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Poland dragged its heels on some key elements of its pension reform and now it is catching up. Katarzyna Gontarczyk details the latest developments

Although Poland started its pension reform a decade ago, it is only now completing the process by putting a payout framework in place.

The crucial element of the reform was to move the state pension arrangement from a DB to a DC basis. As a result, the implicit pension debt and future public pension expenditures were curbed while participants were given incentives to contribute to the system, as what they will receive depends on what they have paid in.

In addition, the reform introduced a funded second pillar. Consequently, future pensioners will receive their public pension from two individual accounts, the state PAYG notionally defined system managed by the state-owned Social Insurance Institution (ZUS), to which the contribution level is 12.22% of gross salary, and from an open pension fund (OFE) managed by commercial pension managing companies (PTEs) where the contribution rate is 7.3% of a salary. Both pillars are mandatory. Currently, there are 14 OFEs with total net assets under management of around PLN136bn (€35bn).

Although the accumulation system was designed in 1999, the shape of the payout market was left unresolved. Successive coalition governments neglected to push through legislation to determine how the savings accumulated in the funded pillar would be paid to retirees.

In addition, political tensions made it impossible to resolve another threat to the system, the early retirement privileges granted to selected occupations during the communist regime.

The situation changed when the pro-reform Civic Platform (PO) won the October 2007 general election and formed a coalition with the Polish Peasants Party (PSL). PSL member Jolanta Fedak was appointed minister of labour and social policy, and politically independent technocrat Agnieszka Chlon-Dominczak, (pictured right) who had been involved in the reform since the beginning of the process, was named undersecretary of state.

As a result, three outstanding reforms were undertaken. The first was legislation to allow for annuities from the funded pillar, with a bill tabled on annuity products and another on specially created institutions to provide pensions from the annuities. The second was legislation on so-called bridge pensions to replace early retirement benefits. The third boosts contributions to the Demographic Reserves Fund (FRD).

Parliament's lower chamber, the Sejm, passed both annuity bills in November and the upper house, the Senat, has approved the annuity products bill which is awaiting the president's signature. The annuity providers bill is still in the Senat.

The bills foresee the separation of the independent annuity providers from the annuity reserves. "There is no such solution elsewhere in Europe,'' says Chlon-Dominczak. "We chose such a construction to guarantee that future pensioners will be paid their pensions on time. The system is 100% safe because the capital of the pension providers is separated from the capital of the future pensioners."

Pensioners will receive the first life annuities from specially created providers in five years. Those retiring will choose a provider from which the money that they saved in an open pension fund during their working career will be used to buy an annuity product.

There will only be a single life annuity option and it will be calculated on the basis of unisex life tables. Consequently, the annuity system will allow some degree of redistribution from men to women, who tend to live longer. If a retiree who dies within three years of buying an annuity, a proportion of the retirement savings paid into an annuity fund will be repaid to the heirs, the value of the reimbursement falling by 1/36th every month.

The minimum capital requirement for an annuity provider is PLN75m, and will increase to PLN100m on 1 January 2019. Some see these limits as too high to allow an adequate return on the investment within a reasonable time and so may not be attractive to financial institutions. The issue is important. The Financial Supervisory Authority (KNF) foresees that in 2014, when the first cohort of men in the funded pillar will retire, annuity sales will total PLN500m, growing to PLN710bn in 2020.

The payout system will also offer a programmed withdrawal product paid out by the current pension management companies to those who retire before the age of 65. The money accumulated will be still owned by the pensioner, who will be exposed to investment risk. In practice, it will only apply to women who can retire at 60. The programmed withdrawal can last no more than five years as, at 65, all pension savings will automatically be converted into a life annuity pension. The first programmed withdrawals will be paid this year but only to 2,000 or so women, as most women born in 1949 did not join the funded pillar system.

The maximum fee charged by providers is set at 3.5% of the monthly pension benefit, although the reform's authors hope competition will push down the fee. There is also provision for a performance-related fee when the provider exceeds the so-called technical rate of return. The excess will be divided between the provider and the client.

Bridging pensions, which were expected to be introduced at the beginning of this year, were opposed by trade unions, whose supporters occupied the labour ministry in protest. The legislation reduces the number of people eligible to early retirement from 1.3m to 250,000 and cuts the overall cost to the budget to PLN600m a year from the current PLN20bn by limiting eligibility to those who work in difficult labour conditions or whose jobs have special characteristics. Participants would receive a temporary pre-retirement benefit until they reach the statutory pension age of 60 for women and 65 for men.

In addition, faced with one of the EU's lowest birth rates and high emigration, the new government decided to boost the FRD. Created in 1998, it is intended to augment ZUS pension payments from as early as this year. The fund was supposed to receive any pension system surpluses, contributions equal to one percentage point of social insurance contributions and privatisation revenues. However, no privatisation proceeds were transferred and because of Poland's difficult financial situation contributions were suspended until 2002 and in 2002-03 the contribution was only 0.1% of social insurance contributions. From 2003 the level increased by 0.05 percentage point a year, reaching 0.35% of the base of social insurance contribution in 2008. The draft law assumes that this level will be maintained and that the FRD's privatisation proceeds will be invested solely in domestic bonds.

"Some 40% of privatisation receipts will be transferred to the FRD," says Chlon-Dominczak. This year, privatisations are expected to contribute PLN12bn to the state budget.

At the end of June 2008 the value of the FRD was PLN3.95bn and as such would not be able to cover even one month's ZUS pension payments, which currently exceed PLN6bn. And in 2009 only PLN5bn - PLN1.3bn from contributions and PLN3.6bn from privatisations - is expected to be paid to the FRD.

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