Iceland’s funds face acid test
Despite a few hiccups with registration and licensing, the recent pension legislation in Iceland has been enthusiastically embraced by contributors and fund managers alike.
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 funds that are defined benefit (DB) 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 (DC) 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. Asta Thórarinsdóttir of the FSA says that “the new legislation will have a profound effect on the pension system as a whole, and the period of change is nowhere near its end”.
The issue of levelling benefits is one of the most important elements of the legislation. Fridjon Sigurdsson, managing director of Lífeyrissjódurinn Lífidn, points out that it may take some time for the funds to even out payments. “In our case we are a relatively new fund, and are only paying out benefits to around 13% of our members at the moment. This naturally means that our premiums are such that we have moved very quickly towards the target of 56%, in fact we are currently paying 55%. Still, no-one pays the same at the moment. Some funds are paying as much as 60% while others are finding it very difficult to reach the government’s target figure,” he said.
Thórarinsdóttir says that unfortunately the licensing process has held back some of the legislation. “The funds were given until 1st July last year to apply for their operation licences. Unfortunately they all waited until the last minute , and only half of the licences were issued. This has had the knock-on effect of holding up the introduction of some of the main articles of the legislation,
including those relating to investment restrictions,” she says. This may not be quite as serious as it sounds, as the funds operated a self-regulatory investment system prior to the new law. What is more, some fund managers claim that currently only a few smaller funds are without licences and expect this anomaly to be resolved very shortly.
Sigurdsson believes that the investment regulations are some of the most important articles in the new legislation, and confirms that funds are pressing ahead with the guidelines on a self-regulatory basis for the time being. “The new law allows us to increase our equity holdings in foreign and domestic stock to 50% of the portfolio. We have seen most funds investing more in equities, and we certainly aim to use all our 50% allowance, and I imagine most funds will follow suit,” he says.
Traditionally Icelanders invested in government bonds or state housing bonds, roughly equivalent to British building societies, when the pension system was set up in 1969. The move towards equities began with the expansion of the domestic stock exchange, and has been accelerated by the development of a pensions industry. The trend is confirmed by Gunnar Baldvinsson, managing director of the ALVIB pension fund. “We have definitely increased our equity holdings, and I understand almost all the funds have done so, and are close to the upper limit. One of our three portfolios will almost certainly offer members the opportunity to invest in a 50% equity holding.”
ALVIB's contributors have almost doubled over the past year from 6,600 at the beginning of 1999 to over 12,000 today. This has allowed Baldvinsson to spot some trends relating to the level of contributions. 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 employee. “First of all, I should point out 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, and this means everyone really is contributing.”
But what about the levels of contribution? The Althing introduced legislation, effective from 1 January 1999, increasing the tax deductibility of employees contributions to pension funds 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%. Baldvinsson says that around half of his funds’ new members have opted for increased deductions. Sigurdsson has similar figures. “Around 40% of our members have decided to increase their contributions,” he confirms, pointing out an anomaly found in most countries. “The low-paid are reluctant to make further contributions, as they believe they cannot really afford it. I am not sure what the government can do to get around this problem.”
It may be left to the 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,” says Baldvinsson. The 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,” adds Baldvinsson.
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 700mISK in 1998 compared with 30bnISK 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. Baldvinsson says that the additional voluntary contribution to his own fund should be seen as the kind of success which these measures could result in. “They could almost be seen as a kind of third pillar contribution,” he claims.
Sigurdsson believes, however, that the government is concerned about pension provision. “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.”