Testimony: Poland's Pension Reform
Dr. Krzysztof Ostaszewski
It was a mild summer day on June 8, 1995, in a conference room near Warsaw's Nowy Swiat street, in the middle of the historical Royal Tract, when I had my first opportunity to see José Piñera in action.
On that day, he was the keynote speaker at a meeting organized by the leading Polish free market think tank, the Adam Smith Research Centre, entitled "Changing the pension system: Prerequisite for economic growth".
The conference was well attended, mostly by Warsaw journalists and academics, and clearly noticed in the intellectual circles in the Polish capital. There were three speakers: José Piñera, who really does not need an introduction, professor Jan Macieja of the Polish Academy of Sciences, and myself. At that time, I was a Fulbright Research Fellow in Poland, studying actuarial aspects of free market reforms.
While Poland had engaged in rapid economic reform, privatization and rationalization of its economic system since 1990, nearly all serious decision makers were then beginning to admit that the reform was not complete. The shops were full, unemployment was falling, and the Polish currency, the zloty, had gained a respect it had not known since the pre-World War II days.
Yet the pension system was ill. The state was effectively a monopolist in the area of pensions. The state system was in serious long-term actuarial imbalance, and required a budget subsidy, which was in fact the largest single expenditure of the Polish government budget. While there was no immediate looming threat of bankruptcy, even ordinary people in the streets talked about how the state system they had been conditioned to trust was indeed insolvent in the long run, and required some serious reform.
There were people who had thought about pension reform since the very beginning of the Polish evolution out of communism, which began with the free election of 1989. In 1991, Wojciech Topinski, then the President of the Social Insurance Institution, contacted José Piñera to inquire about the Chilean reform, and visited Chile together with Professor Marian Wisniewski.
They took back José's book describing the reform as a special gift for President Lech Walesa, former Solidarity leader and Nobel Prize winner, who subsequently sent a letter of thanks for the gift. The architect of the economic reforms in Poland, Dr. Leszek Balcerowicz, also had indicated at times that the one piece his 1990 reform was missing was addressing the pension crisis. But five years passed (bringing us to 1995) and the old communist state pension system was still in place.
The three speakers spoke in three very different ways. José Piñera was a passionate and effective advocate for the Chilean reform, highlighting its simplicity and familiarity (after all, everyone, even in Poland, knows what a savings passbook is), and the empowerment of the people who previously had been dependent on the state.
Jan Macieja spoke about macroeconomic aspects of pensions, of the inefficiency and bad labor incentives of the state system, and how a private system can generate needed savings.
I had my own pet peeve. I have always believed that if one wants to retire, the way to do that was to save and invest enough to retire on. After all, the working life of an average worker is very long, in the range of 40 years. If one can save five dollars a day and earn 7 percent real (after inflation), over 40 years this add up (mathematically speaking, the term "multiplies up" would be more appropriate, as the end result is a product of the magic of compound interest) to one million dollars.
There were questions from journalists, discussions, and a lot of enthusiasm about these new ideas. Following the conference Andrzej Sadowski and Jan Wrobel of the Adam Smith Research Centre proposed that José Piñera videotape his ideas about pension reform.
One could reasonably ask whether making a viedotape could have a lasting long-term effect. However, to ask that would be indeed reasonable, but also would indicate lack of faith in the talents of two key players of the
event: José Piñera and Andrzej Sadowski. José's power of persuasion and Andrzej Sadowski's creativity in influencing public policy in Poland should never be underestimated.Within a month of this event some new developments moved the ideas of pension reform forward. On June 22, 1995, the main Polish business daily "Rzeczpospolita" published my article entitled "Sprywatyzowac ZUS" ("Privatize social insurance") which laid out the ideas for the full privatization of pensions in Poland following the Chilean model, and criticized reform proposals outlined by the government for their lack of vision and courage. While I am glad to take the credit for the ideas in my article, I do not think my article would have been there if it had not been for the talents of José Piñera, who made the case for the reform in the conference, and Andrzej Sadowski, whose behind-the-scenes work helped my then-controversial piece appear in a prominent spot.
Andrzej Sadowski did not stop there. He was not a novice in fighting for a difficult cause. During his years as a law student in Warsaw under communism, he worked to organize independent student organizations and free market thought, often under the threat and reality of interrogation or imprisonment. In 1989, following the first free election in post World War II Poland, when the first noncommunist government was formed, he worked with leading free-market economists in Poland-among them Wladyslaw Wilczynski, Jan Wilecki, and Cezary Jozefiak-to form the first free-market think tank in Warsaw, the Adam Smith Research Centre. To this day, the Centre remains the leader in free-market thought in Poland, while retaining complete independence from all political parties. Mr. Sadowski is its vice president, and its current president is Cezary Jozefiak, former Senator of the Republic of Poland.
On July 6, 1995, again thanks to Mr. Sadowski, I was invited to radio and television debates concerning pension reform in Poland. First, in the radio debate I faced Dr. Marek Mazur of the Ministry of Finance and Mr. Leslaw Nawacki of the Ministry of Labor and Social Policy. To my surprise, they turned out to be very friendly to the idea of reform.
In fact, Dr. Mazur had already worked on the possibility of reforming Polish pensions in the Chilean fashion. Dr. Mazur met José Piñera in April of that year at a conference in Airlie House (Virginia, USA) organized by the Institute of East-West Studies, attended by Ministers and high officials of every Central and Eastern European country, and dedicated to "Pension Reform in Transition Economies." Convinced of the conceptual idea, he was by now basically just concerned about transition costs.
Mr. Nawacki also reacted quite warmly, while defending the existing system as working much more efficiently than similar systems in other post-communist economies (rightfully so, I must add).
This was followed by a primetime television show on pension reform. The show started with a taped interview with José Piñera (this is why Mr. Sadowski and Mr. Wrobel were so busy with José in June), which was followed by adebate featuring Minister of Labor and Social Policy, Mr. Leszek Miller, Dr. Marek Mazur, representatives of several political parties and myself. Mr. Miller turned out to be the sole defender of the status quo. While he was by far the best debater of the group (to my dismay, despite my best attempts, but not to my surprise as Mr. Miller is one of the key politicians in Poland and the current leader of the former communist party, now reformed to Social-Democratic), even Mr. Miller had to admit that some form of reform had to come. His strongest argument was the cost of transition to the new system.
The summer months of 1995 began the process. In 1996, the Adam Smith Research Centre published José Piñera's book in Polish, entitled: "Bez Obawy o Przyszlosc" ("Without Fear of Tomorrow," that was a translation of his account of the political economy of the Chilean reform, titled in Spanish "El Cascabel al Gato. La batalla por la Reforma Previsional"). The book came with an insightful introduction by Professor Wladyslaw Wilczynski, who opened his article proclaiming strongly: "We should be learning something from the Chileans!"
Soon a special office within the Ministry of Labor and Social Policy was created and charged solely with reforming the pension system. The Ministry of Finance, and especially Dr. Marek Mazur, turned out to be a strong force for reform. Many people have contributed to this important process. Krzysztof Baczkowski, who took over the Ministry of Labor and Social Policy after Mr. Miller assumed other duties within the Social-Democratic government, is widely credited with initiating the reform work during the tenure of that cabinet.
In the 1997 election, the Social-Democratic party was defeated by a center-right coalition of mostly former Solidarity leaders, and the process of reform was accelerated. Under the new leadership of Ewa Lewicka, the office charged with reform worked continuously on a complete reform package, with great contributions from key people such as Marek Gora, Krzysztof Pater, and Leslaw Gajek.
The last Minister of Finance of the Social-Democratic government, Marek Belka, was among key speakers at a December 1997 London conference on pension reform. The conference was organized by the Cato Institute's Project on Social Security Privatization, (José Piñera serves the Project as co-chairman) and was sponsored by the influential weekly The Economist. At the conference, Belka made the case for the Polish reform. In early 1998, the Adam Smith Research Centre organized yet another conference on pension reform, but this time the conference was mostly devoted to unveiling the reform package proposal by Marek Gora and Leslaw Gajek, and discussing its meaning and significance.
I was invited to that event as a third main speaker. This time I put my effort into warning about the need for efficient and energetic government supervision of the emerging pension system, to avoid scandals that could really hamper reforms and hurt an unprepared public.
The ball was rolling.
A comprehensive reform package was prepared and presented to the Polish parliament in 1998. The system was to become effective in 1999. The most important step in the initiation of the new pensions occurred April 1, 1999, the first day Polish workers were allowed to put their savings into new individual accounts.
The Polish reform is not complete, as large portions of the old system remain. But it did create universal access for all Polish workers to professionally managed individual investment accounts, which will allow them to enjoy the miraculous benefits of capital markets.
The key provisions of the new system are as follows:
- Persons born before January 1, 1949 remain in the old state system, and receive benefits as prescribed by appropriate legislation. Those born between January 1, 1949 and January 1, 1969 are allowed to choose betweenthe old and the new systems. Younger workers must join the new system.
- The old payroll tax for pensions was 45%, which was paid by the employer. Of this, in the new system, 9% is redirected for workers to contribute to new accounts that they can set up with a private investment fund of their choice. Those accounts closely follow the Chilean model.
-The remaining payment is used by the government to continue a scaled-down state system. That system also now has individual "virtual" accounts. Deposits are held in workers' names, and interest is attributed to them based on the rate of growth of taxable payroll (not a market rate, unfortunately, but this peculiar way of crediting interest may create a hedge for the government against giving away benefits not supported by the economy). The state system allows that money to be paid out only in the form of a pension at the statutory retirement age. The amount of the pension is based on the life expectancy of the cohort of the worker (creating an amazing incentive for workers to encourage their contemporaries to lead unhealthy lives, since if people in their generation die younger, they receive a larger state pension).
- Companies managing private accounts must receive the approval of a special newly created regulatory agency, the State Office for Pension Supervision. This agency is headed by Cezary Mech, who was in fact one of
leading and effective advocates of reform before its implementation. Hopefully this choice of the lead regulator will help the reform.
- Companies must meet minimum capital requirements, and their activities are subject to regulation and supervision. In particular, if they deliver returns significantly below the overall industry average, they may have to make contributions to their customers' accounts from their own capital.
Additionally, there is a state guaranty fund to cover any losses due to any bankruptcy of a pension plan provider/manager (which is unlikely, but always possible). Companies managing pension money also face restrictions on their portfolios, limiting their foreign and derivatives exposures.These restrictions are somewhat heavy-handed, and one could only hope that over time they will be gradually lifted. But it is also quite clear that they are a product of the political process that led to reform-a process that required compromises and calming fears about revolutionary changes.
At this point, 19 private companies have received licenses to be pension plan providers for Polish workers. Most of them are alliances of Western and Polish financial institutions. Among the western financial institutions which entered this new market are:
Aetna, Citibank, Bank Paribas, Credit Lyonnais, Allianz, Commercial Union, Pioneer, Amvescap (in a joint venture between Invesco and the Polish Catholic Church), and Norwich Union (which happens to be the oldest life insurance firm in continuous existence in the world). There is also a pension plan provided by the Korean conglomerate Daewoo, and by the largest Polish cable TV station, Polsat.While the workers could start putting their savings into the new system on April 1, 1999, it was at the beginning of 1999 when advertising campaigns for the new pension plans started. One can see ads everywhere: on billboards throughout Poland, on television, and radio. Commercials are quite ingenious, referring to the need for financial security, but also to familiar characters from popular movies or books.
The most popular commercial shows a little boy named Bogdan, playing soccer with his teddy bear, giving the bear instructions on proper performance of its duties as a goalie. The message is Bogdan says "Bankowy." Bankowy is the name of the pension fund provided by a consortium of leading Polish banks. I am not sure if I would take Bogdan's advice, but this is the most popular and most noticed commercial. Maybe it will work.
The reform has only started. It is incomplete, and retains a large state system. But it does represent a great step towards empowering Polish workers and their families. Let us wish them all the best. Poland has been the successful leader among the post-communist economies of Eastern Europe.
Let us hope that this great step will help it strengthen this position.
Dr. Krzysztof M. Ostaszewski - FSA, CFA, MAAA- is Professor of Mathematics and Actuarial Program Director of the University of Louisville, U.S.A. His coordinates are:
Telephone :1-502-852-2730
Facsimile :1-502-852-7132
Email : krzysio@louisville.edu
Website: http://www.louisville.edu/~kmosta01/
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