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It is hard not to marvel at the Poles as they build their
financial architecture. Starting, in the main, with a blank sheet
of paper, they develop solutions of mind-boggling complexity -
combining international best practice with purely local
methodologies. The launch of the Polish pension industry in 1999
continued this grand tradition - surpassing the establishment of
capital markets in the early 1990s and the National Investment Fund
programme of 1996.
A frenzy of activity was unleashed in March. Four hundred
thousand pension advisers were licensed - more than 1% of the
population became pensions salesmen - for periods of up to nine
months. Twenty one pension funds, owned by 48 different corporate
shareholders, were given six months to sign up an estimated six
million Polish citizens aged below 30, and as many in the 30 to 50
age group (potentially a further seven million) as they could
manage.
Only agricultural workers and members of the armed forces
escaped this onslaught of financial advice. It is an
emerging-market Klondike and, as with any gold rush, some big
winners and losers are being thrown up. Whereas the leading
investment banks have tended to benefit most in the past from
arranging privatizations from emerging markets, this time it is the
turn of foreign retail financial services giants to make hay.
Andrzej Jacaszek, CEO of the Norwich Union Fund, captures the mood:
"Poland is undergoing massive, historical changes. We're starting
from scratch - it's a great adventure."
Poles, like their counterparts in Chile, Mexico and Hungary,
have recognized the need to defuse the pensions time bomb sooner
rather than later. Michael Harvey, head of the Polish office of
Robert Fleming Securities, describes the old system as "decrepit -
meeting neither the needs of those in retirement, those in
employment nor the state". There is simply no way in which an
unreformed system could have hoodwinked a financially astute
populace much longer. A triple whammy of longer life expectancy,
increased baby-boom retirement and enhanced material and lifestyle
expectations had undermined the credibility of the old state
pension system.
The new pensions legislation structures a solution around
three "pillars". The first - targeted at the over 50s - continues
with the existing, defined benefit, pay-as-you-go system. Pillar
two, where all of the excitement has focused, provides for the
mandatory participation of Poles under 30 in pensions schemes.
Those over 30 but under 50 can either stay in the state social
security system, known as ZUS, or go private. Once the decision is
made, though, it is irrevocable.
Once an individual is committed to the private sector,
pension cash is paid directly by ZUS into his or her personal
pension account; contributions thereafter accumulate tax-free,
being converted into an annuity at retirement age. The third pillar
is voluntary, supplementing pillars one and two. It allows
individuals (or more likely their employers) to make additional
voluntary contributions. This final pillar has not yet been
implemented in earnest but to Miroslaw Kowalski, CEO of the Zurich
Solidarity Fund, "it will be very, very important. It could easily
be as big again as the second pillar."
The period during which the under 30s can sign up was
extended to nine months, coinciding with the time available to sign
up those aged 30 to 50. Both will have ended on 31 December 1999.
Industry estimates of total take-up have run as high as 14 million
people although most in the market are focusing on 10 million to 11
million total subscribers.
Selling policies into this market was pretty close to
shooting fish in a barrel. Foreign and Polish financial services
firms licked their lips at the prospect. Over 20 pension fund
groups set out to win this new market, with a top dozen soon
emerging, ranging from the wholly domestic to the entirely foreign.
There were also several joint ventures. Some have fared better than
others, with two of the most successful three groups being
dominated by foreign firms: Commercial Union and ING. Domestic
banks, which might have expected to sell large numbers of pensions
through branch networks, fared poorly. The great Polish pension
sale of 1999 is an interesting test of the effectiveness of
bancassurance in advanced emerging markets and will re-emphasise
the worth of such networks to foreign acquirers hoping to use them
to sell sophisticated retail financial products. And
developed-market fund managers will take note of the potential
market value they can attain through rapid acquisition of
emerging-market pensions customers.
Stories abound of overzealous sales teams completing
applications from infants, the homeless and even the deceased.
There is certainly scepticism about the apparent success of the
less well known syndicates in signing up applicants. With no
official numbers yet available, exactly who has sold what and to
whom is far from clear.
The most infamous case of pressured sales involved the Post
Office, the major shareholder in the Pocztylion syndicate. Not
unreasonably, management felt it had the best door-to-door
distribution of any organization. It did not, however, have a
focused, committed direct sales force and efforts to motivate the
postmen - a leaked internal memo discussed evaluating job
performance on the basis of policies sold - drew public criticism
from the regulator.
It is worth stepping back to March 1999 to understand the
atmosphere - described by Alastair Ryan, Polish analyst at Warburg
Dillon Read, as "a mix of barely bridled optimism and complete
uncertainty" - in which the starting gun set off this financial
sprint. Ryan constructed a matrix of estimated market shares in
March based on management interviews and an assessment of
distribution networks and sales force capacities. At this stage,
every competitor in the new Polish pension market was convinced of
its own inevitable success. With total estimated market shares
running to around 150% of the market there was clearly a high
degree of confidence.
The reality has proved to be very different and a
bitter-sweet experience for most involved. On the one hand the
market is proving to be every bit as large as the most optimistic
forecasters envisaged. On the other hand, it has proved to be much
more elusive than most of these intrepid funds had ever thought
possible. As James Mellersh, emerging Europe bank analyst at Morgan
Stanley Dean Witter, puts it with only a hint of exaggeration:
"Over 70% of this market looks like going to just three players.
The rest have just, sort of, disappeared."
The biggest surprise - other than this tripartite dominance -
has been the actions of the 30 to 50 age group. "We estimate as
much as 80% of this non-compulsory group will opt out [of the state
system]", says the Norwich Union Fund's Jacaszek. "There is no way
the government was expecting this." This group has been
particularly attracted by a slightly morbid, although logical,
sales pitch: if they die before retirement age contributions can be
transferred to beneficiaries - a facility that's not available in
the ZUS system.
Artur Nieradku, a member of the management board at Bankowy
Fund, believes: "ZUS has completely misjudged this level of take-up
and will be shaken by this vote of no-confidence in the old
[pay-as-you-go] system." Certainly ZUS will have a real problem on
its hands since the state remains heavily reliant on ongoing
contributions to finance existing pay-as-you-go schemes. "I expect
there to be major problems," predicts Nieradku, "although solutions
will be found." Harvey concurs. "It's going to be a big hole," he
says, indicating that it may eventually "represent percentage
points, not basis points, of GDP".
Jacaszek, who reckons the popularity of private pensions
among this older age bracket is "yet another example of the Polish
public's financial maturity", backs changes in excise duties on
drinks and tobacco or possibly diversions of resources from the
privatization programme as the most likely way to fill the funding
hole. Kowalski, at Zurich, goes a step further, pointing to a
virtuous circle of pension funds, with Z 1 billion ($237 million)
to 2 billion a month to invest in a small stock market, driving the
pace of privatization and thus transferring back to the government
the money to fill the deficit.
"The pension funds will give an enormous boost to the Polish
capital markets," says Fleming's Harvey. "The impact on equity
prices will be very positive." Over the first two years the funds
should add some 7% to 8% to current market volumes if they invest
10% of their contributions in equities. "That in itself is not
terribly exciting." adds Harvey. "Where we see the real growth is
five years out - dramatically increased funds under management
moving, perhaps, to 30% equity exposure. With convergent bond
yields driving equity flows and pan-European funds likely to be
entering the market in real size for the first time, the scenario
is extraordinarily bullish".
Krzysztof Rybinski, ING Bank's Polish pension specialist, is
also positive on the prospective impact of the funds. He focuses on
the long-term positive impact of the massively boosted pool of
funds on market regulation, liquidity and attractiveness to
international investors. Focusing on the near term, he considers
the impact "straightforward" with the "recovery in economic
activity and significant incremental demand from pension funds
supporting equities, especially in 2000. We expect equity purchases
by pension funds to represent around 6.4% of the Warsaw Stock
Exchange free float next year. The impact on treasury market
capitalization will be even greater - we estimate new flows at
around 13.5% in 2000."
Piotr Chudzik, a senior relationship banker at Deutsche Bank
in Warsaw, is also convinced that the creation of the pension funds
is a defining moment for the Polish capital markets. "It will make
a big difference and must have a major impact. It will boost demand
for new issues. Polish retail investors have typically subscribed
to the big privatizations and then sold quickly. Finally we will
have domestic investors who have a buy and hold strategy." By
implication, foreign investors will have to pay more for their
allocations as the local funds settle down.
The market shares taken by CGU, National Nederlanden and PZU
are outstanding and, with the exception of PZU, have substantially
surpassed expectations. The process has also led to some red faces
in Warsaw - quite how the banks, in particular, failed to sell more
than they did has raised many questions.
Colin Thurston, a director of CGU's European division,
comments: "Of course we are pleased with our performance. It is not
every day that you get the opportunity to sign up an extra two
million customers with these demographics". Marian Czakanski, CEO
of the National Nederlanden Fund - another winner - is ebullient:
"It's been like winning the lottery," he says.
So what differentiated the winners from the losers, the
satisfied from the disappointed? CGU's Thurston identifies three
key drivers as lying behind his fund's success, "preparation,
preparation, preparation".
More prosaically, accurate pricing was critical. CGU
developed an agenda-grabbing charging structure - mixing high
up-front and low continuing charges - which still positioned the
product at the low end of the government-controlled price range.
CGU went early and hard with this mix and, according to Thurston,
"completely focused on the once in a lifetime opportunity to sell
this unique high-value product in size". NatNed positioned itself
similarly.
Charges remain high by western European standards but are not
expected to stay like that. "Price competition is inevitable -
someone will break the line," says Bankowy Fund's Nieradku "It's
happened everywhere else." Jacaszek at Norwich Union disagrees:
"We've had the price war - it was started at the beginning. We
already have absolutely low prices. The shape of the market is
already determined".
A second crucial component was brand strength. CGU already
has an estimated 40% share of individual life policies in Poland
and an 18% overall share of the life market. NatNed, which, like
CGU, has been seven years in Poland, had the same benefit.
Czakanski at NatNed is amazed by those groups that chose to build a
brand from scratch - Bankowy, Ego and Dom are examples. In his
view: "How could they not be focused solely on selling? They have
lost everything. Their advertising spending, their investment,
their brand equity, their opportunity."
The third leg of a successful rollout was technology driven.
Jonathan Hyde, operations director at CGU, identifies the
robustness of his fund's proprietary systems and recent investment
in verification software as crucial. At the critical juncture this
ensured minimal flowback of applicants and maximum momentum to a
commission-hungry salesforce. NatNed too made massive investment in
processing technologies and Czakanski proudly notes: "I was told by
our [Amsterdam] head office that in Poland we have the most
automated business unit in the whole ING Group. We are a paperless
operation."
Thrown into stark contrast is the performance of banks such
as Bank Handlowy, BIG, PKO BP, Citibank and PBK. Bankowy's Nieradku
pulls no punches: "Sure we're disappointed with our performance
when compared with our expectations - we're about half the size we
wanted to be - but all the banks which did not have life arms
performed much worse than expected. So relative to the other banks
we're pretty happy with our performance."
Nieradku squarely focuses on Bankowy's "lack of experience"
in pensions but also feels that the only distribution system that
worked was direct sales - wrong-footing his and other disappointed
groups. "Quite simply, the Polish consumer wanted to be sold to at
home, and never intended signing up at the branches" he adds. CGU's
Thurston acknowledges: "We have a lot of experience with this
product. We never felt this phase of the programme was about either
brand-building or bancassurance-style distribution. In our view the
direct sales model was always what was required".
Morgan Stanley's Mellersh, suggests that the real quality of
the Polish bank networks will be eventually decided by their
handling of more natural bancassurance-type products such as
mortgages or mutual funds. Mellersh concedes, however, that "this
poor pensions performance will, at its most benign, have raised a
few eyebrows - if not provoked outright shock - among some of the
major foreign shareholders in the sector".
Mellersh also believes that several global fund management
groups will be attracted by CGU's success, putting ever-increasing
pressure on local banks and their international shareholders.
Bankowy's Nieradku says the pension fund experience proved that
there are no universal distribution channels in Polish banking
"Cosy assumptions based on this model need to be torn up," he says.
The banks were not the only ones disappointed. Zurich
Solidarity Fund, for example, despite being in the top six
providers, missed targets. Zurich's Kowalski, whose team may end up
around 25% under target, comments: "Ours was not a bad performance.
Our cost structure is under control but I am worried about price
competition. It could hit our break-even negatively." But, like
Nieradku, Kowalski can find some solace in his numbers: "It's
probably the best result of those companies that entered this
market in the last 12 months and we are pleased with that. But,
with hindsight, should we have entered this market earlier? That's
now a fair question."
Looking forward, the predominance of three major players has
thrown up a number of issues for Polish pensions regulator UNFE. It
has a simple view of competition - it wants lots. Having backed a
multi-fund industry, but found itself with one that looks
increasingly as if it will be an oligopoly, it is now worried by
three issues - the prospects of modest absolute and relative fund
performance, a perceived lack of choice for consumers and how to
handle consolidation among funds if it occurs.
UNFE will be particularly concerned about the first of these.
In a twist to the regulations, fund manager investment performance
is assessed relative to peer group - with any fund that fails to
achieve half the average performance in any one year (or which
falls more than four percentage points below the average) forced to
make up the difference from its own funds. With the calculation of
the benchmark to be weighted by funds under management it seems
likely that investment performance will be largely set, for better
or worse, by the activities of the fund managers at only three of
the groups.
The major players naturally view the situation with a degree
of equanimity - a regulator can hit out painfully at the
overbearing. Thurston, not unsurprisingly, comments: "We find it
hard to imagine what moves can be made." The pensions are sold, the
customers in place, new business likely to be tiny. It's a done
deal. UNFE has little room for manoeuvre. In Nieradku's view:
"There are only two ways for most funds to become commercially
viable: acquisition or merger. UNFE will need to face this."
Kowalski is clear on how he sees progress: "Zurich is open
for discussion" with other groups. Czakanski too wants to see a
market solution - though NatNed will not be involved directly -
pointing to the recent BIG/Eureko acquisition of 30% of PZU and the
merger discussions of BRE and Handlowy as offering the basis for a
way forward. One thing is certain: local investment bankers are
already sharpening their pencils in anticipation.
There is no possibility of a natural recovery among those
consortia that have failed to achieve critical mass. The market has
been so comprehensively canvassed that there is no chance of
unearthing meaningful new business. The short-term failure to
acquire customers will be a long term and costly problem for most
funds.
Platforms for administration, fund management and marketing
are expensive and volume dependent to break-even. Harvey at
Flemings believes: "With so few variable costs in the industry,
there is little or no chance of the laggards operating without
steady and mounting losses." Nieradku, with grim Polish humour,
believes, that "without consolidation, there are only two ways
forward: hope, which has sustained many a failing operation
briefly, or magic".
In the City of London, analysts are gushing about the success
of CGU. What is clear is how lucrative and remunerative the Polish
business has become in a short time. "We think CGU's performance
will become a casebook study in value creation by multinationals in
an emerging market," says one analyst.
The long-term cashflows of pension and life products lend
themselves to discounted cashflow-based valuations with substantial
variations in assessed value generated by only very small changes
in key assumptions - particularly the discount rate applied. City
insurance analysts model three components: embedded value, similar
to current net asset value; to which is added a valuation for
inforce, that is the future value of business that is already
written; to which is finally added the estimated value of new
business - that is discounted profits on business yet to be
written.
The insurance team at Robert Fleming, closely assisted by its
Polish office, has staked out the high ground in the CGU debate,
taking the UK market to task as early as August of this year for
overlooking the value being created out of Warsaw. They suggest a
valuation of £2 billion ($3.2 billion) for the pensions arm, with
life worth a further £400 million. A cornerstone and highly
sensitive component of the valuation is the discount rate. Fleming
has adopted a stepped rate in their actuarially modelled, 50-year
cashflow - 12.5% falling to 7.5% in 2007 - to reflect the
likelihood of Poland joining the EU and EMU by that date.
The team is anxious to point out how conservative most of its
assumptions are. There is no attempt to model the growth of funds
under management - a key driver of future profits - if EU
convergence does occur. No account is taken of the profit potential
of cross-selling additional products to the new, vast client base.
The cashflow, it is pointed out, could actually support an even
lower discount rate with monthly payments compulsory, and actually
collected by and effectively guaranteed by the state this is an
unusual high quality and predictable cash stream.
Both Morgan Stanley's Mellersh and Warburg's Ryan blanch at a
£2 billion plus valuation - interestingly, though, neither
disagrees significantly on key modelling assumptions bar the
discount rate. Mellersh is keen to draw attention to the
conservative nature of his assumptions. Ryan points out his
difficulty: extrapolating such a figure to the other Polish funds
"suggests the industry is worth around $9 billion - 7% of GDP -
created from $600 million of capital - 0.4% of GDP - in six months.
I find that improbable".
Morgan Stanley, using a disposal value model, assesses the
gross value of the Polish life and pensions businesses at £783
million; £431million for the former and £352 million for the
latter. It adjusts this for CGU shareholders to reflect the capital
gains tax, currently 28%, that would be payable under any disposal
scenario. Warburg develops a goodwill value for the Polish
operation of £670 million - £210 million representing the value of
the pensions business and £460 million for life insurance.
Quite how rapidly the value creation in this emerging market
is flowing back to the developed market parent company becomes
clear on a closer reading of the Fleming note. In its view, the
Polish businesses could be worth as much as 22% of their estimated
CGU valuation - placing Poland, in terms of value, behind only the
UK franchise and well up with the developed-market French and Dutch
operations.
Warburg Dillon Read - despite placing a significantly lower
valuation on the Polish businesses - still views them as the most
valuable assets outside the core UK and US, Dutch and French
businesses. No mean feat - when almost 35% of that value has been
created since April 1999. Warburg, steeped in bathos, considers the
value created - close to $1 billion on their numbers - "a
reasonable amount for a business set up with $5million seven years
ago".
CGU offers by far the purest play on the dramatic opportunity
presented by Poland. As Mellersh points out, commenting on the
other developed-market operators, "only ING has come close to CGU
[for value creation] - but they are a much larger bank - and their
Polish [pensions] operation is a good bit smaller at this point.
I'm sure Norwich Union's management are happy to see the value
accretion - but it really doesn't have the same impact" referring
to the fact that Norwich Union's Polish business lacks life
distribution at present and in pensions is only around a quarter
the CGU size.
In Chile, the first emerging-market country firmly to grab
the pension reform thistle, transactions generating broad-brush
valuations of up to $2,000 per customer have been reported.
Admittedly, an outlandish number when valuing CGU's business today.
But with the likelihood that Poland - well within the working lives
of most subscribers - will become a full member of the EU, it is a
top-end possibility that only the foolhardy would completely
ignore. A world gone crazy? Pension funds in an emerging market
generating internet-style valuations? It is happening now and it is
happening in Poland.
Estimated pension funds cumulative equities' holdings
(year-end)
Source: ING Barings
Estimated pension funds cumulative treasuries' holding (year
end)
Source: ING Barings
Note: These estimates do not take into account pension funds
short-term investment bias
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Forecast Market Shares – Top Twelve Polish Pension Providers –
April 1999
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Fund
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Ownership
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Forecast Share (%)
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Commercial Union
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CGU (80%), BPH (10%), WBK
(10%)
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7.5
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PZU
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PZU (100%)
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25
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National Nederlanden
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ING (80%), Bank Slaski (20%)
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7.5
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AIG
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Alico (50%), Amplico (50%)
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8
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Norwich Union
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Norwich Union (100%)
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7
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Zurich Solidarni
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Zurich (97%), Solidarity (3%)
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10
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Skarbiec
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BRE (75%), Hestia (25%)
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8
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Bankowy
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PKO BP (50%), Bank Handlowy
(50%)
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10
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Winterthur
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Winterthur (70%), EBRD (30%)
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7.5
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Orzel
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PBK (60%), Aetna (40%)
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9
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Ego
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BIG (55%), Eureko (45%)
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7.5
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Dom
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Warta (50%), Citibank (50%)
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7.5
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Total Top 12
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114.5
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Other Nine Funds
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34
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Total
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148.5
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Souce: Warburg Dillon Read estimates
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Estimated Market Shares – Top Twelve Polish
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Pension Providers – November 1999
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Estimated Number
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Estimated
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Fund
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(m)
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Share (%)
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Commercial Union
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1.9
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21
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PZU
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1.7
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19
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National Nederlanden
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1.38
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15
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AIG
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0.69
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7
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Norwich Union
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0.51
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6
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Zurich Solidarni
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0.39
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4
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Skarbiec
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0.36
|
4
|
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Bankowy
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0.32
|
3
|
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Winterthur
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0.27
|
3
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Orzel
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0.27
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3
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Ego
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0.23
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3
|
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Dom
|
0.22
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2
|
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Total Top 12
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8.24
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90
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Other Nine Funds
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0.93
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10
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Total
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9.17
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100
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Source: Local market estimates
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