Central & Eastern Europe: Confusion reigns
Gail Moss reports on Lithuanian regulatory and legislative turmoil. Far-reaching reform is still needed to strenghten the pension system
Lithuania’s pensions industry has experienced an autumn of confusion.
Parliament passed a number of reforms in mid-September, but before the legislation went to a (mandatory) second vote, October’s parliamentary elections resulted in a change of administration.
Voters turned against the previous administration’s austerity policies, giving the Labour Party and Social Democratic Party enough seats to form a coalition with a number of other parties.
But this still left the outgoing government with a further two weeks to tidy up business.
After some contentious changes in the legisalation were dropped following industry opposition, the legislation was approved for the second time in the dying days of the administration and has now become law.
The main change is to allow pension fund members to make additional contributions to their pots, to be topped up by the government.
At present, employees who choose to make second-pillar provision get 1.5% of their social tax contributions redirected into a personal account with their chosen private pension fund, instead of paying the full amount into the pay-as-you-go system (Sodra).
This means they forego a share of their state pension, receiving a second-pillar pension instead.
In 2014, when the social tax contribution will be 2% of salary, members will be allowed to contribute an extra 1% as an optional payment from after-tax income. This will be boosted by a government subsidy of 1% of the statistical average national salary.
The so-called ‘2+1+1’ scheme will become ‘2+2+2’ from 2016.
Alternatively, second pillar participants can stop paying into their second pillar scheme, relying more on Sodra.
As with other European countries, Lithuania’s state pension system is under demographic pressure – out of 3m citizens, 720,000 are pensioners and the 1.3m strong workforce, is shrinking because of emigration.
Two-thirds of the workforce have second-pillar arrangements, offered by over 30 pension funds from nine asset managers. Most of these are well-diversified fund of fund products offering in aggregate a wide choice of asset class combinations.
Nearly one-third of total assets are invested in Lithuania, mostly in sovereign bonds, with the rest abroad, in eastern Europe or globally.
“It’s essentially a good system, but the average monthly contributions are €7-8, which isn’t enough to make a difference,” says Gediminas Milieska, CEO of SEB Wealth Management.
Like many of its peers, SEB Wealth Management runs three pension funds – low, medium and high-risk. The vast majority of clients – 83%, with an average age of 39 – invest in the medium-risk fund, while only 6% (average age 32) invest in the high risk fund, 80% of which is made up of equities.
Milieska laments the small numbers of young people in that fund.
“People are very conservative towards equities because they have lost a lot of money in the past through stock market crashes,” he says. “Given their low level of wealth and rather limited understanding of capital markets, people prefer to trade returns for security.”
On the regulatory front, Milieska says the second pillar should be made mandatory for younger people: “This would make the system more credible, helping pension funds add to the capital of the country.”
Vitalijus Šostak, director of the fund management department at Finasta Asset Management, says the biggest improvement to the system would be higher contribution rates to pension funds from Sodra, to ensure a higher replacement rate for retired participants.
“Other improvements would be life-cycling in asset allocation, self-managed pension accounts for employees, and direct contributions from employers to pension funds, bypassing Sodra,” he says. “That would increase transparency and avoid misunderstanding. At present, the public often treats transfers to pension funds as just another social security expense.”
Ramūnas Stankevičius, CEO of asset managers MP Pension Funds Baltic, suggests introducing standard and composite benchmarks for all types of pension fund, to make comparison easier for clients.
Looking forward to the effects of the recent reforms, he is hopeful that only a small number of participants will go back into Sodra.
“I think few people will decide to pay the voluntary 2% contribution,” he warns. “For highly-salaried individuals, a 2% of average salary top-up is not enough of an incentive to lock away 2% of their actual salary until retirement. And though it’s a good deal for low-paid workers, they are less well-educated and don’t have surplus money.”
He says that there has also been a breakdown in trust: “People are not sure if the government will change the conditions again and cheat them. The most likely outcome over the next four years till the next parliamentary election is that the second pillar system will muddle along with the 2% payments from Sodra.”