The pension debate - part 2

A follow-up to the previous post.

Issue 3: the reform is to crack down on budget deficit and avoid reforms in the election year.

Me: sad, but true. The pension system is overhauled because public finances are in a pitiful state, if they had not been, status quo would have been maintained.

JR: state expenses on infrastructure, education and reduction of public debt contribute to development.

Me: When I look at how private universities and private-run motorways function in Poland I can go along with this.

JR: There is no difference between government bonds and accounts in ZUS.

LB: In ZUS there is nothing, but politicians’ promises. Real securities are kept in pension funds.

Me: A very important point in the discussion in which both LB and JR are partly right. Both government bonds and promises in ZUS are promises of money made by the government. If things go bad, pensioners will have their benefits cut before the government goes officially insolvent and bondholders will be paid off. If things go very bad, both pensioners and bondholders will lose. If things went really bad, the state would probably take over all assets from pension funds (they belong to the state!) to protect itself from bankruptcy! Changing promises in ZUS into government bonds is like buying insurance policy against political risk. The problem is, for me, that insurance premium (fees paid to pension funds and costs of higher interest paid by the state on government bonds) is much too high and hence the whole insurance is not cost-effective.

JR: After the new reform, state-run ZUS will be balanced in the long run, i.e. contributions will cover benefits and the government will not have to subsidy it.

Me: I cannot check, I have no data.

LB: Pension funds will offer higher pensions, because they contribute to economic growth.

JR: Reduction of payments to pension funds will contribute to economic growth, through lower public debts.

Me: At the end of the day both effects of both moves are more or less the same…

Summary:

LB: Pension funds will offer higher benefits because they propel economic growth. Scrapping pension funds undermines the trust citizens put into the state.

LB: Pension funds create huge public debt. Higher public debt means higher costs of servicing it and higher taxes (interests paid on government bonds are taxpayers’ expenses). Means in state-run ZUS are protected by the constitution, hence safe and can offer high pension.

Me: Both guys have annoyed me. Dear Mr Balcerowicz, I do not trust state that secures revenues of 14 private companies owned by multi-national corporations, when other companies struggle to compete on free market! Dear Mr Rostowski, you are promising the moon. The Polish state cannot afford to revalue balances of personal accounts in ZUS at rates you suggest and cannot afford to let part of the money paid into ZUS to be inherited!

The debate however, did not touch upon some other important issues.

A) Nobody called into question that investments on stock markets fetch higher returns than other investments. In the past it was true, but in the era of deregulation, speculative capitals flowing and ebbing, reckless monetary policy, cycles of boom and bust I would not be sure this old rule will be true. It might not be true for the same reasons for which the pension system would collapse – demography…

B) Nobody brought up the issue of real (issued securities) and hidden (obligations towards future pensioners) public debt. Mr Balcerowicz wants the to convert hidden public debt into real one, Mr Rostowski wants to increase hidden debt at the expense of real one. Both types of debts have to be settled, however hidden debt can be redeemed (for example if someone dies before pensioning off) and does not have to be refinanced on ‘ruthless’ financial markets and hence increases the state’s flexibility.

C) Both advocates and opponents of the current pension reforms cited their calculations to prove which variant offers higher benefits. Why has nobody mentioned on what assumptions were these calculations based?

D) “Last but not least” – costs of pension funds, not those borne by taxpayers as higher costs of servicing public debt, but fees paid to pension fund managers. PTEs charge a distribution fee of 3.5% deducted from each contribution and management fee of 0.6% per year. Round the total figure down, and you will get costs of a pension fund standing at around 4%. It means if you pay 100.00 PLN into a pension fund only 96.50 PLN is invested, from the rest management fee is charged over the year. Let’s calculate it. If we assume inflation is at Polish central bank’s target of 2.5%, the rate of return brought by a pension fund has to be 6.5% to break even in real terms! Can pension funds offer a rate of return averaging out 6.5% in the long term? Honestly speaking the rate until now averaged out 9%, so maybe they can. But despite this most people (me too) have less money in ‘their’ accounts in pension funds than they have paid in, because sky-high fees have eaten up the profits! Now the distribution fee stands at ‘only’ 3.5%, but in first five years (1999 – 2003) it was 10.0% and from 2004 to 2009 it was 7.0%. With such fees breaking even in nominal terms was barely feasible (interest of government bonds was high at that time). Returns of pension funds are shown in ‘accounting units’ which is another distortion, because ‘accounting units’ are not purchased by the whole sum paid into a pension fund, but by what remains after charging all fees. So all those arguments about high profits brought by pension funds to future pensioners are a spoofery. Profits are, but for companies that manage funds…

And the winner of the debate was:
- in my, my parents’ and colleagues’ opinion – Mr Rostowski,
- in fellow students’ opinion and according to polls – Mr Balcerowicz
- the ultimate winner was one of the moderator – Tadeusz Mosz, for saying a few times there is as shortage of money in Poland.

As you can see, both parties have their own “truths” (a propos truths – one of the best articles about pension reforms I have read), assumptions and calculations. But this is still a positive dimension of the dispute. Unfortunately, I want to share two unsettling observations:

Firstly, there is an old rule, dated to ancient times, saying no-one should be a judge in their own cause. In the case of pension funds this rule has been broken, as many times those who stand up for status quo draw measurable financial benefits from the reform, by having cushy jobs in supervisory boards of PTEs or being in charge of organisations funded by PTEs. It is quite clear that if the flow of money into pension funds is stemmed, their revenues (secured by the state, not earned on free market) will drop. I actually do not want to deny them the right to defend their own interests (lobbying can be civilised as well), but I would prefer if they did not hide their true intentions. PTEs do not give a damn about benefits of future pensioners, but care about their own profits. This absolutely normal and rational in business, if I were in their shoes, I would also try to preserve the current system, but I would not go overboard with resorting to feigned care about future retirees. This hypocrisy should be finally condemned.

If the punch line of the paragraph above is not clear yet, let’s illustrate it with another example. I work at a bank. The government is planning to introduce a bank tax. It is also quite obvious that if the bank tax is levied, my income can decline, as my bank will have less money for bonuses. Should I voice my disapproval and take part in the debate about the new tax? There is no clear answer to this question, but I would personally deny myself the right to do it. For sake of integrity and decency I would keep my mouth shut. And if, for any reason, I decided to raise an objection, I would stress my personal interest before stating any opinion.

Secondly, sides of the discussion have been beforehand categorised into better (for pension funds) and worse (against them). The consensus about pension funds can be compared to situation in Polish politics in 2007. Then it was ‘cool’ to vote for PO and ‘not cool’ to support PiS. The same trick has been done about pension funds. It is generally acceptable to be for them, and those who say something is amiss about the shape of pension reform are hailed as ‘cranks’ (oszołomy). Thus I have joined (long ago) the group of cranks, whose views are too controversial to be reckoned with. The most powerful detractor of the current pension system is the ultra-liberal think tank Centrum Adama Smitha, which has come up with a proposal to take a leaf out of Canadians’ book and reshape our pension system, so that the state would guarantee a low pension benefit (enough to scrape along by, funded from taxes) and for the rest taxpayers would have to take care on their own. This would mean scrapping both state-run ZUS (in fact only its part responsible for collecting pension contributions and paying out pension benefits) and obligatory contributions to pension funds.

The determination defenders of pension funds display is enviable. In the wake of the government’s decision Krzysztof Rybiński announced he would file a class action against the government. Alas, he did not read the new class action law carefully and did not notice the basis for filing a class action is a measurable loss incurred by each member of the class, not an estimation. The problem is that before someone retires, they cannot measure their loss. There is, nevertheless, somebody who can sue the government under that law. Those are companies that manage pension funds and charge sky-high fees. Their unearned revenues are measurable and are a solid basis for lawsuit against the Polish state…After all these companies and people affiliated with them (some of them are authors of the reform) are the key beneficiaries of the reformed pension system…

The saddest thing in the whole case is that many people believe (usually because they have been misled) assets (i.e. mainly government bonds and stocks) pooled in pension funds are their money, which is a big departure from the truth, for a single, yet meaningful reason – the ruling of supreme court, dated 4 June 2008, the money obligatorily paid into pension funds is not owned by the person who pays it

W 1998 r. ustawodawca wybrał określony model ubezpieczeń społecznych. Państwo ma zaś konstytucyjny obowiązek zapewnienia środków na zabezpieczenie społeczne każdego obywatela. Nie można się zatem powoływać na normy konstytucyjne o ochronie własności prywatnej, bo podlega ona ograniczeniom. Składka odprowadzana do OFE ma charakter publicznoprawny, zaś świadczenie z II filaru jest gwarantowane przez państwo. SN zwrócił uwagę, iż w praktyce będzie dochodzić do sytuacji, kiedy pewne osoby będą żyły dłużej niż środki zgromadzone na ich kontach, przewidywane na określoną długość życia; w takim przypadku oczywiście ich świadczenia będą musiały być finansowane ze składek innych osób. Z tego wynika, że ta składka nie jest prywatną własnością ubezpieczonego

In practice it means assets in pension funds are owned by the state and managed by private companies under public-private partnership. After all benefits from pension funds are guaranteed by the state (if the worst comes to the worst and the reform turns out to be a big flop). It also means citizens do not have any influence on investment portfolios of pension funds, nor can use the money at their discretion. Opponents of government say prime minister Tusk and finance minister Rostowski want to deprive us of our money and here is the catch. They indeed can do what has been done in Hungary or Argentina, where all assets kept in private-run pension funds under state-owned systems have been taken over. In Poland this or another government can do the same, because the law allows for it. Therefore I am against compulsory payments into pension funds. The contributions there are not safe, as my savings in stocks, bonds, bank deposits, investment funds are and assertion that transferring money into pension funds under state-owned system increases security of our pensions is a daydream…

While the government, deemed to be liberal, dismantles the reform which has been said to be pro-market one (I would call it into question), opposition parties, deemed to be rather statist, struggle to take a line on the reform. Both PiS and SLD spite the government, just for principle. PiS puts forward that each Pole should be given the freedom to decide whether to save in ZUS or in pension funds. This proposal does take my fancy, but I could not find any technical details of its implementation. Technically transferring huge amounts of money between ZUS and pension funds is barely feasible. Leftist SLD should, in principle opt for state-run social security rather than private funds, but this time their reasoning does the other way round. At the end of the day the left-wing party organised a public hearings and suggested that share of contribution paid into pension funds by citizens born after 1980 should be higher than paid by those born earlier. Those born from 1949 to 1968 should be able to return to state-run insurer. Both counter-proposals seem to make sense, but unfortunately we have too think pragmatically here and pragmatism has its painful limitations…

Is the whole current reform a good move? I have long been in two minds about it, but all things considered I am for the current reform. Given the choice, as put forward by PiS, between ZUS and pension funds, I would after all opt for the former, even if I had to put all my eggs into one basket, have a lower pension benefit and believe in promises rather than in real assets. The social security system in Poland is bound to collapse, so it the reform can postpone the moment it happens, may it be. May at least my parents get their pensions before they die, I do not expect much from the state. Obligatory payments into private companies in the way pension system in Poland is arranged are a typical example of privatising profits and socialising losses and it stands at odds with my values. Pension funds are too expensive (in terms of fees they charged) and hence cannot, as I pointed out earlier, in the long run, offer me a high rate of return. And after all I considered the failure of pension funds to be a government failure, not a market failure. Pension funds are so stringently regulated that the environment in which they operate is far cry from free market. Form of ownership is not the only determinant of a company’s efficiency.

The biggest pity about the whole issue is that most Poles do not understand what actually is going on and what is at stake…