Pension system in Poland – pending overhaul…

The topic of private-run pension funds in Poland (the biggest scam in the history of Poland after 1989 IMHO) has been shelved on this blog over two years ago. Back then I outlined a relatively decent (how modest of me) summary of its workings and the government’s plans at that time. As I see no point in flogging the dead horse, if you need to catch up, please revert to ample previous posts where you can find both my private opinion on the workings (and pathologies) of second pillar of Polish social security system, as well as an unbiased description of it.

By the end of first half of 2013 the government plans to carry out a long-awaited comprehensive review of the whole pension system in Poland, the review is bound to cover not only the private-run pension funds, but also other contemptible features of it, such as privileges for many groups of professionals that need to be funded from taxpayers’ purse.

As the results of the review have not come to the light, there have been speculations regarding what the government might do to enhance workings of the private-run pension funds. As some of the government-liked economists claimed, any outcome was conceivable, including fully scrapping the pension funds and moving assets from there to state-run social security fund (running deficit for years), if their existence was deemed detrimental to future pensioners and public finances. This most abject plan has been given up, as one of three main rating agencies threatened to downgrade the rating of Poland if the government seized assets accumulated there. The Polish government is aware that you shouldn’t mess with ruthless financial markets and it quickly backed out of such option, declaring it had never come into play. I’m in two minds about such stance, but it’s hard to deny the government the foresight in this respect. Lucky streak of low debt service costs will not last forever…

Now to the point. Pension system is an element of public discourse; several economists, politicians and, let’s speak it out, lobbyists make several statements to shape Poles’ opinions on it. The problem is some of them are not home truths. I will confine to pointing at just three most blatant… Distortions? Misleading statements? Departures from truths? Misrepresentations?

Misrepresentation 1: Money amassed in pension funds are Poles’ private savings.

The sentence above could be a nice illustration of the English idiom “pack of lies” – let’s count how many lies can you pack into one sentence.

“Money” – what money? Pension funds are a pool of assets, including two key types: government bonds – ca. 55% and shares of publicly traded in Poland companies – ca. 40% (the rest are miscellaneous assets, also cash and bank deposits). These assets are hence securities which represent either a government obligation to redeem its bonds, or ownership stakes in companies.

“Private” – further on, pension funds keep records of their participants in relevant registries, thus each participant is allocated a share in the pool of assets (recorded as number of “settlement units” allocated to them), each share has the same composition of assets. Now how come it is “private”? How come many claim those “money” belong to future pensioners, or is even owned by them? Let’s look at some facts? On 4 June 2008 the Supreme Court of Poland handed down a ruling (quoted and linked in one of previous posts) which clearly stated assets in pension funds are a part of public social security system, hence contributions to pension funds are obligatory. This should dispel all doubts – whatever assets are allocated to the account assigned to you in a pension fund, they are owned by the state. If however, just like many other people, including dr hab. Leszek Balcerowicz (interesting why everyone titles him “professor”, if Mr. Balcerowicz does not hold this academic title, it is only his position at the university I graduated from), claim this is your money, ask yourself a few fundamental questions:

If it is your money – why can’t you withdraw it and spend it the way you want?

If it is your money – why can’t you have influence on how it is invested?

If it is your money – why can’t you use this assets as a collateral for a loan you wish to take out?

If it is your private money – why are you forced to pay huge load fees to private companies managing it?

The only advantage of it “savings” in pension funds is that they are inheritable. There are of course some restrictions aimed to keep “money” in the system, but indeed there are case when contributions, depleted by fees charged by management companies, can come out of system in real cash. Unfortunately the only such circumstance is death…

“Savings” – peculiar are savings funded by debts run up by the Polish state of the taxpayers… With some “little” help of 14 useless, yet expensive intermediaries. No comments…

Misrepresentation 2: Pension funds fetch high profits.

Remember the adage there are “lies, damned lies and statistics”? You could add financial reporting tricks to that list. Here the trick is simple and only recently somebody bothered to analyse its impact on returns brought by pension funds.

The mechanism is very simple – what in all statistics is presented as rate of return is a growth in value of “settlement unit” – a book record representing market value of some portion of assets in a fund. Example: let’s assume now your contribution to a pension fund is 100 PLN. The moment you make a payment one settlement unit is value at 10 PLN. 100 divided by 10 is 10, so you should have allocated 10 settlement units to your account. And here’s the catch! Because load fee for each contribution is 3.5%, only 96.50 PLN out of 100 PLN is invested in assets in the pension fund, the rest goes to oil the wheels of the pension system, majority of which to private management companies. Now let’s assume the value of funds’ assets rose by 4% over the reporting period, so the end-of-period value of one settlement unit is 10.40 PLN. Now recall you bought 9.65 settlement units. Value of assets allocated to you is 9.65 times 10.40 = 100.36 PLN. Your rate of return is 0.36%! Surprised? Now let’s face some other facts: I omit management fees, as they are included in valuation of settlement units, at the reform inception load fee was 10%, then 7% and some 3 years ago it went down to 3.5%. Imagine then break-even rates of return, i.e. by how much market value of funds’ assets had to increase to let their participants earn at least a nominal return (answer: they are respectively: 11.11% and 7.53%), let alone above-inflation one. To recap, given that yields on government bonds run near inflation rate and returns on stocks are very volatile, this system cannot (has a built-in inability to) generate profits to future pensioners. The only beneficiaries are private companies administering it.

Misrepresentation 3: Obligation of the state in form of issued bonds, purchased by pension funds, better secures future pensioners’ interests than promise in form of book record in state social security fund.

Giving lie to this statement takes very little. Let’s look at the example of Greece on the verge of bankruptcy. Bondholders had to accept 53.5% face value haircut, which means out of each single Euro they recover 46.5 Euro cents. Most pensioners have not seen their benefits declining by such percentage, usually in nominal terms their benefits fell by 30%. Media reported single cuts by 60% or 70%, however these hit most privileged Greek pensioners. Moreover in November 2012 Greek Supreme Court declared pension cuts unconstitutional. The same, under the current legal framework, would probably happen in Poland, if it, heaven forbid, was nearing default. Get real! Promise on form of bonds has no higher value than constitutionally protected right to participate in the social security system!

One more misrepresentation is in the calculation of state’s liabilities towards future pensioners. Pension funds advocates claim thanks to existence of pension funds, they become explicit, while in the state-run social security fund they are hidden. They also calculate book record of sum of liabilities on technical accounts with social security fund. They only forget about one detail – these are all contingent liabilities – the state does owe that much to people, as this worst-case scenario comes to a pass only if all people reach pension age. Once somebody dies before retirement, liability towards them is erased. There is no indecency in it, as social security system in Poland functions as insurance – if you pay contributions, you may, bit not have to get the benefit.

Hope it has given you some food for thought, and not for the last time.