Finnish Pensions a Hybrid System. Jukka Rantala Rotman ICPM Discussion Forum, Helsinki

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1 Finnish Pensions a Hybrid System Jukka Rantala Rotman ICPM Discussion Forum, Helsinki

2 Contents Pillar I in Finland The history of the Hybrid Features of the Hybrid Administration Summary The Finnish Centre for Pensions 2

3 Pillar I in Finland The residence-based national pension, including the guarantee pension flat rate pension, which is reduced if earnings related pension is received (national pension 50%, guarantee pension 100%) financed by the State The (decentralized) earnings-related pension scheme (ERPS) covers all employees (all sectors) and the self-employed mainly financed by employers and employees The Finnish Centre for Pensions 3

4 Coordination within Pillar 1 pension systems No pension ceiling Finnish Centre for Pensions 4

5 The history of the Hybrid The Finnish Centre for Pensions 5

6 First steps The first statutory pension, the national pension, was introduced in 1938 defined contribution system with a low contribution rate collapsed due to high inflation during and after WW II replaced by a means-tested flat rate pension in 1956 A committee to explore the establishment of a statutory pension system was appointed in 1956 comprised of representatives from labour market organisations, main political parties and government officials A new system for private sector employees was introduced in 1962 condition set by the employers: private execution The Finnish Centre for Pensions 6

7 From expansion to reduction Later the pension benefits were improved and the coverage extended survivors pensions in 1967 pensions for the self-employed and farmers in 1970 accrual rate increased from 1.0% to 1.5% in 1975 different types of early retirement benefits Around 1990, benefits that were too generous were cut and the financing base was strengthened early retirement opportunities were strongly reduced in the 1990s, as was the indexing of pensions major reform in 2005: the life expectancy coefficient was introduced and the transition to CARE was finalized reforms in 1995 and 2007 increased the proportion of risky assets the next major reform will take place in 2017 The Finnish Centre for Pensions 7

8 Convergence of private and public sector benefits The public sector pensions were aligned to the private sector principles in the 1960s however, better benefits, higher accrual rates and lower retirement ages (also partly based on occupation) were maintained at first voluntary private sector pensions, which existed before 1962, were mainly amalgamated to the new statutory system, too Later public sector pensions were gradually harmonized with private sector pensions in the 1990s: benefit changes restricted to those born or recruited after a certain year harmonization completed in the 2005 reform, with the exception of certain transitional rules the 2005 changes applied to all employees regarding the future accrual The Finnish Centre for Pensions 8

9 Historical summary Almost all major reforms have first been agreed on by the labour market organizations and later legislated by the Parliament based on a Government s bill The already accrued benefits have been protected in all reforms As a result, the Finnish earnings-related pension system, although a part of the statutory social insurance (Pillar I), includes many features that are usually associated with occupational (supplementary) Pillar II pensions The Finnish Centre for Pensions 9

10 What makes the Finnish ERPS a Hybrid? Public legally, ERPS belongs to Pillar I covers all employees and employers the benefit rules are the same for all in national accounts, the funds are a part of public economy Private decentralized administration primarily governed by private law labour market organisations hold a central role both in developing the ERPS and in governance choice for employer regarding the pension provider and competition between actors substantial partial funding The Finnish Centre for Pensions 10

11 Features of the Hybrid The Finnish Centre for Pensions 11

12 Fulfils the main needs of employers and employees Finnish Centre for Pensions 12

13 Promotes labour mobility Same rules apply to all employees, regardless of the job no pension-dependent barriers to change jobs, which may be the case in countries with multiple pension arrangements All-encompassing in practice, no groups are excluded Easier to administer (=lower costs) and easier to understand than multiple arrangements Saves time and transaction costs The Finnish Centre for Pensions 13

14 Diminishes pension-dependent risks of the employer The risks relating to insurance are transferred to a pension insurance company Also in the case of the employer s own pension fund, the PAYG-element gives partial cover for: the longevity risk risks related to a reduction of the work-force Assets of the scheme are out of reach of direct political intervention constitutional protection of property The Finnish Centre for Pensions 14

15 Combines scale benefits of a monopoly with the benefits of competition From the individual s point of view, the principle of the last pension provider (LPP) guarantees an easy processing of a pension case the LPP is the pension provider in which the person is currently insured the LPP issues a pension decision based on the pension accrued from all employments during a person s working life and collects the necessary data to do so the LPP pays the whole pension centralized registers and the clearing of the pension money via the Finnish Centre for Pensions The number of pension institutions is limited, meaning lower administrative costs compared with the separate genuine Pillar I and Pillar II systems The Finnish Centre for Pensions 15

16 Number of pension administrative bodies in certain countries in 2011 Finland 37 Norway 114 Denmark 212 Sweden 283 The Netherlands 565 Switzerland 2,034 Germany 11,482 The Finnish Centre for Pensions 16

17 The operating expenses of statutory schemes and occupational schemes, per member (adjusted by purchasing power). Note: For Norway, figures only show the information of the statutory scheme, since it was not possible to separate the expenses of occupational pensions from the operating expenses as a whole. For Germany, the figure is a lower limit approximation, since for occupational pensions it only contains information on private-sector Pensionsfonds and Pensionskassen. However, figure also includes an (uncertain) estimate of total expenses. Eläketurvakeskus 17

18 Administration The Finnish Centre for Pensions 18

19 Decentralized administration There are altogether 36 institutes managing the pension system: 6 pension insurance companies 20 company or industry-wide pension funds Keva (public sector pensions) Kela (national pensions) 5 monopolies for smaller sectors 2 separate funds managing only assets The Finnish Centre for Pensions functions as a coordination organisation The Finnish Centre for Pensions 19

20 Governance Long-term development: an increasing involvement of labour market organisations in the governance structure and a more elaborate legislation the administrative legislation (e.g. requirements on processing and transparency) applicable to public entities is extended to apply also to private pension providers The pension insurance companies were separated from other insurance companies and from other financial institutions as a result of joining the EU, and they got a governance act of their own in 1997 Board decides on all important matters of the company organisation and administration of the company, appointment of the leadership, investment policy and major individual investment decisions, risk management policy, internal control and reporting at least half of the members must represent (fifty-fifty) labour market organisations, the rest usually come from client employers and represent the owners (most of the companies are mutual) The Finnish Centre for Pensions 20

21 Summary The Finnish pension system is hybrid in many ways, between parliamentary and labour market decision making between Pillar I and Pillar II system between public and private execution between funded and PAYG system between monopoly and competition between DB and DC The Hybrid provides many benefits such as balanced sharing and control of different types of risks, but Since a compromise, there are some drawbacks: any single feature is not maximized, minimized or optimized The Finnish Centre for Pensions 21

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