1 Polish Pension Funds: Does The System Work? Cost, Efficiency and Performance Measurement Issues Antwerp, 5-7 May 2003 Dariusz Stanko Osaka University & Warsaw School of Economics

2 World Bank (1984) three pillar concept: public PAYG system (notional accounts in Poland) capital-based public pension funds market employer & individual private supplementary pensions

3 Pension reform: 1 January Funds started operating in April – September 1999 new system coverage: below 30 (compulsory), (optional), above 50 (unrelated) 16 (initially 21) fund operators m accounts 8.4 b USD savings = approx. 4.15% GDP retirement age: 60 ( f ), 65 (m) premiums: 19.52% gross earnings first pillar 12.22%, second pillar 7.3%

4 Basic facts on Polish pension funds end of March 2003 (Stanko, 2003b) average real returns: from 2.22 – 7.93 % p.a., median: 5.88 % p.a. members: 127 – thousand, average 702, median: 385 thousand net assets: 35 m – 2,450 m USD, average: 538 m, median: 241 m USD oligopoly: first three funds up to 75% of assets and members contributions: average 22 USD/month, average basis: 297 USD/month portfolio structure: bonds 68%, equities 25%, bank deposits 4%, T-Bills 3%

5 Problems and challenges (1) IT infrastructure (6 million payments a month) missing premiums: 2.3 b USD not paid threat of domestic capital market saturation  no international diversification (investment limits, cost incentives)  current assets already 30% of stock market capitalization and 17-18% of free-float  net assets growing fast High share of TB in the investment portfolio:  artificial PAYG system (Cesaratto)

6 Problems and challenges (2) state benchmarking and market oligopoly (Stanko, 2003b) “dead accounts” 17%: 2 m out of 12.2 m (March 2003) investment regulations:  no flexible investment options for members of varying age and human labour asset profiles  limited foreign diversification (5% ceiling)  instrument limits: real estate, derivatives (hedging)

7 What is wrong? only 20% of pension premiums allotted to capital market (average 22 USD/month) system’s nominal rate of return: % real rate of return*: – 10.6% (March 2003) (*static approach and only after 4 years, however indicating problem of fixed costs) but… positive investment skills: industry’s alphas % p.a., top funds 3-4% (Stanko, 2003b) …therefore the framework may need some adjustments! Are fund managers bad investors?

8 Danger of insufficient pension coverage low absolute premiums (budget constraints) high fixed costs (entry fees, systematic costs) investment disincentives (fee structure, benchmarks)  short-run and passive investment strategies Low system’s overall efficiency in spite of positive abnormal results.

9 Costs (1) upfront charges too high for small premiums management fees OK but higher share of equity should justify them state-imposed costs and other systematic costs (Table 5)

10 Second pillar – flow of premiums Costs (2) ZUS Social Insurance Institution ZUS transfer fee 0.8% of PREMIUM entry fee average 8.5% of PREMIUM assets investment units calculation fees: - brokerage - various services - depositary pension fund: accumulated assets units calculation returns from investment management fee (end of month) 0.6 pa % of ASSETS units calculation pension fund: premium

11 Performance measurement (1) Current benchmark (Polish law): peer index market-weighted average (AR) and minimum required rate of return (MR) MR = min { AR – 4%, 50% AR} Drawbacks of such a solution:  herding (big funds create average)  low risk-taking, short-time investment horizon  window-dressing  misleading information, potentially deceptive Linear fee structure gives no proper motivation: benchmark-excess based premium system needed

12 Performance measurement (2)