The Finnish government is the envy of its European counterparts when it comes to the pensions issue. Old age pensions have a minimal impact on Finland’s fiscal situation as no public money goes towards them, the budget only being called upon to provide a basic state pension for those with no employment history or with a minimum earnings-related statutory pension. And yet the government gets to have the final say on how the rules are changed.
And the rules have been changed, often dramatically, with pensions moving from being based on a final salary to a career-average salary and the official retirement age being increased. The government also plans to integrate three private sector employee pension acts into a single law, with effect from the beginning of 2007 in an attempt to ensure that pension benefits and their financing are on a stable basis.
This has been achieved without the civil unrest seen elsewhere in Europe.
“We made some very drastic reforms in the 1990s because of the dire economic situation after the collapse of the safe Soviet market,” says Matti Leppälä, director responsible for international and legal affairs for the Finnish Pensions Alliance (TELA). “Major changes in the pensions area were accepted without any social disorder.”
So impressed with his Finnish colleagues’ performance was the demonstration-and-strike-beset French minister of the day that when he was carrying out his own reforms he visited Helsinki to examine how it was achieved without confrontation, recalls Leppälä.
He discovered that Finland is indeed different. Part of the secret is that responsibility for the first pillar pension has been delegated to the private sector, with seven pension insurance companies providing obligatory statutory DB earnings-related employment pensions that cover all people in work.
“We don’t have a second pillar because the pension insurance companies, pension funds and company and industry-wide funds serve the purposes that a second pillar delivers elsewhere,” explains Leppälä. “As a result, the pension funds are not fully funded, but are 25-30% funded and 70-75% PAYG.”
And another crucial factor is that the government has in effect outsourced the formulation of pension policy. “The social partners negotiate an agreement and pass it to the government,” says Leppälä. “It in turn is free to accept or reject a proposal but so far whatever the social partners have agreed has generally been accepted by the government as a basis for legislation.”
Consequently, once agreed, reforms provoke little controversy from the social partners because they emerge from an on-going consensus-seeking dialogue rather than from spasmodic governmental initiatives.
But the negotiating process is not without friction, the contribution level being a case in point. “The aim is to raise the statutory pensionable age by two or three years by 2030 – we have abolished the fixed retirement age and introduced flexible retirement between 63 and 68, but in reality people have retired at 59 or 60,” says Leppälä. “And with real returns of 3.5% annually we estimate that the contribution level will have to increase to 25-27% of a gross salary.”

But employers groups say that this is too much. Vesa Rantahalvari of the Confederation of Finnish industries (EK), which represents the industrial and services sectors, notes that increasing the contributions rate by a further five or six percentage points, half of which would come from employers, would act as a tax in employment and be unacceptable. “For the EK the alternatives would be further reductions in benefits and allowing pension funds to pursue higher returns through less regulation, for example, looking at further equities.”
And steps have already been taken in some of the areas Rantahalvari highlights. “We changed the calculation period for a pension from the average of the last 10 years to the average of a career as part of a reform introduced from the beginning of this year,” says Leppälä. ”And this also included the introduction from 2010 of a life expectancy coefficient, which means that as life expectancy rises people will have to work longer to receive the same pension. We estimated that for the first year it may mean just a few days longer but in a few decades it may mean working additional months or even years.”
The reform process is continuing with the proposals of three working groups currently under scrutiny. “The system emerged from labour market relationships that existed in the wake of World War II,” Leppälä says. “Now pensions policy is handled by the social partners – employer and employee organisations – within a special negotiating committee known as the permanent negotiating group of social partners or the Puro Commission after its chairman, Illmarinen president and CEO Kari Puro.”
“The pensions system has been based on decisions of the central labour market organisations since 1961,” says Puro. “In the early 1990s, at a time of great difficulty for the Finnish economy, the labour market organisations asked me to guide – I won’t say to lead – their negotiations on reform of the pensions schemes. Since the early 1990s it was agreed that this negotiating group would provide a forum for the consideration of pensions issues.”

The group is not an official body, its members being those responsible for pension policies at the central level of labour and employer organisations and not state nominees.
“The first issue we resolved, in 1992, was that the insured themselves should also pay contributions,” says Puro. “Until then only employers made payments. This initiative set a tradition that major pension questions would be negotiated in the group. The group also enables the labour market representatives to express suggestions and ideas about how to develop the system and part of my role is to martial the resources and expertise to shape and formalise these proposals into solutions.”
Another investigation, by Bank of Finland board member Matti Louekoski , was charged by the social and health ministry to examine the effects of the reform of the Companies Act and a resulting change to the Insurance Companies Act on issues relating to competition, regulation and the independence in the pensions industry. In an interim report delivered in September it proposed strengthening the position of labour market representatives in pension insurance companies and alternating their chairmanship between employers and employee representatives.
The third probe, chaired by deputy director general at the ministry’s insurance department Katriina Lehtipuro, recommended implementing the EU pension fund directive in a simplified form, applying it only to country and industry-wide funds and excluding insurance companies and contribution-based schemes from its scope.

Of these the most important is the Puro committee’s work on investment regulation.
“One of the key issues facing pensions in Finland is the allocation of pension fund investments and whether to invest more in equities or in the bond market,” says Jan Hurri of the Taloussanomat newspaper. “Depending on the fund, they can have up to 20-30% in equities while the local bgovernment pension fund, which is governed by other laws, has no restriction and at the moment it stands close to 50%. There is also an issue over the taxation of investments in property, with direct investments being taxed lighter than indirect investments through property funds. Pension funds feel that it’s senseless, they would like to change the way that they are regulated.”
The Puro committee’s interim recommendations are a typical Finnish compromise. “Our proposal will increase the proportion of a portfolio that a pension institution can invest in equities,” says Puro. “But mindful of the market collapse earlier this decade it will spread the associated risk throughout the sector as a whole rather than leave it with the individual pension funds.”
This reflects the system’s approach to the failure of a player, with all statutory pension institutions being jointly liable in the case of the bankruptcy of any of the other sector players and responsible for paying the pensions.
“We foresee the creation of a new buffer fund that would be part of the liabilities of each company and sectoral fund and pension insurance company,” he adds. “That would be determined by the average yield of their investments in listed shares. It would be included in the method of technically calculating liabilities.”
Ilkka Oksala, secretary general of the opposition National Coalition Party sees a trade-off between the Puro and Louekoski proposals. “We understand that the labour unions and the left will be ready to make it easy for pension funds to invest in equities, but their price was more power to the unions inside the pension funds,” he says. “And that will be a Finnish compromise.”
Leppälä has another view. “Employers have insisted that having more exposure to equities does not in itself entail any need to reform the participation rights of the social partners on the boards,” he says.
The consensus model of reform has many advantages, one being that it keeps politicians at arm’s length. The EK is happy to see a consensus emerge from contacts between itself and the three employee groups through the Puro committee, Rantahalvari says. “Employers and workers make the contributions and there is no taxpayers’ money involved in the system so it would be inappropriate for the government to impose a solution,” he says.

Others are more outspoken. “Off the record, I feel that people in government don’t know too much about the financial markets,” says an industry observer who does not wish to be identified. “For example, I’m not sure that if you tried to engage members of the government in a discussion about real returns many would know what you’re talking about. That’s very dangerous and it concerns me as a taxpayer because it can lead to a situation where politicians are playing politics with financial questions, with the danger that they will promote populist policies such as requiring that investments should be made in Finland to support the labour market rather than be used to pursue a real return for the future.”
“The question of pension funds investing in Finland has been a heated issue for a couple of years,” says Leppälä. ”In 1999 almost all the investments of the pension insurance companies were in Finland, but now it has is a minority in Finland. One of the issues discussed over recent months has been why has the amount dropped. In reality our investment in Finnish equity has not declined but it has not grown that much as that elsewhere.”
Sinikka Mönkäre, the Social Democrat former minister of social affairs and health, the department that oversees the pensions sector, has gone on record as saying that it is important that as money was collected from Finland it should be used to boost employment in Finland. And earlier this year the National Coalition Party toyed with the possibility of adopting such a policy. “We reviewed how to make the kind of reforms that make it easier for Finns or foreigners to invest in Finland,“ says Oksala. “In the event we decided not to say anything about pension fund money.”
But it is an issue that pension funds understand. “We need to ensure that there will be people working in Finland who will pay our pensions when we retire,” says Jari Eskelinen, head of fixed income at Illmarinen. “The most difficult question is to establish the best way to support the domestic economy so that we will have people working here. Some people believe that just investing in Finnish equities will help. But that’s a little naïve. We already have many ways of supporting those who have a good idea and want to start their own company. So what should be the role of pension investment?”
For Hanna Hiidenpalo, director of investments at Tapiola Pension, such an idea offers politicians a painless option. “I’m responsible for a group in the Puro committee looking at tax matters and I feel it’s easy for politicians to make proposals involving money from pension companies because it is not tax money.”

However, Puro dismisses the whole issue. “We are a member of the EU and that is now our home market,” he says. “The single market is well understood by politicians and they realised that they could not possibly pass such legislation. But it is important for Finland and the future of Finnish pensions that we have production in Finland, and this is under negotiation in our group. I’m sure that no stupid decisions will be made but in a democracy you always have the question of how to take the voters with you.”
But although the Finnish search for consensus, of which the Puro committee is a prime example, helps smooth the reform process, does it not allow politicians to abdicate responsibility? They are, after all, paid to take occasional tough decisions.
“It does make it easy for politicians,” agrees Puro. “But many of the problems, such as the tax issue for real estate, are due to the position of tax officials that all companies should be taxed equally. This question is now under discussion and I feel that in the near future the position will be changed.”
And politicians still have a role, notes Leppälä. “Despite the central role of the social partners, there is a link between pension policy and the government and parliament,” he says. “For one thing, people ask ’why doesn’t the government do this or the parliament do that?’ And while the initiative lies with the social partners decisions are not made in a vacuum. Politicians and political parties are involved behind the scenes. And the agreements go through the normal legislative process.”
A second criticism is that as consensus by definition moves at the speed acceptable to the slowest mover, it delays changes and draws out the process. Earlier this year, for example, the IMF urged the government to take more politically difficult reform measures, saying that agreed reforms, “while significant, are acknowledged to be insufficient by themselves to make the long-term fiscal position sustainable”. Similarly, the OECD welcomed the pension reform as a big step in the right direction but said that the measures undertaken were not enough.
“That’s how consensual policies are made,” concedes Leppälä. “But the advantage is that you can rely on the result. A problem with countries that do not have such a system is that you can have a policy for two or four years, but you cannot make sustainable pension reforms based on such a short time scale. You need to have a consensus that both the parties in power and the opposition will continue. I agree that they may not be such radical reforms and that they may not go far enough from the IMF’s point of view, but then it has been shown that the ‘far-enough’ proposals that look to be the best possible solutions from a theoretical point of view may not be so in reality because you cannot force people in these situations. There have to be compromises. That’s the Finnish way.”