Faced with increasing difficulties in maintaining the outmoded and underfunded social security system, Lithuania is now contemplating the introduction of private pension insurance. The Lithuanian Free Market Institute, embarked on a pension reform project in 1994, aiming to promote a shift from the fraying pay-as-you-go system into a viable private scheme.

During the first years of independence, Lithuanians incurred large-scale losses by entrusting their money to private schemes that were based on dubious rules and principles and lacked ownership protection mechanisms. The losses undermined significantly confidence in the private sector and triggered widespread resistance to economic reforms. Under such circumstances, LFMI recognized the need to promote sound and viable principles of private pension insurance as well as a clear relationship between pension funds and their members. It was also crucial to work openly and market the ideas to a vast audience, including both decision makers and the general public, thus building a broad-based support for the policy reform initiative.

With these objectives in mind, LFMI began by developing a conceptual framework for pension reform, submitting legislative policy advice, and launching an educational campaign. The combination of policy-oriented research coupled with dynamic outreach via mass media, conferences and round-tables have helped immensely in promoting a sound approach to pension reform.

Presently, no one in Lithuania seems to question the need for private pension funds. Yet, the policy-making process has spawned numerous debates not only on the legal principles of private retirement provision but also on the role of the market and government intervention. LFMI has taken concerted effort to advocate a maximum reliance on the market, extensive investment in wide-ranging financial instruments as well as internal risk control mechanisms as the cornerstones of a credible and sustainable operation of pension funds. LFMI has been working against suggestions to allow government interference in the system.

At this point the Lithuanian government has scrutinized and endorsed the conceptual framework for private pension insurance. It is notable that this was the first time that the administration debated a reform conception rather than a law, a procedure that had been proposed by LFMI in its policy paper on how to improve the policy-making process. This approach helped to focus on the most debatable issues as well as to spotlight outstanding fallacies. During a cabinet meeting, the prime minister and other government executives addressed the concerns and arguments that had been widely presented by LFMI in a well tailored public relations campaign. The discussion concentrated primarily on the legal status of pension funds and the principle of profit making. As a result, provisions that required further revision were amended. It should be noted that the idea of non- profit funds was rejected.

Lithuania is going to institute a defined contribution system, under which pension fund members will contribute to personal accounts, and investment returns will be accrued on those accounts in proportion to the accumulated amount. The ultimate level of future benefits will depend on the level of contributions and investment performance. Pension funds will be portable and inheritable, which will enhance their competitiveness and efficiency.

Private pension insurance in Lithuania is going to be optional. A mandatory scheme would require a range of external government guarantees, which, LFMI argues, would reduce considerably the viability and efficiency of the system. Lithuania has therefore opted for a voluntary scheme based on internal safeguards, such as investment portfolio diversification requirements and participation of pension fund members in the management of their savings plans.

Contracting of asset management companies to administer pension funds will not be a must in Lithuania, either. Pension funds will be able to carry out the management themselves provided they have appropriate qualificational capacities required by law. Pension funds without such abilities may choose to delegate the task of administering the scheme to private asset management companies.