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International Internet Magazine. Baltic States news & analytics Friday, 29.03.2024, 09:48

Bank of Lithuania submits position on necessary pension system reform

BC, Vilnius, 16.05.2017.Print version
The Bank of Lithuania, after conducting a study of the country’s pension system, states that, with no significant and immediate reforms undertaken, the future pensioners’ position will only deteriorate. The Bank of Lithuania is submitting a package of proposals that could change the situation if a long-term political agreement on the implementation of necessary measures is reached.

‘Our position is unambiguous – the current model of the pension system is not viable enough. The scale of emigration, low birth rate, population ageing – the entirety of these facts suggests that, without pushing through significant reforms in the near future, the state will fail to ensure sufficient income for residents without increasing state debt. We have faced a real threat that today’s trend, if we do not reverse it in the near future, will continue increasing income inequality and poverty, and will eventually undermine public finances,’ Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania, says.


According to him, on the basis of a study carried out by Bank of Lithuania economists and scientists, the Board of the Bank of Lithuania has approved a package of proposals that would help withstand challenges.


The proposals are classified according to strategic directions, which are aimed at increasing transparency in the 1st pillar pension scheme in the face of unfavourable trends and tackling income inequality and social inequality through consistent taxation principles within and across cohorts and through safeguarding a strong connection between contributions and benefits.


Specific proposals are as follows:

A) to introduce personal accounts that would closely connect the person’s contributions paid throughout their lifetime and benefits received, irrespective of their years of service. The State would obligate to pay out the amount accumulated on a resident’s account, while persons would be able to see every day what sum will be accumulated. Transparency and clarity will increase motivation to pay contributions. The returns to accounts would be additionally indexed in line with the economic growth rate. For the 1st pillar of the pension system to be more resilient to shocks and adequately react to the projected population ageing and emigration, automatic stabilisers of contributions and/or payouts should also be introduced, i.e. the returns to personal accounts would be adjusted to certain demographic parameters as well. It is proposed that an independent institution computes the parameters of returns to accounts so that the pension system does not become hostage to a political cycle. In parallel, it is proposed to establish a reserve fund, which would enable stabilising the income of people of retirement age during a crisis period;  

                                                                                           

B) to introduce more flexible forms for work and retirement of the elderly, which would be a response to population ageing. The measures include partial pension for those working, combining pension payments with part-time or full-time work. It is also proposed to reduce the value of retirement age and at the same time to provide incentives for the elderly to work longer. This would increase the motivation for working pensioners and pensioners able to work to stay longer in the labour market, while the time for retirement would become more voluntary;


C) to introduce mandatory life cycle investment for those accumulating in the 2nd pillar. Analysis by the Bank of Lithuania indicates that the bulk (about 70%) of 2nd pillar participants, given their age, accumulate in the wrong pension fund, i.e. assume either too little or excessive risk; thus, the threats of insufficient return earned or loss of funds arise. Moreover, pension accumulation system participants are passive, not inclined to changing their fund, i.e. adjusting it to their risk profile. Once life cycle investment strategies are legitimised, a pension accumulation participant would not have to take active action for their assets to be managed optimally, which would ensure better protection of participant interests. The Bank of Lithuania has already prepared draft legal acts providing for changes and submitted them to the Ministry of Social Security and Labour.


D) to encourage adequate level accumulation. Some pillars of the pension system help diversify risks. And yet such additional accumulation must be sufficient to have a significant influence on old age income. It is therefore necessary to encourage persons whose additional pension is currently accumulated from 2 per cent contributions to accumulate more or to return to SoDra, as the accumulation of a 2 per cent additional part of pension is insufficient for a person to have adequate income in old age. It must also be ensured that the aggregate level of contributions to funds is not lower than that which was planned at the time when the pension system began to be created. It is necessary to maintain the possibility for participants to voluntarily increase contributions from their wages and salaries and to support this possibility.


To improve the 2nd pillar system, it is also proposed to consider the possibility that the annuity risk is assumed by the State, i.e. a pension benefit would be accumulated by the State from the funds accumulated in the 2nd pillar. If a positive decision is taken, to assess the possibility to establish a pension fund managed by the State. Administering the annuity system would be expedient for the State, as private insurance undertakings offering annuity may theoretically be financially vulnerable, whereas for the the State such risk is lower. The existence of a State-managed pension fund may have a positive impact on lower administrative taxes, competition; however, a comprehensive analysis should be carried out to assess the expediency of such a fund and risks. In any case, for residents, participation in the State-administered annuity or fund systems should be voluntary rather than compulsory.

The Bank of Lithuania, in the context of the pension system reform, also proposes to evaluate once again the expediency of the tax relief of 3rd pillar pension funds, i.e. whether it achieves its objective to encourage accumulation for old age across all resident income groups.


According to the Chairman of the Board of the Bank of Lithuania, vitally necessary changes require a wide-ranging long-term political agreement. Examples of such agreements can be found in Sweden and Norway.


‘The pension system in Lithuania is closely related to the political cycle. Short-term issues were addressed at the system’s expense, inconsistent proposals deformed the fundamentals. This reduced credibility in the pension system itself, and has imbalanced it. It is time to put an end to that. To deal with rooted chronic issues, a long-term political agreement is inevitable, and it must be reached as soon as possible. The agreement should include mechanisms that would eliminate the dependence of the pension system and residents on a political cycle,’ says Vasiliauskas.


According to him, the first question which should be answered before signing a political agreement is how much importance in restructuring the pension system we will assign to consumption smoothing throughout the life cycle and how much to income inequality and poverty reduction aims. What should be the ratio between these, sometimes conflicting, aims? Taking this into account, mechanisms to implement the reform should be construed. With the inequality issue in Lithuania being especially acute, it is namely this aim that could be more important.






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