Poland's Pension Reform: 1995 and 2005 (two articles)


By Dr. Krzysztof Ostaszewski (Professor of Mathematics and Actuarial Program Director, Illinois State University, Normal, Illinois, U.S.A.)

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.

II. 2005: Ten Years After

By Dr. Krzysztof Ostaszewski (Professor of Mathematics and Actuarial Program Director, Illinois State University, Normal, Illinois, U.S.A.) and Dr. Stanislaw Kluza (Department of Statistics, Warsaw School of Economics, and Chief Economist, Bank Gospodarki Zywnosciowej, Warsaw, Poland)


In the summer of 1995, the Adam Smith Research Centre in Warsaw, Poland, held a conference on the prospects of pension reform in Poland. While many economists and politicians discussed the problems of the Polish pension system inherited from the communist era and weighting heavily on the economy of the country then undergoing a transformation to free markets, this was the first comprehensive effort to present possible solutions to the looming crisis. The keynote speaker at the conference was Dr. Jose Pinera, who presented the Chilean reform in a lively and educational manner, very effectively relating it to the experiences of Chile and of Poland. One of the authors of this article, Dr. Ostaszewski, was then a Fulbright Research Fellow in Poland, studying actuarial aspects of free market reforms, and was also a speaker at the conference, arguing that the Chilean-style pension reform would result in a better efficiency of capital markets, and better allocation of capital, because of the market pricing of capital asset replacing command economy approach.

A decade has passed since that event. It started a sure and slow process of pension reform in Poland. The election of 1997 resulted in a new government, whose program included numerous reforms, with pension reform being one of the key elements of the program. In 1999, the reform was implemented. Its initiation was delayed by serious bureaucratic problems of the state social insurance agency (Zaklad Ubezpieczen Spolecznych, or ZUS), with funds arriving in individual accounts about a year later, but arriving after all. The new system has been now effectively in existence for approximately five years. Its functioning and its results can now be reviewed and evaluated for the first time. We will attempt a discussion of its successes and failures now.

Overview of the Polish reform

Polish reform only partially resembles the Chilean system of fully individual accounts. In fact, Polish reform can be viewed as a compromise between the Swedish approach of „virtual accounts” in a social insurance state-run system and the Chilean system of private accounts. Before the reform, 45% of post-social-insurance-tax wages was paid by employers into a state-run pay-as-you-go system administered by the social insurance agency (ZUS), with benefits determined by law, based on the history of wages. After the reform, all workers obtained individual accounts with the state system, which are not invested in capital markets, but rather are „virtual accounts” (as in the Swedish system), accruing interest at a rate established by the state, and paying a benefit based on the value of the accrued account and life expectancy of the birth-cohort of the worker. Additionally, workers age 30 or less in 1999 must divert a portion of their social insurance tax to join private pension system of individual accounts in vested in capital assets (similar to the Chilean system), while workers between age 30 or 50 were given a choice of staying in the old system, or joining a new system, and workers over 50 stayed with the old system. As of late 2005, about 11.6 million workers chose to participate in the private system, of the total employed population of approximately 13 million employed workers. Unfortunately, Poland also has over 3 million unemployed workers currently, and has experienced a high unemployment rate between 15% and 20% (this high unemployment rate figure was partially affected by a change in methodology of calculating unemployment as of 2000, increasing the rate by about 2%) for the entire period of functioning of the reform). Private pension accounts, known as Open Retirement Funds (Otwarte Fundusze Emerytalne), now hold approximately 26 billion dollars of assets, mostly Polish bonds and stocks, with large allocation to Polish government bonds, but also with over 500 million dollars in foreign assets. The total rates of return for private accounts for the period of functioning of private accounts vary between approximately 10% per annum and approximately 13.5% per annum, with inflation in the range between 2% and 4% per annum for the period. These high rates of return have been achieved in a rather difficult period in the Polish economy, and are quite impressive. They are somewhat forced by a peculiar structure of regulation, which requires funds with rates of return low in relation to peers to pay a solvency insurance premium, which has resulted in a reduction of the number of funds to currently 15, through mergers and acquisitions. The fund with currently best rate of return is run by ING, while the leader in terms of number of participants is Commercial Union (whose British parent is Aviva), and also the leader in total assets (over 7 billion dollars).

In addition to the above two tiers of a retirement system, mandatory Tier 1 in the state-run „virtual accounts” and mandatory Tier II in individual private accounts, there are also opportunities for tax-privileged voluntary pension plans organized by employers. But after five years of functioning of those voluntary employer-sponsored plans, only 100,000 workers were covered by them, and the government decided to supplement this voluntary Tier III by a system of individual accounts (Indywidualne Konta Emerytalne, known also as IKE), exempted from investment taxes.

Polish employers and workers pay the following contributions to support their pensions and social insurance system, as a percentage of wages before these contributions:


Employer Contribution Employee Contribution

Retirement Fund

Disability Fund

Illness Fund

Workers Compensation








2.03% (average) 


Total contribution amounts to average of 37%. This is, of course a substantial burden, but of this, 7.3% of wages is contributed to the individual private account of the worker, if the worker chooses to participate in the private Tier II system.

Was this reform a success?

The Polish reform has created a system of individual private investment accounts, and put constraints on the state system by creating individual accounts instead of standard pay-as-you-go features. This individualization of the pension system has been its undeniable success. It freed the workers from capricious changes in benefits by the legislature, and created a direct, understandable relationship between contributions and benefits. While complete privatization of the pension system was not achieved, the reform was a step in the right direction, and probably was the best that could be achieved politically at the time. Creation of the retirement funds was a significant boost to the private capital markets in Poland. Those markets experienced a period of „irrational exuberrance” following the fall of communism, especially in 1993, when the Polish stock market was the best performing stock market in the world, but this was followed by a massive collapse in 1994 and 1995. Returns since the start of the reform have been more stable and rational.

One could argue that private capital markets need pension reform, but also that pension reform needs private capital markets. It is no accident that privatization of pensions was accompanied by privatization of state assets in Chile, and transformation of the role of the state from that of the owner to that of a regulator of the private markets. In Poland, many of the reforms of the role of the state have been incomplete, and often delayed because of uncertainty of the Poland’s accession to the European Union. In May 2004, Poland became a member of the European Union, and, as a result, will be merging its system of regulation and supervision of capital markets with that of the EU.

Private capital markets provide an efficient method of pricing capital assets, and thus give true price signals to market participants, and firms seeking capital. This can lead to both more efficient capital allocation, and greater trust of markets, resulting in attracting new capital, domestic or foreign. Pension reform can be a part of that process, and can benefit from it. In Poland, this process has been somewhat delayed because the pension reform was so greatly delayed in relation to the reform of the overall economy (free market reforms started in 1990, while pension reform started in 1999, and even then there were significant delays because the state social insurance agency for a while did not have a mechanism for identifying ownership of individual contributions and delayed forwarding them to individual accounts). But positive effects of the stability of the capital markets, helped by the pension system, are already visible: private firms are increasingly interested in acquiring capital through capital markets in Poland. On the other hand, large amounts of investments from pension funds chasing few investment opportunities, especially in the stock market, can create instability, so further deepening of the Polish stock market and growth of the private sector are very important for the long-term success of the pension reform.

Polish bond market remains largely underdeveloped. It effectively consists only of government debt. Creation of private debt market would benefit both the pension system and private firms functioning in Poland. This should be facilitated by the state through enabling legislation and reasonable regulation.

But one cannot argue that at this point Polish workers are assured of comfortable retirement. While individualization of the system created correct incentives, it did not automatically alleviate long-term gaps between levels of benefits promised and expected, and ability of the economy to deliver them. Polish social insurance system developed significant problems already in the early 1990s, not due to bad demographics, but rather due to extreme mismanagement of the national economy under communism. Demographic problems will arrive in the future, nevertheless. Their extent cannot be evaluated precisely at this point. Following the accession to the European Union, Poland experienced rather dramatic drop in fertility rate, resulting in the adoption of new incentives for parents implemented by the new government elected in 2005.

The percentage of retirees in Poland will double in the next 25 years. Percentage of children is projected to be half of what it is today in 25 years. The number of people of working ages will decline in relation to the number of retirees by 50%, and the number of children in relation to the number of retirees will decline by 65%. This will make keeping the existing welfate state design extremely difficult. Poland is already experiencing significant budget deficits, and a growing financial pressures on its health care system. Private pensions cannot automatically change these negative demographic and fiscal developments, although private pension can and do improve work incentives. Bringing the fertility rate above 2.1, required for keeping the population stable, would do wonders to long-term stability of all forms of welfare benefits, not just pensions, of course assuming that the newborn children can be educated and employed (but inability to educate and employ them would be equivalent to a total failure of the economy, not beneficial to even the most efficient private pension system).


Regulation of financial institutions in Poland is still developing. Dramatic improvements of regulatory bodies in Chile that accompanied the Chilean reforms have not been matched by the Polish experience. Efficiency of the Warsaw Stock Exchange is somewhat in question. There is a common suspicion of existence of „front-running”: investors who purchase large blocks of shares expected to be acquired by the pension funds. Many Polish investors are also suspicious of the fact that the majority of pension funds are controlled by foreign financial institutions, and all of them but one have substantial foreign ownership. This can, of course, be an irrational fear, but it could be addressed and alleviated by more efficient regulation.

Gajek and Ostaszewski (2004) also argue that the method of calculation of the minimum required rate of return uses an inefficient market index, and results in unnaturally high financial penalty for underperformance, which can explain significant consolidation of funds experienced in the first six (but really effectively only five) years of their functioning.

Consumers’ point of view

Retirement funds coexist with regular mutual funds in Poland. The mutual fund marketplace used to be quite small, nearly nonexistence, but it has developed substantially in the recent five years. The unfortunate side effect of that process is the visible phenomenon: regular mutual funds have lower fees and expenses than the retirement funds. This is partially a result of the fact that the state social insurance agency often delays contribution of funds to pension accounts, and collects a fee for that inefficient delivery. Pension funds also have substantial additional regulatory expenses, as well as marketing expenses. Nevertheless, customers are disturbed to see that the investment vehicle that is obligatory costs them more than a voluntary one.


While the reformed Polish pension system has some imperfections, these authors would like to stress that it is a step in the right direction. There should be no turning back to the inefficient massive state social insurance system. Individualization of accounts has resulted in good returns and improved efficiency of the Polish economy. Improved work incentives are especially positive. Some would argue that the Tier II contribution should be made voluntary, but given the small amount promised by the Tier I system this would be probably not a good idea. Further development of the Tier III voluntary system would also be very beneficial. At this point, Tier III is free only from investment tax, but not of regular income tax. Of course, Polish government is struggling with insufficient revenue already, so additional tax exemption may be difficult, but it is worth a consideration. Such exemptions do exist in the United States and Canada, and function quite well.

One very troubling development has been recent adding of, previously abandoned (as a part of the 1999 pension reform package), system of additional pension privileges for some groups of workers, e.g., coal miners, by the government replaced in the 2005 election. This increase in pension benefits, required by law, was not accompanied by any funding, in effect requiring private pension plans to provide additional benefits for some selected workers, without any corresponding contribution. This political intrusion into a functioning market system is very disturbing and may have unexpected consequences in the future. Of course the postulate of higher benefits for specific groups could be addressed by higher contributions required from that group, but this had not been proposed.

On balance, however, Polish pension reform has resulted in an increased role of the market process in the Polish economy, and it is developing into a very important part of the Polish economy.


• Gajek, L. and K. Ostaszewski, Financial Risk Management of Pension Plans, Elsevier, Amsterdam, The Netherlands, 2004.

• Glowny Urzad Statystyczny (Central Statistical Office of the Government of the Republic of Poland), http://www.stat.gov.pl/, accessed January 3, 2005.

• Wirtualna Polska site on the retirement system, http://emerytury.wp.pl/, accessed January 3, 2006.



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