In common with other Baltic states, Latvia has found that post-soviet pensions are inadequate for the 21st century, and have set out on a process of reform which has more in common with their western neighbours, rather than their communist past.
The first step towards a restructuring of the system was taken in 1995, with changes to the state first pillar. The notional pension was converted to a DC scheme after a series of discussion papers were assessed by the government and trades unions. This system is financed as a pay-as-you-go scheme, and administered by the State Social Insurance System.
This basic pension is to be supplemented by a compulsory funded system as of July next year. Originally it was hoped to have the plan in place by 1 January 2001, but administration problems, and an increasingly complex debate about funding has meant a six month delay. The scheme will be administered in the same way as the existing pension provision, and run by the government for the first two years. It is then hoped that a fully funded scheme can be contracted out to independent management.
Most of the debate concerning the new plan has centred around how much of the social contribution, set at 20% of wages, will be dedicated to the new pension, and just how the changeover will be financed. Latvia is not alone in finding it difficult to narrow the gap between expectations and financial reality. Even so, the scope of the new pension is far lower than that originally set out in the government’s consultation papers.
Contributions are set to begin at 2% from the social contribution. Originally it was hoped to begin at a figure at least twice that amount. Although the government plans for a steady increase in the percentage over the next decade, for the first few years it will be set at 2%. Some analysts believe the government’s projected figures of 8% by 2008 and 10% by the end of the decade are optimistic, and will be difficult to attain, at a time when they are attempting to lower the budget deficit.
Nonetheless, a government spokeswoman confirms that the changeover will be funded by long-term debt, in a manner similar to the basic pension, until contributions make up the funding gap. With the privatisation process almost complete, the government has insisted that funding will be found from the existing budget.
The new scheme will affect around a quarter of the 1m workforce, being mandatory for anyone under the age of 30. This is lower than the cut-off figure in neighbouring states, and it is not yet clear how those above the age limit will react. Older workers may stay within the existing first pillar, or opt to join the new scheme. There are no clear market indications of how many will opt for the latter, although with wages depressed and the government aiming for fiscal tightening, the climate does not seem ripe to encourage workers to move to the new scheme.
The next pillar is made up of private pension funds, supervised by the State Insurance Supervision Inspectorate (SISI). Although this sector got off to a slow start, the number of schemes is now rising on a steady curve. There are 12 plans in place, authorised by the SISI with just over 5,750 members. The accumulated capital of these funds is LVL4.7m (e9.1m), and in the second quarter of this year LVL3,856 was paid into the schemes by the members.
Janis Bokans the deputy head of the SISI, charged with the regulation of the new funds, is concerned that too few workers are actually taking up the third pillar. “At the moment salaries are low, and consumer spending perhaps higher than it should be, thus savings are depressed. Consequently there has been little discussion or interest among the general public.”
He points out, however, that although by far the largest fund is run for the largest telecoms company in Latvia, other companies are expressing interest in setting up schemes for their employees. “Trades unions are also involved, via the collective bargaining system in advocating pension funds as part of the employees overall benefit package,” says Bokans.
As in other countries across Europe, foreign asset managers have expressed interest in the new pillar, but not for the first time have been disappointed at the level of funding. Although all management companies must be registered with the SISI, Bokans says this is no bar to foreign involvement in the future.
After a brief hiccup earlier this year, the pension reforms seem on track again, and although as Bokans points out, new ideas take time to get hold, Latvia seems to have prepared a climate for private provision to grow.