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Norway's giant E120bn fund

Tucked away in Norway’s plans to modernise its pay as you go pension system, announced earlier this year, is a proposal to merge the two giant wealth accumulators of the current system – the Petroleum Fund and the National Insurance Scheme Fund. Together these funds which respectively manage the country’s oil revenues and meet the expenses of the national insurance scheme have capital assets of over NOK 1,000bn (e120bn).
The Petroleum Fund, which ranks only behind ABP and Calpers in asset size, is owned by the Norwegian Ministry of Finance, which defines the strategic asset allocation, sets the benchmark and monitors the manager. It is managed by Norges Bank Investment Management (NBIM). NBIM’s mandate is to “seek to achieve the highest possible return on investments denominated in foreign currencies”. It currently has 50 mandates with 26 external managers to help it achieve this.
The National Insurance Scheme Fund was set up in 1966. Its primary purpose is to “make an optimal contribution to the national insurance through the accumulation of wealth”. The fund is managed by Folketrygdfondet, which has a mandate to ensure that the fund’s capital is invested to secure the best possible return. The fund’s capital may be invested in only Norwegian bonds, Norwegian equities and up to 5% in Scandinavian equities.
The Norwegian Pension Commission, which was appointed by Jens Stoltenberg’s government in 2001 to “clarify the main objectives and principles underpinning a comprehensive system,” has proposed combining the two funds to form a new entity. The proposed new fund would help safeguard future pension liabilities.
The commission proposes to call it the State Pension Fund. (Statens Pensjonsfond). Sigbjørn Johnsen the chairman of the commission and a former Minister of Finance, says that it is important that the new fund should be named specifically a pension fund: “The government wanted something more general but we wanted to make it clear that the fund is dedicated to pensions.”
In its report, ‘Modernising the national Insurance Scheme - Sustainable Pensions for the Future’, the Pension Commission points out that the experience of countries suggests that it is hard for governments to accumulate financial wealth in reserve funds. There will often be strong political pressure to spend the funds immediately unless, like Ireland’s National Pensions Reserve Fund, it is ring-fenced by legislation.
The commission believes that, by having a dedicated pension fund, it will be easier to gain government support for a long-term fiscal policy based on sufficient funds being set aside over the next few years.
Johnsen emphasises that there will be no change to the management of the funds that are currently managed by NBIM and Folketrygdfondet. “The petroleum fund and the National Insurance Fund will have the same role. So we do not propose any changes in the regime of managing those two funds.”
Both funds have been quietly successful, even during the market volatility of the last five years. The Petroleum Fund has achieved a total excess return since 1998 of 3.6 percentage points, equal to NOK 11.4bn, while last year the National Insurance Scheme Fund achieved a return of 16.2%, its highest return since 1993.
Yet however well managed the Petroleum Fund is, it meets only a fraction of Norway’s pensions bill. The government’s overall pension liabilities under the National Insurance Scheme were NOK 3,700bn at the end of last year, while the assets of the Petroleum Fund were estimated at NOK 850bn.
Pension obligations under the National Insurance Scheme are estimated to increase by about NOK 150 bn a year to around NOK 12,000bn in 2050. Petroleum Fund assets will only NOK 4,000bn by then.
The commission says setting up a state pension fund will, in itself, make pension system neither more nor less sustainable. Whether pension obligations under the National Insurance Scheme can be met in the future will depend more on fiscal policy and economic developments.
However, the commission believes there should be a clearer link between developments in the capital reserves of the Petroleum Fund and the overall pension liabilities under the National Insurance Scheme.
The commission decided against a pension fund based on solely actuarial considerations; that is where assets are matched to liabilities. Instead it said the new fund should be created in the form of a general accumulation of funds, reflecting developments in both government petroleum revenues and pension obligations.
“So this is not all the way out to an individual fund but it is half way there,” Johnsen says. “It’s not a general fund for the Norwegian economy. Nor is it a fund where each individual inhabitant in Norway has a stake in it. It is something in between.”
There are several reasons for this, he says. First, Norway will probably be able to fund an only limited share of the current pension liabilities from the date of the start up the pension fund.
Second, with a model based solely on actuarial considerations it is difficult to calculate how much should be allocated to the fund each year, given the expected fluctuations in the return on capital.
Third, creating a pension fund based solely on actuarial considerations, which would have a large degree of autonomy, would make it more difficult to engineer ‘trade-offs’ between pension expenditure and government expenditure and revenue within other areas.

The Pension Commission, however, wants to define a clear link between the State Pension Fund, pension liabilities and long-term economic policy challenges. To reinforce these links, the commission proposes that annual budget documents from the government should include balance sheets for the pension fund. The old age pension liabilities would appear as a debt item, while the capital reserves of the fund would appear as assets.
Assets would also include government receivables to the amount of its unfunded pension liabilities. So even if all petroleum revenues are allocated to the State Pension Fund, the fund will continue to have a receivable outstanding from government in the amount of the unfunded pension liabilities.
A key proposal is a measure to keep these unfunded pension liabilities in check through a system of guidelines, says Johnsen. The aim is to ensure that the gap between future pensions liabilities as a percentage of GDP and the State Pension Fund does not increase over time:. “We are introducing a new fiscal guideline that says that the relation between the pension fund and the pension fund liabilities should be such that the unfunded element is not allowed to increase as a tax in Norway. If that happens, the government should put forward a report to the Storting Parliament explaining what is happening and why it is happening. They will also have to put forward proposals to restore the fiscal balance it over time.”
The aim is to provide a more transparent system where the relationship between the state's commitments through the National Insurance Scheme, the new State Pension Fund’s management of capital, and overall economic policy is clearly visible. For example, the commission is proposing that the annual distribution of information on individual accruals of pension entitlements should show what share of these entitlements is actually funded by the State Pension Fund.
The commission says the new fund does not need a new fund management organisation, and should base itself on the existing fund management resources of Folketrygdfondet and NBIM.
NBIM should also continue to be responsible for investing internationally while Folketrygdfondet should continue to invest domestically, the commission says. The use of external managers should be broadened, however. Currently only the Petroleum Fund uses external managers. Folketrygdfondet assets are managed internally. The commission wants the State Pension Fund to use external managers for at least part of the capital reserves. It also says the Ministry of Finance should prescribe more detailed guidelines as to how NBIM, Folketrygdfondet and external fund managers should perform fund management.
The Ministry of Finance should decide the balance of investment between international and domestic assets in the fund, the commission says. The ministry should prescribe detailed rules on the allocation of fund capital between investments at home and abroad, with a strong emphasis on monetary policy.
Most of the petroleum fund revenues will continue to be invested in international assets. This is because the present Petroleum Fund has a key role reinvesting foreign exchange revenue abroad. This prevents an inflow of foreign currency de-stabilising the Norwegian krone and unsettling the Norwegian economy. This will continue to be a consideration within the new State Pension Fund.
The Norwegian government has yet to decide whether it will consider the Pension Commission proposals before or after the general election in September next year. However, the commission warns that a reform package must be introduced in 2010 to avoid future problems, and to reach this deadline, a decision should be made not later than 2005.



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