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Baltics roundup: Latvia, Lithuania look to system reforms

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“Significant and immediate” reforms are needed to Lithuania’s pension system in order to halt a worsening of future pensioners’ interests, according to the Bank of Lithuania (BoL).

The BoL, regulator of the country’s second and third pillar funds, reported in a study that the current pension system model was not viable enough.

Vitas Vasiliauskas, chair of the BoL board, said: “The scale of emigration, low birth rate, [and] population ageing suggests that, without pushing through significant reforms in the near future, the state will fail to ensure sufficient income for residents without increasing state debt.”

The BoL has accordingly proposed a package of measures to withstand these challenges, including:

  • Introducing personal accounts for the first pillar, to pay out amounts relating to the individuals’ contributions over their lifetime, irrespective of years of service. Returns would be indexed in line with economic growth, but would also be adjusted in line with specific demographic parameters. A state reserve fund would also be set up.
  • More retirement flexibility, including a partial pension for those still working, and incentives for older people to work longer.
  • Mandatory ‘lifecycle’ investing pre-retirement. The BoL said 70% of second pillar participants assumed either too little or too much risk, leading to insufficient returns or loss of funds. Participants were also not inclined to adjust their fund to their risk profile. The BoL has already submitted draft legislation to the Ministry of Social Security and Labour.
  • Encouraging individuals paying 2% contributions for additional pension either to save more or return to SoDra, the social insurance fund. Participants should also be supported in voluntarily increasing contributions.
  • A state pension fund to pay benefits under the second pillar system, thus assuming annuity risk. The BoL said this would incur less risk than using private insurers which might be financially vulnerable, while having a positive effect on administration charges and competition. Participation should be voluntary.

In addition, the BoL said it would evaluate whether tax relief on third pillar pension fund contributions succeeds in encouraging retirement saving.

Vasiliauskas also called for a long-term political agreement on pension reform.

“Short-term issues have been addressed at the system’s expense, and inconsistent proposals have distorted the fundamentals. It is time to put an end to that,” he said.

Latvia seeks to boost first pillar savings

Meanwhile, the Latvian state audit office (SAO) has concluded that the decision to create the country’s three-pillar pension system over 20 years ago was correct.

It said the system provides stability regardless of economic and demographic changes, while allowing the government to make unpopular decisions such as increasing the retirement age in order to ensure sustainability.

However, the SAO’s report highlighted the system’s failure to achieve the first pillar goal of a minimum pension of 20% of the average gross wage.

One reason for this is the large number of individuals paying low, or no, contributions, including employees of very small companies and the self-employed. The SAO is seeking ways to ensure that these individuals pay their legal contributions into the system.

It also recommended a review of fund management fees for second pillar pension funds, observing that the current level of 1% of asset values means increased charges as funds grow, regardless of the actual cost of the service.

The SAO suggested setting up a pension budget reserve to ensure payment of pensions when the ratio of pensioners to working people rises.

But it also warned that there was little public trust in the ability of the system to pay individuals a pension dependent on the capital accrued during their working life, and that publicly available information on the pension system was inadequate.

The Ministry of Welfare has committed to implementing a number of the SAO’s recommendations by end-2020.

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