Employees obliged to hold private pension plans

  • 2001-09-20
  • Kairi Kurm
TALLINN - The Estonian Parliament adopted on Sept. 12 a bill on the so-called second pillar of the three pillar pension reform. The second pillar, which foresees funding pensions by paying monthly installments into a pension fund, was promoted as a way of invigorating Estonia's capital market.

But Olev Raju, a member of the opposition Center Party is skeptical. "This bill was framed without proper consideration," he protested. "That's why the whole opposition voted against it. The new bill is a way of regulating the finance market at taxpayers' expense. What needs regulating is the pension reform process."

The Tallinn Stock Exchange and the Central Securities Depository welcomed the bill. The stock exchange's management believes the second pillar will increase levels of domestic saving and investment on the Estonian securities market. It will add to the stability of the economy, making it is less dependent on volatile inflows of foreign investment, said Gert Tiivas, chief executive of the stock exchange. "This is a bold and farsighted political move, which will have a long-term positive effect on Estonia's economy.

"It has been clear for a long time that the current pension system is not able to guarantee normal living standards for tomorrow's retirees. Parliament has now taken a big step toward encouraging private savings so people will be better off in the future."

Jaanus Erlemann, chairman of the Central Securities Depository, said that together with the other state institutions and banks involved the depository felt responsible for the successful launch of the system. "We are convinced we can guarantee a modern, efficiently operated infrastructure," he said.

The second pillar system will become effective on Oct. 1, having been approved by the president. People will be able to join the scheme and choose an obligatory pension fund starting from March 1, 2002. Payments to the fund will begin on July 1, 2002.

Under the bill employees will pay 2 percent of their income and the Tax Board will contribute 4 percent of the 20 percent social tax which employees currently pay under the so-called first pillar of the social security system. The state will cover payments transferred from the Tax Board, which may total up to 1 billion kroons ($57.14 million) per year.

Raju believes pensions may decrease as a result of the removal of money from the first pillar social insurance fund. "Pensioners are expected to receive 6.8 billion kroons per year. But if we take 4 percent from the first pillar, pensions will decrease by one-fifth. Do we have the guts to decrease their pensions?"

Estonia's social tax is 33 percent of the monthly gross wage, 20 percent of which is allocated to the Tax Board for pensions. Today, for each person receiving a pension in Estonia there are 1.7 people in employment, a ratio which is set to decrease further.

Payments under the second pillar will be mandatory for anyone born in 1983 or later, meaning it will be about 40 years before all those in employment are obliged to contribute. Those born before 1983 who decide to join the system do not have the option of pulling out later. Sums paid into the scheme can be inherited.

The three-pillar pension system was first introduced in June 1997. The first pillar is a state pension and the third one is a voluntary endowment pension, which enables people to invest the equivalent of up to 15 percent of the amount they pay in income tax free of charge in one of four pension funds. Today only about 7 percent make use of this option.

Kadi Oorn, of the Ministry of Finance, said people will eventually be able to choose between three or four pension funds.

"We've placed strict requirements on fund managers," she said. "The manager's stake in the fund has to reach 2 percent and all the transactions go through the account operating bank, which controls the correctness of the deal."

But Raju believes the manager's share should be at least 4 percent, as is common in many other countries.

Under the scheme, fund managers are limited in how they invest in securities and deposits. If they fail to follow the rules and make a mistake, losses are to be covered first from their stake in the fund, then by their equity capital and a compensation fund. If these three are not sufficient, the state guarantees to make up the rest in the form of a loan to the fund manager.

Robert Kitt, administrator at LHV Pension Fund, one of the companies planning to manage second pillar pension funds, says investors' money will be safe. "The current pension is small and under present arrangements will stay that way forever. Someone has to support the growing number of pensioners, so why shouldn't people support themselves?"

The state, he added, is offering good terms.

According to Kitt, a person with a 10,000 kroon gross salary joining the second pillar with 40 years to go before retirement stands to get a pension half the size of his or her present income. For those willing to pay an additional 750 kroons monthly, their pension will be similar to the salary they have been used to. By contrast, those not investing in the second or third pillar stand to get a pension that is 20 percent of their income.

Today an average pension is about 1,500 kroons. The retirement age for women is 58 and for men, 63.

Harri Taliga, social secretary at the Estonian Central Trade Unions' Association, said people would be unable to understand the pension scheme:

"The higher the productivity rate of the fund, the more alluring the pension becomes. But how should I know what the future brings? By how much will inflation rise? How much will the funds yield and how much will the administration costs be?

"People know that if they put 2 percent in the account, the state will add another 4 percent. And if they die, their children will inherit the money. But that is all that they understand."