Poland
compiled by Allianz Global Investors
Pension System Design
Poland was one of the first movers in reforming its pension system among the CEE countries. Its size and the early moves toward funded pensions make Poland the biggest asset management market in the region. The Polish reforms went very far and did not only introduce a mandatory second pillar, but also reformed the first pillar according to the principles of a notional defined contribution (NDC) system, thereby establishing strict equivalence between contribution and benefits. These reforms replaced in 1999 the old pay-as-you-go system, which was under heavy financial pressures mainly due to the rising number of pensioners.
The first and second pillars are complemented by voluntary pension savings, which were reformed in 2004. In addition to the voluntary occupational pension plans, also introduced in 1999, personal voluntary schemes, sometimes referred to as the fourth pillar, were introduced in order to encourage additional private savings. Furthermore, Poland established a demographic reserve fund in 2002 to cover future deficits.
Poland’s size and the early move towards funded pensions make the country the biggest market in the region, it captures 60% of CEE pension markets. Polish second pillar assets run up to EUR 30 billion, third pillar assets to EUR 571 million. The former are expected to grow by 17% p.a. until 2015, the growth rate of the latter will lie between 17 and 23% p.a.
Its demographics are similar to the other CEE states: over the next four decades the dependency ratio will worsen to 51%, which is slightly below the EU-27 average.
Public Pensions
The first pillar is a mandatory pay-as-you-go scheme based on NDC accounts, run by the state-owned Social Insurance Institution (ZUS). It replaced the former defined benefit pay-as-you-go system. The old system ran into difficulties due to an early retirement wave as a result of economic restructuring. Pension spending increased from 6.5% of GDP in 1989 to 15.6% in 1995. The NDC accounts mimic the principles of funded pensions in the public system. Benefits depend strictly on contributions. In an NDC system there is a hypothetical or virtual account for every participant, which contains all contributions made over the working life. Benefits are calculated taking into account average life expectancy at the time of retirement. Hence, incentives for early retirement are diminished and an actuarially neutral basis for pension calculation is ensured. The government pays contributions for the insured in several predefined circumstances, such as military service, periods of unemployment or maternity leave.
The reform left the retirement age unchanged: 65 for men (with 25 years of employment) and 60 for women (with 20 years of employment). Early retirement without reduction in benefits is possible if the retiree contributed for more years than required; deferred retirement with higher benefits is also possible. The retirement age itself is not such a pressing issue in an NDC system like in other pay-as-you-go systems since benefit payment depends on accumulated contributions even though they are notional. Hence, early retirement does not imply a financial burden for the state. Nevertheless, early retirement has still been an issue for those people who remained in the old system, but from 2008 onwards it will be eliminated.
Joining the NDC system was compulsory for all employees younger than 50 years at the start of the system. Those aged over 50 years had to stay in the old system. Rights accrued in the past were transferred to the NDC system by crediting an “initial capital” based on an actuarial valuation of their social insurance contributions as of the transition date. The self-employed have to participate in the system.
The total contribution rate is 19.5% of the employee’s taxable income, split equally between employers and employees. Of the total contribution rate, 12.2% go into the public, notional DC scheme. The remaining 7.3% is credited to the private individual account scheme, which is paid entirely by the employee. Contributions are paid up to the limit of 2.5 times the average Polish salary. For members whose total pension – from the first and second pillar – is below the minimum pension and who contributed for the minimum amount of time, the state pays the guaranteed minimum pension from public funds.
Regarding future public pension expenditure, Poland is quite unique among EU countries in that its expenditure will decrease over the next decades. In 2004, Polish public pension expenditure stood at 13.9% of GDP, in 2050 it will decrease to 9.3%. In this sense, the reforms reached their goals in terms of financial sustainability. However, due to transition costs, the first pillar will probably remain in deficit until the mid-2030s. The Demographic Reserve Fund is intended to cover these deficits. It is financed by a portion of old-age contributions – 0.2% of wages in 2005 increasing to 0.4% in 2009.
Apart from the public system, Poland runs several schemes for certain occupational groups, such as farmers and selected civil servants (for example judges, policemen, military personnel and prosecutors). The farmers’ pension scheme is subsidised by more than 90% by the state. These payments account for 1.8% of GDP. Both contributions and benefits are flat-rate and amount to roughly half the average of the public pension benefits.
Second Pillar – Mandatory Individual Accounts
The mandatory individual accounts in Poland take the form of open pension funds (OPF) and are of the defined contribution type. The Social Insurance Institution passes the 7.3% rate of the mandatory system on to the OPFs. In 1999, when they were introduced, those born between 1949 and 1968 were given the choice to opt for the new second pillar system or to contribute only to the reformed first pillar. This decision could not be reversed. The accounts are managed by specialised pension fund companies. Open pension funds are independent legal entities created and managed by a joint-stock company, a so-called general pension fund society.
Until 2004 each pension fund society could only create and manage one open fund. Since 2004, each pension fund society can run two open funds, one of which may have a higher share of equity investments whereas the other is invested more conservatively. The creation of a pension fund society requires a permission from the Insurance and Pension Funds Supervisory Commission (KNF). In terms of the governance structure, the pension fund society must have a management board (which is also the management body of the OPF), a supervisory board and a general meeting. The OPFs created by the pension fund society must be independent legal entities.
Investment regulation
Similar to most other CEE countries, Polish pension funds are subject to quantitative investment regulations as well as minimum return guarantees.
Open pension funds can invest at most 40% in equities from the regulated stock exchange market; 10% in equities in the regulated non-exchange market; 40% each in mortgage bonds, municipal bonds, corporate bonds; 10% in certificates of close-end investment funds; 15% in units of open-ended investment funds; 20% in bank deposits and bank securities. Investment in real estate is prohibited, whereas there are no limits to investments in state-issued bonds. Foreign investment is restricted to 5%. Except for mortgage, municipal, and corporate bonds, these restrictions have remained stable over the last years. For the above-mentioned instruments they have been eased. Other restrictions apply to investments in financial instruments – such as securities, investment certificates, or mortgages – from a single issuer. Open pension funds must not invest either in shares or other securities of the pension fund managing society.
In Poland minimum return guarantees are set in relative terms and are defined as the lower of the following two values:
- The average real annualised rate of return of the last 36 months of all pension funds minus 4 percentage points or
- The average real annualised rate of return of the last 36 months of all pension funds minus the absolute value of 50% of this average rate.
The pension fund society must establish a reserve account for the open fund from its own resources. This account is used to offset deficits arising from investment returns below the mandatory minimum return. If the reserve account is not sufficient to offset the deficit, the pension fund society must cover it through its own resources. If it is unable to do so, its management board is obliged to file for bankruptcy. In this case the National Guarantee Fund, whose resources must not exceed 0.1% of the cumulative net asset value of all open pension funds, stands in for the pension fund.
Distribution of benefits
Members have to buy a life annuity at retirement. However, the regulations concerning the types of life annuities among which members may choose at retirement have not been issued yet. Draft regulations propose the following types:
- Life annuities for the member only;
- Life annuities with guaranteed benefits for survivors during a period of at least 10 years;
- Life annuities paid until the death of the spouse, with the survivor's pension equaling at least 75% of the original benefit.
Annuities must be indexed at least in line with inflation. The first benefits under the system will be payable from 2009.
Tax treatment of contribution and benefits
Poland runs an EET system, i.e. contributions are tax-deductible, and investment income is tax-exempt, whereas benefits are taxed.
The Third Pillar – Voluntary Occupational Pensions
Third pillar pensions had a slow start in Poland. In 1999, voluntary occupational pension plans (PPE) were introduced, but they have not proved very successful so far.
The idea behind the introduction of PPEs, which are defined contribution plans, was to create an additional layer of pension provision.
The low participation is due to two main reasons. Firstly, tax incentives were quite limited – PPE contributions are on an after-tax basis – and so was the popularity among employers. There is only a capital gain tax exemption for plan members and an exemption from social security contributions up to 7% of employees’ salary. Secondly, due to the extraordinarily high unemployment in Poland, which is the highest in the EU, employers did not see the necessity to establish incentives for staff retention. In 2004, the PPEs were reformed:
- Registrating and running PPEs was simplified;
- The self-employed were allowed to participate;
- Greater individual choice was implemented;
- Suspending contributions for a specified period was made possible.
If an employer establishes a PPE, he is obliged to pay contributions for its staff. The contribution cannot exceed 7% of the employee’s salary. The contributions paid are exempt from social security levies up to 7% of the employee’s gross salary. Employees can make additional contributions that supplement those of the employer. These cannot exceed 450% of the average monthly salary, which is now around EUR 630. All of the contributions are subject to income tax. There are no rules stipulating how pension benefits must be paid out, but they cannot be withdrawn before the member reaches retirement age.
Employers are restricted in plan design, with minimum requirements including a legally defined ‘basic employer contribution’. The fund must be offered to more than 50% of employees in the company. Plan conditions must be negotiated with the unions or employee representatives.
There were 27 companies managing a total of 906 schemes in 2006. All the managed schemes must be based in Poland. Investment funds, life insurance companies, specially established company pension funds, or foreign management companies manage the voluntary occupational pension schemes.
Compared to the OPFs, the PPEs enjoy more freedom in investing. Portfolio regulations do not foresee any limits on equities, certificates of closed and open-ended investment funds, or bank deposits. There is a 10% limit on mortgage, municipal and corporate bonds. Investments in real estate are prohibited. A crucial portfolio regulation is that there is a cap on investments in OECD securities markets of 5%, the same as in the case of OPFs. This limit seriously hampers proper diversification.
Outlook
The Polish pension system has been transformed substantially and has become the by far biggest asset management market in the region. The structural reforms resulted in lower financial long-term burdens for the state and in a contribution orientation in all pillars. In the first pillar transition costs remain an issue as well as the separate and costly system for farmers. The transformation entails high costs, which have to be compensated by the state or the demographic fund.
In the mandatory and voluntary pension pillars, regulation impedes more efficient long-term investment strategies. The low cap on international investments of Polish pension funds in particular impedes appropriate international diversification of assets; hence participants have to accept higher risks and lower returns. The relative minimum guarantee of mandatory pension funds results in a conservative asset allocation, which meets the guarantee in the short term but misses long-term opportunities in the capital market and therefore higher returns.