Latvian scheme is benchmark
Latvia will witness the birth of its first closed end industry pension fund within the next few months, as telecommunications group Lattelekom gets the go-ahead to commence investment operations.
The scheme’s development is being closely watched in Latvia, and throughout Eastern Europe, as a benchmark for the country’s success or failure in tackling the crucial question of pensions and social benefits, as Rudite Zwirgdina, consultant to the fund, explains: “The reason such a system is able to develop here at Lattelekom is that due to union and employee foresight we are the only company in Latvia which has been making pension contributions of 5% for employees into a fund for the last four years, although without any real pension fund framework to oversee and manage this money.
“At present we are sizing up the options for how this money will be managed in future and for the implementation of a proper retirement plan, which is not easy because it is completely alien territory for us. And the whole system offers almost a microcosm of what is happening in Latvia as a whole at the moment.”
Lattelekom itself is the only partially privatised, fixed-line telecommunications company in Latvia, comprising 51% state capital, with the remainder owned by foreign investors, and around 4,800 employees in Latvia.
In 1994 the country’s government and social partners produced an umbrella agreement through which it was proposed to introduce suitable future employee pension schemes, as soon as the country’s legislative and tax framework permitted.
As an interim measure form 1995 the company began contributing an amount of 5% of pensionable pay into a fund. Subsequently, the fund’s trustees then commenced investing this money in government bonds and deposits. The sum collected stands today at in excess of three million Lats (£3m).
National legislation stipulated that any fund have at least 85% in Latvian investments, and a maximum of 15% abroad.
Furthermore, 10% of the total pension fund assets is permitted in securities investment to a 25% limit, with a maximum 20% placement with one issuer, except in the case of Latvian government or municipality securities, which are unrestricted.
Similarly, investments in a single holding of real estate may not exceed 15% of total assets, with a maximum of 25% of the aggregated value of the fund allowed in property as a whole. Pension fund assets may not be used for any form of business loans now either.
1998 Latvian law on private pension funds, effective from July 1, also required pension funds to be registered as separate companies in the state enterprises register before any operations commenced, and that an asset manager and custodian be appointed to the scheme to oversee the investment of the retirement money.
Lattelekom is presently at this stage in its development; the exact shape of the proposed scheme has yet to be determined and no decision has yet been taken on the criteria and conditions for pension plan affiliation and withdrawal.
Zwirgdina explains: “The plan may just cover those employees on long term contracts, although there are issues of temporary contract workers and employees who are no longer with us, but for whom contributions were previously made, to consider also.
“We also have to think about employees who may join the company with other pension arrangements, or alternatively nothing in the way of retirement provision in the future, before we take any concrete steps. At the moment though everything is fairly academic, as we must wait to become a legally recognised body under Latvian law, because the pensions money still belongs to the Lattelekom company. This is expected imminently though.
“Once we know for definite that the money is to be transferred and the employer will pay 5% retirement provision for each person, then we must decide what the system will be for the actual pension investment and payments.” Zirgdina adds that the list of other issues still to be finalised is substantial, including definite company contribution levels, risk parameters for investment, and scheme administration.
When the scheme first gets the regulatory green light, money will firstly go from the Lattelekom company to a selected custodian.
By law, custody may only be carried out by Latvian approved banks or credit institutions.
The custodian will then in turn hand over the assets to the newly authorised pension fund company, whilst also ensuring the overall asset security and reporting aspects of the scheme.
Management of pension capital, cash facilities and other assets accumulated by a pension fund - including new investments and their capital gains, may only be performed by either the corporate itself, or a bank licenced by the Bank of Latvia and approved by the Securities Market Commission for brokerage activities.
Zwirgdina continues: “Once we receive the money from the custodian here at the pension fund, and we have been informed by the company what the final rate of contributions for employees will be, then we will decide on an investment strategy and outsource the money to investment managers.
“We may also leave the asset manager a free hand though and just stipulate geographical or sectorial preferences for the investments.
“The reason for having what may seem from the outside such a complex system, is that by keeping assets in circulation we cannot lose all the money in the event of any financial misfortune,” she says.
In terms of direction and administration the fund will have a pension plan committee consisting of half fund and half employee representatives, backed up by another two supervisory bodies, composed of pension fund board members, directors of Lattelekom and social partners within the company.
The overall Latvian pensions system itself was finally ratified in law on Jan 1 1996, taking the form of a three pillar pyramid structure.
At its base comes the state social security net, where pension levels depend on the amount of social tax paid, coupled with the longevity of an individual’s career.
The first pillar is a pay-as-you-go unfunded state scheme, also eminating from social tax payments, currently standing at 37.09% (9% coming from the individual and 28.09% from the employer).
The second supplementary pillar is the ‘state manadatory funded pension scheme’ with provision for real capital accumulation for individuals via social tax.
However, the scenario as it stands, is that no payments are yet balanced out between generations, due to the demographic situation in Latvia, whereby 24% of the population is already retired. Statistics show that already each Latvian employee now pays for 1.5 dependants.
“Only when there is actually enough money in the coffers to level the balance of payments in the system will it actually represent the equivalent of future pension payments to those that currently pay for it. It’s difficult to say when this will happen, but undoubtedly it won’t be before the end of next year,” Zwirgdina explains.
In 1996 the retirement age levels were changed in Latvia, from the previous ages of 55 for women and 60 for men, to a progressive system of equality, where 60 will be the overall retirement age.
The age rise for women has been on a half yearly increment, so the retirement age is presently 57.5 years, although, the possibility still exists to take a pension at 55 with concordant penalties - and this is only possible for women.
The social budget in Latvia is entirely independent from the state budget, and includes four special independent finance operations; the pensions, employment, disability and maternity/industrial accident budgets. All however are covered on the administration side by the state budget.
The third pillar of the Latvian system is for private pension provision, and for the most part waiting still to be implemented - although appropriate legal forms have been in place since July 1 1998.
Presently there is only one open ended fund with a licence founded by Salus Banka (Sun Bank) and two Latvian insurance companies Ezerzeme and Salamandra Baltik.
Another possible provider Sociâlais Nodro Inâjums (Social Security), founded by another bank and two insurers is having its application considered by the regulators.
Although Lattelekom are the first to look to this fund style others are looking to do it in another fashion, ie solely via life insurers - with some looking to go through the new open vehicles.
However, should Lattelekom’s initiative prove successful, then the structure of the whole pensions system could begin to change.