Considering the magnitude and multitude of economic problems facing Finland during the first half of the 1990s, the country’s achievements during the latter half of the decade have been remarkable. A macroeconomic rebound, full membership of the EU and Euro-zone, and the start of a sweeping reform of the pension system.
A heavely underfunded and generous pension system, seriously damaged during the 1989–94 crisis and magnified by a rapidly greying population, caused a series of political initiatives to reduce benefits from the pay-as-you-go national scheme and to implement fundamental reforms of mandatory occupational pension schemes.
Both schemes pay retirement pensions from age 65, disability and survivor’s benefits as well as unemployment benefits. The national scheme is based on citizenship and residence to guarantee a minimum income, thus primarily providing minimum social welfare, whereas the other scheme is based on length of employment and related earnings. The employment pension is an integral part of the Finnish social security system, being compulsory with benefits defined by legislation.
This comprehensive pension system, in principle covering the entire private sector work force of well over 2m people, is distinct from most other EU countries in the sense that it is largely administered by private pension institutions under central government supervision by the Central Pensions Security Institute. There are altogether nine laws on different statutory employment pensions, the main ones being the public sector schemes and the schemes for private sector employees (TEL), in total covering a working population in excess of 2m.
Basic benefits are almost identical in all schemes: a retirement pension at age 65 with the possibility of early retirement from age 58; disability pension; survivor's and children pensions, and an unemployment pension for people between 60 and 65 who have been unemployed for long periods before age 60. The target level for retirement benefits is minimum 60% of final salary levels after 40 years of employment. One of the important elements of the Finnish pension system is that both wages, paid out pensions and pension liabilities are fully inflation-indexed and that the entitlement to a paid-up scheme is immediate. It is therefore no surprise that total pension costs of the Finnish society remains relatively high at about 12% of GNP, relative to a 7% OECD average.
The TEL system is partly funded. In the wake of the pension reforms implemented successively from 1993–97, contributions have been raised to average 16.8% of the 1998 payroll from employers and 4.7% for employees. Contributions depend on, among other things, the structure of the insurance portfolio and the size of the enterprise in question. A greying population and a relatively high level of structural unemployment indicate that the system may not be fully funded until 2015 versus the present funding ratio of only about 50%.
Employment pension schemes may be arranged through authorised pension insurance companies or pension foundations, who by convention are members of the Federation of Finnish Employment Pensions Institutions, or the Federation of Pension Foundations. All schemes outside the public sector must be insured, either through insurance companies or the semi-private credit insurance company Garantia.
One consequence of the pension reform in 1998, was a total separation of statutory pension insurance companies from their respective private insurance groups, turning into independent “mutual pension insurance companies”. The market shares of the dominant players of the private TEL market (measured by size of pension assets), are: Varma-Sampo Pension (34%); Ilmarinen (Pohjola) (31%); Tapiola Pension (11%); Fennia (8%) and Verdandi-Pension (3%). The remaining assets, about 13% of the total, are held by 41 individual pension funds or foundations.
Outside the insurance groups, and under separate legislation, the Local Government Pensions Institution (Kommunernas Pensionsförsäkring) is by far the largest individual institution with premium reserves of substantial size.
Voluntary supplementary pensions have little importance to the overall pension provision, due to the relatively high pension level and coverage of the statutory employment scheme. The main purposes of an optional group pension insurance, however, mostly introduced before the statutory arrangements, are to lower the age of retirement, compensate for missing job history, and to raise provision to 66% of final salary levels for a full 40-year employment career. These supplementary schemes are fully funded and are provided by about 100 pension foundations, and increasingly by life insurance companies, as the former may no longer accept new members in the wake of the pension reform.
The operations of pension foundations are regulated by act of parliament since 1955, revised in January 1996 as part of the general pension reform. Pension foundations are defined as insurance and/or pension institutions providing social insurance for private individuals, including the granting of pensions and other benefits to the insured and their family members. As a rule, pension foundations used to be pension institutions for one employer. Today, most pension foundations are joint institutions within a group of private companies, a co-operative, a general or a limited partnership, authorised by the ministry of social affairs and health. Besides the statutory pension cover referred to in the Employees’ Pensions Act (TEL), pension foundations can provide voluntary additional pension cover. Foundations providing voluntary additional pension cover only, are often referred to as A-foundations, while TEL-providing institutions are referred to as B-foundations, and institutions providing both mandatory TEL pensions and voluntary additional benefits as AB-foundations. As mentioned above, voluntary foundations can no longer accept new members, and may accordingly be regarded as closed funds.
On top of the pension system, private life insurance companies are supplementing individual preferences for higher retirement savings. Stimulated by tax incentives, the voluntary share of life and pension arrangements have increased drastically over the recent years.
Asset allocations for the majority of institutions are not optimal, biased towards domestic bonds, domestic property, and domestic lending back into their own employer sector, increasing overall portfolio risk significantly. Table 1 indicates the problem.
Approximately 95% of assets in this sector are invested domestically, of which almost 80% in interest bearing assets, and only a small portion in equities, preferably placed in domestic market cap heavyweight Nokia.
Unless the funds are allowed to merge (or be entirely administered by the few large statutory pension institutions) and increase the portion of real assets (despite underfunding), including foreign equities, the objective of full funding seems unachievable and cost-effectiveness a village in Russia.
Hasse Nilsson is chairman of Alafor Advisory Associates in Denmark