security through diversity 1 funding of social security pensions: poland presenter: dariusz stańko...
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SecurityThroughDiversity
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FUNDING OF SOCIAL SECURITY PENSIONS: POLAND
Presenter: Dariusz Stańko
Pension Reform WorkshopChisinau, Republic of Moldova
Chisinau, 10-11 June, 2008
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1. Linking of contributions and benefits
through notional accounts
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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
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4Mandatory Social Security System
New systemArchitecture
NDC
PAYGmandatory,administered by thepublic institution,individual accounts
First Tier
Open Pension Funds (DC)
Fundedmandatory,administered by privateinstitutions,individual accounts
Second Tier
Savings and additional insurance (DC)
Fundedvoluntary,administered privately,individual accounts
Third Tier
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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 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
Source: Polish Chamber of Pension Funds
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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)
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Notional Capital
Pension
Average Life Expectancy at the
retirement age
=
First Pillar
NDC Pensions
Employment
Self-employment
Unemployment
Maternity and child-care
Army service
unisex life tables
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For people who had worked before the introduction of reform, an initial capital is calculated according to the following rule:
Initial Capital
(NDC)
Hypothetical old-age pensioncalculated
according to the old system rules as of December
31, 1998
Average Life Expectancy
Unisex at age 62(209 months)
= *
First Tier
Initial Capital
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First pillar
Demographic 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
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Mixed pensions
For those who did NOT join OFEs: year 2009
80% 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
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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
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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
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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
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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%
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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)
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2. Pension system for farmers
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2.1. Farmers as a social group
• historical grounds• some basic statistics• low productivity• problems with moving to other sectors
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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)
o 25,3% - farming as a source of main income (>50%)o 52,5% - pensions and disability pensions
source of main income for 24,1 % of individual farmers and 14,1% of individual farmers with > 1ha
o 51,5% - salaried worko 14,2% - non-farming activityo 11,4% - other
• average area 6,7 ha, 6,2 person/farm, output 4 061 PLN, (27 208 PLN/farm 4 388 PLN/person farm), vs GDP/capita 27 742 PLN• PKB: 3,9% vs 22,1% (industry), 17,1% (trade)
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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:
1. Contribution Fund of the Farmers Social Insurance,
2. Pension Fund,
3. Prevention and Rehabilitation Fund,
4. Administrative Fund,
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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
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2.3. Pension formula
• current formula – consists of two parts:o contribution part = number of contribution years * 1% of minimal pension
(MP=minimal pension =636,29 PLN)
o supplementary part = [95% - (x-20)*0,5%] * minimal pensionwhere 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
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2.4. LegislationThe 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.
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2.5. Contributors and beneficiaries
year beneficiaries insured2005 1,66 m 1,58 m
2006 1,59 m 1,62 m2007 1,51 m 1,60 m
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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)
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3. Disability issues
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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
o new disability formula (old disability vs new pension)o elimination of 70% and 130 % income ceilings for
working early pensioners, working disability pensioners and working family pensioners
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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 yrsfor each missing year of contributions (up to max. 30 yrs) the hypothetical value (= actual capital/actual contributing period)
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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
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Panel 1 on Lessons Learned from Second Pillar:
• Overview of the market
• Performance
• Costs
• What might be done differently
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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.
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31Source: Own calculations based on data from KNF (www.knf.gov.pl).
Polish Open Pension Funds' market (% of Net AuM)as end of May 2008
Generali OFE; 3,80%
Nordea OFE; 3,51%
Bankowy OFE; 2,98%
OFE Skarbiec-Emerytura; 2,48%
OFE Pocztylion; 2,03%
AEGON OFE; 1,98%
Pekao OFE ; 1,61%
OFE WARTA; 1,47%
AXA OFE; 4,46%
AIG OFE ; 8,20%
OFE PZU „Złota Jesień”; 13,62%
ING OFE; 23,78%
Commercial Union OFE BPH CU WBK ; 26,67%
OFE Polsat; 0,92% Allianz Polska OFE; 2,49%
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Open Pension Funds’ Market:
Basic Statistics (as of 30 May 2008)
Open pension fundNumber of members
Accounting unit's value
(in ZL)
Net assets value(in ZL)
Market share as a % of members
Market share as a % of assets
AEGON OFE 338 543 26,11 2 773 959 926 2,51% 1,98%
AIG OFE 1 096 405 25,81 11 484 760 812 8,14% 8,20%
Allianz Polska OFE 335 897 24,89 3 495 804 975 2,49% 2,49%
AXA OFE 637 164 26,41 6 248 255 870 4,73% 4,46%
Bankowy OFE 442 141 25,61 4 174 125 489 3,28% 2,98%
Commercial Union OFE BPH CU WBK
2 787 187 27,03 37 366 400 939 20,68% 26,67%
Generali OFE 576 852 27,66 5 318 689 895 4,28% 3,80%
ING OFE 2 693 196 28,71 33 326 645 224 19,98% 23,78%
Nordea OFE 742 705 27,32 4 925 080 172 5,51% 3,51%
Pekao OFE 317 480 25,68 2 252 467 955 2,36% 1,61%
OFE Pocztylion 442 364 24,96 2 848 378 818 3,28% 2,03%
OFE Polsat 321 230 28,90 1 292 602 528 2,38% 0,92%
OFE PZU „Złota Jesień” 1 983 241 26,98 19 090 213 244 14,72% 13,62%
OFE Skarbiec-Emerytura 453 337 25,27 3 472 092 919 3,36% 2,48%
OFE WARTA 309 596 27,34 2 058 432 631 2,30% 1,47%
Total 13 477 338 27,13 140 127 911 396 100,00% 100,00%
Source: KNF (www.knf.gov.pl) and own calculations.
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Performance of OFE
PeriodNominal rate of
return* (p.a.)
1999 (since June) 32,48%
2000 13,03%
2001 5,69%
2002 15,27%
2003 10,91%
2004 14,22%
2005 14,99%
2006 16,41%
2007 6,21%
2008 (until June) -9,70
* average rate of return weighted by market share
Source: Own calculations based on the data from KNF.
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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
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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
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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%
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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.
• 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.
Source: Polish Chamber of Pension Funds
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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
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Panel 2 on Second Pillar Introduction:
• Readiness conditions
• Macro-fiscal conditions
• Capital market conditions
• Administrative framework conditions
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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?)
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First pillar
ZUS - Correctness of information
70%
80%
90%
100%
September2001
March2002
September2002
March2003
September2003
March2004
Identification of employers Identification of employees
Formal control Identification of payments
Overall efficiency
Source: ZUS
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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
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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
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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
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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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