Polish Pension Funds: Does The System Work?

1. Polish Pension Funds: Does The System Work? Cost, Efficiency and Performance Measurement Issues Antwerp, 5-7 May 2003 Dariusz Stanko Osaka University & Warsaw School of Economics

2. World Bank (1984) three pillar concept: • public PAYG system (notional accounts in Poland) • capital-based public pension funds market • employer & individual private supplementary pensions

3. Pension reform: 1 January 1999. Funds started operating in April – September 1999 • new system coverage: below 30 (compulsory), 30-50 (optional), above 50 (unrelated) • 16 (initially 21) fund operators • 11.23 m accounts • 8.4 b USD savings = approx. 4.15% GDP • retirement age: 60 (f), 65 (m) • premiums: 19.52% gross earnings first pillar 12.22%, second pillar 7.3%

4. Basic facts on Polish pension funds end of March 2003 (Stanko, 2003b) • average real returns: from 2.22 – 7.93 % p.a., median: 5.88 % p.a. • members: 127 – 2 525 thousand, average 702, median: 385 thousand • net assets: 35m – 2,450 m USD, average: 538 m, median: 241 m USD • oligopoly: first three funds up to 75% of assets and members • contributions: average 22 USD/month, average basis: 297 USD/month • portfolio structure: bonds 68%, equities 25%, bank deposits 4%, T-Bills 3%

5. Problems and challenges (1) • IT infrastructure (6 million payments a month) missing premiums: 2.3 b USD not paid • threat of domestic capital market saturation • no international diversification (investment limits, cost incentives) • current assets already 30% of stock market capitalization and 17-18% of free-float • net assets growing fast • High share of TB in the investment portfolio: • artificial PAYG system (Cesaratto)

6. Problems and challenges (2) • state benchmarking and market oligopoly (Stanko, 2003b) • “dead accounts” 17%: 2 m out of 12.2 m (March 2003) • investment regulations: • no flexible investment options for members of varying age and human labour asset profiles • limited foreign diversification (5% ceiling) • instrument limits: real estate, derivatives (hedging)

7. What is wrong? Are fund managers bad investors? • only 20% of pension premiums allotted to capital market (average 22 USD/month) • system’s nominal rate of return: + 10.8% • real rate of return*: – 10.6% (March 2003) (*static approach and only after 4 years, however indicating problem of fixed costs) • but… positive investment skills: industry’s alphas 2.7-2.8% p.a., top funds 3-4% (Stanko, 2003b) • …therefore the framework may need some adjustments!

8. Danger of insufficient pension coverage • low absolute premiums (budget constraints) • high fixed costs (entry fees, systematic costs) • investment disincentives (fee structure, benchmarks)  short-run and passive investment strategies Low system’s overall efficiency in spite of positive abnormal results.

9. Costs (1) • upfront charges too high for small premiums • management fees OK but higher share of equity should justify them • state-imposed costs and other systematic costs (Table 5)

10. premium ZUSSocialInsurance Institution ZUS transfer fee 0.8% of PREMIUM pension fund: entry fee average 8.5% of PREMIUM units calculation returns from investment fees:- brokerage - various services - depositary assets investment units calculation pension fund: accumulated assets management fee (end of month) 0.6 pa % of ASSETS units calculation Second pillar – flow of premiumsCosts (2)

11. Performance measurement (1) Current benchmark (Polish law): peer index market-weighted average (AR) and minimum required rate of return (MR) MR = min { AR – 4%, 50% AR} Drawbacks of such a solution: • herding (big funds create average) • low risk-taking, short-time investment horizon • window-dressing • misleading information, potentially deceptive Linear fee structure gives no proper motivation: benchmark-excess based premium system needed

12. Performance measurement (2)