Republic of Poland: Selected Issues Paper
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This Selected Issues paper considers the case of Poland to analyze global financial spillovers to emerging market (EM) sovereign bond markets. Foreign holdings of Polish government bonds have increased substantially over the last decade. Although foreign participation in local-currency sovereign bond markets provides an additional source of financing and reduces sovereign yields, it has also given rise to concerns about increased sensitivity to shifts in market sentiment. The analysis in this paper suggests that foreign participation plays an important role in transmitting global financial shocks to local-currency sovereign bond markets by increasing yield volatility and, beyond a certain threshold, amplifying these spillovers.

Abstract

This Selected Issues paper considers the case of Poland to analyze global financial spillovers to emerging market (EM) sovereign bond markets. Foreign holdings of Polish government bonds have increased substantially over the last decade. Although foreign participation in local-currency sovereign bond markets provides an additional source of financing and reduces sovereign yields, it has also given rise to concerns about increased sensitivity to shifts in market sentiment. The analysis in this paper suggests that foreign participation plays an important role in transmitting global financial shocks to local-currency sovereign bond markets by increasing yield volatility and, beyond a certain threshold, amplifying these spillovers.

The Polish Pension System: Fiscal Impact of the 2014 Changes and Remaining Policy Challenges1

This chapter presents an assessment of the long term fiscal impact of the 2014 pension changes and discusses key fiscal risks stemming from pre-existing flaws in the pension system. Under baseline macroeconomic and demographic projections over 2014–60, and assuming that half of the contributors switch to the first pillar, the 2014 pension changes will deliver an improvement in the fiscal accounts of about 30 percent of GDP in net present value terms. However, this improvement will be matched by an increase in implicit pension liabilities. More fundamentally, the 2014 pension changes do not address legacy flaws in the pension system, including old age poverty associated with low replacement rates; zero-floor indexation of first pillar notional accounts; a misalignment in the disability benefit formula; and pending reforms in special pension schemes. The chapter discusses policy alternatives to tackle these issues and highlights the need to ensure that fiscal policy remains prudent.

A. Introduction

1. The Polish pension system is based on three pillars. The 1999 pension reform entailed a move from a financially unsustainable defined benefit system to a defined contribution system, thus protecting its actuarial solvency. The reform also entailed the creation of a three-pillar system. The first operates as notional defined contribution (NDC), pay-as-you-go system (PAYGO), operated by the social security administration. The second entails a system of individual accounts managed by private pension funds (OFEs). Pension contributions to these two pillars are mandatory, with the largest part channeled to the first pillar and used to help pay current pensions. In addition, a third pillar of individual accounts is voluntary and not widely used.

2. The pension system underwent significant changes in 2014. Following an official review, the second pillar was scaled-back with the transfer of about half of pension fund assets (and corresponding liabilities) to the first pillar. The changes also entailed, inter alia, a redirection of contributions to the first pillar and the centralization of the payout phase in the first pillar. These changes led to a sharp one-off drop in (explicit) public debt in early 2014 and are expected to further improve fiscal aggregates going forward. However, they would also entail an increase in long-term (implicit) fiscal liabilities.

3. This paper presents an assessment of the long-term fiscal impact of the 2014 pension changes vis-à-vis the no policy change scenario. The assessment is based on projections of relevant fiscal flows over the period 2015–60, taking population trends as given and ignoring potential feedback effects between the pension system and the macroeconomy. Sensitivity analysis is carried out using four sets of adverse macroeconomic scenarios.

4. Baseline results indicate that the 2014 pension changes would deliver an improvement in the fiscal accounts, vis-à-vis the no policy change scenario. The gain originates from the partial unwinding of the funded second pillar, which leads to the fiscal recapture of a fraction of incurred transition costs from the 1999 pension reform.2 Moreover, the permanent drop in the size of the funded second pillar would also lead to a decrease in transition costs over the projected horizon. Given population projections, this would translate into positive cash flows to the fiscal sector until around 2050, followed by increasing negative flows in the outer years of the projection (and beyond). Overall, under the assumption that half of the contributors switch to the first pillar, the pension changes would generate fiscal cash flow gains of about 30 percent of GDP in net present value terms between 2014–60, compared with no policy change.

5. However, the pension changes would be fiscally neutral if the increase in implicit liabilities is taken into account. Asset transfers and redirections of pension contributions to the first pillar would lead to improvements in the fiscal balance and to reductions in explicit public debt. However, these would be exactly matched by increases in pension liabilities since the system operates as NDC. Therefore, if implicit and explicit liabilities were treated equality, the pension changes would be fiscally neutral (Mackenzie, 2003).3

6. Despite the improvements in the fiscal accounts, fiscal prudence remains essential. On impact, the pension changes will avert mandatory (and highly procyclical) fiscal consolidation, by reducing public debt below the 55 percent of GDP legal threshold.4 However, the since the pension changes entail larger payments in the more distant future, there is a need to maintain fiscal prudence and continue the fiscal consolidation currently under way. The new permanent expenditure rule will be important in this regard.

7. The pension changes do not address the fiscal risk of a sharp drop in replacement rates over time. The initial 1999 pension reform entailed a move towards a NDC scheme, protecting the actuarial solvency of the system through substantial declines in replacement rates (defined as the ratio of average pension benefits to wages) over time—from around 60 percent currently to 30 percent in the future according to the calculations presented in this chapter. Meanwhile, the creation of a funded second pillar did not generate an increase in economy-wide savings, as the accumulation of assets in OFEs between 1999–2013 was almost perfectly matched by an increase in public sector debt. Together, these two factors give rise to risks of old-age poverty, which may result in pressure on public finances in the future.

8. In the event of adverse economic developments, the fiscal sector would remain exposed to risks stemming from legacy issues in the pension system. In particular, non-negative indexation limits on the NDC accounts in the first pillar could lead to fiscal imbalances in a crisis scenario (as the growth of pension liabilities could exceed the growth of contributions). A misalignment of disability benefits with benefits in the core pension system could also increase incentives to claim retirement as disabled, weighing on fiscal resources. Unaddressed imbalances in special pension schemes for farmers, miners, and uniformed services could also lead to additional fiscal pressures over time.

9. Fiscal risks could be also ameliorated by undertaking parametric changes in some components of the pension system:

  • Addressing the drop in replacement rates. Options include expanding pension coverage to workers under special temporary contracts (who are also likely to be low-wage earners at greatest risk of old-age poverty), assessing alternatives to incentivize private savings in the voluntary third pillar, improving financial literacy.5

  • Revising the indexation of the first-pillar NDC accounts to allow for negative coefficients. A second best option could entail setting the indexation of the main account to the five-year average growth of the wage bill to reduce the negative fiscal impact of adverse temporary shocks to labor market developments.

  • Adjusting the disability formula. Disability benefits should be aligned to the largest extent possible with those of the core pension system to avoid adverse incentives and moral hazard problems.

  • Tackling special pension schemes. Special pension schemes need to be subject to parametric reform and aligned with the core pension system to ensure their actuarial solvency. This is not likely to generate substantial fiscal impact in the short term, but would translate into fiscal savings in the long run, helping to balance the flows under the PAYGO system.

10. The rest of the chapter is structured as follows. Section B presents a brief background of the 2014 pension changes and outlines the methodology and the main assumptions. Section C presents the baseline results and a sensitivity analysis, based on four adverse macroeconomic scenarios. Section D discusses legacy fiscal risks stemming from the pension system and presents some policy recommendations to help ameliorate them. Section E concludes, emphasizing the main policy recommendations.

B. Background and Methodology

11. Following the 1999 pension reform (Box 1), additional changes were implemented in 2011–2012. In the context of a fiscal consolidation strategy, pension contributions were partially redirected from the second to newly created subaccounts in the first pillar staring in 2011. These subaccounts were indexed to the average nominal GDP growth of the previous five years (Annex 1). Afterward, statutory retirement ages were increased starting in 2013, improving the financial footing of the pension system.

12. A substantial downsizing of the second pillar was implemented in 2014. The changes entailed the transfer of pension fund holdings of government debt and government-guaranteed debt (about half of pension fund assets), together with the corresponding pension liabilities, to the social security administration. The transferred Treasury bonds were subsequently cancelled, and the corresponding pension liabilities were registered in individual NDC sub-accounts in the first pillar. Individuals were given the choice to maintain their accounts in the pension funds, and to contribute 2.92 percent of their salaries to these accounts which required filing an administrative request within a four-month window. Otherwise, all new contributions would be redirected to the first pillar (the default option). Pension funds were banned from investing in government bonds and previous benchmarking and penalty systems were removed to encourage a more active portfolio management. Limits on holdings of foreign securities are expected to be lifted over time, from 5 percent in 2013 to 30 percent by 2016.

13. In addition, the payout phase will be centralized in the public system. The first cohort of men with private pension fund accounts begins retirement in 2014. The pension changes envisaged a centralized administration of the payout phase through the social security administration. All the contributions of individuals 10 years before retirement will be directed to the first pillar. In addition, assets in the second pillar will be gradually transferred to the first pillar starting 10 years before retirement (the so-called zipper).

14. The assessment in this paper compares the fiscal impact of the 2014 pension changes to a no policy change scenario. The baseline projections assume that 50 percent of OFE members, and 50 percent of new labor market entrants decide to contribute to the second pillar. Sensitivity analyses were conducted assuming extreme switching and entry rates of zero and 100 percent to assess a full range of possible outcomes.

The 1999 Pension Reform

In 1999, the Polish pension system was converted from defined-benefits to defined-contributions under a three-pillar structure. The first pillar entailed a public, NDC pay-as-you-go (PAYGO) system, operated by the social security fund (FUS). The second, a system of individual capitalization accounts managed by private pension funds. Contributions to these two pillars were compulsory for individuals below the age of 30 at the time of the reform. Those aged 30–49 were allowed contribute to the second pillar on a voluntary basis, while individuals aged 50 or more at the time of the reform were not allowed to open private pension fund accounts. In addition, a third pillar of individual investment accounts was offered as optional.

The creation of a funded second pillar, together with the recognition of inherited pension liabilities, entailed sizable transition costs. Pension contributions were maintained at 19½ percent of the wage bill. Between 1999 and 2011, 7.3 percent of the wage bill was transferred to the second pillar, and the remaining 12.2 was retained in the first pillar.

The reform ensured the actuarial solvency of the system but led to declining replacement rates. Individuals born before 1949 were grandfathered and allowed to receive pension benefits according to the previous system. For the younger cohorts, however, pension benefits were linked to their contributions, underpinning the actuarial solvency of the system. Contributions channeled to the first pillar helped pay current pensioners (as the first pillar operates as PAYGO) and were recorded in individual notional accounts indexed to the evolution of the nominal wage fund. In turn, contributions channeled to the second pillar earned market returns (net of fund management fees) based on the portfolios of pension funds. Upon retirement, pensions are determined by dividing the individual’s capitalized accounts in the first and second pillars over life expectancy. Over time, pensions are indexed by CPI inflation plus 20 percent of the real wage growth. Under this system, replacement rates were projected to drop over time (from around 60 percent in 2014 to 30 percent by 2060).

15. The exercise builds on a simplified static cohort model. It uses information on the age and gender profiles of balances in first- and second-pillar accounts as of end-2012, and on data on cohort-specific participation rates, age-earning profiles (seniority) and social security contributions. Demographic projections for 2015–60 are taken from Eurostat. The model assumes no behavioral responses and no feedback effects from pension changes to macroeconomic and labor market conditions. In the projections, cohort-specific contributions and payments are conditional on projected macroeconomic scenarios (summarized by GDP growth and average wage dynamics), fixed age-earnings profiles, and demographic projections. The macroeconomic scenarios are assumed to homogeneously affect all cohorts and both genders and are identical under both policy scenarios. In terms of retirement probabilities, the model uses the simplifying assumption that all beneficiaries enter the system at the statutory retirement age. While this assumption is in variance with observed behavior, it implies a narrowing gap between effective and statutory retirement ages and has no tangible impact on the marginal fiscal effect of the 2014 reform.

16. The model also assumes equal returns between NDC and second pillar assets. Financial returns on first pillar accounts are based on statutory indexation formulas, while returns on second pillar assets (net of fees) are assumed to evolve according to the average GDP growth of the previous five years (these are in fact close to the effective average returns obtained by pension funds between 1999–2012).6 The assumption of return equality entails a useful constraint to the analysis as it ensures that the results are not biased by imputed return differentials. All else equal, an increase in returns in the second pillar will generate higher pensions and also an increase in fiscal aggregates within the projection horizon due to the zipper (since the associated pension payments materialize later in time).

17. The effects of the 2014 pension changes are measured by the net present value of the incremental cash flows vis-à-vis the no policy change scenario. The fiscal impact is computed by taking the difference of annual cash flows to the public sector under the 2014 pension changes and those under the no policy change scenario. The net present value of the difference, expressed in terms of GDP, is used as a summary measure of the net fiscal impact of the pension changes. The calculations use a discount rate equal to GDP growth, which implies that the opportunity cost of fiscal resources (and the productivity of fiscal expenditures) matches the growth rate.7 Under this metric, a positive net present value implies that the 2014 pension changes produce a long-term improvement in the fiscal aggregates.

18. The estimations leave outside some important risks that are difficult to model. Material risks (both positive and negative) stemming from age-specific employment probabilities, productivity changes, and underestimated life expectancies are not assessed in this paper. Periodic updates of the financial soundness of the pension system offer an alternative to track major trends and fill this gap, providing the ground to assess the need for corrective measures.

19. The analysis focuses on cash flows and thus abstracts from differences in accounting criteria across various methodologies (Box 2). The one-off transfer of public debt and subsequent asset transfers in the context of the zipper are treated as positive fiscal cash flows (Annex 2).8 Corresponding transfers of pension liabilities are registered in notional accounts and indexed over time according to statutory formulas. The associated pension payments, which materialize at a later stage, are computed by dividing the capitalized balances in the first-pillar accounts at retirement (properly adjusted by pre-retirement asset transfers) by life expectancy. The resulting annuities are also indexed according to legal provisions.

Accounting for the Fiscal Impact of Pension Changes

The 2014 pension system changes affect the government accounts through several channels:

  • One-off asset transfer: in early 2014, pension funds transferred to the first pillar holdings of T-bonds (written-off immediately), government-guaranteed bonds, municipal bonds, and cash totaling at 51½ percent of their total assets.

  • Opt-out from second pillar: insured could opt-out and redirect all their new contributions to the first pillar (their assets will remain in private pension funds until they are gradually transferred to the first pillar starting 10 years before their retirement).

  • Lower contribution rate to second pillar: at 2.92 percent instead of 3.5 percent of income.

  • Redirecting contributions of the elderly: all the contributions of workers close to retirement will go the first pillar starting 10 years before reaching the retirement age.

  • Gradual transfer of assets: assets of persons 10 years before the retirement age will be gradually transferred to the first pillar.

The pension changes are registered differently by various fiscal methodologies. While there is a consensus to book additional contributions as revenues and pension payments as expenditures, there is no uniform treatment of asset transfers:

  • Polish statistics: the one-off debt transfer is registered above-the-line (government-guaranteed securities, and cash are booked as first pillar revenue); the gradual transfer of assets of the elderly is also classified as first pillar revenue;

  • ESA95: EU current methodology classifies both the one-off asset transfer and gradual preretirement transfers as revenues;

  • ESA2010: EU new methodology (to be implemented in late 2014) will classify the one-off debt transfer as a below-the-line financing transaction. The accounting of subsequent asset transfers in the context of the zipper may also be registered as below-the-line financing, and gradually registered as revenue as pensions are paid out.

  • IMF GFS: The IMF methodology also classifies the one-off debt transfer as a below-the-line transaction. Asset transfers in the context of the zipper would be registered as a financing item below-the-line, and gradually reversed when the corresponding pensions are paid out.

Methodological differences will lead to discrepancies in the fiscal accounts. Classifying asset transfers either as financing or revenues will affect the comparability of fiscal accounts. If asset transfers are registered below-the-line, as in ESA2010, there will be a downward pressure on public debt without matching entries on the fiscal balance (the latter will capture only a fraction due to lower interest costs). At the same time, asset transfers increase implicit liabilities, materializing in higher pension payments with matching fiscal revenues at a later stage.

C. Assessing the Impact of the 2014 Pension Changes

Baseline Results

20. The baseline scenario uses long-term official projections to facilitate the comparability of the results. Key macroeconomic variables (i.e., real GDP and real wage growth) follow MoF long-term projections (Text Figure 1). In the left panel, wage dynamics are stronger than GDP growth and compensate for a decreasing labor supply, leading to a stable labor share in GDP. In turn, the right panel shows the evolution of contributors to notional accounts in the first pillar and the number of contributors under the notional defined contribution system. It also shows the evolution of contributors to OFEs. The sharp drop in 2014 follows from the assumption that half of the contributors opt out from the second pillar (there is no matching increase in the number of contributors to the first pillar since the switching changes their OFE affiliation but not their first pillar membership). The cash flows under the status quo and the pension changes are computed using these projections and applying the static cohort model. Thus, the estimated fiscal impact of the pension changes under the baseline scenario can be compared with the latest official results.

Text Figure 1.
Text Figure 1.

Poland: Model Assumptions

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Note: “FUS contributors” refers to the number of contributors to the first pillar; “FUS sub-account contributors” to those that have a notional account in the first pillar; “OFEs contributors” refers to the number of contributors to OFEs; and “Reformed FUS pensioners” reflects the number of pensioners under the notional contribution system implemented in 1999.Sources:MoF, Eurostat and staff estimates.

21. The impact on fiscal cash flows is positive over the projection horizon, and broadly in line with official estimates. As a result of the 2014 pension changes, cumulative cash flows build-up in the short- and medium-term and peak to about 31 percent of GDP by 2050. Afterward, the increase in pension payments starts to offset the incremental pension contributions and the interest savings, which causes a decline in the cumulative gains to around 29 percent of GDP by 2060 (Text Figure 2). This is broadly in line with official estimates.9 The factors which affect the net cash flows are:

Text Figure 2.
Text Figure 2.

Cumulative Fiscal Gains of Pension Changes

(Percent of GDP)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, GUS, KNF and Eurostat.
  • Higher flow of contributions to the first pillar. The additional stream of contributions to the first pillar vis-à-vis a no policy change scenario will cause a substantial drop in transition costs. The gains originate from: (i) individuals who are assumed to opt-out of the second pillar; (ii) a reduction in contributions to OFEs for individuals who chose to maintain their accounts in the second pillar; and (iii) individuals approaching retirement age, as their contributions will be entirely redirected to the first pillar starting 10 years before retirement. Overall, using a rate of return equal to GDP growth, these additional contributions generate an improvement in the fiscal accounts by some 30 percent of GDP in net present value terms between 2014–60.

  • Asset transfers. Pension fund holdings of government debt and government-guaranteed debt transferred in 2014 represent 9 percent of GDP, resulting in lower debt service during the projected horizon. Additionally, assets in the second pillar transferred to the first pillar starting 10 years before retirement provide a cumulative 18 percent of GDP in cash flows to the fiscal by 2060.

  • Higher pension payments. While pension benefits remain unaffected by the 2014 changes, the increase in contributions and asset transfers to the first pillar will lead to higher pension payments by the public sector by a cumulative 28 percent of GDP by 2060, partially offsetting previous cash flow gains.10

22. The positive effect of the pension changes on fiscal aggregates is likely to be smaller under an infinite horizon. The improvement in cash flows as a result of the pension changes is exactly matched by an increase in implicit pension liabilities that have to be repaid beyond the projected horizon. Implicit pension liabilities will be covered by the stream of pension contributions under the PAYGO after the system reaches its long-term equilibrium. However, the fact that net fiscal gains are on a downward trajectory at the end of the projection suggests that this equilibrium is not yet reached by 2060. Thus, an assessment over an infinite horizon is likely to produce lower cash flow gains than those reported in this chapter.

Sensitivity Analysis on the Impact of the 2014 Pension Changes

23. The results are broadly robust to alternative switching rates to the first pillar. Contributors’ decisions to stay in private pension funds are not crucial for fiscal impact. The 2014 reforms envisage voluntary participation in the funded second pillar, with the insured having to decide in April-July 2014. These decisions could be then confirmed or reversed in 2016, and every four years afterward. In the case of no explicit choice, all new pension contributions will be redirected to the first pillar (i.e., the default). Under the assumption that all the contributors decide to stay in the second pillar, the net present value of the fiscal gains will represent 23 percent of GDP under the baseline scenario. At the other extreme, under the assumption that all the contributors decide to opt-out of the second pillar, the net present value of the fiscal gain will increase to 35 percent of GDP. These results show that voluntary participation in the second pillar is not the key component in terms of the long-term fiscal impact, and other elements the pension changes (especially the gradual transfer of assets prior to retirement) will play a more significant role.

24. The robustness of the baseline results is also assessed using four macroeconomic scenarios. The relative dynamics of the macroeconomic variables under each of these scenarios are based on historic correlations, calibrated with the help of Vector Autoregression (VAR) models. The scenarios are as follows:

  • Scenario 1: Historical Dynamics. Macroeconomic variables are assumed to remain at their historical averages (i.e., levels observed during 200-13) (Table 1). In this scenario, real GDP growth averages 2.4 percent and, wage bill growth averages 2.5 percent. As a result, the ratio of the wage bill to GDP stabilizes at around 25 percent.

  • Scenario 2. Severe Downturn. This scenario assumes a 3.8 percentage point drop in GDP growth (two standard deviations) relative to the baseline in years 2020–23, followed by a permanent drop in potential growth equivalent to one standard deviation over the rest of the projected horizon. The impact on inflation, wages, and employment is based on historic correlations. In this scenario, real GDP growth averages 1.7 percent, with a minimum of −3.2 percent and 7 years of negative performance.

  • Scenario 3: Sluggish Wages. This scenario assumes that labor productivity slows down going forward, which materializes in slower wage and employment dynamics. GDP growth performance is comparable to the baseline scenario, but the growth of the wage bill averages 1.7 percent during the projection. As a result, the ratio of the wage bill to GDP drops from 26 ½ percent in 2014 to 22 percent at the end of the projection horizon.

  • Scenario 4. Protracted Crisis. This scenario assumes a severe protracted crisis. The scenario implies a cumulative 23 percent and 20 percent drop in GDP growth and wages over 2020–25 relative to the baseline.

Table 1.

Summary Statistics of Selected Variables Under Alternative Scenarios

article image
Source: IMF staff calculations.

25. The baseline results are fairly robust to the sensitivity analysis. Overall, the fiscal impact of the pension changes under each of the distressed scenarios deviates from the baseline results by less than 6 percent of GDP (Text Figure 3). Consequently, the conclusion that the pension changes have a positive impact on fiscal aggregates appears fairly robust to changes in the macroeconomic assumptions. This robustness rests on the stability of the share of the wage bill to GDP. Since the indexation of the sub-accounts is linked to average GDP growth, a downturn scenario would translate into slower growth of pension liabilities, helping counteract the weaker pension contributions. Thus, the stream of cash flows would mainly depend on the relative dynamics of the wage bill and GDP. An eventual slowdown of the wage bill growth relative to GDP dynamics will tend to erode the net fiscal inflows, and vice-versa. This is why the sluggish wage growth scenario has the largest adverse impact.

Text Figure 3.
Text Figure 3.

Sensitivity of Baseline Results to Macroeconomic Shocks

(Cumulative percent of GDP)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, KNF and Eurostat

Impact of the 2014 Changes on the Second Pillar

26. The 2014 pension changes entail a scaling back of the second pillar. The one-off debt transfer will lead to a sharp decline in the size of the second pillar (from around 18 percent of GDP in 2013 to around 9 percent of GDP in 2014). In addition, the subsequent drop in the assumed flow in contributions to the second pillar will add to the effect of asset transfers as a result of the zipper. Under the no policy change scenario, the assets of the second pillar would have reached 36 percent of GDP by 2060 (Text Figure 4). In contrast, projected second pillar assets under the 2014 pension changes are projected to stabilize at around 7 percent of GDP in 2060. Thus, the difference in the size of second pillar assets matches the estimated increase in cash flows to the fiscal and the increase in implicit pension liabilities for the government.

Text Figure 4.
Text Figure 4.

Projected Evolution of Second Pillar Assets

(Percent of GDP)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, KNF and Eurostat

27. The long term viability of the second pillar would depend on the share of contributors opting-in. The number of contributors that opt in to second pillar accounts is of crucial importance for its viability. Under the assumption that all contributors decide to shift their contributions to the first pillar, the second pillar will cease to exist before 2050, when remaining assets are transferred to the first pillar in line with new pension payout framework. Alternatively, if all current and future contributors opt in, second pillar assets will increase to about 17 percent of GDP by 2030 and stabilize at around 14 percent of GDP by 2060.

D. Assessing Legacy Fiscal Risks

28. Despite their positive fiscal effects, the pension changes do not eliminate the fiscal risks stemming from legacy flaws in the system. The larger first pillar following the 2014 pension changes will still require further reforms to mitigate fiscal contingencies. This section presents an assessment of fiscal risks stemming from indexation of notional pension accounts, inadequate replacement rates, special pension regimes, and disability benefits, together with some policy recommendations to address these risks.11

First-Pillar Indexation

29. The indexation of notional accounts in the first pillar does not guarantee the long-term financial viability of the pension system. A defined-contribution pension scheme could be financially viable (including an unfunded PAYGO), providing that indexation of notional pension capital does not exceed the dynamics of pension contributions (Samuelson, 1958). The original 1999 pension reform aimed at achieving this outcome by setting indexation of the notional capital below the dynamics of the pension contribution base (also referred to as covered wage bill) and by allowing negative indexation coefficients. However, the rules were revised subsequently to fully reflect the growth of the covered wage bill and to impose a zero-floor limit on indexation. In turn, the indexation of the notional sub-accounts created in 2011 was set to the 5-year average nominal GDP growth and also restrained by a zero-floor limit. The analysis in this section estimates fiscal risks arising from such asymmetric indexation mechanisms in case of adverse macroeconomic shocks.

30. Adverse economic shocks could undermine the solvency of the system. An episode of slow growth, or a crisis scenario, could activate the zero-floor indexation limit and lead to financial imbalances in the pension system (as the growth of revenues would fall behind indexation of the notional accounts). To assess the fiscal risks of asymmetric indexation, the projections under current rules are computed for the set of distressed macroeconomic scenarios discussed above, and then compared to a counterfactual policy that allows for negative indexation. This allows isolating risks related to asymmetric indexation and quantifying them in a long-term.

31. Indexation of the main accounts may pose a large fiscal risk. Each of the shock scenarios would activate zero-floor indexation limit in the main account, with adverse fiscal consequences compared to a scenario allowing negative indexation. In the projections, this impact would range from 3 percent to 25 percent of GDP (Text Figure 5). Shocks heavily affecting the wage bill (as under the Sluggish Wages and the Protracted Crisis scenarios) could be particularly costly for public finances under the current indexation mechanism of the main account.

Text Figure 5.
Text Figure 5.

Shock Scenarios: Cost of Zero-Floor Indexation 1/

(Cumulative, in percent of GDP)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

1/ Difference vs. system without zero-floor indexation constraint.Source: Staff estimates based on ZUS, KNF and Eurostat

32. Fiscal risks could be mitigated by changing the indexation mechanisms. The analysis suggests that the largest fiscal risk emanates from the indexation of the main account, while the sub-account could cause imbalances only in extreme cases. The most transparent way to address such risks would be to allow negative indexation of notional accounts, as envisaged by the original pension reform. Fiscal risks related to short-lived wage shocks could also be mitigated by making indexation of the main account dependent on multi-year instead of annual dynamics of covered wage bill. Such a change would suffice to eliminate the risks under the Historical scenario, and it would significantly mitigate risks under Severe Downturn and Sluggish Wages scenarios, all modeled as randomized scenarios based on VAR model. However, this would not suffice to reduce the substantially adverse fiscal impact of the Protracted Crisis scenario.

Replacement Rates and Old-Age Poverty Risk

33. The pre-reform pension system was unsustainable. At the eve of 1999 pension reform, the system was characterized by low effective retirement age and high replacement rates (Text Figure 6). Given adverse demographic trends, growing deficits generated by such scheme would undermine public finances. The 1999 pension reform addressed this challenge by gradually moving from the old defined-benefit formula, only partly linked to contributions, to a defined-contribution, where pensions almost fully depend on contributions paid. Other things equal, decline in replacement rates would be the result of stabilizing the system by changing the pension formula.12

Text Figure 6.
Text Figure 6.

Unsustainable Pre-Reform Pension System

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: ZUS, GUS, Eurostat.

34. The projections suggest a sharp decline of pensions relative to wages. The model assumes that returns in the second pillar (net of fees) are equal to first pillar indexation, which is broadly in line with the experience so far. This implies that market returns follow GDP and wage bill dynamics, which makes pensions indifferent to the split of contributions between the two pillars, and the 2014 reforms neutral for replacement rates. On this basis, the replacement rate is projected to decline from around 60 percent currently to some 30 percent by 2060 (Text Figure 7). While different estimates of future benefits unavoidably vary, as they depend on modeling parameters, various projections point to a sharp decline in replacement rates. For example, the latest EU Commission Ageing Report (EC, 2012) suggests a 27 percentage point drop in replacement rates by 2060.

Text Figure 7.
Text Figure 7.

Replacement Rates

(Percent of average wage)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

1/ In contrast to projection, actal data covers legacy define benefit system and special pension schemes in ZUS.Source: IMF staff estimates based on ZUS, GUS, Eurostat:

35. The 2012 increase in statutory retirement ages prevented an even deeper drop in pensions. The above estimates incorporate the gradual increase in retirement ages (from 65 to 67 for men and from 60 to 67 for women). This reform prevented a 7 percentage point deeper drop in replacement rates (Text Figure 8). Gender equalization of the retirement age also helped to reduce pension disparities between men and women.

Text Figure 8.
Text Figure 8.

Estimated Replacement Rates, 2060

(Percent of average wage)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, GUS, Eurostat

36. But old-age poverty risk still stands out as an important long-term issue. The risk of poverty among Polish retirees is currently below EU average, but will likely become more pronounced along the projected decline in replacement rates. The estimates suggest that the share of pensioners at risk of poverty could increase substantially in the long-run (Text Figure 9).13 The threat of old age poverty appears particularly high assuming that poverty thresholds remain unchanged relative to wages, as for social minimum and equivalised income, which may, however, overstate long-term risks. On the other hand, keeping partial indexation to wages, as for legal minimum pension, may not be sustainable in the long run.

Text Figure 9.
Text Figure 9.

Share of Pensioners Below Selected Income Thresholds

(Percent)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, GUS, Eurostat.

37. The minimum pension guarantee may not suffice to alleviate old age poverty. While there is a legally guaranteed minimum pension, its level relative to wages is bound to decline gradually since its indexation accounts only for only 20 percent of real wage growth (Text Figure 10).14 By 2060, almost no retirees are projected to fall below the minimum pension, which will practically eliminate the fiscal risk of topping-up their benefits. However, this provides little comfort in terms of alleviating old-age poverty risk. Thus, developing efficient social assistance mechanisms for poor pensioners stands out as an important long-term policy challenge.

Text Figure 10.
Text Figure 10.

Legal Minimum Pension

(Percent of average wage)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: IMF staff estimates based on ZUS, GUS and Eurostat

Special Pension Regimes

38. In Poland, special occupational pension schemes have a broad coverage and pose a fiscal burden. Beyond the core pension system, there are several occupational schemes for miners, “uniformed services” (police, military, border guards, etc.), and farmers. Together, these sub-systems covered 2.1 million beneficiaries in 2010, equivalent to 29 percent of those in the regular system. Outlays on special pensions were 2.7 percent of GDP or 29½ percent of regular pensions (Text Figure 11). The ratio of contributions to pension outlays in occupational schemes tends to be low, with the uniformed personnel scheme fully paid by the state budget (Text Figure 11). In 2010, the gap between contributions paid by farmers and miners and pension spending under their retirement schemes was around 1½ percent of GDP. This gap would increase to 2.4 percent of GDP if uniformed personnel pensions are also included.

Text Figure 11.
Text Figure 11.

Special Pension Schemes in Poland, 2010 1/

(Percent)

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

1/ Figures include old-age, disability, and survivor beneficiaries.2/ Regular system only.3/ Estimated from mining sactor wages and employment data.Source: IMF Staff estimates based on ZUS, KRUS and Wiktorow (2011).

39. Occupational pension schemes are more generous than the regular system. While the ratio of contributions to pension spending in the core system should increase as it moves to defined contribution basis, this is unlikely to happen in the special schemes, which continue to be based on a defined-benefit formula. Also, pensions of uniformed services and miners are significantly higher than regular old-age pensions whereas their effective retirement age is lower (Text Figure 12). Uniformed retirees have an unlimited possibility to work regardless of age, while benefits of early retirees in the core system are reduced or suspended above certain thresholds. Farmer benefits are well below the average, but also the contributions are very low (covering only 10 percent of outlays).

Text Figure 12.
Text Figure 12.

Generosity of Special Pensions Schemes, 2010

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Sources: ZUS, KRUS and and Wiktorow (2011).

40. Against this background, there are possible alternatives to reform the special schemes. Separate pension schemes stand against the principles of the original pension reform, which envisaged the universal coverage of the regular system.15 Given the need to recognize the accrued pension rights, reforming the special schemes is unlikely to yield fiscal gains in the medium-term. However, it would make the system more coherent, with the potential to deliver long-term gains and improve fiscal sustainability. The issues and policy alternatives for each sub-sector are slightly different:

  • While there may be merits to have uniformed services outside the regular scheme, the system could be rationalized with parametric changes. Some important changes were implemented in 2013, when the work period to obtain pension rights was lengthened from 15 to 25 years, and a minimum retirement age was set at 55 years. These rules, however, are still milder than in the regular system. Thus, consideration may be given to further changes to link pensions more closely to the nature of work.

  • The system for miners may be seen as a hidden subsidy for the mining sector. A possible option, considered also by the authorities, would be to keep privileges only for those truly working under hardship conditions. A more transparent solution, however, would be merging miners with the main system and paying for their privileges by explicit budget subsidy or higher employer contributions.

  • Official plans for farmers assume gradually covering them with personal income tax and making their pension contributions and benefits dependent on income. While this appears to be the right direction for reforms, specific legal initiatives for implementation have yet to be articulated. Additionally, enrollment in the farmers’ social security scheme depends on land ownership regardless of whether agriculture provides the main source of income. This creates incentives to misuse the system. Therefore, revision of the enrollment criteria should be considered.

Disability Benefits

41. Maintaining the current disability formula implies growing incentives for misuse. The incidence of disability was very high in the early 1990s, when the number of disabled pensioners almost matched old-age beneficiaries (Chlon-Dominczak, Agnieszka, 2009). This reflected lenient disability assessments (to mask open unemployment), leading to widespread abuse of the pension system. Subsequent tightening of disability regulations radically reduced this problem, but there may nonetheless be incentives to seek disability rather than a retirement pension. As retirement pensions are projected to decline over time relative to wages, disability benefits will become increasingly appealing: under current rules, disability benefits could exceed projected pensions some 10–15 years before the statutory retirement age for the lower income groups and among workers with shorter contribution periods (Text Figure 13). While the disability formula should retain an insurance component, there is room to seek better alignment with old-age pensions to ameliorate adverse incentives.

Text Figure 13.
Text Figure 13.

Attractiveness of Disability Benefits vs. Old-Age Pensions

Citation: IMF Staff Country Reports 2014, 174; 10.5089/9781498367868.002.A004

Source: Staff estimates.

E. Conclusion

42. The analysis presented in this paper indicates that the pension changes undertaken by Poland in 2014 would deliver an improvement in the fiscal accounts. The partial unwinding of the second pillar will generate an increase in contributions to the first pillar and a sustained drop in (explicit) public debt (and associated interest payments). At the same time, the public sector will take on larger pension payments in the future. Since statutory indexation clauses in the notional accounts in the first pillar are indexed to the evolution of the nominal wage bill and GDP, they tend to provide a link—under normal conditions—between the growth of implicit pension liabilities and the flow of pension contributions under the PAYG scheme. Furthermore, the fact that pensions are based on capitalized contributions (through the NDC system) also tends to support the actuarial balance of the system.

43. The pension changes do not address legacy issues in the pension system:

  • Excessively low replacement rates (associated with the original 1999 pension reform) may increase the incidence of old-age poverty, possibly leading to higher fiscal contingencies not assessed in this paper. To ameliorate this risk, it is important to promote awareness of the insufficiency of projected pensions and explore alternatives to stimulate additional private savings.

  • The indexation mechanism of the main account merits revision. The non-negative indexation in the first pillar (particularly in the main account) may jeopardize the financial soundness of the system and translate into fiscal contingencies in the event of adverse macroeconomic developments. These risks could be mitigated by relaxing the non-negative indexation clauses or by linking the indexation of the main account to multi-year wage bill dynamics.

  • The relatively generous disability formula should be aligned to the extent possible with old pension benefits to reduce adverse incentives as replacement rates drop over time.

  • Longstanding reforms to the special pension schemes for farmers, miners, and uniformed services also need to be tackled.

Annex I. Major Reforms and Modifications to the Polish Pension System

The 1999 Reform

1. The 1999 reform of the pension system helped improve its long-term sustainability but entailed sizable transition costs. With the reform, the single public scheme was replaced with a two-pillar mandatory system: a public pay-as-you-go (PAYGO) first pillar, and a funded second pillar (OFEs). Pension rights accrued under the old (and actuarially insolvent) defined-benefit scheme were recognized, but the benefit formula under the new system was changed to defined-contributions (Box 1). Thus, pensions under the new system would depend on contributions paid to the first pillar (booked in individual notional accounts and indexed by the growth of the contribution base) and to OFEs (invested in market assets, yielding market returns). The reform implied an immediate fiscal cost due to the partial diversion of pension contributions to the OFEs. Official estimates (Ministry of Labor and Social Policy, 2013) suggest that fiscal cost of the original reform would be around 80 percent of GDP by 2060, which is also consistent with the estimates presented in this chapter.

2. The financing of the transition gap led to growing fiscal constraints. Since the launch of pension reform, the accumulation of assets in the second pillar led to fiscal costs and was broadly matched by growing public debt. Over time, public debt approached legal limits, leading to fiscal constraints and exposing clear trade-offs on the allocation of scarce fiscal resources.1 Meanwhile, risk diversification in the second pillar was also limited by regulations and incentives facing pension funds, which led to the prevalence of public debt in pension fund portfolios.

The 2011 and 2012 Reforms

3. Transfers to the second pillar were reduced in 2011. As part of a fiscal consolidation program, transfers to the second pillar were cut to 2.3 percent of the wage bill starting in May 2011, and the remaining 5 percent was redirected to subaccounts in the first pillar, boosting fiscal revenues. These sub-accounts would be indexed at the average nominal GDP growth of the previous five years. The authorities planned a partial reversion of pension contributions back to the second pillar, starting from 2.8 percent of the wage bill in 2013 to 3.5 percent of the wage bill by 2017.

4. Statutory retirement ages were increased starting in 2013, improving the financial footing of the pension system. A decision to gradually increase the statutory retirement age to 67 and equalize for men and women is expected to increase activity rates among the older age groups and improve replacement rates. In parallel, an increase in the retirement age for new entrants to uniformed services implemented in 2013 would also contribute to improve the financial soundness of the pension system.

5. Long-term demographic trends, however, pose substantial challenges going forward. The combined effect of declining fertility rates and increases in life expectancy would lead to adverse population dynamics. In fact, the pace of the aging process in Poland is projected to exceed that of other European countries. As a result, the old-age dependency ratio (defined as the number of persons aged 65 and older, relative to those between 15 and 64) is projected to increase from about 20 percent in 2012 to 70 percent by 2060 (Jabłonowski, and Müller, 2014). If continued, these population dynamics are likely to exert substantial pressures on the PAYG system, with adverse fiscal implications.

Annex II. A Stylized Example

1. The pension changes create a gap between the fiscal deficit and (explicit) public debt dynamics. Increased contributions from the second- to the first-pillar generate an improvement in the fiscal deficit, particularly in the short- and medium-term (since the corresponding pension payments materialize later in time). On impact, the fiscal deficit (and its financing) also improves with the transfer of public debt from the second to the first pillar, as it leads to lower interest expenditure. Similarly, asset transfers associated with the zipper reduce public debt and the associated interest bill. In contrast, the implicit fiscal cost associated with indexation of the (new) notional account is not captured above the line on an accrual basis, and only resurfaces over time when higher pension payments are made from the first pillar.

2. A stylized example of the fiscal impact of pension changes serves to illustrate the accounting and the methodology used in the assessment. Let Wt be the economy-wide nominal wage bill at time t, and α the share of wages that collected as pension contributions in the first pillar under the status quo policies. As a result of the pension changes, the share of social security contributions collected in the first pillar will increase to αR>α, where the increase reflects the redirection of pension contributions from the second to the first pillar and also depends on the number of workers choosing to switch back to the first pillar (the default option). Pension contributions from workers that participate in the reformed defined-contribution pension system are registered in three types of accounts:

  • Individual notional accounts in the first pillar (A1) which are indexed to the evolution of the nominal contribution base, and subject to a zero-floor.

  • Individual sub-accounts created in 2011, after the redirection of pension contributions from the second to the first pillar (A2), which are indexed at the average GDP growth of the previous five years. The sub-accounts are also subject to a zero-floor indexation. Between 2011–13, these sub-accounts have accumulated the partial redirection of pension contributions to the first pillar that is included the status quo policies.

  • Individual sub-accounts after the pension changes (AR2), which reflect the additional balances resulting from the additional redirection of pension contributions to the first pillar and the gradual transfer of assets under the zipper (i.e., AR2>A2).

  • Individual accounts in the second pillar (A3), which growth in line with market returns net of management fees.

Let Pst denote the economy-wide pension payments that result from the different accounts in the pension system, denoted by the sub-index s=0, 1, 2, 3. Where s=0 refers to the yearly pension payments of the grandfathered pensioners and workers at the time of the 1999 pension reform; s=1 refers to pension payments that correspond to balances in the A1 notional accounts in the first pillar; i=2 refers to the pension payments that correspond to the A2 accounts in the first pillar; and s=3, which correspond to pension payments associated with the A3 capitalized balances in the third pillar.

3. The relevant cash flows for the fiscal sector are as follows. For the status quo policies, the cash flows comprise: (i) pension contributions, minus (ii) pension payments, and (iii) interest payments on pension-related public debt:
αWtiDt1(P0t+P1t+P2t)[1]
where P2t captures the portion of pensions associated with contributions registered in the first pillar sub-account under the status quo policies. In turn, the corresponding flows for the pension changes are given by:
αRWtiDRt1(P0t+P1t+PR2t)[2]
where PR2t captures the portion of the pensions associated with contributions registered in the first pillar sub-account under the pension changes, which includes the additional contributions and the asset transfers (i.e., PR2t> P2t)). The impact of the pension changes on fiscal flows is given by subtracting [2]-[1]:
(αRα)Wti(DRt1Dt1)(PR2tP2t)[3]

The first two terms are positive as a result of the pension changes. The first one reflects the higher pension contributions to the first pillar, and the second the interest savings on public debt (which is positive since public debt associated with status quo is larger than that under the pension changes. These two terms initially dominate the fiscal dynamics. The third term, which grows over time as current contributors retire, reflects the larger pension payments by the public sector.

4. The pension changes also have an effect on public debt. In the computations, public debt is restricted to explicit public liabilities associated with pension reforms. The initial stock of debt for the purposes of the analysis reflects the capitalized cost of financing the transition gap since the 1999 pension reform until end-2013. Explicit government debt associated with status quo pension reforms is denoted by Dt. In turn, DR,t denotes the evolution of public debt as a result of the 2014 pension changes. The latter is lower than the status quo debt starting in 2014: the transfer of public bonds from pension funds to the first pillar in 2014 causes a one-off drop in public debt of about 9 percent of GDP. Since asset transfers under the zipper, Tt, represent a positive cash flow, they also affect the evolution of explicit debt. Using i to denote the interest rate, public debt under status quo policies evolves as:
Dt=(1+i)Dt1+P0t+P1t+P2tαWt[4]
While public debt under the pension changes is given by:
DRt=(1+i)DRt1+P0t+P1t+PR2tαRWtTt[5]
Thus, the incremental impact of pension reform on explicit public debt is given by [5]-[4]:
(DRtDt)=(1+i)(DRt1Dt1)(αRα)WtTt+(PR2tP2t)[6]

This expression implicitly assumes that the interest rate is the same under the status quo and the pension changes (since i is not modeled endogenously, this assumption ensures that any interest rate path is neutral on the results). Equation [6] is equation [3] augmented by debt amortization and the zipper. As noted above, the first term of the right-hand side is negative on impact, as the pension changes cause a sharp one-off drop in explicit public debt. Furthermore, public debt under the pension changes keeps dropping for several years relative to the status, as the second and third terms of the right-hand side are also negative. In the long-term, however, the last term of the right-hand side, grows in relative terms as capitalized pension payments from the notional account A2 are repaid to pensioners. Population projections imply that the latter term will not overcome the effect of the pension changes within the period under analysis.

5. Beyond the effects on explicit public debt, the pension changes also affect implicit fiscal liabilities. The later are accumulated in the notional accounts in the first pillar. The evolution of the main account (A1) is the same under the status quo and the pension changes. These balances are indexed at the nominal growth of the contribution base ωt, and evolve according to the following:
A1t=A1t1(1+ωt)+αWtP1t[7]
In turn, the incremental impact of the pension changes on the notional sub-accounts is given by:
A2RtA2t=(A2Rt1A2t1)(1+yt)+(αRα)Wt+Tt(PR2tP2t)[8]

Where the indexation yt reflects the average GDP growth of the previous five years. The net increase in implicit liabilities associated with the active policy is given only by [8], as notional account A1 is common to the two policy alternatives.

6. The net effect on overall fiscal liabilities—which also reflects the accrual impact of the pension changes—tends to be neutral. Adding together the net increase in explicit public debt [6] and the net increase in implicit public liabilities [8] gives the net impact of the active policy in a generic year t, which collapses to:
(1+yt)(A2Rt1A2t1)(1+i)(Dt1DRt1)[9]

The first term reflects the evolution of the change in implicit liabilities stemming from the pension changes and the second term the savings on public debt service. Thus, the net effect on overall fiscal liabilities will depend on the relationship between interests on public debt and the indexation rate of the notional account. Since redirected contributions and asset transfers from the second to the first pillar are exactly matched with an increase in the notional account balances, the net effect of the pension changes on overall public debt will be zero under the assumption of equality between the interest rate on public debt and average GDP growth. In an alternative scenario, if interests on public debt were higher than the indexation rate, the impact of the active policy on public liabilities would be positive, as savings on public debt service exceed notional account indexation.

References

  • Chlon-Dominczak, Agnieszka, 2009, “Retirement Behaviour in Poland and the Potential Impact of Pension System Changes”, ENEPRI Research Report No. 61.

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  • European Commission, 2012The 2012 Ageing Report”, European Economy 2/2012.

  • Jabłonowski, Janusz and Christoph Müller, 2014, “Sustainability of Fiscal Policy in Poland”, Background paper for World Bank Saving CEM. Unpublished.

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  • Mackenzie, G.A., Peter Heller, Philip Gerson, and Alfredo Cuevas, 2003, “Pension Reform and the Fiscal Policy Stance”, Public Budgeting and Finance, 23:1, 115127.

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  • Ministry of Labor and Social Policy, 2013, “Regulation Impact Analysis of Law Determining Pay-Out Framework of Assets Accumulated in Open Pension Funds”, Warsaw.

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  • Ministry of Labor and Social Policy and Ministry of Finance, 2013, “Synthesis of the Pension System Review”, Warsaw.

  • Samuelson, Paul, 1958, “An exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money”, The Journal of Political Economy.

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  • Wiktorow, A., 2011, “Pension System for Uniformed services and the Regular Pension System in Poland”, ZUS.

1

Prepared by Krzysztof Krogulski, Robert Sierhej (Res.Rep. Office), Francisco Vazquez (EUR), and Csaba Feher (FAD).

2

Transition costs reflect the partial redirection of pension contributions to fund second pillar assets.

3

In practice, when assessing fiscal sustainability, financial markets and international institutions tend to focus on gross public debt.

4

The Polish Constitution caps public debt (according to a national definition) at 60 percent of GDP, and the Public Finance Law requires mandatory fiscal consolidation if debt to GDP exceeds 55 percent of GDP. In addition, a recent law amendment established two preventive debt thresholds at 43 and 48 percent of GDP, in substitution for a previous threshold of 50 percent of GDP.

5

In Poland, some temporary contracts fall under the civil code (rather than the labor code) and therefore do not require employers and employees to contribute to the social security system.

6

The ex-post returns of the second pillar between 1999–2012 were close to the indexation of the notional account in the first pillar during the same period: average real returns were about 3.4 percent in the second pillar, and 3.9 percent in the first pillar, compared with 3.9 percent GDP growth.

7

In theory, the rate of return to compute the net present value should measure the opportunity cost of fiscal resources, or a risk-free return on assets with a maturity equaling liabilities. In the absence of such assets, GDP growth provides a reasonable and technically manageable discount rate.

8

Alternatively, the cash flows associated with the one- off debt transfer could be measures by the drop in the associated debt service over time. The financial result will be equivalent to the one presented in this paper (under the assumption of equality between the interest rate on public debt and the rate of return used to compute the net present value).

9

According to calculations in the bill presented to Parliament, the gains of the FUS will accumulate to 19 percent of GDP. If adjusted by the one-off debt transfer totaling some 9 percent of GDP in 2014, cumulative gains would reach 28 percent, almost matching the outcome presented here.

10

In particular, effect of one-off transfer will be largely wiped out by 2060, as 82 percent of the initial cash flow gain will have been paid out in pension benefits.

11

The calculations differ from those presented in the sensitivity analysis in two respects. First, the shocks are applied to all the notional accounts in the first pillar (including the main accounts and the full balances of the sub-accounts). Second, the calculations are compared with a counterfactual policy that allows for negative indexation in the first pillar.

12

Replacement rates measure the size of pensions relative to wages. In this paper, replacement rates are defined as the ratio between average pensions and average wages (net of social contributions).

13

The three poverty measures under analysis include: (i) social minimum defines a threshold below which the household is considered to be in poverty; (ii) legal minimum pension refers the minimum old-age benefits guaranteed by the Law for those reaching retirement age with a contribution period of at least 25 years; and (iii) Eurostat equivalised income, which takes into account the impact of differences in household size and composition.

14

Maintaining the partial indexation mechanism over an infinite horizon will imply that the ratio of minimum pension to average wage will asymptotically approach zero.

15

In fact, miners and new entrants to uniformed services were covered by the regular scheme at the time of the 1999 reform, but subsequently moved out.

1

The Polish Constitution caps public debt (according to a national definition) at 60 percent of GDP, and the Public Finance Law requires mandatory fiscal consolidation if debt to GDP exceeds 55 percent of GDP. In addition, a recent law amendment established two preventive debt thresholds at 43 and 48 percent of GDP, in substitution for a previous threshold of 50 percent of GDP.

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Republic of Poland: Selected Issues Paper
Author:
International Monetary Fund. European Dept.
  • Text Figure 1.

    Poland: Model Assumptions

  • Text Figure 2.

    Cumulative Fiscal Gains of Pension Changes

    (Percent of GDP)

  • Text Figure 3.

    Sensitivity of Baseline Results to Macroeconomic Shocks

    (Cumulative percent of GDP)

  • Text Figure 4.

    Projected Evolution of Second Pillar Assets

    (Percent of GDP)

  • Text Figure 5.

    Shock Scenarios: Cost of Zero-Floor Indexation 1/

    (Cumulative, in percent of GDP)

  • Text Figure 6.

    Unsustainable Pre-Reform Pension System

  • Text Figure 7.

    Replacement Rates

    (Percent of average wage)

  • Text Figure 8.

    Estimated Replacement Rates, 2060

    (Percent of average wage)

  • Text Figure 9.

    Share of Pensioners Below Selected Income Thresholds

    (Percent)

  • Text Figure 10.

    Legal Minimum Pension

    (Percent of average wage)

  • Text Figure 11.

    Special Pension Schemes in Poland, 2010 1/

    (Percent)

  • Text Figure 12.

    Generosity of Special Pensions Schemes, 2010

  • Text Figure 13.

    Attractiveness of Disability Benefits vs. Old-Age Pensions