POLAND. National Strategy Report on Adequate and Sustainable Pensions

Transcription

1 POLAND National Strategy Report on Adequate and Sustainable Pensions Ministry of Social Policy Warsaw, August

2 TABLE OF CONTENTS INTRODUCTION... 3 CHAPTER 1. BASIC FEATURES OF THE PENSION SYSTEM, MAIN DEMOGRAPHIC AND SOCIO-DEMOGRAPHIC CHALLENGES PENSION SYSTEMS IN POLAND CHALLENGES FOR THE FUTURE DEMOGRAPHICAL CHANGES... 8 CHAPTER 2. ACHIEVEMENT OF COMMON OBJECTIVES ADEQUACY OF PENSION SYSTEMS PENSION POLICY OBJECTIVES PRESENT SITUATION: PENSION POLICY INSTRUMENTS AND ACHIEVEMENT OF OBJECTIVES FUTURE FORECAST AND CHALLENGES STRATEGIES FOR ENSURING ADEQUATE INCOME IN THE FUTURE FINANCIAL STABILITY OF PENSION SYSTEMS OBJECTIVES OF THE POLICY PURSUED PRESENT SITUATION FUTURE FORECAST AND CHALLENGES STRATEGIES FOR DECREASING FINANCIAL DEFICIT MODERNISATION OF PENSION SYSTEMS AND ADJUSTING THEM TO THE CHANGES ADJUSTING PENSION SYSTEMS TO LABOUR MARKET REQUIREMENTS AND NON-STANDARD EMPLOYMENT GENDER EQUALITY AND THE FUNCTIONING OF PENSION SYSTEMS CHAPTER 3. CONCLUSIONS ENCLOSURE. BASIC STATISTICAL INFORMATION

3 Introduction The National Strategy Report was prepared as part of the open method for the co-ordination of pension systems. This method allows EU countries to assess and compare the way their pension systems carry out the three primary objectives, adopted jointly, that is: adequacy of benefits, financial stability and modernisation. Poland is preparing such report for the first time. The document has been prepared six years after launching the pension reform. In 1999, the implementation of the new pension system started, preceded by the public, experts and social discussion. The reason for the reconstruction of the pension system was the increasing financial unbalance and ongoing demographic processes growing birth depression and progressive ageing of the population. Today the problems that gave rise to the implementation of the reform are becoming even more current. The social security system is in need of continuation of the reform process. The Tripartite Commission on Social and Economic Affairs continues a debate on the condition and prospects of the social insurance system. Its purpose is to make a comprehensive assessment of functioning of the social security system, its financial condition and management methods. Among the problems to which attention was devoted one should name: with respect to the functioning of the Social Insurance Fund: - assessment of performance, balancing and forecasting of the Fund s financial condition; - full implementation of the computer system, including individual pension accounts; - maintaining the separation of individual insurance risks and the need to monitor their situation; - making the system resistant to demographic movements, efficient operation of the Demographic Reserve Fund; - public access to information about the condition of social security system; - building efficient mechanisms of control over the system; - increasing the revenues and optimising costs of the social security system; with respect to the functioning of the Social Insurance Institution (ZUS): - making the results and financial plans of ZUS public; - pursuing a transparent information policy; - developing and implementing Strategy Plans for ZUS. The National Strategy Report covers also the social security system for farmers. This system has been a topic of discussion in recent years. In the middle of 2004, the supervision over farmers social security was entrusted to the minister competent for social security matters. The reform of farmers social security system, aimed at a better linking of contributions to the farmers income as well as creating a system favourable to the professional mobility between agricultural and non-agricultural system, constitutes a crucial challenge for the next years. The first chapter presents a short description of the pension system in Poland, including the challenges they face. The next chapter is devoted to the assessment of the implementation by retirement systems of the primary objectives of their functioning, specified within the scope 3

4 of the process of open method of co-ordination by EU Member States, i.e. adequacy, stability and modernisation of pension systems. The third chapter contains conclusions resulting from the assessment. The draft National Strategy Report was prepared in the Ministry of Social Policy and subsequently presented for broad social and inter-departmental consultations. The final text of the NSR reflects comments and opinions submitted to the Ministry in the consultation process. 4

5 Chapter 1. Main features of the pension system and policy and main demographic and socio-demographic challenges Pension Systems in Poland In Poland, pensions are paid out from two insurance systems: general and for farmers. Security provision systems for military forces, police and similar services as well as judges and prosecutors function separately. Each of those systems operates under separate rules and concerns another group of people. The largest, general pension system, pays out old-age, survivor and disability pensions for nearly 78% of all pensioners. Benefits for 18.5% of pensioners are paid out from the agricultural system. Other pensioners receive their benefits from the security provision systems (chart 1). The systems are based on different rules for paying contributions and receiving benefits. The benefit indexation rules, however, are the same. General Pension System The history of operation of social security system in Poland goes back to After WW II and until 1999, the system s rules were close to those of traditional systems on the European continent. It was a pay-as-you-go system, operating on the basis of a defined benefit formula. According to the forecast prepared in 1998, the pension system deficit would have been increasing on average by 1% GDP (about 8 billion PLN) every 10 years to reach over 2% of GDP in 2030 and nearly 4% in Financing such a large deficit would have involved the need to considerably increase social security contributions or taxes. Social insurance in Poland includes insurance against old age, illness, maternity, inability to work, loss of the person who supported the family, work injury and professional diseases. The general social insurance system in 2004 covered 13 million people. From this system benefits have been paid out to 7.2 million old-age, survivor and disability pensioners. In 2004, benefit expenses amounted to billion PLN (11.8% of GDP), out of which 96.3 billion PLN (9.2% GDP) was for old-age, survivor and disability benefits. Supplementary subsidy for the system in 2004 amounted to 19.4 billion PLN. 1 The reform that was launched on January 1, 1999, has fundamentally changed the system s construction, aiming at significant reduction of pension system s insolvency risk in the long term (it limited the implicit debt of public finance which resulted from the large scale accrual of pension liabilities). The basic reason for the reconstruction of the system was to adjust it to demographic changes and to accelerate the economic growth of the country. The pension system should provide an appropriate level of benefits (with special consideration to the minimum benefits), be financially stable and encourage the participants to continue their professional activity. The reform is to contribute to a higher level of savings in the economy. The system hitherto, which was based on the defined benefit rule, was transformed into a system based on a defined contribution. The mandatory part of the system was divided into 1 Additionally, 3.5 billion PLN was transferred in the form of purpose subsidy to finance benefits paid from the state budget and 10.6 billion PLN as refund to cover contribution loss due to transfer to open pension funds. 5

6 two parts: non-financial and financial. The former is managed by a public institution Social Insurance Institution (ZUS), the latter by private institutions, i.e. general pension fund societies. For each insured person in this system two accounts are kept. The first account (non-financial) is kept by ZUS, the other is kept in an open pension fund. The retirement age applicable so far has been preserved: 60 years of age for women and 65 for men. There is no option foreseen for the persons covered with the new system to retire earlier, which should lead to a rise in the effective retirement age. In 2004, the average actual retirement age was 56.8 years (58.7 for men and 56 years for women). Old-age pension contribution amounts to per cent of gross wage and are payable in equal parts by the employer and by the employee. In the event of a member of an open pension fund, part of the contribution in the amount of 7.3 per cent of the wage is transferred by ZUS to the fund of member s choice. The remaining part, i.e per cent stays in ZUS. Contributions for the remaining insurance risks are also paid to ZUS including contribution to disability and survivor pension insurance amounting to 13 per cent of the wage, (paid in equal parts by employee and employer). 2 The mandatory system should be supplemented with voluntary saving in the framework of Employee Pension Plans and Individual Retirement Accounts. The contributions registered on the individual account of the insured with ZUS are indexed. The indexation can be considered as a sort of rate of return on pension savings. on,. Indexation factor is equal to consumer price index increased by the real growth of the contribution revenue, measured on contribution due. Indexation cannot be lower than the Consumer Price Index. The funds transferred to the Open Pension Funds (OPF) are converted into settlement units. Their value depends on investment performance. The benefits paid from the system are indexed at least with the price index. In 1999, people who were subject to insurance were divided into three groups: 1. those born before January 1, 1949, who retire according to the old pension system rules (defined benefit principle); 2. those born after December 31, 1948 and before January 1, 1969, who retire according to the new system rules (defined contribution principle), save that their pension rights acquired before the implementation of the new system were converted into initial capital, registered on the account with ZUS; 3. those born after December 31, 1968, who retire in accordance with the new rules and obligatorily have two accounts (full defined contribution principle). The reform had impact on the general system s income due to the transfer of part of pension contributions to the OPF. Pensions financed from savings in OPF, will be paid out in the future, as people who are covered by the reform, will retire. The first old-age pensions in the new system will be paid out from Therefore, when assessing the new system, we can now rely only on the projections of the amounts of future benefits. 2 Additionally the employee finances the sickness insurance contribution equal to 2.45 per cent and the employer work injury contribution, which depends on the work injury risk in a given branch of industry and company and varies between 0.97 and 3.86 per cent. 6

7 Farmers Pension System Since 1977, farmers and their families are subject to compulsory social insurance. Until 1991 that system was managed by ZUS, and since 1991 by the new established institution: Agricultural Social Insurance Fund (Kasa Rolniczego Ubezpieczenia Społecznego KRUS). The separate administration is connected with the implementation of specific solutions, addressed to that population group, in particular preventive activities, rehabilitation treatment, separate medical decision-making system, different manner of paying contributions and calculating benefits since At the end of 2004, there were 1.5 million people subject to insurance, while old-age, survivor or disability pension benefits were received by 1.7 million beneficiaries. Pension insurance for farmers is financed from the Pension Fund (Fundusz Emerytalno- Rentowy FER), whose expenses in 2004 amounted to 16.5 billion PLN. FER s revenues, meanwhile, derive primarily from the state budget subsidies (in 2004, 15.1 billion PLN) and partly from the contributions from professionally active farmers (in 2004, 1.1 billion PLN). The contribution for old-age, disability and survivor pension insurance is payable quarterly and amounts to 30% of minimum old-age pension (that pension currently amounts to PLN ). The proceeds from contributions for old-age and disability pension insurance cover only 6% of the expenses for the old-age and disability pension insurance. Such a share of revenues from contributions in the financing of the old-age pension costs is associated, first of all, with the initial assumption that this system would be receiving subsidies from the state as well as with an unfavourable relation of the number of the insured to the number of beneficiaries. Furthermore, the contribution burden is spread very unevenly as the contributions form quite a considerable burden on small farms, while for the larger ones contributions are almost unnoticed. An insured farmer is entitled to a farmer s old-age pension upon meeting the following conditions: he/she attained retirement age (60 years for a woman, 65 years for a man), he/she was subject to the old-age and disability pension insurance for at least 25 years. A farmer s old-age pension is calculated in relation to the amount of minimum old-age pension and consists of a contribution part and a supplementary party. The contribution part depends on how long the farmer was subject to insurance and it is determined by an assumption of 1% of the minimum old-age pension for each year of being subject to old-age and disability pension insurance. This part of the farmer s old-age pension is paid out regardless of cessation of agricultural activities, i.e. transfer of the farm. The supplementary part equal between 95% and 85% of the minimum old-age pension and decreases with the period of insurance. The supplementary part of the benefit is payable after the transfer of the farm. As a result of such rules for calculation of the old-age pension amount, the distribution of old-age pension amounts is highly concentrated. Security Provision Systems Security provision systems are entirely financed by the state budget. They include benefits for the police, army, fire-fighters, officers of the Government Protection Bureau (BOR), Internal Security Agency, Foreign Intelligence Agency, Polish Border Guard, prison guards, judges and prosecutors. In comparison with the general system, it has two distinguishable features: 7

8 - the acquisition of retirement rights depends on the work service period one can retire as soon as after 15 years of service, which means that those systems have relatively the youngest retirees; - the amount of benefit is determined in the basis of the amount of final salary or wages, so in a different manner than in the general system. In 2004 a total of 329 thousand old-age and disability pension benefits is paid out from this system (which was about 3,6 per cent of all beneficiaries). The expenditure for security provision system amounted to 8.3 billion PLN, which was about 7 per cent of all Polish expenditure on pensions (it was also 4.2% of the state budget expenses 3 ) During the consultations of NSR, several institutions pointed out that there is a need to reform these schemes, including extending the period of performing public duty. As it is designed currently, people with significant experience to early withdraw from this duty Demographic Changes 2004 was the sixth year in a row when a real decrease in the population was recorded and the third when there was a negative natural growth of the population. Since the 1990s, there has been a continuing drop in the number of births (a so-called birth depression). Since 1989, the number of births does not guarantee a simple generation replacement. In 2003, this ratio was 1.22 and was the lowest in over 50 years. At the same time, a permanent improvement in the mortality rate positively affects the life expectancy of Polish people. In comparison with 1990, male life expectancy at birth increased by 4 years, and female life expectancy at birth by 3.4 years. The research and analysis conducted by demographers show that the drop in the number of births that has been continuing for over ten years has not ended yet and affects more and more subsequent generations of young people. The phenomenon we observe in Poland is known as second demographical transition, which is characterised by a decrease in the number of births as a result of occurring social phenomena, including, inter alia, the way in which the role of the family is perceived in the society. Among direct reasons for the decreasing number of births the following are named: the difficult situation on the job market and difficult social and economic conditions for the generation of procreation age. According to the opinions of experts, a further drop in the number of births should be expected in the years to come. The decreasing number of births and increasing life expectancy cause ageing of the population and that will result in a significant shift in proportions between people in production age and those in post-production age. According to a EUROSTAT projection, the number of people in productive age (15 65 years) will start dropping in This phenomenon has a direct impact on the old-age dependency ratio. The number of people in post-productive age (over 65 years) falling to every 100 people in productive age will rise from 14 in 2003 to 44.8 in 2050 see chart 2. 3 State budget expenditure for pensions from security provision. 8

9 Chapter 2. Meeting the common objectives 2.1. Adequacy of pensions Common Objectives Common Objectives Member States should safeguard the capacity of pension systems to meet their social objectives. To this end against the background of their specific national circumstances they should: 1. Ensure that older people are not placed at risk of poverty and can enjoy a decent standard of living; that they share in the economic well-being of their country and can accordingly participate actively in public, social and cultural life; 2. Provide access for all individuals to appropriate pension arrangements, public and/or private, which allow them to earn pension entitlements enabling them to maintain, to a reasonable degree, their living standard after retirement; and 3. Promote solidarity within and between generations Policy objectives The new pension system, based on the defined contribution rule, makes the amount of future benefits dependent on the contributions paid throughout one s professional life and on the average life expectancy at the retirement age. 4 The rates of return on pension accounts depend on the situation in the job market, which results in changes in contribution proceeds, as well as the return on capital investments. As a result, the future pension will depend on the length and amount of contributions paid during one s period of professional activity and it will promote prolonging working lives. Simultaneously, thanks to the rules of functioning of pension accounts, the insured participate in the benefits resulting from the country s economic development (job market and capital market). The formula for the calculation of future pension makes the amount of pension dependent on the further life expectancy which allows the burden of demographic risk to be spread evenly across present and future generations. The essential element of intergenerational solidarity and adequacy of benefits is the existing guarantee of minimum pension 5. In the old pension system (people born before 1949) and in the agricultural system as well, such a pension is financed directly in the framework of insurance. In the new pension system, the guaranteed minimum pension will be financed from the state budget and paid out in a situation when the total pension from the compulsory system is lower than the minimum. This way, the functions of the pensions system, meant as an organised and compulsory manner of saving for one s old age (on two accounts), and the functions of the state in regard of income redistribution, which is financed through the state budget, i.e. all taxpayers participate in such financing, are separated. A supplementary element to the pension system guarantee is the minimum level of income, determined in the social assistance system, below which every citizen is entitled to access to the social assistance benefits. 4 Based on the current life expectancy tables published by the President of Central Statistical Office. 5 The minimum pension guarantee applies to persons that meet contribution period required by the law. 9

10 The pension reform capped the amount of contributions, similar to the amount of benefit earlier, at 250 per cent of an average annual wage. This means that people with higher income can expect relatively lower benefits in relationship to their earnings. On the other hand, after 1999 due to the introduction of the cap on insurable income, their net income increased. Those additional revenues can be the source of additional, voluntary savings so that those people could achieve higher income after retirement in the future. Functioning of the pension system, with abovementioned guarantees allows to meet one of the systems goals, which is reducing the poverty risk among the elderly Current situation: policy tools and achievement of goals Extreme poverty (subsistence minimum) in the families of pensioners Retirees families are in a relatively better situation than the totality of families in Poland. Poverty measured with the level of subsistence minimum affected 5.6% of the totality of retirees families and that ratio (the lowest among those for examined socio-economic groups) has remained unchanged in The respective ratios for the totality of families were 10.9% and 11.8%. The family of disability pensioners were in a worse situation as the poverty ratios for them were on the higher level than average and amounted to 15.1% in 2003 and 16.8% in The relative poverty rate for persons older than 65 years of age is also lower than for younger groups (0-64 years) and in 2001, according to EUROSTAT it was 6.6 per cent (compared to 18 per cent for the younger people). Poverty risk is higher for older women (8.2 per cent) than for older men (4.2 per cent). Minimum pension The primary objective of any pension system is to provide the sources of maintenance to people who, due to their age, have ended their professional activity. In the Polish pension system, people whose work period is long enough, but who did not achieve high income during their professional career, are guaranteed a minimum old-age pension or disability pension. A minimum pension is an entitlement vested in people who have attained 60 years of age (woman) or 65 years of age (man) and have an insurance period of 20 and 25 years respectively. If the insured obtains from the first and second pillar an old-age pension lower than the minimum pension, then his/her old-age pension is increased up to the amount of minimum pension. Presently, the minimum pension is PLN (23,6% of the average monthly wage) and is indexed with the consumer price index, i.e. in the same way as other pensions paid out by ZUS. Similar to other income, the minimum pension is subject to personal income tax as well as being covered with the compulsory health insurance. Supplements to old-age and disability pensions If a person has the old-age or disability pension and is recognised as entirely incapable of work and live independently or is being 75 years old is entitled to receive a specific amount of nursing supplement. Full orphans granted a survivor pension are entitled to receive an additional allowance a constant amount. The supplements are subject to indexation on the terms specified for all pensions. 10

11 Outside the pension system, there are supplements and discounts intended for elderly and disabled people. Many of them are financed from regional budgets, e.g. discount for city transportation, discounts in cultural institutions etc. The poorest pensioners can apply for social assistance benefits. Those people whose income does not reach the income threshold, due to age or disability, can receive a regular allowance that increases the net income up to PLN 461 in case of a single person and to PLN 316 per person in a family. Interim problems can be supported with temporary allowance in the amount determined by the difference between the income criterion level and the actual income of the person applying for benefit. Additionally, a one-time support is offered to people suffering from the consequences of unexpected events or natural disaster. Social assistance also offers nursing benefits and services to ill people and people living alone. In special cases, an institutional nursing assistance in social assistance houses is offered as well. The pensioners with low income, who do not manage to cover the payment of housing payments, can apply for housing supplements. The amount of supplement depends on the individually examined situation of the beneficiary, in accordance with detailed criteria (related to the income, level of housing expenditures, standards for the standard area of a flat), and the amount of supplement is transferred to the bank account of the entities managing the flats. Participation in the pension system Both pension systems functioning in Poland are commonly available and mandatory. As the comparison of the number of the insured and the number of employees shows, at present the vast majority of professionally active people participate in one of the forms of the social protection system. The situation should stay the same in the future. In the event of non-working periods such as child care leave, maternity leave, periods of nursing disabled family members, including children, unemployment (for the period, in which unemployment allowance is collected) or basic military service, the contributions for pension insurance are financed from the state budget. This means that people who have a break in employment for the aforesaid reasons, do not lose their pension rights. The issue that remains pending is the large number of inactive people, who are not covered by social security. Activation of these people is crucial, not only from the perspective of improving the financial sustainability of the system, but also in order to reduce the poverty risk among older people in the future. Survivor pensions In the Polish pension system, survivor pensions play an important role in the provision of adequate income, first of all to widows. Widows often prefer to use the survivor pension after the deceased husband, which ensures higher benefit than their own old-age pension. This results both from shorter insurance periods for women as well as their lower earnings. As a result, about 74% of women benefiting from survivor pensions are over 50, while only 9% of men of the same age receive this kind of benefit. 11

12 Voluntary savings Through the creation of special incentives and preferences, the Polish state supports voluntary forms of saving for pension purposes in the form of Employee Pension Plans (EPP) and Individual Retirement Accounts (IRA). The first employee pension plans were created in 1999, and IRA in The Employee Pension Plans are not that popular yet as in countries with longer insurance tradition, even though the schemes enjoy a number of incentives. Additionally, a difficult economic situation in recent years and low saving capabilities in Polish society have affected adversely the development of EPP. In September 2004, 100,000 people were members of EPP. An Individual Retirement Account is an account which enables additional saving for old-age with no need to pay income tax on capital gains. Saving with IRA allows additional savings to be accumulated which can be used later to supplement the pension income from the general system. Due to the short period of functioning, it is not possible yet to assess the effects of the implementation of the new solutions 6. Redistribution and intergenerational solidarity The new pension system clearly defines the rules of intergenerational solidarity and distribution of risk between individual generations. The old-age contribution rate was set at a constant level also for the future generation. The old-age pension depends on the sum of all old-age contributions paid throughout the entire work period and on the life expectancy at the retirement age. The ratio of current value of contributions to current value of future pensions is constant for all cohorts. As a result, the risk of longevity is incurred by that generation to which that risk applies. Demographic risk is diversified between the working generation and the pensioners generation. In the old pension system, theoretically speaking, there was a redistribution of funds from those who earned more to those who earned less. The amount of old-age pension depended among others on the total work period, but only wages covered by contribution, earned in 10 consecutive years out of 20 last years of professional activity or 20 calendar years chosen by the future pensioner from the entire work period were taken into account when calculating the amount of benefit. As a result, it was possible that people who worked longer, but their income remained at the same level relative to the average, had a lower old-age pension than those who worked for a shorter period, but their income increased significantly in the last years of their career. It happened even though the first group has paid more contributions to the system during their professional career. Thus, as a result, the assumed direction of redistribution was disturbed. There was also a ceiling of 250 per cent of average wage on the calculation basis, on which the old-age pension is computed, while there was no such limit on the contributions side. It meant that for people with higher earnings part of the contribution de facto constituted a tax, since having paid it did not result in an increase in pension rights. Only after January 1 st, 1999, similar ceiling was implemented in the covered wage contributions are paid until the limit of 30 times monthly average wage in the economy, projected for a given year is exceeded. Those and other phenomena were eliminated in the new system, where every contribution paid in has impact on the future old-age pension. 6 During first four months of IRA s functioning (September December 2004), about 180 thousand people created an account. 12

13 To calculate the benefit, the new pension system uses the same life expectancies for men and for women. This results in a redistribution between men and women which removes the differences resulting from demographic reasons. This system does not compensate for the differences resulting from different level of earnings of men and women. Those differences should be removed by the labour market policy aimed at equal treatment of the employed, regardless of their gender. The tax system in Poland is the same both for the employed and for the pensioners Future prospects and policy challenges In the future, the relationship between the old-age pension and wages will change. Firstly, due to the adopted rule of price-based indexation of benefits, the relationship of an average oldage pension to an average wage will be undergoing changes. Secondly, the relationship of individual old-age pension to the salary achieved before retirement, i.e. the so-called replacement rate, will change. This will be the result of applying defined contributions system as well as forecasted increases in life expectancy. The projections made indicate a drop in replacement rates in the future. It is essential that the future to ensure that wage level was high enough for the real purchasing power of future oldage pensions to grow as well. Therefore, the values of old-age pension benefits should be monitored so that in case of a risk of losing the financial adequacy, measures could be taken aiming at its improvement. Keeping the guarantee of a minimum old-age pension should protect against poverty. This is why that guarantee should be subject to periodical assessment as to whether it meets the goals set for it Strategies for securing future adequacy. The real value of future benefits depends first of all on the increases of wages and on the performance of the financial market. Thus ensuring proper conditions for dynamic growth in the economy and the labour market in Poland should be for a priority. Ensuring dynamic economic development which should stimulate a rise in wages and return rates of open pension funds should make it possible to accumulate savings large enough and minimise the risk of the need for the state budget to subsidise the minimum pension guarantee. Regular monitoring and preparing projections of future benefits may result in some changes in the framework of old-age and disability pension systems. An example of this can be the amendment of the Act on Pensions from the Social Insurance Fund of The amendment increased the rate of return on an individual account in ZUS up to the full change in the real growth of contributions due. This measures the of growth in the covered wage fund in the economy which is subject to mandatory insurance. According to the projection, the implemented change has increased the future old-age pensions in relationship to remuneration by about two p.p. 13

14 The future old-age pensions are greatly influenced by the individual decisions of the insured. In a defined contributions system extending one s working life brings double benefit. Firstly, the value of savings for old-age pension increases by the contributions paid and by the returns achieved on the savings made so far. On the other hand, the value of further life expectancy decreases, which as a result also affects the increase of future pension (last example in table 24). Analysis of replacement rates 7 When assessing the adequacy of the new pension system, one can rely now on projections of the relationship between the future old-age pension and the wage, i.e. so-called replacement rates. The projections made for the NSR purposes were prepared in several scenarios. In the basic scenario, they were calculated for a person who retires at the age of 65 after having worked for 40 years and whose earnings equal 100% of the national average. The ratios were calculated for the persons retiring in 2005, 2010, 2030 and In the first two cases, they are people retiring under the old system (as they were born before 1948). In 2030, a retiree will be covered by the new system already, but the amount of his/her benefit will be affected by the initial capital. In the case of a person retiring in 2050, the benefit will be fully calculated in accordance with new rules and such a person will be covered by the new pension system from the beginning of employment. The results presented do not take into account the division into the financial and non-financial system. This results from the fact that in each period the share of old-age pension from specific accounts will be different due to the existence of initial capital. The initial capital, i.e. part of the old-age pension right stemming from the old system, is added to the account in ZUS and its share in shaping the future benefits depends on how long a given person worked for before The projections made do not take into account the old-age pensions accrued in Employee Pension Plans, because participation of EPP is not common. Those plans cover as little as 2% of the insured. The results of projections show a drop in replacement rate value in 2050 as compared to This results firstly from the forecasted increased life expectancy in 2050 and from greater share of initial capital in the old-age pension calculated for a person retiring in The scenario where, on the basis of historical data, a higher real rate of return was assumed (gross 4% instead of 3%) shows that increasing the rate of return by 1 p.p. results in the increase of the replacement rate by nearly 4 p.p. In the next example, for a woman retiring according to current rules at the age of 60 the replacement rate is lower by as much as 12 p.p. This results from the fact that women save for their old-age pension for 5 years less; additionally, the accumulated funds have to last for a longer period of receiving the old-age pension benefit. The gender-neutral life tables were used in the example (in accordance with regulations in force, i.e. it was assumed that on average women live as long as men) and no difference was made between the amount of remuneration of women and men. 7 This part of the strategy is devoted to the analysis based on simulation assumptions, same for all EU, the results of which are presented in the enclosure. 14

15 The scenario, in which a person retires after 42 years of work at the age of 67 shows how the economic incentives to continue professional activity after having attained retirement age. The decision to work for 2 years longer allows for increasing the replacement rate in the discussed example by 6 p.p. The level of replacement rate is to a great extent affected by the macroeconomic assumptions. A low replacement rate ratio does not mean a low old-age pension. One should remember that the replacement rate shows the relationship of first old-age pension to the last wage, and with the assumption of higher ratios of salaries rise, lower replacement rates are achieved Financial sustainability of pension systems Common objectives Common objectives Member States should follow a multi-faceted strategy to place pension systems on a sound financial footing, including a suitable combination of policies to : 4. Achieve a high level of employment through, where necessary, comprehensive labour market reforms, as provided by the European Employment Strategy and in a way consistent with the BEPG;. 5. Ensure that, alongside labour market and economic policies, all relevant branches of social protection, in particular pension systems, offer effective incentives for the participation of older workers; that workers are not encouraged to take up early retirement and are not penalised for staying in the labour market beyond the standard retirement age; and that pension systems facilitate the option of gradual retirement; 6. Reform pension systems in appropriate ways taking into account the overall objective of maintaining the sustainability of public finances. At the same time sustainability of pension systems needs to be accompanied by sound fiscal policies, including, where necessary, a reduction of debt4. Strategies adopted to meet this objective may also include setting up dedicated pension reserve funds; 7. Ensure that pension provisions and reforms maintain a fair balance between the active and the retired by not overburdening the former and by maintaining adequate pensions for the latter; and 8. Ensure, through appropriate regulatory frameworks and through sound management, that private and public funded pension schemes can provide pensions with the required efficiency, affordability, portability and security Policy objectives A lack of financial stability in the pension system and a significant share of subsidies to the Social Insurance Fund and the Pension Fund of KRUS are a challenge for the pursed policy, in particular in the context of increasing public debt and systemic deficit of the public finance sector. Broadening the base of contributions, through increase in employment and labour productivity, is particularly important for enhancing the financial stability of general pension system. The present, high level of contributions for social insurance leads to a situation where 8 More on this subject in the attachment Analysis of Influence of Macroeconomic Assumptions on the Replacement Rates. 15

16 we are dealing in Poland with one of the highest levels of tax and quasi-tax imposed on wages, i.e. the so-called tax wedge in the EU area. This affects both supply and demand for work. The adopted actions aim at limiting the amount of contributions as well as at changing the social perception of their nature on the part of the market players. The level of contributions for disability and survivor insurance is considered particularly high and decreasing it will be possible after rationalisation of expenditures on disability pensions paid from that insurance. On the other hand, the new old-age pension formula forms 9 a direct relationship between the amount of contribution paid to the system and the amount of benefit. The old-age pension contribution is not treated as social tax, by as a kind of investment for the old age. Simultaneously, the priority of the labour market policy is to increase the employment rate among all age groups and first of all among those groups where there was the strongest decline in the last decade the youngest and the oldest employees. There is a need to adopt actions aimed at promoting additional, voluntary forms of old-age pension security. The initiatives that have been undertaken so far deserve further development and support by way of creation of incentive system. In the field of the social insurance of farmers, it is a crucial challenge to increase the role of contributions in the financing of pension benefits through implementation of contributions linked to the income from the farm. Simultaneously, the existing financial support for farmers pension system should be better addressed, first of all to the poorer farmers who cannot finance contributions in the amount allowing for financing of benefits to be paid out in the future Current situation The expenditures on old-age and disability pension benefits in Poland constitute a significant part of the public finance sector. In 2003, the expenditure on old-age and disability pensions from the Social Insurance Fund constituted 11.3% of GDP, KRUS expenditure were 2% and the expenditure of the security provision systems in total 1.4%. The total public expenditure on old-age, disability and survivor pensions constituted nearly 15% of GDP. A detailed information about expenditure is presented in the attachment. Subsidies to the social insurance funds and financing of the security provision systems also make an important element in the state budget s expenditure structure. In 2003, the subsidy to benefits paid out from the Social Insurance Fund constituted 13.1% of the budget s expenditures and the subsidy to KRUS 8% of those expenditures. Benefits from the security provision systems 6% of the budget s expenditures. All in all, over one fourth of the state budget s expenditures are associated with financing of pensions. Financing benefits in general system. The Social Insurance Fund is a separate state purpose fund. 10 The Fund s revenues come from: 9 This applies also to the anticipated rules for payment of benefits from the financial part of the general system. 10 It is a fund, established on the basis of public finance law for financing of specific defined benefits. 16

17 1) obligatory contributions financed by the employees, employers and in some cases (specified by law) from public sources, 2) purpose subsidy from the state budget, earmarked for payment of assigned benefits (benefits for the veterans, people disabled in war and the military disabled), 3) supplementary subsidy resulting from the guarantee by the state budget of payment of benefits resulting from the social insurance. The Social Insurance Institution may also draw commercial credits on behalf of the Social Insurance Fund for payment of benefits. In the recent years the balance of the Social Insurance Fund has been becoming worse. That was a result of: - smaller revenues from contributions in connection with the implementation of the new system, in particular with the large number of members in open pension funds as well as with the ceiling of the basis for contributions for old-age as well as disability and survivor pension insurance down to 250% of the average wage; - a decrease in the number of the insured: in 2003 the number of the insured was one of the lowest in the last decade, only in 2004 it grew by 0.9%; - stabilisation of the number of people receiving old-age and disability pensions at the level above 7 million people; - an increase in the relationship between the average old-age and disability pension and the average remuneration from 54.2% in 2000 to 57.6% in 2004, which makes it the highest relationship since As a result, the amount of supplementary subsidy from the state budged rose from PLN 17.4 billion in 2001 to PLN 24.7 billion in 2003 and PLN 19,4 billion in A heavy burden for the old-age pension insurance finances and consequently for the state budget that covers the deficit is supplementing the deficit in the Social Insurance Fund which occurred due to the transfer of part of the contributions to the open pension funds. The expenditures of the state on that account in recent years equalled over PLN 10 billion (over 14% of total revenues on account of contributions for social insurance). According to the forecast, the deficit in financing of old-age pension benefits will continue in the years to come, which means the necessity to provide subsidies for the system from the state budget. Since 1999, the Social Insurance Fund has had the possibility to draw bank credits to cover current expenditures. Due to the regular nature of such activity, borrowing from commercial banks has become one of the ways of financing the payment of pensions. The high level of debt of the Social Insurance Fund with commercial banks is maintained and the costs of system functioning are increased by the costs of servicing those credits. A considerable limitation of the Social Insurance Fund s need to take bank credits should be striven for as their price for the public finance is higher than the price of bonds. The old-age pensions paid out from the new pension system will bring about a decrease in the burden on the pension system and the state budget as compared with the old-age pensions paid out from the defined benefit system which was actuarially unbalanced. The defined contribution formula allows for the rule correlating individually the contribution to the system with the level of old-age pension paid out to be observed. However, the full effect of implementation of the reform on the expenditure side will become visible when the system reaches maturity, i.e. around The amount of supplementary subsidy in 2004 is not comparable to earlier years, as a result of change in the rules for financing the deficit resulting from contributions transferred to open pension funds. 17

18 Open Pension Funds Since 1999, the open pension funds (OPF) managed by private pension fund societies (PFS) are the mandatory element of the system of old-age pension insurance. The funds receive a contribution of 7.3% of its calculation basis (wage). Presently, OPF maintain 11.8 million accounts in which funds are accumulated that will be used to finance part of the old-age pension. From the launching of the new pension system until the end of 2004, the OPFs assets amounted to PLN billion, constituting 7.09% of GDP. By the end of April 2005, ZUS had transferred PLN 54.6 billion in total to OPF and the OPFs assets exceeded the value of PLN 68 billion, which was possible thanks to the effective investment policy of the OPFs managers. The dynamic growth of OPFs assets should be still observed for at least a dozen or so years to come. The OPFs investment portfolios are similar to each other. According to the data as of the end of March, the investment portfolio managers invested most of the entrusted funds (63.75%) in treasury debt certificates. the investments in shares of listed companies constituted 29.91% of the OPFs assets. Two other major categories of OPF investments, namely bank deposits and bank securities as well as non-treasury debt certificates constituted 4.53% and 1.36% of the assets value respectively. A similar structure of the investment portfolio has been kept since the beginning of the system s functioning. The financial part of the pension system is available to all insured 12. The policy of the state should contribute to the creation of appropriate conditions for the functioning of the capital market, favourable to the achievement of satisfactory rates of return. When assessing the structure of the OPFs investment portfolio with respect to challenges and possible risks, one should notice the funds engagement on the Warsaw Stock Exchange and the small share of non-treasury debt certificates. OPFs share in WSE free float 13 at the end of 2003 amounted to approximately 23% dropping to 15.3% at the end of 2004 (this was mainly caused by the large issues of new entities - MOL, PKO BP - entering the market). In addition to ensuring an appropriate demand for registered securities and access to the profitable investments in debt certificates, those actions should be supported that aim to increase the role of debt securities in financing Polish enterprises. Such actions should be helpful in maintaining OPFs investment efficiency. The rates of return being achieved since 1999 (that is since the creation), translatable into building up funds saved for the future old-age pension, are satisfactory. The average assetweighted rate of return of all Open Pension Funds for the last 3 years settlement period (March 29, 2002 to March 31, 2005) amounted to 41.48%. The system of monitoring OPFs investment efficiency is based on the three-year rate of return of the funds, determined twice a year. On that basis, rankings of all OPFs are made and two measures used for assessment of efficiency of the managers investment policy determined three-year average asset-weighted rate of return and the minimal required rate of return. In the history of OPF so far, one of the funds achieved worse investment results than the minimal rate of return for three times and the managing PFS made additional payments to the accounts of that fund s customers. 12 Born after Share market volume, measured with the part of shares in effective trading, i.e. after deducting block larger than 5% of the total number of shares. 18