The impact of changes in second pension pillars on public finances in Central and Eastern Europe: The case of Poland

This paper studies the impact of the recent weakening of Poland's fully funded defined contribution second pension pillar on (i) the long-term sustainability (the deficit and implicit debt) of the full pension system and (ii) the implications for pension benefits (gross replacement rates). Simulation results, based on a stylised version of the Polish pension system, show that, in the baseline scenario, the weakening of the second pillar would permanently lower future pension system debt, chiefly as a result of a cut in replacement rates. But using a combination of pessimistic assumptions including strong population ageing, low real wage growth and an indexation of existing pension benefits on nominal wage growth rather than inflation coupled with bringing in tax expenditures related to the third voluntary pension pillar and an increase in the share of minimum pensioners leads to higher pension system deficits and eventually more public debt at a very long horizon. The simulation results also suggest that if Poland had not transformed its pay-as-you-go first pension pillar into a defined contribution from a defined benefit system, the weakening of the second pillar would deteriorate fiscal sustainability relatively quickly in the baseline scenario. This result suggests that the Hungarian pension reversal would reduce deficit and debt only temporarily, mainly because of Hungary's costly defined benefit first pension pillar: the weakening of the second pillar is tantamount to swapping low current replacement rates (in the defined contribution second pillar) against high future replacement rates in the defined benefit first pension pillar.