the primary part of the Guarantee Fund, next – in their additional parts of the Guarantee Fund and – finally – the Treasury.

48. Fees for participating in OFEs
Amendment of pension law (15 October 2003) – substantial changes in commissions.
Three main sources of income for PTEs:
distributional (up front) fee
management fee
transfer fee (for changing membership in a fund)
Gradual change of weights of first two commissions:
2002 – up front fee 79,4% of all revenue for PTEs, management fee - 19,2%
2004 – 62,9% and 25,7% – 60,9% and 33,8%
,2% and 31,8%
2006 – 75,5% and 24,5%

49. During the years 2004-2010 cannot exceed 7%.
Up front fee
Charged as a % of contribution entering an account of an insured
During the years cannot exceed 7%.
Next, a gradual reduction:
2011 – 6.125%
2012 – 5.250%
2013 – 4.375%
2014 – 3.500%
Commission on a contribution equal to 7,3% of gross salary, i.e. for a 7% up front fee, we have: 0,073*0.07*salary = 0.511% salary
In 2014 this value will drop to 0,2555% (0,073*0,035).

50. Management fee – FIXED part, regressive
Charged once a month as a % of net assets in an insured’s account.
Source: Own calculations based on the pension law.

51. Management fee – VARIABLE part
Depends on the results of a fund in comparison to competitors. It can be between 0% (the worst) and 0.005% (the best) net assets per month.
1. A pension fund puts aside in the PTE’s account up to 0005% of net assets per month on the last working day.
2. PTE pays this money into a premium account (these assets are still the property of a fund and are recalculated into accounting units).
3. On the first working day after the announcement of the average rate of return (end of March and September) of all OFEs, a distribution of assets of the premium account occurs.
a) the best PTE takes all – money becomes its property.
b) the worst PTE receives nothing – money comes back to an OFE
c) other PTEs receive the following part of the accounts (determined by the so-called percentage premium ratio PWP):

52. VARIABLE part – example:
Ri – rate of return of a fund, RMIN – rate of return of the worst fund, RMAX – rate of return of the best fund.
Other part returns to a fund.
Example: i) the best 10, other 8, the worst 6
ii) the best 10, other 7, the worst 6
iii) the best 10, other 9, the worst 6
i) PWP= (8-6) / (10-6) = 2/4 = 0.50 funds goes to a PTE, 0.5 returns to an OFE
ii) PWP= (7-6) / (10-6) = 1/4 = 0.25 funds goes to a PTE, 0.75 returns to an OFE
iii) PWP= (9-6) / (10-6) = 3/4 = 0.75 funds goes to a PTE, 0.25 returns to an OFE

53. Costs of open pension funds 2006
Open pension funds: 1,49% of average yearly assets
Mutual funds (stable growth): 1,67% of average yearly assets
Fees in open pension funds regulated, more transparent – cheaper? Mutual funds are expensive in Poland, however.
Source: Polish Chamber of Pension Funds
Total expense ratios TER in weighted average actively managed equity funds: 0,92% US vs 1,79% Europe vs 3,73% in Poland.
Source: and Analizy on line.

54. Readiness conditions IT infrastructure Wide political consensus
„Window of opportunity” (Polish case)
Market infrastructure (depositary banks, clearing houses, size and liquidity, instruments available vs investment limits)
Staff (managers, investment advisors)
People’s ability to understand financial markets and financial information (informed choice?, drivers for competition?)

55. Lessons learnt

56. First pillar: Information is a challenge
The philosophy of the new systems is to assign contributions to individual accounts
This requires efficient and well designed IT technology
But also ways to avoid errors made by those who transmit information:
employers
banks
Contributions that are not assigned and not registered and do not increase individual’s pension rights

57. First pillar ZUS - Correctness of information
Source: ZUS

58. First pillar Account statements
First account statements for 2001 – summarising contributions paid mailed in 2003
In subsequent years:
Contributions for current periods (up to 2005)
Plus contributions paid in 2000
In 2007: first information on full NDC account status

59. First pillar Initial capital
Initial capital calculation turned to be a difficult administrative task
Equivalent of retirement of 11 million individuals
Problems in retrieving past wage and earnings history
Changes of the employers
Creation and destruction of companies
But: problem would have been more acute in the future
Initial capital calculation completed by the end of 2006

60. First pillar Pension debate after 1999
Still different retirement ages for men and women at 65 and 60 respectively
No political nor social consensus to equalise retirement ages
Problem of falling future replacement rates:
Particularly for women due to lower retirement age
Increased indexation of notional accounts
from inflation plus 75% of real wage bill growth
to inflation plus 100% of real wage bill growth
Financial stability of the pension system in the long run
Poland assessed as low risk country in long-term perspective
Early retirement
Preservation of early retirement rights for additional year until the end of 2008 – watering down the initial reform plan
Still no decision on the bridging pensions that replace early retirement for some groups

61. Conclusions Lessons up to date
Quality of information must be assured
All participants are equally responsible for adequate performance of the system
Computer system is important….
…. as well as system managers
Proper identification should be ensured
Procedures should be designed to avoid errors
Implementation takes time – also as far as retrieving past wage history
Difficulties in overcoming societal believes:
Retirement age of women
Widespread early retirement widely accepted
Political opportunity needs to be seized: all reform items should be placed as soon as possible

62. Challenges for the future
Raising retirement ages for women
Reducing the poverty risk for women
Promoting more gender equality
Re-defining the role of minimum pension
Current indexation mechanism is reducing the role of minimum pension guarantee
Projections show its limited role in reducing the poverty risk for those with low wages and short working careers
Re-design is needed to develop adequate poverty protection mechanisms in the future
Relatively fast economic growth may lead to increased income differences between retired and working generations
Building pension-literacy so that people react to the incentives
OFE – multifunds, investment limits, performance evaluation needs to be revised/introduced
Annuities market

63. Pros and cons of the reforms undertaken

64. Pros and cons
social problems – lack of solidarity (redistribution), low pensions for worse-off (particularly in the initial period)
funded system not that immune from political influences
political backlash (transition costs – euro criteria, annuity market, etc.)
DC – problem with investment risk, people’s rational choices and education
curbing the implicit debt, showing explicit debt – long-term financial stability
adjusting to current social and demographic situation
labour market incentives
externalities (growth, savings, capital market development, financial market stability, mgmt efficiency etc.)

65. Management of the transition and reform process

66. Transition method – by cohorts
Management of the transition and reform process
Transition method – by cohorts
Method of calculating accumulated capital in the previous system – by initial capital (not by bonos de reconocimiento)
Financing of transition costs – privatization revenues, government taxes
Government Plenipotentiary for Pension Reform – „super office”
Stability of political commitment – cases for revising of the reform (miners, Slovak case – euro problem etc.)