Norway's pension sector has been held back by its cradle-to-grave social security system and rather conservative approach to investment. However, record low interest rates, four years of rapid growth in stock market valuations and changes to the way the country's massive oil revenues are managed have conspired to accelerate the pace of change in the sector.

Traditionally, the Norwegian state has relied on an unfunded pay-as-you-go scheme called the Folketrygden or state pension to look after the retirement needs of its citizens.

This scheme was supplemented in the 1970s with the Folketrygdfondet which received contributions from tax authorities to be invested in domestic bonds and the home stock market. Contributions to this scheme ended in 1989 but it is still being actively managed today although it is not clear what use will be made of the substantial funds it contains.

These two state-run programmes provide the basic cover, topped up by private pension schemes held with insurance groups via large companies or industry groups, corporate schemes or individual arrangements. The life insurance companies make up the largest part of the private pensions market, with only a few Norwegian and foreign managers in the market. Most of the large corporate funds are run by the multinational conglomerates such as Norsk Hydro, Kvaerner and Orkla.

There is Nkr90bn-100bn ($12bn-13bn) under management in Norway by pension funds and life insurance companies providing pensions, according to Danish-based consultancy Alcifor. This excludes the Folketrygdefondet, alone worth around Nkr130bn.

Private pensions totalled around Nkr43.1bn at end-1996, accounting for about 28.1% of the total market, according to the Norwegian private pension funds association, Norske Pensjonskassers Forening.

The reliance on pay-as-you-go pensions has been undermined in most northern European countries by increasing concerns that the burden on the state will outstrip its future ability to pay. Revenues from Norway's massive North Sea oil reserves will almost certainly meet future demands for pension payments, but the political will to continue paying out has been eroded.

Financial conservatism by the state and private sectors as a result of the banking crisis of the late 1980s and early 1990s has meant that the bulk of investment has been concentrated in the domestic bond market. The preferred instruments have been fixed income state issues with a high degree of security, together with international issues with high standing. It was not until 1993 that Norwegian pension funds were allowed to invest in foreign securities, two years after a relaxation of rules for insurance companies. The Folketrygdefondet can still only invest domestically.

The current legislation allows 100% of premium reserves to be invested in high-grade paper within the OECD area, while only a maximum of 20% can be invested in listed equities at home and abroad.

This financial conservatism is not purely a state phenomenon. According to the Norske Pensjonskassers Forening, at the end of 1996 only 16.7% of funds were held in domestic and foreign shares, compared with 61.2% in bonds.

Hasse Nielsson, chairman of Alcifor, estimates that most Norwegian funds are still below the 20% ceiling. However, the rapid rise of equity market valuations have taken many closer to the limit, he says.

Nielsson puts the total equity holdings by pension funds and insurers at between 16-17%, compared with around 11.5% two years ago.

Only the largest corporate funds tend to invest in foreign equity markets. Runar Gulhaugen, treasury director for Norsk Hydro, which has the biggest corporate pension fund, says he is close to the 20% limit for equities but still has only 2% of his fund invested in foreign stock markets. Norsk Hydro has around 50% of its pension fund in the domestic bond market, but the record low return in that market is making it more difficult to maintain returns.

A Norwegian fund manager said the traditional arguments for preferring domestic equities rather than foreign were breaking down. It is not necessarily a worse risk to invest abroad rather than at home any more. The Norwegian market is very dependent on the dollar and world oil prices and it is no longer insulated from international trends."

The rising value of shares in domestic and international markets has meant that some pension funds have already sold down their holding to ensure that they stay below the upper limit, he added.

Legislation that requires funds operated by insurance companies to generate an annual return for their clients of around 3%, excluding administration costs, is accelerating the trend towards equities. Turnover in bonds has also fallen as a result of the decline in returns, making it "awkward" to manage the portfolio, according to Gulhaugen.

The pressure on portfolio managers to increase the proportion of the funds held in shares has led to calls for a lifting of the 20% ceiling. The issue is being discussed by the government and the pension and insurance sector. The government has already shown its willingness to relax the legislation by allowing accident insurance companies to invest up to 35% of their reserves in equities, rather than 20%. In the run-up to the changes, Norway's central bank called for all financial companies to be allowed to hold up to 50% of their assets in shares and it is this figure that most pension managers hope the government will settle on later this year.

The decision by the Norwegian government to allow the Petroleum Fund, which manages around Nkr100bn of oil revenue, to invest between 30% and 50% of its fund in international equities has the potential to usher in a new era in the pension sector, according to Nielsson. He sees the decision as a stamp of approval to the idea of investing abroad.

"It is indicative of the changes in the way the government is thinking that they have opened up the fund to equities and foreign fund managers," says the fund manager.

There are now similar hopes that the management of the Folketrygdefondet could also be broadened, giving extra impetus to the fund management industry in the country.

"We are a little bit behind when it comes to expertise in managing funds, simply because we have not been able to," says the manager. "A change in government regulations will certainly allow us to refine the skills of the industry further.""