Finland: Small is beautiful
Finland’s smaller pension funds argue that they can deliver better solvency levels and returns for their member than the larger pension insurance companies, says Pirkko Juntunen
In Finland the six large pension insurance companies have been successful in attracting new clients. So much so that there are now only four industry-wide pension funds and 14 company pension funds in the country.
Some argue that the regulatory and legislative framework favours larger entities and that this needs addressing. They argue that better solvency ratios and more optimal fund size give corporate pension funds more flexibility in allocating their assets and, if they wish, in taking more risk. This has also been reflected in solvency levels and in returns.
The average solvency buffer of industry and company pension funds stood at 42.2% at the end of June 2015, compared with 32% for the pension insurance companies. Returns for the smaller players for the six months to the end of June were 5.6%, outperforming the larger players by 0.6 percentage points.
Two pension funds that fall into this smaller category are Apteekkien Eläkekassa, the pharmacies’ pension fund, and Eläkekassa Verso, the pension fund for the private forestry businesses, which say they are in a better position to manage their own pension funds than a large pension insurance company. They argue that being small is a competitive advantage as they are closer to their customers and are more nimble.
Hannu Hokka, CEO of the pharmacies’ fund and Pasi Strömberg, CEO of the forestry fund, both maintain that being closer to their members leads to a better-run fund in terms of solvency levels and returns, while also enabling it to lower costs through efficiently managing a smaller unit. Hokka, who has led the €550m fund for four years, says keeping the fund independent is the best solution both from a solvency and return perspective.
The solvency level has enabled the fund to reduce contribution levels for employers that are members of the fund. According to Finnish law, however, an industry fund is not allowed to reduce the contribution levels of individual employees, irrespective of its solvency position. Hokka argues that this needs addressing as it would level the playing field between larger and smaller entities.
He also says that if the law were neutral more companies and industries would create their own pension funds. Being a 30-year veteran in the Finnish pensions industry, Hokka is fairly cynical about any meaningful changes in the future and adds that the “big boys continue to make the decisions”.
Strömberg, head of the €242m forestry fund and former head of the Finnish pension fund association, says he is keeping the investment operations simple. For example, the fund does not invest in hedge funds and most equity investments are done through indexed products, for cost effectiveness (see Finland article in this report). He adds that for a small pension fund the selection of securities is of utmost importance and that Verso’s position in selected securities tends to be fairly large relative to the portfolio size.
Academic studies show the benefits of scale by bringing down units of costs but in Finland this has not necessarily been the case. Keith Ambachtsheer’s 2013 evaluation of the Finnish system showed that the administrative costs of funds were high when compared internationally.
In particular, Finnish pension insurance companies spend considerably more time and energy interacting with employers than their international peers. According to the study, pension insurance companies reported that 55% of their administration costs were employer-related compared with 10% for the global sample. One of the stated reasons for this greater employer focus is competition among pension insurance companies to retain and attract new clients.
This competition between the six dominant players has not proved to bring about superior investment returns or create more cost-efficient administration. The study pointed out that while the large pension insurance companies are not-for-profit, they compete for market share and clients. This competition adds to the overall costs because of marketing and sales expenses.
A recent study by Esko Advisors, an investment consultancy and fiduciary management provider, which conducted the research with Jari Käppi, associate professor of finance at the International Business School Suzhou, shows that smaller funds in fact outperform larger ones by 0.6 percentage points per year on average, as well as having substantially lower pension administration costs. Petri Kuusisto, founder and CEO of Esko, argues that one of the factors is that smaller funds have longer-term investment objectives and focus on strategic allocation rather than shorter-term tactical allocations.
The investment policies of the pension insurance companies are not identical but have a tendency to converge and Kuusisto argues that the fierce competition drives these short-term tactical decisions.
Critics of the Esko study argue that it is a superficial and one-sided. A CIO of one of the large pension insurance companies said the study does not look at solvency and risk, which should be studied before jumping to any conclusions about what is the best solution. Kuusisto, Hokka and Strömberg, however, argue for more diversity and more efficient implementation alternatives.