Changes to Polish Pension Fund System

24th January 2011

Today saw an announcement of long anticipated changes in the Pension Fund system, where the fees paid to the private run OFE system are reduced from 7.3% to 2.3%, the difference (5%) which, will be paid to the National Pension Fund system, in the designated user accounts.   This event has led to a lot of debate, yet as with most topics nowadays, it appears that people are talking a lot but missing the main points.

The main point is that Poland is moving from the system of prefunded pension funds, like OFE system, to that of PAYG, or Pay As You Go (which is a common system in most "developed" countries, and of course it is a wrong system that will lead to immense social problems, deficits and probably inflation).  Though we should say that we do not know if the government will actually spend less on pension funds following the change of system (the plan is to save PLN15% of GDP in debt), it is highly likely that this is its aim, meaning that current pensions will be financed from current contributions, leading to significant savings for the government in its budget, and its continuous ability to live on credit, not engaging into difficult reforms, and generally pretend that good work is being done.  Such behaviour is not unusual for this government, or frankly any government across the world, and I would personally expect the opposition in Poland to be no different and even potentially worse.

This is the main point, which does not impact people individually, but more collectively via its impact on long term stability of the country. I have recently wrote on the real debt levels in UK, which officially is GBP1trillion, but its pension fund liabilities are estimated to be GBP4trillion.  Please read this link.

Now to the smaller issues:

1) in my view, ironically, pensioners will be better of, as:

     a) they will be guaranteed the rate of return equivalent to the nominal growth rate of the country, and even though I know that in the past the pension funds have outperformed this rate, there is no economic reason to expect the stock market to grow faster than the economy, furthermore having a floor of 0% (Estonia's GDP lost some 20% in two years, so a floor like this is not so unreasonable)

     b) they will be hereditary, what is a great advantage for married couples - but why allow nominate someone third (this no longer actuarial science, but that of classic investment fund)

     c) possibly the fund management fees will be smaller, or even eliminated - though I am not sure about this point from what we know so far

2) of course the whole country will be more indebted, via long term off balance sheet obligations, as assuming that the government contributions for ZUS will decrease, this will mean that the pensions today, will be paid by the the adults of today, and the pensions tomorrow will be paid by the current children.

3) an amazing news however is the plan to raise the OFE's equity ratio from 40% to 62% (2.5% shift this year, and 2% per year thereafter till 2020), meaning significant outflows of cash from debt, mainly government debt of course, and inflows into equity, mainly risky ventures - and possibly already attractively valued.  This is contrary to the logic that the government should show, ie acting in a way to stimulate the market for its own debt.  Furthermore, being conservative and seeing what can happen to equity, I would personally feel more confident if my pension would be linked to the growth rate in the country, what to me is absolutely a perfect measure.

4) naturally the private funds who oppose these moves will significantly lose out, as their did not forecast in their business model such significant reduction in their growth rate

So these are real issues to mention when one is talking on TV.