Lattelekom: one of a kind
First Closed Pension Fund, the pension fund for
telecoms and electricity supply workers in
Latvia, is the only registered pension fund in the
country where the employers are also the pension
One of the legal requirements of the Latvia’s reformed pension system is that companies that wish to set up a voluntary contributory pension funds for their employees must become shareholders of the pension fund.
Yet, unlike a normal company, shareholding confers no benefits on the shareholders. The pension funds are incorporated as non-profit making companies, and any excess income must be distributed to pension fund members.
Anri Leimanis, chairman of the fund’s board of directors explains: “First Closed Pension Fund is a closed pension fund, which means that membership is limited to the employees of these shareholders. So the employer itself defines which employees become members and
who becomes eligible for their contributions.”
The pension fund, then named Lattelekom Closed
Pension Fund, was set up in 1999 by Latvia’s telecoms company Lattelekom in a collective agreement to manage a pension scheme for some 4,500 company employees.
The fund was re-named First Closed Pension Fund
when Latvenergo, the state electricity monopoly,
joined as a second shareholder in 2001. At the end of 2004 there were three collective agreements covering almost 12,000 pensions plan members. Ownership of the fund is divided equally between Lattelekom and Latvenergo.
The fund belongs to the third pillar
of a three pillar pension system which Latvia introduced in 1995 – one of the first countries
in central and eastern Europe to do so
The law ‘On Private Pension Funds’ in 1998
authorised voluntary pension funds (PPFs), schemes funded by additional voluntary
contributions made by individuals or employers
on behalf of their employees.
PPFs funds may be closed or open. Closed pension funds, as their name suggests, are closed to all but the employees of the companies that run them. Open PPFs, which can only be owned by Latvian banks and insurers, are open to everyone.
There are currently six PPFs in Latvia and all are
operated on a defined contribution basis. There are
no final salary options. First Closed Pension Fund is currently Latvia’s only closed PPF. It is also the largest of the PPFs in terms of assets. Assets have grown from €5.3m in 1999 to €23.2m. This compares with a total of €39.8m for all PPF assets.
The bulk of the contributions into the First Closed
Pension Fund comes from the employers, says
Leimanis. “The normal situation is that a person who has served a company for 12 months is entitled to get a contribution of 5% of salary from the employer.
Individual pension fund members are also entitled to
add their own contribution if they decide so.”
Employers’ contributions are tax deductible and do
not attract social insurance contributions, although
there is an annual limit of 10% of the employee’s salary.
Employees may also contribute to pension funds, but to take advantage of the income tax benefits, their total contributions must not exceed the 10% of salary limit.
Yet employees’ contributions are far below this limit, Leimanis says. “For the moment average employee contributions are low because people do not really understand the pension product. It is the nature of our economy that pension fund money is normally accrued by contributions from the employers rather than employees. So currently, a small amount of people are accruing a small amount of money.”
The fund has a conservative investment policy dictated by its core function, which is to accrue and invest contributions. Rudite Zvirgzdina, managing director of the First Closed Pension Fund, explains: “The fund is a low risk balanced fund with capital preservation as the main objective. The target portfolio structure is up
to 20% in equities with the remaining 80% in fixed
income and money market instruments.”
At the end of the first quarter of 2005, debt securities, including fixed income investment funds, comprised 55.8% of the portfolio, term deposits 24.4% and equities, including equity
investment funds, 19.8%. Pension fund
assets are managed by S u p r e m a , until recently a pan-Baltic investment bank and asset manager. Suprema’s merger with the Nordic investment bank and asset manager Evli Bank led to a reorganisation and expansion of Suprema asset management activities at the beginning of 2003. This has meant a broader offering of investment capabilities, says Zvirgzdina.
“Starting from 2004, the fund manager began to
offer core and satellite investment strategies. Core
investments include a comprehensive range of
domestic, regional and European investments.”
The board of the pension fund has set a real long-term yield level of 3% annually, excluding local inflation.
The nominal long-term yield level is updated at
the beginning of each year, taking into account projected inflation.
Last year the investment portfolio’s yield was 6%,
with local inflation of 6.2%. Fund assets increased
19.6% to €21.9m. The yield since the pension fund’s launch has been just over 9%.
The portfolio’s performance has been broadly in line
with expectations, Leimanis says: “We set 3% above inflation as our long-term target a number of years ago, and we’re still looking at that as our target. “ We had hoped for a slightly higher return last year, but taking into consideration the market development we were quite pleased with what we achieved, noting our risk tolerance level.
“However, we are doing everything possible to find
ways to increase the level, and we have given instructions to the fund manager to look for a bit higher returns which of course can be achieved by taking on some risk.”
The fund is now increasing its exposure to higher
returning assets, he says. “Before the market developments we achieved pretty high returns on the very low risk investments that we had. Now the pension fund board has decided to raise the risk levels somewhat and take some more equities.”
By the end of the first quarter of this year the fund had increased its equities exposure from 5% to 20% of the total portfolio. In the same period it reduced exposure to government bonds from 50% to 38%.
Until recently, investment in European instruments
was hampered by restrictions on investment in foreign currencies. Under the current investment rules, the open position in a pension plan’s foreign currencies may not exceed 10% of the pension plan assets for each foreign currency separately, or 20% of the pension plan’s assets for all pension plan assets taken together. At the beginning of the year, however, the Financial and Capital Market Commission, which regulates pension funds, exempted the euro from the investment
restriction on foreign currencies. Leimanis says this move will help the fund to increase its exposure to both equities and fixed
income. “With the limitation on the euro as a currency we were very much limited in respect of foreign investments into Europe.”
First Closed Pension Fund’s investment strategy has been successful enough to outperform its peers. “Being a closed pension fund we are not direct competitors with
anyone, since we are not attracting funds from new customers.
But for our own performance purposes we
benchmark ourselves against our competitors in the
market. Looking at the performance of the third tier
pension funds we found ourselves 0.6% above the average
pension plan’s revenue performance.”
A closed private pension fund in Latvia currently has
one significant drawback when compared with its open
competitors, however. When pension fund members
leave the employment of the shareholder companies
they can no longer contribute to the fund.
First Closed Pension Fund is currently lobbying to
have the rules changed. “We would like pension fund
members to be able to continue making contributions
into their accounts, and we are currently discussing this
with the legislators,” says Leimanis.
This has met with objections from the open pension
funds, he says. “They think that we are trying to take
business away from them. But we think it is not fair that
if people who are pension plan members leave their
employer they are not allowed to add anything to their
already accrued funds.”