Despite a few hiccups with registration and licensing, the recent pension legislation in Iceland has been enthusiastically embraced by contributors and fund managers alike.
The old age pension scheme is based on a tax-financed public pension scheme and mandatory funded occupational pension schemes, which are generally run by pension funds. The public pension is payable at age 67, and the basic pension is raised by the addition of a means-tested supplementary pension. This results in an income of approximately 44% of the average before- tax wage of a male industrial worker.
All employed and self-employed persons have had a legal obligation to pay contributions to their respective occupational pension funds since 1980. That duty had, however, been self-regulatory since 1969. There had not been any general legislation on the operations of such funds until a new act was passed by the Althing in December 1997, coming into effect in June 1998.
Most of the Icelandic pension funds are mandatory funded occupational pensions. There are 16 defined benefit funds with employer guarantee either by the Treasury or municipal authorities, the majority of which are to a certain extent pay-as-you-go funds. The majority of the funds can be called defined contribution funds although there are no individual accounts, and the risk is borne collectively.
The main planks of the new legislation relates to minimum pension rights, comprehensive rules governing the operation of funds relating to size, risk, internal auditing and funding, and investment policy.
Parliament paid particular attention to the question of equal pension benefits. Previously the existing 66 funds paid differing benefits to members, depending on their relative financial strength. The new law provides for a minimum benefit of 56% of monthly salary, based on a 40-year contribution period. The Financial Supervisory Authority (FSA), which oversees the operation of the funds believes that over-funding of many of them and the prospects of high returns in the years ahead make it highly likely that the benefits may turn out to be higher than this. Still, it is taking some time to equalise payments among the funds. Some funds are paying as much as 60% while others are finding it very difficult to reach the government's target figure.
Until 1987 contributions were only paid on basic daytime earnings, but in a general nationwide settlement it was decided to introduce contributions based on all earnings including overtime and bonuses. It is estimated that a typical occupational pension will provide an income of between 45% and 58% of the earnings of 40–60-year-olds and that the basic public pension will add another 11% to this. The overfunding of the funds, however, will probably result in pensioner spending power being higher than this.
Under the new legislation contribution to funds must be no less than 10% of gross salary, 6% being paid by the employer and 4% by the employer. This means that everyone now has to pay into the pension funds. Although that was the case in theory before the new legislation, there was no real way of checking. Now however, the tax authorities are involved, ensuring 100% contribution. Failure to contribute has led to some funds operating inefficiently in the past.
From 1 January 1999, the tax deductibility of employees contributions to pension funds rose from 4% to 6%. Moreover, if the employee decides to exercise his option and increase his contribution, the employer is obliged to add 10% to this increase, making a total additional payment of 2.2%. Around half of the funds new members have opted for increased deductions. It is however common for the lower paid worker to stick with the statutory minimum contribution, and the government is keen to resolve this anomaly, possibly with new tax incentives.
It may be left to the labour market to solve this problem. Unions and employers associations are currently negotiating a new round of pay increases, and the question of pension contributions has been high on the agenda. One bone of contention is that the 6% contribution paid by the employer is charged at cost and not taxed. According to the trades unions, this, coupled with other tax breaks given by the government, means that employers are not making an appropriate contribution. The unions are demanding that employers match any further voluntary contribution made by the employee. Already one large union and employer has signed an agreement under which matching contributions will be made. This could mean contributions to funds of up to 14% of gross wage in some cases.
Voluntary private pension savings, the third pillar of the Icelandic system, are small. The most recent available figures showed life insurance premiums (insurance for death rather than old age) amounted to ISK700m (e9.7m) in 1998 compared with ISK30bn paid to pension funds. The government has legislated for banks, investment companies and insurance companies to offer private pension schemes, and is also encouraging extra savings through tax incentives. These tax incentives often result now in additional contributions to occupational pension funds.
The government has said pension funds must develop and show that they are providing adequate provision. The government will probably look at the position again in 2002 and draft competition legislation, and possibly allow tied contributors to move to other funds.
Investment regulations are some of the most important articles in the new legislation, and funds are pressing ahead with the guidelines on a self-regulatory basis for the time being. The new law allows them to increase equity holdings in foreign and domestic stock to 50% of the portfolio. Most funds are now investing more in equities, with many aiming to use all their 50% allowance.
Pension fund assets have been steadily increasing, and were given a boost when contributions were switched to a base of total earnings. In 1996 assets amounted to 64% of GDP and 34% of the assets of the credit system. The latest figures available confirm that the funds are bigger than the banks in terms of assets. Having locked high real returns into their portfolios the funds will benefit if real interest rates, as is anticipated, are greater than GDP growth in the years ahead. The funds are expected to reach their peak sometime in the middle of this century when it is estimated they will be one and a half times GDP.
Although the pension burden is increasing, that is the ratio of payments to contributions, it is still only around 50%
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