Poland’s second-pillar pensions system, launched in 1999, was hailed at the time as a pioneering template for central and eastern Europe’s increasingly ageing pop-ulation. Now the Polish centre-left government has decided that the system is proving expensive for members and has drawn up a package of reforms that includes capping fees. Despite a mixed response from the industry, the Sejm, the lower house of parliament voted through the govern-ment’s proposals on July 29. There-after it moves to the Senate (the upper house) for legislative scrutiny, and presidential approval. Assuming no hitch, the majority of the amend-ments will come into effect in April next year.
“The basic aim is to reduce the cost of the system, and at the same time pass on these reductions to fund members,” explains Krzysztof Pater, undersecretary of state at the Ministry of Economy, Labour and Social Policy. “Additionally, we want to increase competitiveness of the funds and create a situation where it will be more profitable for a pension fund management company to be managing one of the best performing funds.”
The government also wanted to address the currently high concentration of the market, which Pater describes as ultimately risky. There are currently 16 open-ended pension funds or OFEs in the second-pillar system. Of these, the top three (Commercial Union, ING Nationale-Nederlanden and PZU, the former state-owned insurer) had between them, as of the end of June, 56% of the 11.3m fund members. In terms of net asset value, which stood at PLN37.769bn (E8.6 bn), they controlled 65%.
In the case of cost reductions, the government is setting new limits on both the fee charged as a percentage of contributions and management fees. As of 2010 contribution fees will be capped at 7%, falling annually thereafter to 3.5% by 2014. The asset management fee, currently a legal maximum of 0.05% of managed assets per month (with quarterly limits depending on individual fund statutes), will be replaced by a sliding scale. The fee will start at 0.045% on the first PLN8m-10m (the exact amount has not yet be determined) of assets, decreasing thereafter. In addition the government is introducing a management premium, with the fund achieving the best returns receiving an additional 0.005%, the worst zero, and the remainder an intermediate amount.
“Since the system started we have not observed price competitiveness,” explains Pater. “There have been many comments that pension funds are too expensive.” Michal Szczurek, CEO of the ING Nationale-Nederlanden pension society, counters that the administrative fee controls expressly reduce price competition. “No player will voluntarily reduce fees because the political risk of further fee reductions is too high,” he predicts. He also believes the controls were unnecessary as the larger funds already reduced contribution fees for existing members, and that the industry intended to lower them as assets grew.
“The proposed fee_system would have been appropriate at the beginning but is inappropriate now,” adds Iain Batty, partner and head of the international pensions group at law firm CMS Cameron McKenna in Warsaw. “Providers have entered the market based on certain expectations of what they could charge. They have made large financial commitments and it's inappropriate for the government to change the fundamental basis on which they make their profits so soon after they made those commitments.”

Arguably another amendment, preventing pension company management board members from also serving as board members of banks and insurance companies, adds costs to the system. “If an individual is dedicated to one institution, the costs will be placed on that institution and not spread around,” notes Batty.
Another amendment concerns the allocation of eligible individuals who have not signed up for a second-pillar fund. The system is compulsory for individuals born after 1969 (and voluntary for those born between 1949 and 1969), but last year 100,000 failed to register. At the moment they are allocated by lottery once a year, with the greatest number going to the larger funds. The amendment would restrict the funds eligible for these extra members to those with less than 10% of market share, but a rate of return over the last two quarters of more than the industry average. This system would give the smaller but better perform-ing funds a chance to increase their membership.
Whether the amended legislation would hasten consolidation of the smaller funds remains a moot point. Although the number has shrunk from the 21 in 1999, there are still too many. Some of the smaller funds are also burdened with a high proportion of ‘inactive’ accounts, 50% of total membership in one case, which were set up by commission-hungry salespeople in the early days – some 450,000 were recruited initially – for ineligible, dead or non-existent persons. Regulation of agent practices has since tightened up, while the new law would also prevent those that leave a pension fund management company from joining a new one within six months. This is designed to stop agents who switch jobs inducing their clients likewise to switch.
Consolidation was expected to speed up after the merger of the pensions regulator – which had resolutely opposed the larger funds increasing their market share – with the insurance supervisor but this did not materialise, largely in the industry's opinion because of the impending legal changes and uncertainties about the implications on pension company valuations. “No one is going to take the risk when one parliamentary amendment can overnight change the value,” observes Szczurek.
Whatever the industry thinks about the government's proposals, the two sides had at least consulted. The same cannot be said for some of the ad hoc amendments tabled from the parliamentary floor. “The quality of some of the proposals was hopeless,” says Szczurek.
It can at least breathe a sigh of relief that the more populist amendments tabled from the opposition benches fell by the wayside. For instance, the centre-right Law and Justice Party's proposals included a ban on any one fund having a more than 15% market share, cancellation of the management fee and a total ban on second pillar funds investing overseas.
Some of the amendments were also positively welcomed. The calculation period for the minimum rate of return (fund management companies that fail to achieve this must compensate the fund from their share capital) has been extended from 24 months to 36, while the calculation itself will be performed every six months instead of quarterly. The reserve fund, which takes up 1.5% of managed assets, has been replaced by a so-called ‘solidarity fund’ receiving 0.5% of assets.
However, one of the major cost burdens on the second pillar pensions system, the initial computer problems at ZUS, the social security system, falls outside the scope of the law. The original reforms separated social security into old age, disability, illness and work injury. ZUS’s role is to collect all social security contributions including first and second pillar old age contributions, and transfer the latter to the individual fund. According to Marek Gora, Professor at the Warsaw School of Economics and co-designer of the system, operationally the old-age pension system only required four pieces of information: the individual’s name, contribution am-ount, date of contribution and wage. However, the backlog built up because ZUS’s IT system initially could not handle either the segmentation or accrual accounting on which the new system was based. Furthermore, says Gora, ZUS’s load could be eased if certain operations, such as the collection and tran-sfer of contributions were privatised.
Although its transfer success rate has improved this year to around 96%, it still owes the funds PLN9.5bn in earlier backlogs and fines. This sum has been taken over by the government as a state obligation, but with Poland already running a budget deficit of around 4% of GDP, cannot be paid off immediately. Instead the debt is being securitised into 10-year bonds similar to government Treasuries. However, as Szczurek points out, the 5% or so yield that they pay does not match the 20-25% return that pension funds have recently provided.
What the industry also failed to get was an easing on investment. The new amendments have widened the investment categories marginally. For example, mortgage securities, currently limited to publicly traded entities and thus in practice non-existent in Poland, will now be extended on non-traded securities as long as they meet other prudent requirements. However, the much-disliked 5% cap on overseas investment, the lowest in the region, stays, although the government will probably relax it for euro investments in the future.

The largest part of this investment inevitably flows into govern-ment debt, and eases the govern-ment’s ability to roll over its debt, which Marek Gora opposes in prin-ciple: “Last year the Polish pension funds had high returns on govern-ment bonds, but this will eventually have to be paid for by higher taxes.”
It is also questionable whether Poland’s acceptance of the chapter on free movement of capital in its negotiations on EU accession, or any existing EU directive, could be applied. “Polish second pillar funds do not largely fall within the remit of the EU's new pensions, third-generation insurance or UCITs directives, so the government may be free to impose quantitative restrictions on investments,” observes Iain Batty. “The government would also contend that second-pillar funds are not private-sector entities but part of the social security system.”
The fund managers argue that the strict overseas limit itself limits their scope for portfolio diversification, which will become more critical as assets grow. “In addition open pension funds can still only have one investment policy, with the same risk-return profile, regardless whether they are a 15-year old male set to retire at age 65 or a 55-year-old woman with five years to go,” adds Szczurek. Other countries in the region expressly allow for lower-risk bond-oriented portfolios for older members as well as equity-weighted ones for younger workers.
In addition to changes in the second-pillar law, the government plans further overhauls in the pensions system. Parliament is now set to debate its proposed ‘individual pillar’ system, which would extend capital tax exemptions to other savings such as mutual funds and life insurance, similar to the IRA accounts in the US. Furthermore, it intends to overhaul the complicated and bureaucratic third pillar system, which currently revolves around the employer pensions programmes or PPEs. The changes here include rectifying the fact that currently in PPEs there is no legal way of terminating the programmes or temporarily suspending contributions, irrespective of the company’s financial health. “This will significantly reduce the financial risk for the employer,” notes Pater.