Pension system becomes litmus test of confidence in state

RIGA - The Latvian government has recently introduced the second and last level of a three-tier pension system, offering residents to participate in a state-run pension investment project and allocating part of their income tax free of charge to these investments.

Latvia is trying to prevent the situation that exists in many Western European countries where the number of employed people is much smaller than the number of pensioners, resulting in a situation in which taxes fail to adequately support the retired.

"In creating the pension scheme we have tried to avoid the mistakes other European countries have made," said Ingus Alliks, director of the Social Insurance Department at the Ministry of Welfare.

"Poland introduced all three levels at once, and therefore now has problems with raising funds for pensioners. We on the other hand introduced the levels gradually: the first in 1996, the third in 1998, and now the second level."

The first level provided for the state to inform residents on the amount of social tax that should be paid by them. "Every person has an account where social contributions are indexed, but there is no real money. Everything goes to pay the pensions for those who already need them," Alliks said.

The third level of the pension scheme anticipates that each person may voluntarily accumulate savings for an old age pension.

Registration for the second level began on July 1, with residents aged 30 to 49 being able to voluntarily declare their wish to participate in the program. However, by July 30 only 4 percent had actually applied.

For people aged 15 to 29, participation in the second level is mandatory, but people over 49 cannot apply at all. "Substantial savings may be accumulated only during a longer period of time, that is, by younger people," Alliks noted.

"The decisive thing is the question of trust - not trust toward the pension scheme as such, but trust toward the state," Alliks said.

The social tax in Latvia is currently set at 36.09 percent of the monthly wage, 20 percent of which is allocated for pensions.

Two percent of the tax will be allocated for the second pension level as soon as the taxpayer registers at the State Social Insurance Agency. Within 10 years, this share will increase to 10 percent, the remaining 10 percent being left for the needs of the current pensioners.

Until Jan. 1, 2003, the funds of the second level pension scheme will be managed by the State Treasury. The money will be invested in state securities and bank deposits. After this date, each resident will have the right to choose the manager of his savings from reputable investment companies licensed by the state.

"It is set by law that only up to 25 percent of the pension funds can be deposited in banks, with no more than 10 percent in any one bank, and no more than 20 percent of the funds can be invested in one of the securities," said Dzoja Salnaja, the treasury's senior pension expert.

"It was planned that around 30 percent of people aged 30 to 49 would participate in the program, so that we would be able to put aside 4 million lats for the second level," Salnaja said. Since the response was considerably lower, only 2 million lats will be accessible.

On July 23, Merita Bank plc of the Nordic banking concern Nordea won an auction for servicing the state funded pension scheme. The bank holding the pension funds will have to carry out payments, deal with securities and service accounts. The pension funds will be held separately from any other banking assets, legally protected from any of the bank's creditor claims in case of insolvency.

After 2003, the State Treasury will continue managing the funds of those who have not chosen any other manager or those who prefer more conservative methods of investment. "The possibility of losing one's pension capital managed by the State Treasury is practically zero," said Alliks.

The Finance and Capital Market Commission will carry out supervision of the activities of funded pension scheme managers. In case of fraud, larceny or negligence the losses will have to be covered by the investment companies.

After retirement a person may choose to add the capital accumulated in the second level to the first-level pension, or use it to purchase a life insurance policy.

The attitude of Latvian residents toward the government's new proposals is very diverse. A significant number have taken to the wait-and-see line of reasoning.

"I presume that many people will register only after visible results can be seen," said Alliks.

Some have been convinced by the bulk of information provided by the media.

Inta, a cashier at a private company, said she has already registered and believes the system will provide her with a bigger pension.

Currently, the amount of the pension in Latvia depends on the amount of the social tax you pay to the state budget. The minimum pension is 30 lats per month.