Conceptual Proposal on the Transformation of the State Social Security System (“Sodra”)

The executive summary

Lithuanian Free Market Institute has presented to the Lithuanian government and general public a Conceptual Proposal on the Transformation of the State Social Security System (“Sodra”). It is assumed that the Conceptual Proposal will attract attention from politicians and governments in other countries, experiencing similar difficulties. Situation of social security keeps on getting worse and the increasing gap between inflows and outflows is financed by high interest rate loans. Deteriorating demographic conditions will only deepen Social Security’s problems, meaning that within the next decade the state system will not be able to meet its financial commitments.

Lithuanian “Sodra”, just like all other state social security systems are based on a pay-as-you-go principle, that is, current recipients are financed by current taxpayers. Essentially, this system functions as a pyramid scheme – if contributions were to decrease due to economic, demographic or other causes, the pyramid would begin to crumble.

In addition, the current system has another major flaw: insurance is mixed with welfare. In most cases it is impossible to distinguish whether a certain disbursement is insurance or a social benefit. It is obvious that minor changes within the framework of the current system will not suffice: what is needed is a fundamental transformation. For this reason, LFMI calls on the government to strictly separate the cases where insurance principles can be applied from cases where that is impossible.

As LFMI’s research shows, insurance principles can apply to only two types of disbursements – work injury insurance and healthcare insurance (together with sickness pay). These types of insurance are already offered on the market, so there is no need for the state to offer this insurance exclusively.

Principles of insurance cannot be applied to old age. People should individually prepare for old age by saving a part of their income instead of it being taken away for immediate redistribution. As a compromise, we propose compulsory saving for retirement, so that employers would transfer 10 percent of wages to employees’ personal retirement accounts. Regarding other insurance benefits (such as maternity, unemployment benefits) that are currently offered by the state system, we propose to replace them with voluntary saving. After the state relinquishes its functions to the private pension funds, insurance companies and other market players, state would still remain with one important function – to help those in need.

The proposed transformation would allow for timely and stable pension payments to current pensioners and those who will become recipients soon. It would also ensure viability and sustainability of the current state social security system. As a result of the proposed transformation social security contribution rates would decrease, meaning that people would receive a larger share of their income allowing them to save and/or buy private insurance.