Nie będę płakać po OFE - pension system overhaul

With some considerable delay, the Polish government unveiled this week the long-awaited report containing a comprehensive analysis of the Polish pension system and recommendations for coming changes into its workings. Regular readers of this blog probably know the topic and my opinion on it inside out, yet if somebody has to catch up, follow these posts. The report, in Polish, can be found here. I have not found any English-language summary of it, yet for the sake of brevity, I will not summarise it, nor repeat anything I have written before as there have been no fundamental changes that need to be underlined.

Defenders of private-run pension funds being a part of public social security system have, predictably, torn a strip off its authors, accusing government-linked experts of manipulations, lies and use of propaganda, funnily enough without pointing at any specific example. The critics also say calculations presented in the report are distorted. Due to shortage of time and data, I cannot check accuracy of calculations presented in the report, yet if the only accusation is that the government presented investment results of pension funds net-of-fees, rather than gross-of-fees, then jaw drops open helplessly. For my part, I have found the report surprisingly substantive and unbiased and see in it one of few commendable recent attainments of PO-led government.

Albeit, let’s face the truth, this overhaul is carried out not because minister Rostowski cares so much about future benefits of the Polish pensioners, but the key incentive for pursuing it is the tightness of public finances.

The report analyses inter alia the impact of private-run pension funds on capital markets. As an analyst I have seen a few examples of stock-listed companies in which pension funds were major investors and those companies, actively managed by key shareholders, have been well-run. For many companies capital provided by pension funds was indispensable for development and proved a successful investment. Pension funds also contributed to development of Warsaw Stock Exchange and helped it grow to be the biggest such institution in CEE. But there is also the other side of the coin. The processes which have had favourable impact on Polish capital market will one day, due to changes in demographic trends, reverse. Today pension funds are net buyer of securities, but in a few decades outflows from pension funds will surpass inflows, as fewer people will work and pay contributions and more will be paid benefits. Then pension funds will be putting a downward pressure on stock prices and will have to dispose of some of its assets… Due to active ownership of shares in stock-listed companies, the recklessly made decision to nationalise the pool of assets in pension funds invested in stocks as it would have detrimental impact on Polish stock market and economy.

Pension fund defenders convince pension funds have contributed to higher GDP growth rate, while the government claims the effect on economic growth has been negative. The former back their assertion by arguments I mentioned in the paragraph above, the latter point out transfers of part of pension contributions transferred to private-run pension funds, which had to be replenished by subsidies from state budget, increased government’s borrowing needs, debt-to-GDP ratio and thus debt service costs. However, the same debt was later purchased by pension funds, hence increased demand for borrowing from the government was balanced by increased demand from pension funds – those two have cancelled each other out, leaving yields on government bonds roughly unchanged, with some intermediaries (private companies managing pension funds) charging a considerable percentage of that “hollow circulation of funds” as fee for facilitating the process. Their revenues, from standpoint of future pensioners generated a loss.

The report highlights the problem of “double-tax generation”. One of the goals of the pension reform in Poland was a shift from pay-as-you-go to capital system. Under such move, one working generation had to pay contributions for benefits of current retirees and, at the same time, “save” for their own pensions. Is such burden not to heavy to carry? Authors of the reformed wanted to fill the gap by proceeds from privatisation, as the generation of current retirees, working in socialist Poland, had built many of the big state-controlled companies. Privatisation itself should be a goal, but not at any price and not to, let’s face it, meet current government expenses. The whole concept of privatisation as source of funding for the reform, resembles me a granny who sells her unnecessary jewellery to make ends meet. Whether it is wise – I am not the one to judge it…

The issue hardly anyone broaches is conditionality of state’s liabilities towards pensioners. In the Social Security Fund you have book records, while in pension funds you have government securities. Both are the government’s promise to pay, either directly a pension, either to repay bondholders. However, due to form of insurance, book records in Social Security Fund are conditional – these liabilities turn partly unconditional, when a Fund member retires; in pension funds, where assets can be inherited, the liability is conditional as long as a member does not retire. Minister Rostowski declared the part of assets transferred from pension funds to Social Security Fund will also be inheritable, hence in such way state budget would not be better off.

And the last problem, with which I have not come up – frankly speaking I hatched the idea on one of Internet forums – is the functioning of pension funds in the light of MIFID. Under investor protection regulations, if I was to pay my money into investment fund with exactly the same investment policy as a strictly regulated pension fund, I would be obliged to fill in a survey to check suitability of such investment for me, and in case of unsuitability, I would be warned against it and would have to sign a statement despite the warning I want to invest in a risky product. In the case of pension funds, nobody bothers to follow such procedure, which disproves the untrue claim that “in pension funds there are people’s money”.

The government presented for further discussion 3 variants:

1. The pool of assets in pension funds comprising of government securities is transferred to Social Security Fund and booked on accounts allocated to future pensioners. Other assets in pension funds remain intact, 2.92% out of 19.52% pension contribution goes to private-run pension funds which are not allowed to invest in government-issued securities, the rest goes to Social Security Fund. Furthermore, internal benchmark mechanism (pathological) is scrapped, but indebtedness ceiling level (currently 50%, 55%, 60% of debt-to-GDP) are accordingly decreased to prevent rise in public debt.

2. Citizens are free to choose, whether to participate in private-run pension funds, or to rely only on state-run Social Security System. The proposal, as I far as I could notice, does not pin down the split of contribution between state- and private-run parts of the system. This option is more controversial, as system participants would have to submit declarations they want to stay in a specific pension fund; not submitting a declaration would mean silent assent for transfer of assets to Social Security Fund, plus such decision would be irrevocable, while the decision to stay in a pension fund could be revoked any time in the future). Moreover, there is a problem what to do with shares of companies transferred to Social Security – this would be hard nut to crack, yet feasible, the report contains some recommendations with feasibility and drawback analyses. The idea to “write off” government bonds transferred to Social Security Fund would have to be thoroughly analysed by lawyers, as this smacks of sovereign default!

3. Extended freedom to choose – if someone chooses to stay with a pension funds, pension contribution to private-run funds would be 2 percentage points (in relation to pre-tax salary) higher. If you read between the lines, the message is “if you think private-run pension funds are so good, why not pay them more?)

The government also resolved that state-run Social Security System will be responsible for all benefit payments and assets from pension funds will be gradually transferred to Social Security Fund over last 10 years before retirement, to minimise risk of lower pension due to downturn on financial markets.

As commentators say, variant 3 is least likely to go through, while oppositional parties lean towards variant 2. I also hold the view that, despite some of its drawbacks, would be the lesser of all evils and, if amended properly (I put forward a citizen has to submit a declaration if they want to have assets allocated to them transferred to Social Security Fund and shifts between state-run and private-run funds could be done many times and in both way, of course in minimum intervals of let’s say 6 months), should be implemented.

What I did not like about the report is that private-run pension funds and their managers who have ripped over 17 billion PLN off future pensioners are presented as scapegoats. They are only a beneficiaries of legal framework created by politicians and if somebody is to blame, these are politicians, who passed such law, thanks to social support achieved thanks to several misrepresentations. Imagine you are a wife and your husband asks in his buddies to your house and lets them eat the whole content of your fridge, piss in your garden and demolish your furniture – your husband is to blame, not the buddies who were allowed to do damages.

One of my colleagues from work told me pension funds from the beginning were meant to be the scapegoat (not only the best, for reasons below, business on earth). In fact, to tackle demographic problems you only had to shift from benefit-defined to contribution-defined system, raise retirement age, scrap some privileges and create legal framework for voluntary private-run system of pension saving or insurance. At the end of the day, how high pension benefits will be depends only on standing of the economy, as investment results of pension fund in the long run depend on them. This means obligatory pension funds create little value added, and, provided calculations in the report are accurate, costs they generate are higher than value added they generate.

Now comes the time for consultancies. The debate will be fierce, as the prime minister said, big money is at stake – but for both sides of the argument. Minister Rostowski will play for more balanced budget, pension funds and its defenders will play for state-guaranteed source of profits on risk- and responsibility-free business. And I believe interests of the future pensioners are somewhere near the bottom of the list of priorities defenders are opponents of pension funds have.

I only fear the pension funds will draw another divide line in the Polish society. We have Poles who believe Martial Law in 1981 prevented a disaster and Poles who believes general Jaruzelski (turning 90 next Saturday) declared it despite there was no threat of Soviet intervention only to nip in the bud growing social movement. We have Poles who believe Smolensk crash was a tragic accident being aftermath of human errors and Poles who believe it was an assassination. From now we will have Poles praising government for dismantling the biggest scam in over 20 years of Third Republic of Poland and Poles believing the government wants to take over their money.

For the very end, I was deeply astonished by press conference on Friday by Mr. Balcerowicz, one of leading defenders of pension funds. When I looked at his wrathful face when he avidly spoke of “lies, misrepresentations and propaganda” I feared he would kick the bucket. He did not, but I am curious to find out why he failed to mention a single, specific lie and disprove it. Is it so difficult to say “the statement you can find on page X, paragraph X of the report, i.e. “quote” is untrue, because this and that”? Why has he not done it?

The release of the report coincides also with congress of the Civic Platform, held this weekend. It made me realise if I were to choose, I would opt for Donald Tusk’s platform, not Jarosław Gowin’s one. I opt for moderate economic and social liberalism, not conservatism. But above all, I opt for sound mind and common sense!