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This presentation outlines the main features of Lithuanian pensions, the key components of transition costs, the evolution of transition costs, and the sources for covering the transition deficit. It also discusses replacement rates and the current issues under discussion.
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Transition costs and their impact on adequacy Vidija Pastukiene Seminar on Private Pension Provision Transition costs and decumulation phase Tallinn, 6-7 September 2007 Ministry of Social Security and Labour of Lithuania
Outline of the presentation • Lithuanian pensions: main features • II pillar pension reform: main features • Key components of transition costs • Transition costs evolution • Sources for covering transition deficit • Social insurance fund prognoses • Replacement rates • Issues under discussion
Lithuanian pensions: main features • Old age dependency ratio: 22% in 2004, 45% in 2050. • 85% of labour force are insured • Average pension to average wage (gross) – 32%, net – 44% • Total social insurance contribution rate 34% • CR for pension insurance – 26%
II pillar pension reform: main features • Contribution rate to funded individual DC account: 2004 – 2.5%, 2005 – 3.5%, 2006 – 4.5%, 2007 – 5.5% out of existing social security contribution rate for old age pension insurance (21%) • Participation voluntary for everybody insured under retirement age but no switching back • Benefits available from legal retirement age, compulsory annuity with floor and ceiling • Heritage of pension assets • Benefits non taxed • No central guarantee fund nor explicit state guarantees
Key components of transition costs Each year the size of the transitional deficit is calculated by the following equation: Transitional deficit (year) = A – B • A = flow of contributions into the second pillar • B = reduction in PAYG expenditures as the result of introduction of the second pillar
Key components of transition costs 1. Flow of contributions into the second pillar depends on: • Contribution rate to funded pillar (2.5%-5.5%) • Participation rate evolution (from 55% in 2005 to 75% in 2050) • Income level of participants • Economy real wage growth (sharp changes up to 20% recently)
Key components of transition costs 2. Reduction in PAYG expenditures as the result of introduction of the second pillardepends on: • difference in CR diverted to supplementary part of PAYG pension (10.5 in 2006) and CR diverted to II pillar (5.5 from 2007) • fraction of pensioners getting benefits from funded component (8% in 2008, 58% in 2030 and 75% in 2050) • RR of PAYG component (32.5%, constant due to pension indexation to wages)
Sources for covering transition deficit • Social insurance fund surplus (available until 2020) • Privatization fund assets • Transfers from state budget • Parametric reforms of current pension system (increase in retirement age to 65 from 2012 to 2026 is under consideration )
Social pension insurance fund surplus (available until 2020)
Replacement rates • RR in PAYG mono-pillar system (32.5%) is constant all projection period due to assumed pension indexation to wages (there is no automatic indexation rules in the Law) • The diversification of pension sources and reduction of PAYG program (8.8 % lower replacement rate) will reduce the expenditures of social insurance fund by 0.6% GDP in the end of transition period in 2050. • Due to projected higher real rate of return of funded part switchers of two pillar system are projected to get higher replacement rate by 2 percentage points
Issues under discussion • Financing of transition costs is agreed annually while composing social insurance and state budgets. So far it is shared 50/50 by both. • There are proposals to increase contribution rate up to 10% by 2010. This could lead to enlarging of transition burden to 1.8 % GDP