Estonian Insurance Association CEO, Mart Jesse, discusses the impact the government's plans to make the second pillar voluntary, and give everyone the right to access their funds early, will have on the long-term sustainability of the country's pension system

For the last two decades, the Estonian pension system has been stable, having been built on a three-pillar model. As usual, the first is the state pay-as-you-go pension, the second is a mandatory funded pension and the third is a voluntary funded pension. Minor fixes have been introduced over the years, but the general
principles have remained unchanged.

In recent years, general dissatisfaction regarding the performance of the second pillar has increased due to low investment returns in comparison with the performance of peers in other OECD countries. The conservative regulation of pension products in Estonia should have been reviewed years ago but discussions
regarding a major revamp started too late.

The Estonian experience should be used as an example for all countries to monitor the performance of their pension systems and to use all opportunities to improve it.

After the March 2019 General Election, a populist coalition came to power, agreeing to reform the second pillar and convert it into a voluntary system. This included giving the right to everyone, regardless of age, to withdraw funds. This right to withdraw funds was not limited to the contributions invested by the member but also contributions made by the government.

The funding of the second pillar includes a 2 per cent payment from the employee based on their gross salary, and a further 4 per cent is supplemented by the state budget. Thus, the reform means two-thirds of funds invested by the government originally intended to secure the sustainability of the pension system could be used for consumption and purposes other than providing a pension.

The rhetoric behind the change was to give freedom and flexibility to people. At the same time, projections even by the government itself showed a decline of the future pension replacement rate. However, politically, the change was extremely popular, the draft law was quickly prepared and rushed through parliament without major discussions and amendments.

The changes of the regulation were not promulgated by the President of Estonia and
were submitted for assessment to the Supreme Court, referring to violations of the constitution, including inappropriate use of tax revenues, disrespect for rights of future generations and illicit termination of valid annuities.

The judgment was released on 20 October 2020. While the court noted several
infringements of rights and risks deriving from the law, they were not considered as major violations of the constitutional rights. Thus, the changes to the law were considered lawful and the reform was given the green light.

There are about €5 billion in mandatory pension funds. It is predicted that about 50 per cent of customers will withdraw their investments from pension funds. According to surveys, the people most likely to withdraw the funds are people with less savings and lower level of education. The number of annuities to be
terminated remains unclear, but as the regulation gives the insurer the right to transfer their annuities portfolio to the government with the surrender value, it is expected that most insurers will use this right.

Although the right to withdraw the funds will be granted, the system of funded pensions will remain in place. Individuals entering the labour force will be included automatically, however they will be granted the right to opt out.

It is very unlikely that the mandatory funded pension for all labour market participants will be restored in the near future. The confusion around the second pillar has damaged the image of the funded pension and it will take years of joint effort by the financial sector and the government to restore it. Whether it is doable, or even worth trying, remains unclear.

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