2013-04-02
Survey: 2nd pillar pension funds system can ensure that pensions in the future do not decrease, however, the system will require some time
Citizens actively participating in the 2nd pillar pension funds system can expect an increase in retirement pensions by a third. The two pillar system costs the government annually relatively significant amounts, however, after several decades, the system, with private accumulation, would pay off. Such a conclusion was reached by specialists at the Bank of Lithuania after performing a survey which assessed the influence of the 2nd pillar pension fund system on the population and government finances.
“The research results showed that the confirmed 2nd pillar pension funds system model is well-balanced. The chosen amount of contributions to private funds will not be an unbearable burden for the State, and contributions will be significant enough to ensure that the future retirement pension of Lithuanian citizens will be a large part of their income,” says Vilius Šapoka, Director of the Financial Services and Markets Supervision Department of the Supervision Service of the Bank of Lithuania.
The research, based on mathematical models, also revealed that the size of future pensions will depend largely on whether a person will add additional funds. Having done so, a person would receive government stimulus, and, depending on their age and professional experience, could expect a 15–34 per cent larger retirement pension. However, active participation in the 2nd pillar pension fund system can be very risky for individuals who have less than 7 years left till retirement age.
According to the calculations of specialists at the Bank of Lithuania, if all present participants in the 2nd pillar pension fund system decide to pay additional contributions, the State’s contribution to the system in 2014 would amount to LTL 200 million. In later years the State’s involvement would increase, however, in 2036 the 2nd pillar pension fund system would have paid off, i.e. support of the 2nd pillar pension fund system would become cheaper than that of the pension fund system without private accumulation.
Main conclusions* of the survey “The influence of the 2nd pillar pension fund system on the population and government finances”:
EFFECT ON THE INCOME OF THE POPULATION
- Citizens who pay additional contributions to the 2nd pillar pension fund system can expect, depending on their age and professional work experience, an increase of 15–34 per cent.
It should be noted that the 2nd pillar isn’t the only way to aim for a larger income in old-age, while additional contributions to the pension fund system should be done by spending less now.
- Due to investment risks, small or average income earning citizens of 55 years or older take a particular risk by beginning involvement in the 2nd pillar pension fund system.
- The 2nd pillar pension fund system scenario approved in 2012 creates conditions to support the present future pension and income ratio (replacement rate), without significantly effecting the financial standing of the State Social Insurance Fund Board (SoDra).
EFFECT ON PUBLIC FINANCES
- The State’s contribution to the pension system will affect public finances. Assuming that all participants of the 2nd pillar pension fund will decide to additionally add to the accumulation, the government stimulus (contribution) in 2014–2020 will, on average, amount to 0.29 per cent, and in 2020–2060—0.48 of GDP annually.
- Demand for State funds to finance the current 2nd pillar pension funds system may lead to higher taxes or lower public spending and financial services in the scope of the current generation or more debt for future generations.
- Already in 2036 the 2nd pillar pension fund system will be relatively cheaper than the pension fund without private accumulation, i.e. public financial expenses for financing the pension fund system would decrease.
About the survey
Having created a mathematical Lithuanian pension fund system model, a quantitative assessment of the influence of the 2nd pillar pension fund system on the State’s finances and the income of the population was performed. The results of the pension fund system were evaluated and compared in respect to 50 thousand different wages, pension fund returns, insured incomes and other variable scenarios. In performing the research, also taken into account were ups and downs in the economic and financial markets, as well as the systemic risk of the income of the population. In modelling future scenarios, taken into account was the influence of the ageing of society, decreasing labour force in the long run. Having defined two alternatives—the 2nd pillar pension fund system and without the 2nd pillar—a comparison was made for the expenses to finance both pension fund systems and the replacement rate.
The conclusions are presented by taking into account the most likely preconditions on the ageing of society, the increase in wages, etc. If these preconditions, as foreseen by specialists, would end up not being relevant, the general effect on the population and public finances would be both better and worse.
The reform of the pension fund is long-term, therefore there is a risk, the because of political decisions it might not be possible to ensure the system’s stability, while in the future the size of retirement pensions won’t be the same as forecasted, and this could affect both pillars of the pension fund system.
Although the model uses smaller than usual in practice pension fund investment returns and taking into account the hypothesis that the ageing of society in the long run could have a negative effect on financial markets, and, for example, equity risk premia, there exists the risk that in the future pension fund returns could be smaller. Nevertheless it is still notable, that preconditions for moderately positive likely long-term investment actual returns are much more empirically grounded.