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Strengthening the link between contributions and benefits: Polish NDC (first) pillar. Why NDC in Poland ?. High pension expenditure due to:Relatively generous pension formula on average 80% replacemet ratelittle link between earnings history and pension levelEarly retirementwide-spread early retirement privilegesaverage retirement age: 55 for women, 59 for menvirtually no incentives to postpone retirementPublic preferences:pension should be linked to paid contributionsLong-term outlook197
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1. POLISH PENSION REFORM
Presenter: Dariusz Stanko
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 systemArchitecture
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 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
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
7. First TierNDC Pensions
8. First Tier Initial Capital
9. First TierDemographic 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. FRD (Demographic Reserve Fund): Investment limits
11. Asset allocation of FRD
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 FRD1 Jan 2005 – 30 Sep 2006, stock portfolio
14. Performance of FRD1 Jan 2005 – 30 Sep 2006, bond portfolio
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:- f: @ 55 yrs old – 30 contributory and non-contributory years or @ 55 yrs old – 20 years of contributions and unfit to work- m: @ 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 outcomes 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 insuranceas 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 systemContributions 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 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
25. Population structure in Poland
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
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 exceeding 10% of GDP
Unbalanced pension system requiring state budget subsidies
Between 1999-2006 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
31. 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? 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
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
37. Size of the Polish mandatory pension savings industry (Nov 2007)
38. Members and average premiums as of end of November 2007
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. 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 zl (3,21% of operational costs)
PTE – a general pension society (art. 27-52): 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)
42. Reality of the protection of the whole system?
43. Average industry rate of return
44. Mandatory minimum rate of return
45. OFEs’ rates of return for the period: 30-09-04 and 28-09-07
46. Deficit in the open pension fund
47. System of return guarantees
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)
49. Up front fee Charged as a % of contribution entering an account of an insured
51. 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. Management fee – VARIABLE part
52. Ri – rate of return of a fund, RMIN – rate of return of the worst fund, RMAX – rate of return of the best fund. VARIABLE part – example:
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.
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
58. First pillarAccount 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 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
60. First pillarPension 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. 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. 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
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.)