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Polish Pension Reform – Lost Decade?

Poland was among the first European countries to reform the pension system due to significant demographic changes . The old PAYG Defined Benefit system was replaced by a new multi-pillar solution. The first regulations related to the new pension system were passed in 1997 and were based on the concept document entitled ‘Security through Diversity’ . In 1998, further regulations were passed and, after a short delay , the reform was implemented in 1998 and 1999 . The new multi-pillar system was based fully on the Defined Contribution model. The new pension system comprised three components: PAYG (the Social Security Fund), Open Pension Funds (managed by private Universal Pension Societies) and Occupational Pension Schemes. The first two were mandatory, whereas the third one was voluntary. The first component was based on PAYG mode, while the other two were fully-funded. In 2004, the system was expanded by adding a fourth Defined Contribution, voluntary, fully-funded component – Individual Retirement Accounts . The new mandatory system covers all insured persons born after 1948 , but people born before then were able to choose between splitting their old age contribution between the Social Security Fund and an Open Pension Fund, or transferring their whole old age contribution to the Social Security Fund. The accrued rights of people covered by the pension reform who used to work before the end of 1998 were recognized as initial capital in the PAYG DC component. 
The pension reform originally covered both private and public sector workers and also new members of military and similar services. However, the reform did not cover farmers, who were not part of the common social security system (for farmers in Poland there is a separate social security system which is about 92%-financed by the State) and judges, who were not part of the social security system and were entitled to salary after ,retirement’. But since 2001, steps were taken to exclude some groups from pension reform. All members of military and similar services were excluded from the common system even if they joined such services after the start of pension reform. Prosecutors were also excluded from the common system and the solution which was given for judges was also extended to prosecutors. Due to delays in preparing a special solution for people working in special conditions entitled to early retirement, the old system’s solutions were extended and then, after the miners held violent demonstrations in front of Parliament before the 2005 elections, they were completely excluded from the new DC system and special DB system and the right to early retirement was preserved for them as a final solution. Eventually (in 2008), a regulation was prepared relating to so-called ‘bridge pensions’, which was a solution for people working in special conditions for the period between early retirement age and standard retirement age. The number of workers entitled to this solution was limited in comparison to the pre-reform system. In addition to this, teachers were offered special concessions.
In 2003, a periodic extraordinary regulation was accepted, by which delayed contributions to Open Pension Funds were transferred to them in the form of special T-bonds and not in cash. From time to time, some significant changes were made in the regulations related to Open Pension Funds . Another important issue was related to Poland’s membership of the European Union, since ‘the Chilean type’ pension schemes were not present in the ‘old’ EU countries. Immediately prior to Poland joining the EU , Eurostat issued (in March 2004) an interpretation of the ESA95, according to which, arrangements based on the DC mode shall not be treated as a part of the social security system. Based on this interpretation, transfers to Open Pension Funds are treated as transfers increasing the public deficit. T-bonds held by Open Pension Funds also increase the public debenture. This means that in order to fulfill the Maastricht criteria, Poland must have a budgetary deficit which is about 2 percentage points lower than those countries which did not reform their pension systems . The EU has not accepted any Polish attempt to change this situation, except a temporary solution, by which Poland had the right to include such transfers not from the beginning in total amounts.
Also in 2008, a special solution was implemented, related to the pay-out phase for women in the 60-65 age range. As the retirement age for men is 65 but for women is 60 , the first women entitled to the old age benefit from the new pension system could retire from January 2009 onwards, while the first men entitled to old age benefit from the new pension system will retire not earlier than January 2014 . It was decided in 2008 that the lifetime annuity could be offered only to retirees from the age of 65 , and women retiring between the age of 60 and 65 will not be initially entitled to the annuity, but to ‘the periodic fully-funded old age benefit’ from the Open Pension Fund (a form of the programmed withdrawal), and only at the age of 65 will they have to transfer this payout form into annuity.
There is still a lack of regulation related to annuities. The first draft related to annuities was proposed in 1998 , but it was not accepted until the end of the parliamentary period in 2001. Then for a long time the discussion phase was ongoing in which different concepts were presented or initial draft laws were prepared. However, none of them have been finalized since then . In 2008, the government was closest to finalizing the regulation, when the law related to this issue was accepted by Parliament, but vetoed by the President. Eventually, Parliament supported the President’s reservations about the law .
The financial crisis, which started in 2008 in US and spread throughout the world, so far has not affected Poland in a significant way. As Open Pension Funds were subject to conservative investment restrictions (investment in derivatives is forbidden, and their foreign investment is restricted to 5% of their assets), their losses were not as great as those of pension funds in other countries, which were much more affected by the subprime crisis and its consequences. But also in Poland some serious problems were created by the crisis. Slower GDP growth (but not recession) has led the government to increase the public deficit and the public debenture in relation to GDP. As a result, Poland is no longer in line with the Maastricht criteria. Also, Open Pension Funds lost a major part of the profits earned for their members before the crisis. Due to high market concentration , there is a lack of price and investment competition between Open Pension Funds. All these factors were referred to by the Ministry of Labor in close cooperation with the Ministry of Finance to propose in 2009 and 2010 significant changes to the pension system. The latest proposal by the Ministry of Labor includes not only a significant reduction in the part of the old age contribution that is transferred to Open Pension Funds but also an increase in the part of the contribution used for financing the PAYG scheme. Another element of this proposal is the regulation of the old age pay-outs fully as PAYG scheme (including also part of the old age benefit which is based on savings in Open Pension Funds) , allowing the early transfer of the funds from Open Pension Funds to the PAYG scheme and allowing a lump sum payment in for the members of Open Pension Funds entitled to old age benefit not lower that twice the minimum old age benefit.
If the changes proposed by the Ministry of Labor are accepted by the government and Parliament, the shape of the Polish pension system will be significantly modified. The new shape of the mandatory pension system proposed by the Ministry of Labor will be DC, fully PAYG, with an option to choose an investment of a small portion of the old age contribution on a funded basis only during the saving phase. This new shape of system and the change in the role of Open Pension Funds will open further discussions about the regulations related to Open Pension Funds. Those entities will no longer be a fundamental part of the pension system, which shall guarantee diversification between labor and financial markets. The natural consequence of reshaping the system, in the way proposed by the Ministry of Labor, may be the liquidation of Open Pension Funds or withdrawal from restrictive regulations related to their activity. The issue of opening this segment of the market also to ordinary investment funds may arise, especially if savings in Open Pension Funds are no longer mandatory. After such changes, the Polish pension system will probably be much less transparent than it is currently. The Polish economy may lose part of its stability guaranteed by the assets of Open Pension Funds. However, the Polish statistics may look better than at present, as the long term pension liabilities will not be recognized as a part of the balance sheet. As a result, the Polish situation will be closer to those in the ‘old’ EU member states, at least for statisticians. Those steps will not solve the main problem: demography. The birth rate in Poland is one of the lowest in Europe. The Polish Pension reform introduced in the late 1990s was an attempt to adapt the pension system to challenges related to the aging of Poland’s population. It now appears that due to a strange statistical interpretation of Eurostat from 2004 (that DC schemes are not part of the social security system), the pension reform will be reduced to shift from the DB to the DC mode only (without securing financing of the payouts of benefits when the relation between workers and retirees is worst than now).
Fortunately, nothing has been decided yet and there appears to be no uniform position related to the changes in the pension system in Poland proposed by the Ministry of Labor among the government’s members .

Pawel Pelc
Former: Deputy President of the Superintendency of Pension Funds, Deputy Chairman of the Polish Securities and Exchange Commission, Deputy Chairman of the Pension Funds and Insurance Supervisory Commission, Managing Director of Insurance Supervision in the Polish Financial Supervisory Commission.
This text represents personal view of the author, not necessarily the opinion of the institution in which the author is employed.

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