DC all the way in Estonia
Estonia’s PAYG pension system is suffering from a shortfall between contributions and payments and the need for reform is all the more apparent as the gap is steadily growing. The crisis stems largely from Estonia’s retirement age of 55. In 1996, a quarter of Estonia’s population were retired and, in 1997, 24.5% of the government’s budget was consumed by pension payments. The government drew up legislation in 1997 to tackle this growing problem. At the end of last year it revised it and the final product should come into place either this year or next.
The government is proposing radical changes. The new system is defined contribution (DC). By 2016, the mandatory retirement age will be raised to 63, with early retirement at 60, and by 2046, employer’s contributions will rise from 20% to 28%. The annuity income shall also fund final pension payments.
With regards pillar I and II, the individual will contribute 20% of his or her salary to an account managed by the government. Then, legislation will allow the government to choose between foreign and domestic funds. Under the new proposals, the size of Pillar III contributions will be unlimited. The government has yet to decide who should pay the premiums – employer, employee, or both. Pillar III contributions will be paid into either domestic or international insurance companies.
This new proposed law could turn out to provide a stable, dependable system which is exactly what the country needs. Unfortunately, the plan was the previous government’s brainchild and according to sources, this could put the plan in jeopardy. And according to the source, we might even be seeing a totally revised proposal shortly. Let’s hope not. Estonia is desperately in need for a DC solution; the economy needs it, as do the people. There’s also great potential for international insurance companies whose presence would certainly be appreciated.
But it should be remembered that back in 1996, a law was proposed covering the intermediation of insurance contracts. It had two proposals for brokers regarding the sale of international investment contracts. One was unrestricted and the other said international contracts could only be sold if a similar product was unavailable in Estonia or if it could be proved that the international contract was better. The law has yet to be passed.