Pension funds

Pension funds; Pension Reform in Lithuania

No other word has come to define an entire decade of Central and Eastern European history like ‘reform’. Common sense suggests that poorly conceived or executed reform is worse than no reform at all, yet those enacted across the region since the fall of Communism have often been less than ideal.

Lithuania is no exception. Since regaining its independence in 1991, the country’s legislative process has often retracted, sidetracked, and for long periods entirely abstained ffrom, reformist legislation. The rapid economic growth of the last two years (in 2003, GDP grew by nearly 10%), and the political leverage this offered for expensive structural reforms, only highlight the failure of the government to pursue such a course. It is sufficient to simply take a look at the situation of healthcare or education systems today.

One piece of major, though still relatively modest and cautious, reform nevertheless progressed significantly in 2004. Until the end of 2003, Lithuania rrelied on a simple redistributive mechanism to provide for its elderly. The traditional pay-as-you-go (PAYG) system, employed in many European countries, is based on a money transfer from workers to retirees. This system, otherwise known as the first pillar of tthe three pillar pension model, accounts for 90% of total pension income in the European Union countries. Despite its widespread use, however, the system is flawed in a number of ways:

But most importantly, a PAYG pension system places an unsustainable strain on government social spending. Some EU countries are currently piling up liabilities on the scale of war debts. On current trends, nine EU countries will have accumulated gross debts of 150-300% of GDP by 2050, causing the eventual collapse of a system to which ppensioners have diligently contributed throughout their working lives. However, many countries are beginning to experience the breakdown of their PAYG systems. While the current state pension constitutes 30-40% of the average salary, it is very difficult to maintain a normal standard of living below 70%. Fundamentally, the flaws in the system are encoded in simple demographics. The population of Europe is ageing at an ever increasing rate, and within 30 years, the ratio of over-65s to those aged 20-64 will ddouble. This will create an irresolvable fiscal imbalance wherein a small number of providers will be unable to support a growing number of pensioners.

Acknowledging the inevitable, the Lithuanian Government began modelling what was to become a three-pillar pension reform in 2000. A second pillar was eventually added to the first pillar tax-roll contributions in January 2004, and a third pillar – voluntary savings – is being implemented in the New Year. While Lithuania was the last of the three Baltic States to undertake this reform, the pre-existence of the model elsewhere meant that its implementation occurred relatively smoothly. This is doubly impressive given the extremely short period of time – the package of laws were adopted in July 2003, and the first round of subscriptions completed by December – during which state institutions had to prepare by-laws, and the fund-managing companies had to both acquire licenses and carry out promotional campaigns. In fact, Lithuania’s transition has been much less troublesome than similar shifts in most European countries, despite the truncated timeframe.

The second pillar of the three pillar model (TPM) allows every socially insured employee to direct 2.5% of his earnings into a private pension fund (of his choosing) ffrom January 1, 2004. This contribution rate will be increased annually (at the expense of the first pillar share) until it reaches 5.5% in 2007. All age groups of the employees are free to choose whether to participate in the second pillar and to start private saving in a pension fund or to stay completely dependent on the State Social Security Fund (Sodra).

The introduction of the second pillar does not incur any changes on those willing to remain within the PAYG system. Those taking part in the funded second-pillar system, however, now can accumulate funds that will remain the sole property of the individual, and can also choose the fund and manager who best suits them on a risk/return ratio.

Open to all

These reforms in Lithuania also allow all employees to participate in the second pillar, a provision unique within ...