Lithuania is lagging behind its regional neighbours in pensions reform. The Law on Pensions Reform has still not been passed by parliament. Draft legislation completed last summer by the Lithuanian Securities Commission, the financial industry’s regulator, on pension fund structure and operations, has not even reached the discussion stage.
No-one disputes that changes are necessary. The social security agency SoDra, which is responsible for pensions and other benefits, lurches from one financial crisis to another. A management shake-up, raising the retirement age, and reductions in benefits for working pensioners enabled SoDra to run up a small surplus in 2001, but its cumulative deficit still stood at Litas400m (e115m).
Under the current PAYG defined benefits regime the pension provides an average salary replacement rate of 40%, which falls to 20% for higher earners. “We need to ensure that our pensions system has an institutionalised and adequately regulated element, and to use tax advantages to make it attractive to as many market participants as possible,” says Rolandas Sungaila, project manager at Vilniaus Bank.
Last year the legislators postponed the introduction of the second-pillar system by a year to 2004. The main obstacle to parliament passing a law for a compulsory, privately funded system is the so-called cost of transition – the funding of the shortfall in the first pillar caused by diverting contributions to the second pillar. Other countries in the region have financed the shortfall through privatisation receipts, and Lithuania has built up a reserve fund this way. Unfortunately, there are other calls on the fund from two groups: bank customers whose rouble deposits were devalued by the hyperinflation of the early 1990s following Lithuania’s independence from the Soviet Union, and citizens with restitution claims on property nationalised during the Soviet era. “The political problem is to decide which commitment is the priority,” observes Irma Lazickiene, head of the Securities Commission’s investment management division. Both groups contain sizeable numbers of pensioners, who also make up a large percentage of voters for the ruling Social Democratic Party.
As it stands, the draft legislation has some similarities to the Polish system, including a minimum rate of return. Two key differences are that investment limits are at the discretion of the government, and that pension funds can outsource to licensed management companies.
Although Lithuania has had third pillar legislation in place since 2000, no funds have been established. The rules governing their activities, which initially included onerous guarantees and minimum rates of return, were relaxed in March 2001. Current investment restrictions include a limit of 30% of net asset value in equities, and a 40% limit for overseas investment, although the latter will be lifted once Lithuania joins the European Union. The outstanding issue is that third pillar funds suffered discriminatory tax treatment compared with life insurance companies: while both types of policies carried contributions and capital gains tax exemptions, insurance benefits were also tax exempt, while pensions benefits were taxable at 33%. The law is, however, set to be changed next year to equalise tax on both benefits to 15%.
The financial industry is also negotiating with the government about the prospect of tax benefits for companies that want to offer occupational schemes. “We’ve suggested that such companies obtain social tax exemptions, as is the case in Latvia, in order to stimulate the market,” reports Sungaila.