There was a pension reform in Lithuania back in 2004. Pension funds were introduced then. Though contributions to pension funds are not compulsory, the participation rate is over 80% of the working population. For those who have a certain amount in their pension saving account upon reaching a retirement age the only option to withdraw money is acquisition of a pension annuity. The politicians decided to establish a state-owned Pension annuity fund in 2020 to provide people with fair pension annuities. The newly established fund had a pressure to provide competitive pension annuity rates and assure self-sustaining business operations. Own mortality analysis revealed higher life expectances than initially anticipated and higher than those used by competing insurance companies. Low interest rate environment made it difficult to offer the generally expected guaranteed interest rate of 1% pa.

The solution to the problem was an innovative investment strategy. The strategy enables the fund to provide 1% pa guaranteed interest rate for annuities, build a mortality reserve dedicated for future potential losses due to underestimated longevity risk and allows to increase annuities at a rate of 2% pa to reduce the negative impact from inflation. It may seem unrealistic at a first glance, but it works and the calculations show that it will assure of reaching the targets with 99.8% chance.

The idea of our investment strategy is simple and not new at all. We split the premium into 2 investment portfolios: liquidity and growth. The purpose of the liquidity portfolio is to secure cash for outpayments and we do not expect any investment return from this portfolio. While growth portfolio is expected to earn the needed investment return not later than in n years and then the money will be moved to the liquidity portfolio. The whole trick is how we utilize the new business to extend the time needed for the growth portfolio to reach the target return. Proper accounting allows assuring that we do not lose track of the level of achieved goals.

Find the Q&A here: Q&A on 'Investments and Reserves for Pension Funds'