As in all other European countries, pension plans are under discussion in Norway. It is not surprising to anyone that we will see big changes in regulations, funding requirements and products in the next few years.
Three main issues occupy the Norwegian market today:
o the funding situation of the pension institutions (life insurance companies and pension trusts);
o new pension law or rather changes to existing laws and implementation of new defined contribution (DC) pension law, and
o new tax-financed first pillar pension system for implementation in 2010.
The funding situation of the Norwegian pension institutions is somewhat different to what you will find in other European countries. Their liabilities are better funded because of the use of conservative parameters for calculating the defined benefit (DB) liabilities (nearly 100% of schemes) and traditionally low investments in equities. The discount rates used are 3% or 4%, depending on when the scheme was established. These rates are set by the Ministry of Finance and have been stable since the mid 1990s. The Kredittilsynet is proposing to reduce the rate to 3% for all schemes. It should be used for discounting the liabilities from 2003 for all new earned pension benefits and for premium calculations. This will cause the yearly premium to increase by about 24%.
Pension schemes are well financed. The problem is rather the solvency of the pension providers – life insurance companies and pension trusts. In Norway these two institutions are under the same rules and the required solvency margin is the same. After the financial downturn experienced in the past three years solvency is at the minimum level for nearly all institutions. Some of the owners/shareholders and sponsors have been forced to inject new money in equity capital and/or reserve capital. In addition, the pension institutions have altered their portfolio allocation dramatically to reduce the total investment risk and to reduce the base for calculating their minimum capital requirement. The life insurance companies (78% market share of occupational pensions) reduced their investments in equities from 30% in 2000 to 8% by the end of 2002. The corresponding figures for the pension trusts are 23% to 13% (according to Pensjon & Finans Index).
The recommended solvency margin is about 8% of total investments above the current level. As nearly all the Norwegian occupational schemes are DB plans with a guaranteed return similar to the discount rate (3 or 4%), the required financial return is slightly below current yield in the fixed income market. At the same time the investment in equities is so low that the expected contribution from this asset class will not be material. The main part of funding of the recommended build- up of reserves must therefore come from the employer, insurer or from the shareholders and the build-up is expected to take time.
In 2001 a new occupational pension law was introduced allowing pension suppliers to offer defined contribution (DC) plans and hybrids of defined contribution and benefits plan. Due to some rigid rules for converting schemes from DB plans to DC, this process has had a slow start. The relatively few plans that have been established are for small businesses with few employees. The plans normally cover retirement pension only, excluding disability and orphans coverage.
The government has appointed a commission on bank law to come up with recommendations to modernise the financial laws implemented at the end of the 1980s – among them the law that regulates the life insurance industry. The final report is due this autumn for implementation late in 2004. The bank commission has so far issued 10 reports, two of which concern the pension industry (reports no 7 and 10). One of the most important issues is to change the rigid rules that regulate the bundled DB plans. It is proposed that the sponsor should have the right to choose the investment mix of the plan and the mandatory guaranteed return issued by the supplier should be made optional and priced according to the market for such financial guarantees. Each insurer’s investment portfolio should be recorded separately and treated as a discretionary portfolio. The fee that the pension supplier could charge should be a fixed fee depending on the amount managed.
In report number 10, the commission focused on making competition in the attractive municipality market more real and on measures to modify the rules that regulate the rights to move a scheme from one supplier to a competitor at a reasonable cost and prevention of other obstacles.
The most important outcome of the commission’s final recommendation will probably be that the occupational schemes will go from almost totally rigid DC plans to more modern schemes with a large degree of flexibility for tailor-made solutions for the insurers and sponsors and hopefully can make the DB plans more competitive and less risky to produce.
The government also appointed a pension commission with the previous Treasury secretary Johnsen as chairman. The commission started work in 2001 and is due to make final recommendations by October this year.
Last autumn it issued what it called a discussion paper in which it outlined the premises for the need for change and pointed to different solutions to the problems with the financing of the current scheme. Norway suffers from the same demographic problem as other European countries. It is estimated that by 2040 the number of pensioners will double and the active working part of the population will decrease. The financing cost of the ‘Folketrygden’ (tax-financed pension) will increase by 40% if the current benefits are maintained. The commission pointed to the important issue of promoting by taxes, benefits and other incentives, the ability to extend the number of years an employees can work (the current retirement age is 67). The other main issue is to argue for lower benefits from Folketrygden to all, which highlights the need for improving the second and third pillar of the pension system.
For the first pillar system it sees two alternative solutions:
o basic pension, with a flat rate for all, financed through taxes;
o ‘modernised Folketrygd’ – continue with current system of partial income-related benefits, but make modifications to match the acceptable financing level (estimated at 10– 15% lower benefits than today).
The politicians have already fallen on the second solution, but at this preliminary stage no consensus has been reached regarding definition of the benefit level and distribution, and the way it should be financed. It seems that most politicians can agree on using the Petroleum Fund – now at about Nkr610bn (e78bn) –to fund part of Folketrygden’s liabilities, estimated to Nkr3,500bn.
A huge problem will surface when the benefits of Folketrygden are reduced, starting from 2010, as nearly 50% of employees in the private sector have no pension apart from the Folketrygden. We will expect this particular issue will draw good deal of attention once the main issues of Folketrygden are settled and it is seen by the industry as an excellent opportunity for new business.
Caspar Holter is a partner in Pensjon & Finans in Oslo