Adjusting the Finnish pension system to increase in life expectancy

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1 Adjusting the Finnish pension system to increase in life expectancy Executive summary and conclusions of the report of the pension panel 1 Pension system reform topical in all developed countries The statutory pension system is the corner stone of a modern welfare society. It ensures that citizens are able to maintain their former consumption level after retirement and can enjoy their increasing spare time even when they live unexceptionally long. In addition to earnings-related pension provision, the minimum pension financed by tax funds aims to prevent old-age poverty. The pension system also provides an income in case of disability or the death of the family breadwinner. In the developed industrial countries, the basic structures of pension systems were created after World War II. Now these systems face as radical a need to be reformed as they did a need to be created. Two underlying factors creating this need relate to changes in the age structure of the population. The first change, mainly dating back to the most recent decades, concerns the difference in size of consecutive cohorts. As the pension systems expanded during the first decades after WWII, the demographic dependency ratio was favourable in the industrial countries. The share of the active population grew as the baby boomers gradually reached working age. Now, however, the post-wwii baby boomers have reached retirement age. At the same time, the declining birth rates of the late 1960s mean that the working age population no longer grows in size. This demographic change will present itself as a fierce deterioration of the dependency ratio in the next few decades. In Finland, the decline of the old-age dependency ratio has already started, and it will accelerate during the next two decades at a faster pace than in most developed countries. 1 The Pension Panel is a group of pension experts appointed by the central labour market organisations.

2 2 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY The other demographic feature causing pressure to pension systems relates to the average growth in the population s life expectancy. When creating the bases of our current pension systems, the rapid increase in life expectancy that has occurred during the last few decades was not foreseen. This increase is generally expected to continue without limits also in the future. The favourable development in terms of welfare has raised a question to be answered by pension systems: how should the prolonged life span be divided in a financially and socially sustainable manner between work and leisure time? The reactions to the demographic pressures have led to the emphasis of different aspects in different countries. In defined benefit pension systems, the pressure to raise contributions has been alleviated by lowering the level of starting pensions. This has been done by changing the rules of determination, weakening the price index applied to pensions in payment or by raising the lower age limit of the general retirement age. In some countries, the fluctuation in pension expenditure due to the differently sized cohorts has been addressed by establishing buffer funds and allowing for more profit-seeking, higher risktaking investment operations than before. In purely funded or so-called defined contribution systems, the financing balance is maintained by adjusting the pension benefits to the extended life span. The pension benefits offered by the second pillar systems (agreed on among the labour market parties) have been converted to contribution based systems. In many countries, tax alleviations have been used to promote voluntary, funded and purely contribution-based third pillar pension provision. At the same time, the role of the public, non-funding and benefit-based system operating parallel to the funded systems has been altered. Pensions paid from that system have been integrated with pensions paid based on second pillar pension schemes. Simultaneously, the role of the statutory pension system as a provider of a minimum pension level has been emphasised. As a result of the adjustments, an array of different intermediate forms of the national pension systems has arisen. With their different emphases, they settle in the middle of the principal extremities of two different systems: the funded, contribution-based and the non-funded, benefit-based systems. This middle ground is represented by, for example, the notional defined contribution (NDC) system introduced in Sweden, Italy and Poland. This system maintains the financing balance of the entire system by adjusting pension benefits without transfers to individual pension accounts. For example, in Germany, there is a so-called pension point system, according to which the value of the pension benefits, based on points accrued each year relative to the years of service and

3 Conclusions of the pension panel 3 the earnings, is set at the time of retirement to the level required to maintain the financing balance of the system. The adjustments can be divided, with different emphasis, into the raising of pension contribution, the raising of the retirement age and the lowering of the pension level of starting pensions or pensions in payment. Reforming the Finnish pension system The Finnish pension system and its reforms deviate favourably in international comparison in many respects. The earnings-related pension system created in the early 1960s covered private sector wage earners. The scope of the system and the transfer of pension rights when changing employer have supported the mobility of the labour force. The more favourable pension benefits of the public sector, originating far back in time, have gradually been unified with the benefits of the private sector. The minimum pension provision offered by the national pension has been adapted to the earnings-related pension system. Due to these changes, the Finnish pension system has become unified and offers similar pension benefits regardless of work sector. The adjustment to the demographic change was assisted by the fact that, from the onset, the private sector earnings-related pension system has been partially funded. The significance of funding has gradually increased due to the growth of the size of the funds and changes made to the regulations concerning their investment operations. The participation of both political decisionmakers and labour market parties in the development of the pension system has supported the consensus about the basic direction of the reforms and fortified the endorsement of the system. Aiming for consensus has also meant that the reforms, by nature, have been evolutionary, gradual and committed to the basic principles of the original system. Reforming the pension system in Finland has been a proactive venture. After the initial phase, in which weight was put on improving benefits, preparations for the demographic changes were launched in the 1990s. To control the raise of pension contributions, the weight of the earnings level was reduced in the indexation of pension. An important means to support labour supply has been the raising of the lower age limits of early retirement pensions. Furthermore, the solvency regulations of pension funds were amended to allow greater risktaking. Public sector pension benefits were adapted to the level of private sector benefits. In the public sector, own buffer funds, which later grew quickly, were

4 4 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY established. Along with the pension reform, employment policy was amended and working life developed through, for example, programmes for ageing workers and for the management of work-related stress. In line with the goals of promoting working capacity through vocational rehabilitation, among other things, the number of starting disability pensions has been reduced. This type of development has had a significant impact on the reduction of early retirement. The second stage of the reform was launched at the turn of the century. The reform that took effect as of the beginning of 2005 included several significant improvements. The pensionable wage was to be determined based on the earnings of the entire working life. The impact of the change in life expectancy was neutralised by introducing the life expectancy coefficient, which affects the level of starting pensions. The pressure to raise pension contributions was also reduced by eliminating forms of early retirement and by tightening their terms and conditions. These terms and conditions have been amended further, for example in connection with the working career agreement in In connection with the 2005 reform, the flexible retirement age was introduced. Its lower limit is 63 years and its upper limit 68 years. For work carried out between these age limits, pension accrues at an accelerated accrual rate of 4.5 per cent of the annual earnings. The above reforms have led to a slower than expected increase of pension expenditure in the last two decades. Future expenditure is also projected to be reduced. In 2030, pension expenditure relative to the wage sum should be approximately 10 percentage points below what it was projected (in the 1990s) to be at most. Correspondingly, the increase in pension contributions is considerably smaller than projected at that time. Simultaneously, the level of starting pensions has risen mainly due to an improved earnings level, but also because, compared to previous cohorts, new pensioners have spent more years in service for which pension has accrued. The national pension scheme has also been reformed gradually. In the 1990s, the national pension became fully deductible from the earnings-related pension. At the turn of the previous decade, the minimum pension level was improved by introducing a new pension type, the guarantee pension. This supplement to the pension provision, financed with tax funds, ensures a slightly higher level of pension provision than the national pension for those who receive only a national pension or a small earnings-level pension or for groups that are excluded from the scope of the national pension. At the same time, the guarantee pension, which is fully deductible from the earnings-related pension, expanded the pension benefits with a flat-rate pension component.

5 Conclusions of the pension panel 5 As a result of tripartite negotiations, the aim in Finland is to raise the expected effective retirement age for 25-year-olds to 62.4 years by People have retired later, raising the expected effective retirement rate to 60.9 years in In order to reach the goal set for 2025, the positive development trend must continue. The labour market parties decided in the 2012 working career agreement that preparations for a new pension reform following the 2005 pension reform would be carried out so that the new pension reform can come into force in Utilising experts in preparation of pension reform When assessing and preparing the reform of the Finnish pension system, external expertise has been used to an increasing degree. In 2005, an international evaluation of the 2005 pension reform commissioned by the Finnish Centre for Pensions and the Finnish Economic Association was published (Börsch-Supan 2005). At the beginning of 2013, two international experts presented their assessment of the Finnish earnings-related pension system. Prof. Nicholas Barr s report concerned the adequacy of pension provision and the sustainability of pension funding (Barr 2013), while Prof. Ambatscheer focused on the governance and investment operations of our pension system (Ambatscheer 2013). The European Union and international economic associations, such as the OECD and IMF, have assessed the Finnish pension system at various points in time and presented suggestions for its development. The Pension Panel has made use of these foreign evaluations and monitored the reforms implemented in other countries. The Panel has also made use of domestic expertise. In various connections, research institutions have assessed the sustainability of our welfare system and conduct research on our pension system. The Finnish Centre for Pensions has produced numerous projections on how the various possible measures would affect working careers, the level of pensions and pension contributions. In addition to research based on register data, the Finnish Centre for Pensions has also conducted questionnaire studies directed at employers, wage earners and pensioners. These surveys have charted, among other things, the respondents experiences of the flexible retirement age. Bearing in mind the preparations for the 2017 pension reform, a number of new research projects and surveys have been realised in The Economic Council, supported by the Finnish Centre for Pensions, commissioned an econometric assessment of the impacts of the 2005 pension reform (Uusitalo

6 6 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY and Nivalainen 2013). The Pension Panel has made use of the results of this study. With the support of the Finnish Centre for Pensions and the Ministry of Social Affairs and Health, tools of assessment previously implemented by the Research Institute of the Finnish Economy (ETLA) have been further developed. The tools include the simulation model used to assess the impacts of the 2005 pension reform (Hakola and Määttänen 2007; Määttänen 2013), as well as the general equilibrium model suitable to assess the impacts of the pension system (Lassila and Valkonen 2013). The models can now be used to assess the impacts of the various adjustment mechanisms of the pension system relating to the extended life span on the labour market position and income of different socioeconomic groups and genders. The results of the model computations have been made use of by the Pension Panel in its work. These tools of assessment, which the Pension Panel found very useful, will also offer support in the preparatory work and planning of the forthcoming reform. Why is a reform of the pension system topical now? The Finnish pension system must be further reformed due to the projected change in the demographic structure. When the preparatory work for the 2005 reform was launched 15 years ago, the growth of the expected life expectancy based on the population forecast was projected as clearly more moderate than today. According to population forecasts available at the time, the life expectancy of a 62-year-old person approaching retirement was projected to grow by 2050 by an ample 3 years from the then 80 years. In line with this and together with other factors, the aim of the 2005 reform was to postpone the average effective retirement age by 2 3 years. According to the most recent population forecasts of Statistics Finland, the corresponding expected life expectancy of a 62-year-old is now 7.5 years (an increase of approximately 5.5 years from the current level). 2 The current life expectancy technique means that the increase in longevity does not presuppose an increase in pension contributions. However, unless working lives are extended considerably from the current level, this aim is reached at the expense of the pension level. A decade ago, the life expectancy coefficient was assessed to reduce pensions by approximately 12 per cent in According to the most recent projections, pensions will have to be cut by circa 18 per cent. In the pension reforms implemented at the turn of the century, much attention was paid to early retirement schemes since the effective retirement age 2 The population forecast (Eurostat) of the year 2000 fell short from the realised development in by approximately 1.5 years (the actual rise was as much as 2 years).

7 Conclusions of the pension panel 7 was much lower than the then general retirement age of 65 years. For example, in 2000, a total of 53,700 persons retired, but only approximately 30 per cent of them on a full old-age pension. Now the situation is different. As planned, the number of early exits from working life via various early retirement exit routes has declined. In 2012, roughly 70 per cent of all new retirees retired directly on an old-age pension (retirement age 63+). From this follows that the development of the economic dependency ratio is now increasingly governed by how the average effective retirement age changes. The statutory pension system should be examined as part of public finances more emphatically than before. The financial crisis in 2008, with its indirect impacts affecting international economy, and the impact of the euro crisis have fallen particularly heavily upon Finland. GDP remains below the pre-financial crisis level to this day. At the same time, the status of public finances has become weaker. Public expenditure relative to GDP has grown by nearly 10 percentage points from the 2007 level, while the total tax ratio has remained virtually unchanged. In addition to factors relating to the economic situation, this structurally weakened starting point, along with the currently peaking growth in the old-age dependency ratio, has aggravated the long-term sustainability gap in Finnish public finances. The government has set out to look for solutions to this problem through the structural policy programme it approved on 29 August One of the points of the programme, along with improving the cost-effectiveness of the public service system, is to raise the employment rate. As a central means relative to this, the government refers to the tripartite consensus of preparing the pension reform so that it can come into effect as of the beginning of The pension reform is topical also in terms of the international credibility of Finnish economic policy. The crisis of the eurozone has condensed the coordination of economic policy within the EU. At the turn of last year, Parliament passed an act on the application of a fiscal-political agreement between the Member States. In line with this act, Parliament sets a medium-term goal for the structural balance of public finances. In the stability programme approved in the spring of 2013, the approved goal for Finland was set at -0.5 per cent of GDP. The government is obligated to contribute to the management of not only state finances but also of local government finances and the statutory pension system so that it can reach the set medium-term stability goal. Even if the pension reform cannot be implemented at a schedule which would have

8 8 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY an impact on the achieving of the goal set for 2017, its significance is crucial in terms of the credibility of the country s economic policy. The following sections compile the central conclusions of the Pension Panel from the point of view of the task assigned to it. First, the sustainability of public finances and the impact the pension system has on that sustainability is examined. The economic sustainability of the earnings-related pension system is evaluated based on the recent long-term expenditure and contribution projection of the Finnish Centre for Pensions. Compiled data relating to the social sustainability and fairness of the pension system and the trust it generates is also presented. Finally, the conclusions of the Pension Panel relating to two of the core questions of its assignment are summarised: the impacts of the 2005 pension reform and the adjustment of the system to the extended life span. The sustainability gap of public finances and the pension system According to an estimate of the Ministry of Finance, updated in the early autumn of 2013, the sustainability gap of Finland s public finances will rise to an ample 4.5 per cent of GDP, i.e. to circa EUR 9 billion. The calculation shows the amount with which public finances should be boosted so that the growth of public pension, administrative and care expenditure due to the increasingly ageing population could be financed in a sustainable manner with the given total tax ratio in other words, so that the share of public debt relative to GDP can remain stable. The sustainability gap is a simplified stress calculation reaching decades into the future, not a projection. It is based on the assumption of a static policy. The total tax rate has been set at the level of the base year of the calculation. Policy changes and differences in the base year of the calculation or its assumptions can lead to great anomalies in the end result. The dimensional category of the sustainability gap of Finnish public finances is smaller in the calculations of ETLA and the Labour Institute for Economic Research than in the calculations of the Ministry of Finance. On the other hand, the calculations of the EU, the OECD and IMF made for various countries, in which the same principles have been applied, as well as other calculations comparable to that of the Ministry of Finance in terms of methods applied, show a larger sustainability gap for Finnish public finances than do the calculations of the Ministry of Finance or the Bank of Finland. Although the calculations on the sustainability gap are subject to uncertainty, the conclusion can be drawn that the size of the long-term sustainability gap of public finances is considerable in Finland. This is also the conclusion

9 Conclusions of the pension panel 9 presented in the most recent Ageing Report of the European Commission (European Commission 2013). Another special feature of Finland, mentioned earlier, is that the population of Finland is ageing at a faster pace, i.e. earlier, than in other countries. The decisions made in the next few years are critical in terms of solving the Finnish sustainability gap. In many other countries, where a deterioration of the dependency ratio will reach its peak only after a few decades, this problem is less acute, even if the dimension of the sustainability gap in itself is the same as in Finland. The solutions concerning the statutory pension system are of great significance in the handling of the sustainability gap of public finances. Compared to the long-term financing gap relating to the administrative and care expenditure that local governments face, the gap in the financing of the pension system is relatively small. Preparing for the changing age structure through funding has been an important element in securing sustainability. In light of the calculations, the public sector pension scheme appears balanced in the long term. However, the development of local government finances and services and employment is subject to uncertainty, which is difficult to take into account in the calculations. The pressure to raise private sector earnings-related pension contributions remains. In the sustainability calculation, the dissolving of this pressure by raising earnings-related pension contributions would mean a corresponding need to ease taxation. Handling the sustainability gap would thus become even more difficult in particular in local government finances, which face the largest share of the pressure of the growing public administrative and care expenditure. The sustainability gap can be reduced also by tightening taxation. The total tax rate in Finland is smaller than in the other Nordic countries particularly when taking into account the fact that nearly all pension contributions are included in the total tax rate in Finland, while contractual earnings-related pensions are considerably more important in other Nordic countries. Their contributions are not comparable to taxes. In solutions concerning taxation, attention must be paid to the possible employment disadvantages and impacts on the level of overall production as a result of stricter taxation. It is justified to assess the measures aiming at solving the sustainability gap of public finances also in view of income distribution. The pension system indirectly impacts the entire national economy and other public finances. Labour markets, in particular, function as an intermediary. Earnings-related pension contributions, the pension level and their age limits and other conditions influence labour demand and supply, the

10 10 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY employment rate and the economic dependency ratio. These, in turn, regulate the development of tax revenues and, in addition to pension expenditure, the growth of other public income transfers. The more efficiently the pension system supports a high employment rate, the higher the productive potential of the national economy, the higher the tax revenues and the smaller the need for public income transfers. The existence of these externalities means that a wellfunctioning pension system is also a central goal of economic policy. Long-term projection of the earnings-related pension system At regular intervals, the Finnish Centre for Pensions publishes a long-term projection of the statutory pension system. In the most recent projection, the share of pension relative to the wage sum is estimated to grow from the 26.9 per cent level in 2012 to 33 per cent by the 2030s, then drop somewhat and settle at a slightly lower level than projected in 2011 (Risku et al 2013). The long-term projection of the rising pension contributions has been reduced over time as a result of the implemented reforms and a favourable employment trend among the elderly. The contribution under the Employees Pensions Act relative to the private sector wage sum will remain at approximately 25 per cent from the turn of the next decade until mid-century. This is nearly one percentage point higher than the level agreed on for 2016 (24.4 per cent on average). In the latter half of this century, the contribution will rise to an ample 26 per cent of the wages, i.e. to the same level as presented in the previous projection. Public sector pension contributions may be reduced slightly according to the long term projection. However, in the most recent projection, the pressure to raise pension contributions during the next three decades is estimated to be smaller than forecasted earlier. There are many reasons for this, including a higher rise in the employment rate among the elderly, a declining number of starting disability pensions, and adjustments made to the pension system. All in all, the changes in estimates of the most recent longterm projection are minor. For example, the level of the contribution under the Employees Pensions Act, with an expectation value that is sustainable and stable throughout the projection period (25.6 per cent), is 0.3 percentage points lower than in the 2011 projection. Due to the uncertainty associated with the future, preparations for realisations that fall below the baseline projection must also be made. According to the long-term projection, the life expectancy coefficient will reduce the relative level of pensions at the lower retirement age limit by

11 Conclusions of the pension panel 11 approximately one fourth by The resulting impact on prolonged working lives has been estimated with caution in the long-term projections, in which retirement is deferred sluggishly. The projection of the growth in the expected effective retirement age is based on the assumption of a reducing number of starting pensions. The downward trend in the number of disability pensions is expected to continue although at a slower rate: the old-age pension retirement risk will decrease by 10 per cent by 2025 and by 17 per cent by The retirement risk will decrease by 13 per cent by 2025 and by 41 per cent by This would mean that the expected effective retirement age of a 62-year-old would increase from the current 64.1 years to 64.6 years by 2025 and 65.4 years by In the long term projections, the expected effective retirement age of a 25-year-old is estimated at 62 years by mid-century. In 2025, it is estimated to settle at 61.5 years, roughly one year below the target of 62.4 years set by the government and the labour market parties. Social sustainability of the pension system The sustainability of the pension system should be evaluated not only from an economic but also from a social viewpoint. The social viewpoint focuses on the adequacy and fairness of pension provision and on citizens trust in the provision. In terms of the pension system, all of these should be assessed based on the current situation but also, whenever possible, in terms of the long-term outlook. The coverage of the statutory pension provision in Finland is extensive. Its real level has risen as the new retirees have a higher number of years in service for which pension has accrued and real wages accruing pensions have also risen. The average monthly pension in 2012 was EUR 1,670 for men and EUR 1,320 for women. The real pension level has risen by 25 per cent compared to the year In other words, it has risen at the same pace as the earnings of the wage-earners during this period of time. Overall, however, the real level of average disability pensions has remained unchanged, partly because the partial disability pensions have become more frequent and the pressure has risen. Yet, the level of full disability pensions and partial disability pensions has developed much more moderately than the level of old-age pensions. Based on the long-term projections, the pension level will rise also in the future. The growth will slow down, however, and in time lag behind the development of real earnings. The ratio between the average pension and the average earnings, currently at 50 per cent, will decline by five percentage points

12 12 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY by mid-century according to the long-term projections of the Finnish Centre for Pensions. Although the distribution of pension income has remained virtually unchanged during the last decade, the income gaps between the pensioner households have grown moderately. This is due to the income structure and development of the highest income decile, which deviates from the others in particular in terms of capital income and their fluctuations. The income gaps among the retired population are as high as among the working-aged population. Nevertheless, the relative income poverty risk of pensioners has risen and the number of low-income pensioners increased. The relative income poverty risk is particularly high for single pensioners relying on the national pension and the guarantee pension. The majority of them are women. As in the other Nordic countries, the relative poverty risk among this population group is noticeably extensive in our country. This feature has been emphasised increasingly as the income level considered adequate for single pensioners has been raised in the consumption factors with which the income per individual of different-sized households are converted into a commensurable form. In fact, as a result of this technical reform relating to consumption factors, the relative income poverty risk of all individuals living in single households grew. Measured in this way, income poverty is difficult to reduce cost-effectively only by amending benefits paid by the Social Insurance Institution of Finland (Kela), whether concerning single pensioners or other households with one income earner. There are gender gaps in pension levels. Men receive higher pensions than women. The gap has narrowed but at a relatively slow pace. Due to women s, on average, longer life expectancy, the capital value of pensions, i.e. the total amount of pensions in payment during the retirement period, is equal for both men and women. The pension system also affects the intergenerational income distribution. The return in form of pension benefits for paid pension contributions of various cohorts differs. The return was higher for those generations who retired in the early years of the earnings-related pension system. This is a result of the fact that, in the initial stages of our benefit-based system, various transitional provisions were used to set the pension levels of new retirees on a higher level than the regular pension accrual provisions would have allowed for. The pension contribution was also significantly lower at the beginning than it is now. Similar generational return differentials also apply to later cohorts, albeit to a much

13 Conclusions of the pension panel 13 milder degree. It has been estimated that the return would stabilise at a real rate of per cent per year. The relative generational status can be viewed also from the point of view of the income gaps between the wage earners and the pensioners. From this point of view, it is of significance that the level of pensions relative to the reigning earnings level will clearly decline in the future, unless working lives are prolonged considerably. As a result of the tax solutions made, the differences in the tax treatment of earnings and pensions have narrowed. The intergenerational division of public social security and its expenses is a broader issue and concerns more than just the pension system. Other income transfers and welfare services, as well as taxation, have been unequally distributed between the generations in particular at the construction stage of our welfare society and have shaped income distribution partly in an opposite direction from pension expenditure and contributions. For example, the generation retiring in the 1960s had hardly paid any pension contributions at all in return for their own earnings-related pension. On the other hand, that generation had not received as high-quality free education, health care and other social security than the generation born in the 1960s was to enjoy later in time. No comprehensive study has been conducted in Finland on the intergenerational distribution of the benefits and contribution burden of the entire welfare society. Studies conducted in other Nordic countries suggest, however, that these differences may be rather small. Pension levels are different also between different socioeconomic groups, in compliance with the differences in earnings levels and length of working lives. On average, individuals with a higher education study longer and retire later than those with a lower education. Their higher earnings also yield them a higher pension. Furthermore, they spend the longest time in retirement. At the same time, retiring on a disability pension is more common in the lower social groups. The lengths of working lives vary greatly within the socioeconomic groups. When viewed from the point of view of the return rates, it is noticeable that the ratio between the number of working years and the number of years in retirement varies clearly less in relation to the socio-economic position than do the corresponding differences in life expectancy. When examined by gender, the return rates were considerably higher for women than for men. According to European questionnaire surveys, the trust in the pension promise of the Finnish pension system, which is basically benefit-based, has been relatively strong in international comparison. Generally, in surveys measuring trust, the results show a weaker trust in the future. The changes

14 14 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY made to the pension system and the seemingly constant pressure to make adjustments seem to have weakened citizens trust in the system. The discussions of the ageing population, the problems of public finances, the rising pension contributions and the projected weakening of the pension level relative to the reigning earnings level may have had a similar effect. According to the most recent questionnaire survey, the majority of the working-age population is of the opinion that the younger generations have to carry too big a share of the financing burden. Development of the employment rate and retirement of the elderly A high employment rate is a key factor in terms of the level of overall production as well as the public finances and the financing of the welfare system. The higher the employment rate, the higher the tax revenues and the smaller the need for income transfers paid to people outside the work force. This positive link between the employment rate and the sustainability of the welfare society justifies that the government attempts to adjust the structures of the labour markets and social security as well as the incentives that affect economic choice so that they support the balancing of labour market demand and supply through a high employment rate. Maintaining the incentives of the labour force supply involves education and studies, family leaves, the return to work from unemployment and the reducing of structural unemployment, maintaining work capacity and reducing disability, along with prolonging the working lives of the elderly. An essential factor from the point of view of the employment of the ageing work force is what type of age policy companies conduct and what companies find to be the suitable age limits for retirement. According to an interview survey conducted in 2011, approximately 70 per cent of the employers found the age of 63 to be a suitable retirement age, while 20 per cent found it to be too high. The views of the employers have changed somewhat since Back then, the majority of employers found 63 years to be too high, while a smaller percentage found it suitable. If the demand for elderly employees reacts slowly to the growth in labour force supply, the resulting risk is prolonged periods of unemployment. The weak re-employment of elderly unemployed persons and employers indifference to the raising of the retirement age indicate a slow adjustment to demand. It is therefore justified to review labour force supply and demand in parallel.

15 Conclusions of the pension panel 15 The success of the Nordic welfare model includes a combination of, on the one hand, a high-level welfare system and a high tax rate required to uphold it and, on the other hand, a high employment rate. This applies also to Finland, although the country has jokingly been called the poor man s version of the Nordic model. As a result of the recession in the 1990s, the employment rate plummeted in Finland, and the development has not been favourable in all respects since. The average employment rate is still below that at the end of the 1980s. This is partly explained by the fact that the workforce is now older, on average, than it was a quarter of a century ago. Furthermore, due to several factors, the employment rate of the elderly is lower than that of the labour force s core group of year-olds. Yet, the employment rate of this core group is below the level at the end of the 1980s. The clear improvement of the employment rate of the elderly, i.e. the year-olds, deviates for the better compared to the general development trend of the employment rate in the last quarter century. Already in the mid 2000s, the employment rate of this age group exceeded the level of the late 1980s and has continued to increase ever since. The development has been rapid even in an international comparison. Yet, the employment rate of the elderly, in particular of men, is below that of the other Nordic countries. Furthermore, the difference in the number of working hours is smaller than in the employment rate. This is the case since part-time employment is more common among the elderly in other Nordic countries compared to Finland. The unemployment of the elderly declined up to the financial crisis at the end of last decade. Simultaneously, the expected time of working of 50-yearolds rose after the mid-2000s more-or-less in parallel with the expected years in service of the same age group. Correspondingly, the expected time spent in retirement of those aged 50 and above has been slightly reduced. A striking fact, however, is the growth of unemployment in the age group 60+. This is partly due to the abolishment of the unemployment pension and the raising of the age limits of the unemployment pathway to retirement. At the same time, retirement has been postponed. The rise of the effective retirement age has been particularly rapid since This is partly due to the unemployment pension being replaced by the right to additional days of unemployment security. As a matter of fact, the expected effective retirement age of those approaching the retirement age, i.e. those aged 62, has not risen but remained at 64 years. 3 In other words, the average effective retirement age has 3 On the other hand, lowering the retirement age from 65 to 63 years has not, after all, lowered the expected effective retirement age of 62-year-olds.

16 16 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY risen as a result of changes in the behaviour of those below the lower retirement age limit, not of those approaching the retirement age. Impact of pension reforms on the labour market position of the elderly One of the central questions processed by the Pension Panel is what significance the implemented pension reforms have held on the positive development of the effective retirement age and the employment of the elderly. In line with its assignment, the Pension Panel has paid particular attention to the assessment of the impacts of the 2005 pension reform. Separating the effects of the pension reforms from the development of the labour force, the labour markets and other changes relating to working life has been difficult. The trendy rising of the expected effective retirement age and the employment rate of the elderly population is tied to several changes affecting both the demand and supply of the elderly work force. Elderly people are healthier and better educated than before. The economic structure has changed in a more service-prone direction and is more favourable for continued working among the elderly since the professions involving heavy manual labour have been reduced, the number of occupational accidents has gone down and the disability risk has declined. Nevertheless, the health gaps between population groups are large and have partly grown. When planning the 2005 reform, it was estimated that the combined effect of the above-described positive development trend, the previous pension reforms and the planned new reform would raise the average effective retirement age by more than 2 years by By 2025, the increase should be nearly 2.5 years according to this estimate, and 3 years by The impact of the 2005 reform alone was expected to remain low at first but to rise to nearly 1.5 years by midcentury. Most of the postponed retirements were thus assumed to be the result of a general positive change in the labour market position of the elderly and previous pension reforms. In a later study, it was assessed that the remaining impact of previous reforms would be very small (Kyyrä 2010). A model-based preliminary estimate of the impacts of the 2005 pension reform was published soon after the implementation of the reform (Hakola and Määttänen 2007). Data on the working life and wage profiles of Finnish citizens were compiled for this evaluation. Based on this simulation of the life span model it was projected that the 2005 pension reform would raise the expected effective retirement age by 8 months. The impact of the abolishment

17 Conclusions of the pension panel 17 of the individual early retirement could not be taken into account in this model projection. Including this impact, the reform would have raised the expected effective retirement age by 1.5 years at the most. This maximum impact thus corresponded in size to the preliminary projection made in connection with planning the reform. When the abolishment of the individual early retirement pension was excluded, the projection was much smaller. According to the life cycle model, the largest differing impact on retirement of the 2005 pension reform was the elimination of early retirement pensions. In terms of the change in the expected effective retirement age, the raising of the lower age limit of the unemployment pension and the complete abolishment of this pension type and its replacement with the right to additional days of unemployment security exhibited a particularly significant impact. The changes made to the preconditions for old-age retirement, on the other hand, were assessed to be divergent and relatively small. On the whole, they were expected to more-orless overturn each other. In the course of the Pension Panel s work, the first subsequent evaluation on the impacts of the 2005 pension reform, based on realised development (Uusitalo and Nivalainen 2013), was published. Ignoring the impact of the life expectancy coefficient, the changes made in connection with the pension reform seem to have prolonged the working lives of year-olds by merely one month. Also in this study, the main impact was ascribed to the changes made to early exit routes from work (the unemployment pathway and the individual early retirement pension). Only a preliminary and very uncertain assessment of the impact of the life expectancy coefficient could be made in this research. According to the study, the life expectancy coefficient would raise the expected effective retirement age of the 50-year-olds (i.e. those born in 1962 whose pension will be reduced as a result of the life expectancy coefficient by approximately 8 per cent based on current population forecasts) by 0.5 years by The combined result of the implemented effect and the estimated impact of the life expectancy coefficient on the expected effective retirement age by 2025 would be clearly less than one year. According to the study of Uusitalo and Nivalainen, the changes of the conditions for old-age pension realised in connection with the 2005 pension reform thus did not have a significant impact on the prolonging of working lives. For this part, the research result corresponds to the preliminary study based on the life span model. The result was also to be expected in light of the fact that the change in age limits and accrual rates weakened the incentives

18 18 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY to work for individuals aged 63 and 64 years compared to the abate for early retirement of the previous system, applied to old-age pensions starting under the age of 65. On the other hand, the fact that many continued working until the age of 63 indicates that, in addition to many other factors, financial incentives do make a difference. The individual retirement ages above 63 years in the public sector entail a considerable drop in the pension level for those withdrawing their pension early. Therefore, retirement on old-age pension prior to the individual retirement age has been rare in the public sector. The desire of low-income people to continue working may also have been influenced by the fact that the national pension is paid in full only at age 65. The Quality of Work Life Surveys, in which the respondents were asked how the accelerated accrual rate affected their willingness to continue at work past the age of 63, also speak of the significance of financial incentives (Tuominen et al 2010). In 2008, one third of all year-old wage-earners found the accelerated accrual rate to increase their willingness to continue working. The structural change in the social security of the elderly had a different impact, on the one hand, on the expected effective retirement age and, on the other hand, on the employment rate of the elderly. When the unemployment pension was replaced with the right to additional days of earnings-related unemployment security it meant, in practice, that the source of income of long-term unemployed persons changed from a pension to an unemployment allowance. In reality, this did not prolong working careers although it contributed to a later retirement. Raising the lower age limit of the unemployment pathway to retirement, on the other hand, prolonged working lives but did not impact the expected effective retirement age. Therefore, Uusitalo and Nivalainen emphasised that the impacts of the pension reforms should be assessed not only from the point of view of the expected effective retirement age but also from the point of view of the (working hour- and age-standardized) employment rate. In other words, when assessing the employment effects of the reforms, impacts of changes to the structures of the social security system that only change the source of income from one type to another but do not affect the employment rate of the elderly should be invalidated. On the other hand, the indicators should reflect the actual prolonging of working lives as a result of, for example, the shortening of the unemployment pathway or the increase in working during retirement.

19 Conclusions of the pension panel 19 Achieving the set goal for the expected effective retirement age Based on conducted studies, it is possible to assess how the targeted retirement age (62.4 years) set for 2025 can be attained. According to Uusitalo and Nivalainen, the effects of the 2005 reform would be clearly less than one year, even when taking into account the uncertain assessment of the impact of the life expectancy coefficient. On the other hand, the terms and conditions for an early exit from the work force have been tightened even after the 2005 reform. As agreed, the lower age limit of the unemployment pathway to retirement was raised by one year in the 2010 social agreement relating to incomes policy and by one more year in the 2012 working career agreement. Other reforms were also implemented according to the working career agreement. The 2012 reforms are expected to prolong working lives by a total of 4 months (Määttänen 2012). The combined effect of the 2005 pension reform and subsequent adjustments on the average length of working lives would seem to increase by a maximum of one year. Despite the generally positive notions of the employment development of the elderly and the effects of the implemented reforms, it appears that the targeted expected effective retirement age of 62.4 years by 2025 will not be reached unless further measures are taken. According to the most recent long term projections of the Finnish Centre for Pensions, the assessed expected effective retirement age for 2025 is 61.5 years. The same applies to the baseline career assessed by ETLA (Lassila et al 2013). 4 Although the projections end up with a more-or-less similar assessment of how the expected effective retirement age would develop without further political actions, they are subject to uncertainty. For example, will the trend relating to the declining number of starting disability pensions, which increases the effective retirement age, continue as intensively as so far? The projections are also subject to uncertainty in relation to how the changes in working life and the age-specific attachments to work will impact the development of working lives. Other uncertainties relate to the future impacts of already implemented reforms, such as the life expectancy coefficient. Uncertainty about the future development is also reflected in the fact that, so far, the development of the expected effective retirement age and the employment rate of those aged 55 and above has been more favourable than previously assessed and compared to the results achieved through various models. 4 The result calculated by Uusitalo and Nivalainen for 2025 does not conflict with these projections.

20 20 ADJUSTING THE FINNISH PENSION SYSTEM TO INCREASE IN LIFE EXPECTANCY Despite the uncertainties, however, strong arguments speak for a continued reform of the pension system. The difference of nearly one year between the targets and the baseline career is so large that significant reforms are required to breach the gap. The government s and the labour market organisations joint working career work group assessed in 2011 that, for example, raising the general retirement age limits to years for those born in 1952 or later and abolishing the right to the additional days of unemployment security and the part-time pension would together increase the expected effective retirement age by 8.4 months (0.7 years) by 2025 (Prime Minister s Office 2011). In his projection based on the life span model, Määttänen (2013) assesses that a similar reform would raise the expected effective retirement age by 10 months. Reforming the pension system would also be an integral part of a larger political whole with which the employment rate could be raised, the large production losses suffered in the post-financial crisis years could be amended and the financing of not only the pension system but also the other components of a welfare society could be secured with a reasonable total tax ratio. The pension reform must take a stand on the continuing of the existing early retirement systems, the financial incentives that steer the postponing of retirement and the flexible general retirement age limits. It is also necessary to clarify how the pension system can be adjusted to the continually growing life expectancy. This second key question included in the Pension Panel s assignment relating to the life expectancy coefficient and its alternatives is discussed in what follows. In this connection, a closer look is taken at the questions relating to social fairness and the possibilities offered by the flexibilities of the pension system to adjust to different situations in life, which vary greatly for elderly people. Pension system adjusting to changes in life span According to estimates, the average extension of the life span will continue, although not necessarily at as steady and rapid a pace as in the past few decades. Adjustments to this change, which will maintain the financing balance of the pension system, could be made via the retirement age, the pension level or the pension contributions. In a well-functioning system, the adjustments are to be such that the increasing life span distributed between work and retirement and the pension levels and contributions form a socially and financially sustainable entity. The impacts of the various alternative adjustment mechanisms on