Defined contribution (DC) type pension schemes have had difficulty in finding a slot in Finland’s occupational pension system.
The first pillar statutory earnings-related pension scheme is a defined benefit (DB) scheme, partly funded, but mostly PAYG. Second pillar voluntary occupational pensions schemes are also invariably DB. Only in the third pillar are fully funded DC plans to be found in the form of voluntary personal pensions.
The need for voluntary pensions has been limited in the past, principally because of the generosity of the first pillar scheme. There is no ceiling on earnings and everyone, regardless of income, receives 60% of their final salary.
This marks out Finland from other Nordic countries. In a recent study for the Central Pension Security Institute Tiina Mäkinen, researcher at the University of Turku points out that Finns have not needed to add to their pension income through voluntary pension arrangements to the same extent as Swedes and Norwegians, whose pensions have an upper earnings limit.
Sales of voluntary personal pensions plans grew rapidly during the 1980s. However, Finland’s recession in the early 1990s hit the personal pensions business hard.
Interest in personal pensions has revived since then, In 2002, the number of new contracts for voluntary private pensions rose to from 44,500 to 72,500. There are a number of reasons for this revival. One reason is the flexibility a voluntary pension offers. People can decide to retire early, rather than continue to work up to the retirement age 65.
Another reason is people’s need to extend their pension history. People who have not worked for the full 40 years necessary to receive the maximum statutory pension can use a voluntary personal pension to top up their entitlement.
However, Timo Silvola senior manager in charge of life assurance at the Federation of Finnish Insurance Companies in Helsinki, says the main reason for the popularity of personal pensions is the constant changes that are made to the statutory pension system.
“People no longer trust the statutory system because it may be adjusted by the legislation. During the recession we had several adjustments and every time it meant less pension. So people in Finland now understand that adjustments to the system will mean smaller pensions in the long run.”
Minor adjustments are made every two years, and major adjustments every 10 years. The last major adjustment to the statutory scheme for private sector workers was adopted by the Finnish parliament. In February this year, and will come into force at the beginning of 2005.
There are two key changes. Flexible retirement between the ages of 62 and 68 will now become possible, although people will be encouraged to continue working with a higher accrual rate between 63 and 68. The aim here is to in-crease the average retirement age, which now stands at 57. The other key change is that pensions will also be calculated on an employee’s total earnings. At present only the last 10 years are used to calculate future pensions.
These reforms are designed to ensure the continuing health of the statutory system. But they are likely to cause a substantial re-think of the need for second pillar voluntary group pensions and the future role of third pillar voluntary personal pensions. Both could mean an increasing use of DC plans, or a DC element within existing DB plans.
Benny Tuomolin, managing director of Mercer Employee Benefits Oy in Espoos says: “With the change of the legislation, there will be many interesting options. As all other countries have accepted DC - like Norway even - then I think Finland should follow suit fairly soon. The Finns are a fairly pragmatic people, so what it is possible is to have a defined benefit scheme but funded as a defined contribution scheme. That would mean flexible premiums.”
Tuomolin suggests that the changes to the legislation will lead to changes in the second pillar voluntary group pensions plans. Currently these are provided for senior executives and specialist staff by pension foundations, pension finds and insurers. “The question will be what kind of promises do the executives have at the moment? Is it based on a certain promise – a defined benefit – or is it a question of the premium?” Tuomolin suggest that executives may prefer the flexibility of premiums to the certainty of defined benefits
The move to a career average could also trigger changes in group voluntary pension plans, he suggests. “Going career average would mean a definite gap in earnings for those who are late starters. A lot of the contracts with senior executives will need to be perused very thoroughly because many of them have a promise of around 60% of final salary.”
The introduction of career average will encourage employers to design DC type pension plans for key staff with benefits that are higher than 60% of average earnings. However, a tax ruling by the High Court in April could complicate matters, says Tuomolin. “You have to follow certain rules to be able to write group pensions without the pensions being taxable income for the insured. First of all you have to what is called an ‘objective group’. This could be all workers in a company, or blue collar workers, white collar workers or senior executives. And the smallest possible objective group has been managing directors, which normally only consists of one. The reasoning behind this is that when a managing director retires his successor will have exactly the same benefits, and therefore a managing director can be considered an objective group.” However, the court has ruled that managing directors and other directors are not an objective group. “That makes life a bit difficult for us now. So you’re cutting benefits for senior executives at the same time as you don’t have the possibilities for improving them.”
Eero Sipila, of pension fund consultant Porasto Oy in Helsinki, says the immediate effect of the new flexibility will be to lessen the need for voluntary personal pension arrangements. “Now that we are going to have a flexible retirement age in the statutory scheme, the need for pension arrangements that provide added flexibility will be less in the future.”
Sipila expects the changes in the statutory system will encourage employers to review their voluntary group pension arrangements. “We do not know yet how the large employers will react. It may be that in their personnel policies there will be a place for voluntary pension arrangements. My guess is that those plans will contain two basic elements – the employee should give a personal contribution to the plan and the plans will be DC type.”
The volatility of the markets and the turbulent business environment are likely to accelerate this reassessment, he suggests. “Companies are not willing to accept the investment risk in a rapidly changing environment. Companies also require flexible pension arrangements if they are to be able to re-structure.
“Companies, especially public companies, do not like the fact that pension plans need more funds some years than others and if they are under-funded they must put more money in. So if a company were to create a new voluntary pension plan, my feeling is that it would be more like a defined contribution plan where the risk is transferred to the future pensioners.”
Amendments to pension legislation would have to be introduced to set up DC type pension foundations and to require that employees contribute to the pension plan. Currently, only the employer contributes to a voluntary group pension plan.
One possible influence on the development of group DC type plans in Finland will be the EU’s pensions directive. Finland has been wary of EC’s enthusiasm for developing common strategy on pensions. It wants to keep national pension policy firmly under national control. However, the directive holds out the prospect of more flexible occupational pension plans.
Silvola points out that the tax rules allow voluntary group pensions to be taken at 55, while for voluntary personal plans the threshold is 60. “So of course it is quite natural that those employees who can negotiate a group pension plan from their employer have much more flexibility. The new standards made by the new directive give the possibility to pension funds to provide this kind of cover, at least to those global companies which are also represented in Finland.
“Even when we are talking about smaller groups – maybe department managers and board managers – very many people would like to have these policies because they are funded from the company side.”
Company contributions to pension plans are important, he says, because of Finland’s notoriously high income tax levels. “An employee receives around 35% of salary from their employer. The remaining 65% goes in taxes and premiums on pension and unemployment cover. So if this kind of plan could be funded from the employer’s side an employee can get a group voluntary pension cheaper than when they funded it individually.”
If there is a demand for DC type plans in Finland, the main requirement for the products and skills to meet that demand, he says: “The real question is whether we are going to have a product which is simple enough – a DC type of product giving you old age pension cover and funds which would be linked in the pension plan. And will we have the expertise to sell these products?”
However, Silvola believes there is everything to play for. “This is a marketing area which is going to be quite profitable. Nowadays only 5% in Finland are funded pensions. So there is plenty of room for expansion.”