Latvia’s privately managed third pillar pension funds saw good growth last year, albeit from a low base. Cumulative contributions at the end of 2001 were up by 187% year on year to Lats4.81m (e8.7m), while the number of participants rose to 17,359 from 6,992. Latvia’s economic growth was exceptionally strong last year, with GDP up by nearly 8% year on year in the first nine months of 2001, boosting both individual and company prosperity. “Good companies are now ready to provide additional benefits for employees,” adds Indra Samite, vice president of Unipensija in Riga. Last year’s launch of the second-pillar scheme also highlighted the inherent deficiencies of the state-run PAYG system and focused awareness on retirement provision.
Latvia has three private open pension funds, Unipensija, Parex and Baltikums, and the First Closed Pension Fund (formerly Lattelekom), which between them manage 14 pension plans. The largest by far has been First Closed Pension Fund, the scheme for employees of the former state-owned Lattelekom telephone monopoly and its subsidiaries, and the only occupational pension fund in the Baltic region. The fund expanded further and changed its name in December 2001, adding nearly 7,000 participants in one go, following the purchase of a 50% stake in the fund’s administrative company by Latvenergo, the state-owned electricity monopoly, and now invests for both sets of employees. According to Robert Idelsons, managing director of Suprema Latvia, the fund’s asset manager, the acquisition was the quickest route for the electricity giant to set up an occupational plan.
The majority of Latvian companies lack the employee numbers to make a closed fund worthwhile and have elected to join open schemes. Parex, for example, runs a separate plan for companies, and another for individuals, while the Unipensija fund is a pooled one. Unipensija’s Samite describes the corporate client base as ranging from long-established companies with a tradition of providing worker benefits, to newly established high-tech companies wishing to attract and retained skilled labour. “As the labour market tightens, company private pensions will become more interesting for companies to offer.”
Contributions into private pensions funds of up to 10% of the gross salary are exempt from social and income tax in the case of employees, and not subject to income tax in the case of employers. Capital gains are tax exempt, while benefits are treated as income tax (currently 25%) above an annual threshold of Lats1,200.
Of the three open funds, the two biggest in terms of participants and assets, Parex and Unipensija, have Parex Bank and Unibanka (Latvia’s first and second largest banks) as respective majority shareholders. Baltikums’ major shareholder is the insurance group of the same name, which recently obtained a banking licence. The banks have used their branch networks and corporate client relationships to sell their pensions; additionally, as large employers in their own right, they have signed up their staff as pension fund members. Latvia is also one of the few countries in the region where outsourcing is both legal and feasible. The Lattelekom fund, for example, is managed by the Latvian subsidiary of Suprema, the Tallinn-based investment bank, while Unipensija outsources to the investment company Optimus Fondi.
A newcomer is Hansabanka, the Latvian subsidiary of Estonian-based Hansapank, which recently announced that it will be applying for a third-pillar licence. “The market is developing, and we are a universal bank that has to offer the full range of financial services; the pension fund will also benefit our asset management business,” explains Maris Mancinskis, head of financial markets at Hansabanka. Like the pension funds run by its two major rivals Parex and Unibanka, Hansabanka intends to target its bank retail and corporate clients.
In contrast to Estonia, Latvian pension funds have more restrictive regulations. They can buy only securities listed on the Riga Stock Exchange (RSE), and there is a 15% limit (of total pension fund assets and share capital) on overseas investment. There is also a maximum limit of 10% in any one security. With trading on the RSE essentially confined to a couple of stocks, Lattelekom and Latvian Gas, pension fund managers in practice have to look overseas for worthwhile equity investment. Only two pension funds, First Closed and Parex, invested in equities last year. Parex also had the highest overseas exposure, the bulk in Estonia and Lithuania, with the Tallinn Stock Exchange offering the best regional liquidity prospects, according to Sergey Medvedev, head of investment products at Parex Bank and chairman of Parex Investment Company.
The third pillar open pension fund managers are expected to be the major players in the second pillar programme, which came into effect on 1 July 2001. The scheme, open to all workers to age 49 and compulsory for those aged 30 and under, is funded by a 2% contribution from the social tax, but with no tax breaks, top-ups from the state or other incentives. As the scheme matures, the contribution will rise, to 10% by 2010. The Ministry of Welfare has forecast that up to 50% of the voluntary age group will eventually sign up, and the government is carrying out a major marketing campaign to achieve this target. To date, take-up has been well below expectations, with 26,500 or 5.2% of the eligible group signing up by the end of 2001, against 240,000 in the compulsory age bracket. Medvedev attributes the apparent lack of interest to a combination of unfamiliarity with the private pension concept, inertia, need for further clarity and bad memories of earlier state treatment of savings. “Many people in the former Soviet bloc still don’t trust the state to act in their favour,” says Medvedev.
By regional standards, the unusual feature of the Latvian scheme is that the State Treasury is acting as asset manager for the accumulated funds until the end of this year, investing them, under current law, only in Latvian state treasuries and local bank deposits. To avoid charges of conflict of interest such as colluding to drive down the cost of government debt, the State Treasury asset managers do not participate in primary treasury auctions, have to buy at market price and are restricted in the amount they can purchase of any new issue. Merita Bank, part of the pan-Scandinavian Nordea group, won the custody mandate last July. The introduction of the new scheme also coincided with the establishment of the Finance and Capital Market Commission, Latvia’s new financial regulator, which takes over the central bank’s credit supervisory department, the Securities Market Commission, the insurance inspectorate and deposit guarantee fund administrator.
From the beginning of 2003 second pillar pension fund members can elect to remain with the State Treasury or have their assets managed privately, in this case by licensed investment companies. Such companies (or their parents) need at least a year’s track record of investment management, minimum paid-in share capital of Lats100,000 (compared with Lats25,000 for a third pillar fund) and a Lats50,000 deposit guarantee against mismanagement. Unlike the third pillar plans, the second pillar companies will not be able to outsource asset management.
For both the pension funds and the state treasury, the biggest imponderable is how many will transfer. For example, no-one knows yet how its fees will relate to the rest of the market, whether it intends to charge up for the privilege or undercut to retain as many members as possible. The investment criteria for third pillar funds, which will apply equally to the state and private asset managers as from January 2003, are likewise not known. Most fund managers assume that they will be similar to those for the second pillar, and that their lobbying to raise the overseas limit, and thus their equity investment potential, pays off. “We’re proposing a 40% limit for overseas investment,” says Medvedev. The industry wants the flexibility to offer a range of second pillar plans tailored for different age groups and risk preferences, from equity oriented schemes for younger members through balanced plans to low-risk fixed-income geared schemes for older participants.
The amended sections of the law, currently awaiting parliamentary scrutiny, aim to harmonise Latvian legislation with the European Union’s requirements on free capital movement. “This should enable us to invest without restrictions in the EU, taking into account foreign exchange positions,” notes Samite.

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