Central & Eastern Europe: Conservative mentality
Latvia’s pension industry is clouded by a lack of trust and communication, writes Rachel Fixsen
The Latvian pension system may be young by global standards, but has proved its resilience during and after the current global financial crisis.
Not only has it survived the turmoil since 2008, but it has emerged from the huge domestic crisis that followed, which saw Latvian GDP fall more than 20% and a subsequent plunge in government revenues.
Harijs Svarcs, chief executive of Swedbank Investment Funds Latvia, which manages second and third pillar assets, says few countries would have performed better under such circumstances.
“Despite a social budget deficit over the past three years, the pension system still has an overall positive surplus due to the large accumulated surplus we had before the crises,” he says.
In common with many CEE countries, Latvia followed the World Bank approach and introduced a three-pillar pension system.
The mandatory unfunded pension scheme took shape in 1996, followed by the voluntary pension scheme in 1998 and the second pillar mandatory funded scheme three years later.
The first pension plans from private second pillar managers launched in 2003.
As a system, the Latvian pension system is a good one, according to Dace Brencena, chief executive of SEB Open Pension Fund, SEB Latvia.
“But it’s not really accepted by members involved in it, because of lack of trust, a lack of knowledge of investment, and the fact that people often don’t know how much they have in their accounts,” she says.
The latter problem is largely technical in nature, Brencena explains.
While there is a webportal for state services, which members and private pensions institutions managing the second pillar pensions can access, in practice there is often no information available.
The issue is becoming important, as almost all taxpayers are involved and should choose an investment plan for their pillar two investment savings.
“State first pillar pensions will not be enough for old age, because of the replacement rate, and this means people should save more from the employer side,” she says.
But it is apparent from investment patterns that Latvians are not interested in the investment and performance side of their pensions, she says.
“Our customer research showed that if you are young enough you should choose a more active strategy, and when closer to retirement you should switch to a more balanced approach.
“But at the moment, we see that only around 50% of people are in fact choosing their pension plan according to their age,” she notes.
SEB Latvia is currently working with the ministry of welfare to improve its pension provision and also devise plans to increase awareness and education about pensions issues.
According to Svarcs, Latvian pension funds invest almost twice as much in fixed income instruments as leading global pension fund managers and under-invest in equity and alternative investment asset classes.
As second pillar pension plan participants in Latvia have an average of 30 years to retirement, this asset mix is far too conservative for even for relatively risk averse and conservative Latvians, he says.
“The negative market returns of 2008 are still alive in their minds and many have not even noticed that these losses have turned into big gains over past few years,” he says.
“People need time to get over it and, unfortunately, external conditions and uncertainty in Europe, US and elsewhere is not helping to calm their minds.”
The Latvian government has now passed a law to increase the contribution rate to second pillar pensions, from 2% currently to 4% in 2014 and 6% in 2015, where it will remain.
Brencena believes it is vital that the government does not make the political decision to reduce the contributions level again, because this would undermine public confidence in the system.
“People need to understand how they can influence their savings volume, and that they can rely on the system as such,” she says.
One change in the pipeline is the upcoming option to choose an annuity with second pillar savings from a life insurance company or use the state provider.
Several life insurance companies are planning to enter the marketplace, which Brencena believes will bring improvements by offering a new range of products, including annuities.
A much-needed development in the Latvian pension system is the introduction of the heritability of pension savings, which would bring it into line with that of its neighbour, Estonia, Brencena says.
The vast size of the Latvian grey economy is another factor working against full development of the pension system, she believes.
Unofficial earnings are not only a loss for the tax authorities, but also fail to attract pension contributions from the government for employees, Brencena points out.