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FUNDING OF SOCIAL SECURITY PENSIONS: POLAND

FUNDING OF SOCIAL SECURITY PENSIONS: POLAND. Presenter: Dariusz Stańko Pension Reform Workshop Chisinau, Republic of Moldova Chisinau, 10-11 June , 200 8. Linking of contributions and benefits through notional accounts. Why ( N ) DC in Poland ?. High pension expenditure due to:

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FUNDING OF SOCIAL SECURITY PENSIONS: POLAND

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  1. FUNDING OF SOCIAL SECURITY PENSIONS: POLAND Presenter: Dariusz Stańko Pension Reform WorkshopChisinau, Republic of Moldova Chisinau, 10-11 June, 2008

  2. Linking of contributions and benefits through notional accounts

  3. Why (N)DC in Poland ? • High pension expenditure due to: • Relatively generous pension formula • on average 80% replacement 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. NDC Open Pension Funds (DC) Savings and additional insurance (DC) Funded mandatory,administered by private institutions,individual accounts Funded voluntary,administered privately,individual accounts PAYG mandatory,administered by the public institution,individual accounts First Tier Second Tier Third Tier New systemArchitecture Mandatory Social Security System

  5. New Polish pension system is: defined contribution with two accounts: non-financial and financial The old-age contribution was divided into: NDC 12.22% 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 Design of the new pension system in Poland (1) Source: Polish Chamber of Pension Funds

  6. Close link between contributions and pensions: Shorter working lives Lower wages Result in lower pension savings But: There are significant differences as far as the labour market situation of men and women Promotes: Longer working lives Higher earnings Policies to promote gender equality on the labour market are crucial for equality in the pension system Design of the new pension system in Poland (2)

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

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

  9. First pillarDemographic Reserve Fund • Created in 2002. 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. Mixed pensions For those who did NOT join OFEs: • year 200980% of pension from ZUS calculated according to old pension system DB formula plus 20% of pension from ZUS calculated according to new NDC formula • year 201070% - 30% • year 201155% - 45% • year 201235% - 65% • year 201320% of old pension from ZUS, 80% from new pension

  11. Pension systemProjections 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

  12. Transition costs in Poland1998-2006 (% GDP) The financing of the Social Insurance Fund still requires subsidy to cover deficits Subsidy to cover the transition costs remains relatively stable

  13. 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

  14. Poland –Long-term effects Estimated value of pension liabilities as per cent of GDP until the year 2050: Before the reform 462% After the reform 194% Reduction of liabilities 268%

  15. 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)

  16. 2. Pension system for farmers

  17. 2.1. Farmers as a social group • historical grounds • some basic statistics • low productivity • problems with moving to other sectors

  18. 2.1. cont. Farmers in Poland (2006) • 14,8 m people living in rural areas (out of total 38,12 m) • 2,387 m farm households (with 1,742 above 1ha) • 25,3% - farming as a source of main income (>50%) • 52,5% - pensions and disability pensions • source of main income for 24,1 % of individual farmers and 14,1% of individual farmers with > 1ha • 51,5% - salaried work • 14,2% - non-farming activity • 11,4% - other • average area 6,7 ha, 6,2 person/farm, output 4 061 PLN, (27 208 PLN/farm  4 388 PLN/personfarm), vs GDP/capita 27 742 PLN • PKB: 3,9% vs 22,1% (industry), 17,1% (trade)

  19. 2.2 KRUS (Kasa Rolniczego Ubezpieczenia Społecznego) The Agricultural Social Insurance Fund runs self-governed financial activity. The following funds are the base of insurance and activity of KRUS: • Contribution Fund of the Farmers Social Insurance, • Pension Fund, • Prevention and Rehabilitation Fund, • Administrative Fund,

  20. 2.2. KRUS – cont. farmers’ insurance system • low level of protection yet • strong redistribution towards farmers from other social groups Basic pension and disability pension: 636,24 PLN Average salary in economy (Dec 2007): 2 691,03 PLN Exchange rates (June 2007): USD 2,17 PLN euro 3,39 PLN

  21. 2.3. Pension formula • current formula – consists of two parts: • contribution part = number of contribution years * 1% of minimal pension(MP=minimal pension =636,29 PLN) • supplementary part = [95% - (x-20)*0,5%] * minimal pension • where x = contribution period, each full year over 20 yrs decreases the supplementary part by 0,5% of MP; however supplementary part cannot be lower than 85% of MP • proposed new formula: • = capital / further unisex life expectancy @ 65

  22. 2.4. Legislation The basic law defining farmers' social insurance obligations and entitlements to benefits is included in the act of 20 December 1990 on farmers' social insurance (full text: Official Journal No. 7 of 1998, item 25 with later amendments).Beside the mentioned law, farmers receive their entitlements and benefits according to parliament acts listed below:the law of 13 October 1998 on social insurance system (Official Journal No. 137, item 887 with later amendments),the law of 28 November 1994 on family benefits (Official Journal No. 228, item 2255 with later amendments),the law of 26 April 2001 on structural pensions (Official Journal No. 52 of 2001, item 539 with later amendments), the law of 23 January 2003 on general health insurance (Official Journal No. 45 of 2003, item 391 with later amendments). The basic legal acts of the European Community are: Council Regulation (EEC) No. 1408/71 of 14 June 1971 on the application of social security schemes to employed persons, to self-employed persons and to members of their families moving within the Community,Council Regulation (EEC) No. 574/72 of 21 March 1972 laying down the procedure for implementing Regulation (EEC) No. 1408/71 on the application of social security schemes to employed persons, to self-employed persons and to members of their families moving within the Community.

  23. 2.5. Contributors and beneficiaries year beneficiaries insured 2005 1,66 m 1,58 m 2006 1,59 m 1,62 m 2007 1,51 m 1,60 m

  24. 2.6. Financial problems – need for reform • low real financing level • problems with • „faked farmers” • proposals to introduce • income-based • contributions Source: Own calculations based on KRUS data (www.krus.gov.pl)

  25. 3. Disability issues

  26. 3.1. Disability pensions • high number of disability pensioners • recent reforms – stricter assessment procedures, lower disability contributions • current rules • current disability formula • reform to be introduced in 2009 • new disability formula (old disability vs new pension) • elimination of 70% and 130 % income ceilings for working early pensioners, working disability pensioners and working family pensioners

  27. 3.1. cont. – Disability formulas • current formula: • = 24% Basis Quota + 1.3% *n1*IAB + 0,7%*n2*IAB+ 0.7%*n3*IAB • n1 – no. of contributory years, n2 – no. of non-contributory yrs, ICB – individual assessment base, n3 – no. of hypothetical contributory yrs (n3=25-n1-n2, from moment of disability to age 60) • new formula (for those born after Dec 1948; full formula commencing 2014, mixed formula during 2009-2013): • = [initial capital + actual capital + hypothetical capital] / unisex further life expectancy @ 60 yrs • for each missing year of contributions (up to max. 30 yrs) the hypothetical value (= actual capital/actual contributing period)

  28. 3.1. cont. – Disability formulas • Current values of disability pensions • total disability pension 636,29 PLN • partial disability pension 489,44 PLN • Basis Quota (2008) 2 275,37 PLN

  29. Panel 1 on Lessons Learned from Second Pillar: • Overview of the market • Performance • Costs • What might be done differently

  30. 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. 1997 nr 139 poz. 934) • OFE - open pension fund (art. 9-26), the fund's Articles of Association (art.13, changes: art. 22-23) • A depositary (art. 157-165), paid by OFEs: 2006 – 17,38 m zł (3,21% of operational costs) • PTE – a general pension society (art. 27-52): The governing bodies of the society: 1) the Management Board, 2) the Supervisory Board, 3) the General Meeting plus also: the Audit Commission.

  31. Source: Own calculations based on data from KNF (www.knf.gov.pl).

  32. Open Pension Funds’ Market:Basic Statistics(as of 30 May 2008) Source: KNF (www.knf.gov.pl) and own calculations.

  33. Performance of OFE * average rate of return weighted by market share Source: Own calculations based on the data from KNF.

  34. Impact on adequacy? 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

  35. 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

  36. 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%2005- 68,2% and 31,8% 2006 – 75,5% and 24,5% 2007 – 60,9% and 33,8%

  37. 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: http://www.altruistfa.com/dfa.htm and Analizy on line.

  38. What might be done differently • Tenders for asset management mandates – a few institutional investors for each cohort? • 401k-like mandatory retirement accounts – many institutional providers? • Passive management for core portfolio? • More efficient information campaign on future replacement rates and inheritance of the funds (vide annuity market) Source: Polish Chamber of Pension Funds

  39. Panel 2 on Second Pillar Introduction: • Readiness conditions • Macro-fiscal conditions • Capital market conditions • Administrative framework conditions

  40. 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?)

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

  42. First pillarInitial 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

  43. 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

  44. 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.) 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, peoples’ rational choices and education

  45. 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 Challenges for the future

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