Poland’s centre-left government was returned to power last autumn by a population disgruntled with rising unemployment, deteriorating public finances and a rapidly decelerating economy. The one undoubted success of the outgoing government was pension reform, which in 1999 replaced an unsustainable defined benefits system with a three-pillar system partly funded by private investment.
Nearly double the expected number of workers joined the privately managed schemes. “One cannot underestimate what Poland has achieved in signing up more than 10m people,” observes Iain Batty, partner and head of the international pensions group at law firm CMS Cameron McKenna in Warsaw. “Nevertheless, there are fundamental problems facing the new government.” Chief among them is that the high take-up rate continues to overwhelm the computer system of ZUS, the state social security system, which acts as the central collection point for tax contributions to both the state and privately managed mandatory systems. Although transfer rates to the privately managed accounts have improved, ZUS still owes an estimated $1.5bn (e1.7bn). With ZUS liable for a 30% interest penalty on the outstanding, the government is keen to settle the account, and if it cannot locate the money, has floated the options of either funding the debt with a special bond issue or raising the budget deficit. An earlier proposal by the newly appointed treasury minister to freeze OFE payments until ZUS catches up was rejected by the government.
ZUS allocations are complicated by the so-called ‘dead’ accounts. As of October 2001, nearly 21% of the 10m-odd OFE accounts had never paid a contribution – either because they were never eligible, for example students, never existed or have been perpetually out of work. In the early days commission-hungry sales agents undoubtedly signed up significant numbers of non-eligible bodies, since when the law has been clarified to make the pension societies responsible for their agents. Some of the less well performing funds have high proportions of dead accounts, which nevertheless have to be maintained, and at least 700,000 accounts should be terminated. Sorting these out remains a headache, particularly for funds that are merging, especially as the law does not yet specify who is responsible for their closure.
The Polish Chamber of Pension Societies, formed in February 1999 to represent the pension societies’ interests, is working with ZUS to get a 95% success rate of payments into individual accounts. The chamber is pushing for other regulatory changes, including reductions in mandatory administrative costs – some PLN150m (e42m) last year – which Krzysztof Lutostanski, president of the chamber’s board of directors, estimates could easily be halved. For instance, the societies must inform all their clients at least once a year of their account details by registered mail, at three times the cost of ordinary post. Lutostanski describes this as a pointless expense as the fund details, even if misdirected, cannot be abused.
The funds’ performance benchmark, the two-year rate of return published every quarter is also coming in for growing criticism as short-termism at its most extreme, as well as imposing the additional cost of maintaining a reserve fund. Pension societies whose funds have a quarterly return of less than 50% of the weighted average must draw on the reserve to finance the difference. Three quarterly results have been published so far, with the Bankowy fund penalised for under-performing in the first two sets, largely due to its high investments in new technology stock. In the most recent set, for the fourth quarter of 2001, all the funds exceeded the 10.732% minimum benchmark (see table). “The definition of the mean rate of return should be changed from a two- to a three-year horizon, and it should be published only once a year,” argues Marek Gora, professor at the Warsaw School of Economics and co-designer of the new pension system. “This would create less pressure on the funds and enable them to plan in the long term.”
Lutostanski, who is also president of the PKO BP/Handlowy PTE that runs the Bankowy fund, adds that the current benchmark should be broadened to average asset class performance rather than total portfolio returns, in tandem with allowing the societies to offer a range of funds with different risk profiles tailored to the outstanding years left to retirement.
There is little evidence that the public either understands or bases its decisions on the quarterly benchmarks, as the highest return in the last quarter was achieved by Polsat, the fund with the smallest number of clients, and the transfers to date have not gone to the funds with the highest returns but have been agent-driven. The largest number, 20%, transferred to Kredyt Bank. “Past performance is not always a guide to future performance,” adds Michal Szczurek, CEO of the ING Nationale-Nederlanden pension society, The number of transferring clients, around 180,000 as of last year, is still a small percentage, and clients who leave a fund less than two years after joining incur penalties on a sliding scale starting at PLN200. Nevertheless, Szczurek expresses concern at the transfer rate growing by 50–60% over the last three quarters. “In markets such as Chile and Mexico a few years ago switching between funds was the major cost item in the pension industry. If the trend in transfers in Poland continues, you will have 400,000 switches this year, with costs equivalent to 2% of total annual premiums,” he warns.
Cezary Mech, president of Urzad Nadzoru nad Funduszami Emerytalnymi (UNFE, the pension fund regulator) in contrast argues that potential transferees are deterred by the penalty fees, the complexities of the up-front charges, and downright obstruction by funds. The regulator has fined several pension societies for allegedly hampering clients who want to leave. Fines have also been imposed for other breaches, including investment transactions, further increasing the current friction in the industry. The most bitter issue concerns consolidation, pitting the many fund managers in favour against the UNFE, which has the final say on which mergers go through.
The number of funds has indeed shrunk, from 21 in 1999 to 17 as of the end of 2001. In 2001 Pekao pension society took over the Epoka, Pioneer and Rodzina funds; the Pocztowo-Bankowego PTE, whose two largest shareholders are the Polish post office and the French insurance group Cardif, and Arka-Invesco merged; Finnish financial group Sampo received permission to buy the Norwich Union fund following the British insurance company’s earlier merger with Commercial Union; and the Polish insurance company Hestia, part of the Ergo financial group has been allowed to take over the PBK Orzel fund. Partly for legal reasons UNFE has also approved the merger of the DOM and Kredyt Bank funds: Belgium’s KBC Bank and KBC Insurance respectively hold majority stakes in Kredyt Bank and the Polish insurer Warta, 50% stakeholder in the DOM PTE, while Polish law forbids a company being a shareholder in more than one PTE management company.
All these fusions have taken place among the smaller companies, with UNFE holding out against any of the larger funds consolidating. Marek Gora says the system’s design envisaged consolidation. “So far consolidation has been marginal and arbitrary. Many want it but can’t,” he complains. “The current system freezes the market, as no company is reducing their fees.” “Some of the pension funds do not have the economic conditions to survive in the long term,” adds the chamber’s Lutostanski. “Keeping them artificially afloat while blocking their merger with other funds is a waste of shareholders’ capital and of no benefit whatsoever to fund members.”
The chamber last year sent an open letter to UNFE arguing for easier mergers, but to no avail. UNFE president Mech instead voices his concern over what he considers the unacceptably high concentration in the market. As of the end of 2001 the three largest funds, those run by Commercial Union, PZU and ING Nationale-Nederlanden, had between them 56% of all the clients and 65% of assets. Mech, who applies the Hirfindahl-Hirschman Index as a measure of the concentration in the market, says that the current situation is some 66% above acceptable competition levels, and that the funds should instead focus on growing their business organically. His opponents claim that the index, the sum of the squares of market shares which is routinely used in the US banking market to prevent excessive domination by small numbers of large institutions, is not applicable to Polish pensions, ignores the questionable viability of the small pension funds, and should not in any case be within UNFE’s remit as Poland already has an anti-monopoly office.
Proposals to sell the EGO fund to the Skarbiec PTE will prove a test case. “Skarbiec and Ego are medium-sized funds, and if we approve this merger, it would be difficult not to do so for others. This could lead to an oligopoly in the market, which is not in the best interests of members,” says Mech.
The dispute between the societies and their regulator has now reached the highest political levels. The regulator was appointed by the government’s centre-right predecessor for five years and cannot be dismissed simply for political reasons. So the government has instead proposed creating a new regulatory authority by merging UNFE with the insurance supervisor. Inevitably it has cited the trend towards pan-financial regulatory authorities elsewhere, although it has not published plans to include securities companies or banks further down the line. While a pensions-cum-insurance body make some sense in the Polish context because the largest pension societies are owned by insurers, others are owned by banks, but such is the level of acrimony between the industry and UNFE that many pensions managers would live with it.