An Overview of the Current Pension System in Lithuania
The Lithuanian pension system comprises social insurance pensions paid from a state social insurance fund which is independent of the national (state and local) budget, and state and social pensions financed from the state budget. The level of social insurance pensions depends on the amount of social insurance contributions paid and are payable to people previously employed under labour contracts and to self-employed individuals. The state budget finances special pension schemes for state military and officials of internal affairs and defence, national resistance victims, and distinguished persons. State pensions may be paid along with social insurance pensions. Social pensions are paid for those who are not eligible for any other type of pension.
State social insurance pensions constitute the largest part of the Lithuanian pension system. In 1996 its outlays stood at 36.3 percent as compared to the state budget. State pensions constituted 1.6 percent and social pensions - 3 percent.
The state social insurance fund was separated from the national budget in 1991. The fund is administered by a tripartite council representing employers' organisations, labour unions, and the government.
The social insurance fund is financed by a 30 percent employer contribution on the wage bill plus a 1 percent employee contribution on their individual wages. The size of mandatory social insurance contributions, which has not changed since 1991, is set by the government. The parliament decides what portion is to be paid by employees.
Social security contributions are used to finance old-age, disability and widows' pensions, plus unemployment, sickness and maternity benefits. As many as 23.5 percentage points of the 31 percent of social insurance contributions go toward financing the pension scheme. Pensions constitute the bulk, 72 percent (in 1996), of social insurance expenditures. Old-age pensions account for the biggest share of pension outlays, 79 percent, or 57 percent of all social insurance expenditures.
Social insurance is mandatory for hired labour and self-employed individuals. Self-employed people are insured only for the basic pension. Owners of sole prioprietorship and farmers are insured only for the basic component of the old-age pension. Their monthly contribution equals half the basic pension. The number of farmers and self-employed individuals who contribute to the scheme is fairly negligible (1,622 farmers and 36,905 self-employed persons in 1996). Those who are not obliged to contribute to the state social insurance scheme (artists who work under authorship contracts) can insure on a voluntary basis, but in 1996 merely 371 persons did so.
January 1, 1995 saw the coming into effect of a new Law on State Social Insurance Pensions, regulating old-age, disability, widows' and orphans' pensions, as well as laws governing state pensions, including level I and II state pensions, pensions for victims, officials and scholars, plus social pensions. Before the reform Lithuania operated virtually a flat pension system. This was due to the previously high inflation rate and favourable indexing of the lowest pensions. In late 1990 the lowest pension was three times as low as the average pension, while at the end of 1994 it already constituted 70 percent of the average pension. Such levelling of pensions was viewed as a social injustice, therefore the new law was designed to restore pension differentiation, to strengthen the link between the contributions made and the benefits earned and thus to encourage people to use state social insurance.
The 1995 law replaced the pension formula, tightened benefit eligibility criteria, and raised the retirement age. Yet, the reform failed to relieve the strain on the social insurance budget.
Before the reform, Lithuania provided a variety of early retirement pensions inherited from the Soviet period. They were provided for people in certain occupations, especially for those working in detrimental conditions. This added to the increase in the number of pensioners. The reform abolished all early pensions. To alleviate the transition, small compensations based on the years of service are paid just before retirement.
However, the cutback in social insurance outlays brought pressure on the social safety system. Albeit paid from separate budgets, social expenditures are financed by all taxpayers, therefore any decisions adopted to satisfy the interests of one institution are unacceptable. The implementation of the reform aggravated the conditions of social security for certain occupational groups who cannot pursue their careers until the established retirement age (pilots, ballet dancers, people working in detrimental conditions).
Certain groups that were entitled to early pensions demanded that early pensions be restored. The first concession has already been made: The government resolved to provide artists of state-run theatres with pension annuities which are almost twice as high as the average old-age pension. Such policy decisions illustrate not only the government's failure to maintain a consistent, systematic approach to public pension policy but also violations of the principles the government used in designing the public pension scheme.
With the adoption of the new pension law came a switch to an earnings-related pension scheme. Social insurance pensions are available only to those who have paid social insurance contributions. The insurance record covers only the years for which contributions were paid. This provision triggered problems for enterprises whose payments to the social insurance fund were in arrears. Under such circumstances the right to part of pension benefits was denied to the employees. The responsibility for the payment of contributions is imposed on employees, even though the rate of contributions paid by them is a mere one percent. The employer's failure to pay contributions shortens the insurance period of the employee, denying the right to part of the pension.
The right to old-age pension is linked to three mandatory criteria: the retirement age, a minimum of 15 years of state social insurance and at least three years of state social insurance over the last five years before retirement or a social insurance record for the last year. The last requirement poses the greatest concern, for it implies that in order to preserve the right to pension benefits, a person must work until the very retirement age. Those who cannot satisfy this requirement must have a 35-year record of paying social insurance contributions, a condition that is difficult to fulfil for people with employment gaps and for part-time employees (part-time employees are entitled to a share of the insurance record proportional to the contributions paid).
Because of the aforesaid requirement part of elderly people may be deprived of the right to pension. In current circumstances on the labour market people of pre-retirement age are frequently dismissed and find it hard to find jobs or re-qualify. Even a person who have worked for 30 years and regularly paid contributions may lose the right to pension benefits. It is anticipated that when the new pension law comes into full force about the year 2025, a mere 54 percent of Lithuanian retirees will qualify for pension benefits. Those ineligible will have a right to apply to municipalities for social support, which is extended for a limited period of time after investigating the living conditions of the applicant.
Strict requirements for social insurance record may bring some relief within the social insurance system by reducing pension outlays but will put a strain on social allowances. Such circumstances raise doubts as to the capacities of the new pension system to fulfil its liabilities if it comes to cover only half of the country's population.
In reforming the pension system a new pension formula was adopted. The current social insurance pension consists of two parts: the basic pension and the earnings-related supplementary component. The basic pension is flat and uniform for all individuals having the established insurance record. Set by the government, the size of the basic pension does not depend on a person's earnings and contributions. The supplementary pension component is calculated separately for every individual according to an established formula.
The size of pensions calculated based on this formula depends mostly on income earned and to some extent on the years of service. The formula is very redistributive in that the basic pension is its central component. For a person who earned five times the country's average the replacement rate will be a mere 18 percent. The pension will constitute only half of the monthly social security contributions paid. For those, however, who receive minimum wages, the pension will constitute 48 percent of the wage level. Since the replacement rate is so low (an average of 35 percent in 1996), the number of working pensioners is increasing. In 1993 through 1996 it rose by 2.7 percent, although the total number of pensioners shrank due to the increased retirement age.
The new pension scheme is costly and inflexible. It was designed to achieve two aims, poverty alleviation (the basic pension) and income levelling (the supplementary component). These objectives are usually sought by a two-pillar pension system, comprising a public redistributive scheme and private fully-funded insurance. The basic pension is intended to prevent poverty, while the supplementary component is supposed to alleviate a drop in income at the termination of employment. Integrating these two objectives in one formula makes the pension system inflexible. If the lowest pensions are to be increased for the purpose of alleviating poverty, all pension benefits must be raised. This, however, fails to secure the levelling of incomes. The principle that those who contribute to social security more receive more remained but a proclamation.
Raising the retirement age was another major part of the reform. This policy shift was expected to alleviate the increasingly aggravating demographic situation and its pernicious effect on the social insurance budget. Lithuania inherited from the Soviet era an early retirement age of 55 years for women and 60 years for men. Legislative policy changes adopted in 1995 authorised a gradual increase in the retirement age until it reached 65 years for both men and women. Yet, the law was later amended and the retirement age was set at 60 years for women and 62.6 years for men. To reach these levels the retirement age is increased by four months for women and two months for men every year. The annual increase in the retirement age is providing some relief within the pension insurance system. However, the situation with unemployment insurance is worsening as unemployment among pensioners of pre-retirement age and outlays for unemployment allowances paid from the same fund are increasing. According to the forecasts of the World Bank, this policy solution will relieve the pressure on the social insurance budget but no longer than until the year 2010 (as long as the retirement age is raised). It is anticipated that the pensioner/worker ratio will then start worsening again.
Despite the proclamations that the reform was intended to restore social justice and to establish a direct link between contributions made and benefits earned, certain privileged pension schemes were preserved. They include in the first place pensions for state military and officials of internal affairs (state prosecution, the police, the military) and pensions for scholars. Pensions for scholars, which were introduced in 1992 in response to the pressure from the academic community, are regarded as a compensation for low salaries for academic work. Special state pensions are awarded for distinguished people and resistance victims. All of these pensions are paid along with social insurance pensions.
The provision of state pensions is justified on the point that they are financed not from the social insurance budget but from the state budget. Yet, this argument does not explain why the authorities have failed to adhere to the proclaimed principle of social justice. It should be borne in mind that both budgets are financed by the same taxpayers, of which some enjoy a preferential treatment.
The level of state pensions was linked to the basic social insurance pension. However, this inhibited the indexing of both social insurance and state pensions. For this reason, January 1, 1998 saw the introduction of the basic pension to be used in calculating state pensions. Originally this basic pension was equal to the basic social insurance pension. Officials', scholars' and state pensions continued to be calculated according to the old procedure.
The decision to remove the link between social insurance pensions and state pensions to allow of slower indexing of state pensions may entail negative consequences. The recipients of victims' pensions have a strong lobby in the government, so it is feared lest state pensions rise if not linked to social insurance pensions. That the trend is toward increasing favours is illustrated by the fact that the number of the recipients of privileged pensions has doubled since 1995. The ranks of individuals entitled to state pensions are being swelled by even new categories of recipients.
Outside the state social insurance scheme are social pensions financed from the state budget. When the size of pension benefits was linked to the contributions made, the right to any pension allowance was denied, despite constitutional guarantees, to people who never worked or those who had a short employment record. This gap is partly filled by social pensions which are granted not to all individuals without employment record but only to those who through no fault of their own were unable to work. These are mothers of large families or disabled children and individuals disabled from childhood. All others who have reached pensionable age may apply for means-tested social benefits, but not pensions.
Lithuania's pension insurance problems are similar to those confronting other Central and Eastern European nations. Pension outlays have been on an upward trend and account for over 9 percent of GDP. Social insurance expenditures have grown faster than revenues. The revenues of the state social insurance fund have increased 77.8 times since 1991, while revenues rose 61.6 times. This disproportion was further aggravated when the new pension law was adopted in 1995. The pension replacement rate slumped from 50 percent in 1992 to less than 40 percent at the present moment.
Although the social insurance system is funded from a separate fund, the fund has no accumulated reserves. The social insurance budget ran a slight surplus until 1995. Presently it is suffering from a deficit, even though pensions are far below the subsistence level (the average pension amounts to 70 US dollars). Pensions are frequently in arrears, and the deficit is covered by short-term loans from banks. The state social insurance fund is guaranteed by the state budget which is obligated to cover shortfalls in the fund's revenues. So far the state has never resorted to this measure.
The need to replace the public pension scheme is more than evident. The failure of the 1995 reform showed that changes should be guided in another direction. Social security must be organised on an individual, fully-funded basis. Only this alternative will make it possible to link pension contributions to pension benefits and enhance people's interest and involvement in retirement insurance. Social security should be perceived not as a reward for persona merits but as public entitlements for those who are not in a position to fend for themselves. The introduction of supplementary fully-funded pension insurance with pension funds, which has been submitted for parliamentary considerations, suggests that the policy community recognises the need to redesign the pension system along the lines of personalised, fully-funded insurance. Tthis should be the first step in adopting fundamental reform of the pension system. The largest portion of retirement provision should be supplied by private insurance, while the state's role should be confined to providing social support.
