In March 1997 the Lithuanian Free Market Institute and the Social Policy Unit organised a major seminar "Private Pension Funds: Laying the Foundations", co-sponsored by the International Centre for Economic Growth (ICEG), the United States Agency for International Development (USAID) and the United Nations Development Program (UNDP). The opening speech was delivered by UNDP Resident Representative Mr. Cornelius Klein.The seminar was designed to analyse fundamental principles and major alternatives of private pension insurance and to identify the tasks necessary to accomplish in creating an appropriate environment for the operation of pension funds. The event drew close to 70 participants, including MPs, government executives, members of employer and trade unions, experts on pension insurance, capital markets and financial intermediaries, entrepreneurs, and reporters.This article outlines the main ideas articulated during the seminar by the speakers.

LFMI's Social Policy Analyst Audronė Morkūnienė spoke about worldwide experience in setting up pension funds. The concept of pension fund in the West, she noted, is not homogenous due to a twofold nature of pension funds. They are non-profit organisations on the one hand and financial, profit-seeking institutions on the other. EU documents define pension funds as economic entities. Pension funds as a source of supplementary social insurance have a long tradition in the West. They were established mainly as legal entities managed on a trust basis. German pension funds took another form, "book reserve", which means that pension assets are not separated from the company's assets but included in the general balance sheet. This form of financing pension funds, however, is not recommended for Eastern and Central European countries due to their volatile economic environments.

According to Ms. Morkūnienė, a remarkable example of pension reform has been provided by Chile, an example that is being followed by other Latin American countries in their attempts to reform the fraying social safety nets. Hungary and the Czech Republic were the first to establish private pension funds in Central and Eastern Europe. The need for private pension insurance is widely recognised throughout the region. Unlike the developed nations, however, post-communist countries have no empirical experience in supplementary old-age insurance, a practice that served as a basis for building the legal infrastructure for private pension insurance in the West. It is therefore necessary to work out pension insurance schemes appropriate for domestic environments.

LFMI's Legal Expert Remigijus Šimašius generalised about pension reform debates in Lithuania. Although private pension saving plans provide considerable relief within the social safety net, pension funds in Lithuania are regarded as an economic rather than social issue. The choice of a defined-contribution scheme was a major decision. Under this scheme, (i) pension fund participants own individual accounts wherein pension contributions and investment income are accumulated; (ii) participants have an easy access to monitoring investment performance; and (iii) although there is a risk of underperformance and failure to multiply pension assets, the risk of loosing contributions paid is reduced significantly. Upon the expiry of the contribution phase, participants can purchase pension annuities either from a pension fund that has a right to provide it or an insurance company. Participants have also a freedom of choice if they want to use the accumulated resources in other ways.

Teodoras Medaiskis of the Social Policy Unit highlighted the need to harmonise private pension plans with the public scheme. Private pension insurance, the speaker said, should supplement the mandatory system but not replace it. Mandatory public insurance should be developed moderately so that in the long run private pension funds operating on a fully-funded basis could play a leading role in providing retirement insurance. Mr. Medaiskis proposed setting a limit on wages from which to pay mandatory social security contributions and limiting the scope of mandatory insurance. A proposal was put forward to modify the pension indexation procedure so as to gradually reduce the level of social security contributions, leaving more and more room for supplementary insurance.

Alvydas Žabolis of "Vilfima" brokerage firm addressed pension fund issues in the context of the capital market. The Lithuanian capital market is well established in institutional terms. It now comprises the T-bills market, the equity market, enterprise bonds, savings in commercial banks, the real estate market and investments abroad. It also includes investment voucher companies, which sprang up as a result of voucher privatisation, commercial banks and financial brokerage firms. Joint stock investment companies must restructure as investment companies under the new Law on Investment Companies.

Traditionally pension funds have been set up as employer-sponsored plans, Mr. Žabolis said. The current trend, however, is towards open pension funds that are not related to any company and operate on a commercial basis. Pension funds are major-though state-regulated-saving and investment institutions. They are an integral part of financial national systems. Pension funds are also becoming important enterprise managers, for the trend is towards investing pension fund assets in equity. They are stable, long-term investors stimulating the development of the capital market.

The guest speaker from Latvia, Janis Bokans of the State Insurance Supervision Inspectorate, shared Latvia's experience in drafting the law on pension funds. The key operational principles of pension funds comprise simplicity, flexibility and a multi-pillar protection system, including management peculiarities, licensing of assets management, state supervision, investment diversification requirements, assets management guarantee funds and information disclosure. A decision has been made to grant pension funds the status of non-profit organisations, and the role of founders has been entrusted to banks and insurance companies. The founders cannot receive from pension funds direct income (in the form of dividends), but their interest is determined by the opportunity to manage them for a fixed commission. Amendments proposed to tax law provide that contributions payable to pension funds-both by the employer and employee-are tax-exempt, and pension received are subject to the regular tax rate.

World Bank expert David Lindeman said that, since pension funds are a novelty in Lithuania, the new system should be as simple and explicit as possible, so that it is comprehensible to supervisory authorities and the average person. It is recommended therefore that pension funds be established based on a defined-contribution scheme-that is, individual accounts will be opened for participants, and pension resources will not be redistributed among the insured. This would be one step towards a clear, credible and easily administered system.

In drafting pension fund legislation, it is necessary to define whether pension funds will be a special status. If so, the law should explicitly provide for the establishment of a new kind of legal entity, its ownership, management and protection of the interests of the insured. Appropriate regulatory-that is, internal-rules should guarantee the operational safety of pension funds. External guarantees-such as a guarantee fund, minimum investment return or minimum pension benefit requirements-should be avoided, for they are too costly for the insured or taxpayers in case they are promised from the state budget.

June Crombie, a representative of Bishop and Robertson Chalmers legal firm, Scotland, noted that pension funds have a long tradition in Anglo-Saxon countries. They are employer-sponsored (professional) plans organised as trusts, legal entities managed on a trust basis. The founders of a trust assign trustees to administer the fund. It is not common in Anglo-Saxon countries to prescribe what is allowable and what is prohibited in pension fund activities. They delineate instead the behaviour of trustees, therefore the laws contain a whole range of complicated rules setting forth operational procedures and responsibility. These rules have piled up for almost a century, therefore Eastern and Central European countries would find it fairly hard to adopt this experience overnight.

1994 saw the first pension funds in Hungary, prof. Antal Deutsch of McGill University, Canada said. They provide supplementary voluntary pension insurance. Hungary is now contemplating a pension reform that will make pension insurance compulsory for certain segments of the population (e.g. persons entering the labour market). For this reason the issues concerning the operational safety are of prime concern. The functioning pension funds are subject to strict investment supervisory and diversification requirements. The Hungarian government has proposed the introduction of mandatory individual investment accounts. Some argue that mandatory, as distinct from voluntary, accounts ought to be guaranteed by the government. There is no guarantee for pension benefits.

The speaker proposed distinguishing between two phases in the pension fund operation-the accumulation phase and the annuity phase. There are two kinds of risk relating to the accumulation phase. These are embezzlement and underperformance. The consequences of imprudent management may entail inadequate return on investment and/or excessive administrative costs. The annuity phase may be faced with other risks, that is, bankruptcy of the annuity issuer and failure to adjust for inflation. Prof. Deutsch identified means to reduce such risks.

Actuary Baiginat Kamuntavičienė of "Lithuanian Insurance" company said that people accumulating retirement provisions individually assume all the risks related to decision making and investment activity. They may underestimate the amount necessary to provide for retirement. On the other hand, they may overestimate it and never make use of the surplus amount. Savings may be lost through imprudent investment. If retirement provisioning is entrusted to special saving institutions, such as pension funds or insurance companies, these risks are shifted onto them. In pension funds the risks are estimated and means to eliminate, or reduce, them are proposed by qualified actuaries.

Actuaries calculate the level of contributions necessary to ensure a particular level of pension. They provide advice about where and how to invest in order to reach the optimal ratio of risks to profits, calculate the level of pension that the insured may purchase with the money accumulated. This work rests on the assumptions about life expectancy of the participants, estimated investment returns, inflation and pension fund administrative costs. There is a risk during the benefit phase that these assumptions will not materialise. This risk, however, may be reinsured in another insurance company. Yet, investment risks are reinsured rarely, for it is extremely expensive.

LFMI's President Elena Leontjeva said that a pension fund law in and of itself is not all that is needed in introducing private retirement saving plans. It is equally vital to provide a sound economic environment based on free market principles. One prerequisite of such an environment is an irreversible, large-scale privatisation. Investments should be made only in the market and following market rather than government guidelines. Pension contributions and investment returns should be tax-exempt, and weaknesses in the tax system-weaknesses that continually jeopardise business activity and shareholding-should be removed. The banking system should provide a possibility to separate customers' money from banks' credit resources, and the principles of currency issue should be such as to ensure a long-term currency stability and transparency. It is these prerequisites but not perfunctory government safeguards that will provide viable conditions for pension fund activity.

Jaroslav Krol of McKenna&Co, Poland discussed the means of protecting participants' interests as stipulated in the Polish bill on pension funds. In Poland participation in pension funds will be mandatory for certain age groups, therefore the safety of pension fund members is a subject of primary consideration. Operational safety and credibility will be guaranteed by high minimum capital requirements plus investment diversification requirements. The operation of pension funds will be monitored and supervised by a state supervisory authority with wide-ranging powers. Participants' assets will be separated from the administrative fund. The law sets out detailed reporting obligations towards members and the supervisory authority. Special funds will be set up to guarantee financial safety. A central guarantee fund will be established to deal with illiquidity problems, and an investment return fund will be used in case of failure to provide minimum investment return.

Croatia has not embarked on pension reform yet, Mladen Staničič, Director of the Institute for International Relations, said, and the public pension system continues to operate on the old principles. Yet, pension reform is inevitable, and the only prerequisite for a successful operation of pension funds is sustained economic growth, Mr. Staničič concluded.