Balance through adjustment
BALANCING MECHANISMS react automatically to demographic or economic changes to uphold pension systems’ long-term economic balance. At a recent seminar at the Finnish Centre for Pensions, experts from Sweden, Canada, Germany and the Netherlands discussed the balancing mechanisms in place in their countries.
The Swedish DC system takes life expectancy into account. If the economic balance weakens, the accrued and paid pensions are cut. The mechanism is automatic. “We wanted the balancing system to be politically independent,” explains Ole Settergren (Swedish Pension Authority).
In Canada, a default measure is applied if no other measures are introduced. “If the contribution rate is not high enough compared to our projections and the decision-makers don’t act, pensions cease to be indexed for a fixed period of time and the contribution rate rises,” says Michel Montambeault (Office of Superintendent of Financial Institutions of Canada).
Germany uses indexing to balance its pension system when necessary. “The index takes into account changes in both contribution levels and numbers of insured persons and pension recipients,” Markus Sailer (German Pension Insurance) explains. In addition, there is an upper limit to pension contributions and a lower limit to pension benefits. The German constitution prevents pension cuts.
In the Netherlands, earnings-related pensions are fully funded. Full indexing requires adequate solvency. If solvency falls short, pensions are not indexed and pensions in payment are cut, outlines Benne van Popta (Dutch Metalworkers Pension Fund). Due to the low interest rates, the pensions of many pensioners have not been indexed in over 10 years.
The life expectancy coefficient is Finland’s automatic balancing mechanism. In addition, the retirement age has been raised and the rules on how pensions are determined have been adjusted. Pensions in payment are protected, assures Jaakko Kiander (Finnish Centre for Pensions).
External evaluation of pension system
PROFESSOR TORBEN ANDERSEN (Aarhus University), an expert on public economy and pension systems, has accepted the task of making an external evaluation of the Finnish pension system. The evaluation was commissioned by the Board of Directors of the Finnish Centre for Pensions.
Andersen will evaluate the financial sustainability of the Finnish earnings-related pension system and the adequacy of Finnish pensions.
Although our pension system is solid and durable, it needs to be continuously improved so that the key goals of pensions – removing poverty and achieving a sensible income distribution throughout life – can be realised also in the future. The external evaluation is an important part of that work.
Andersen will visit the Finnish Centre for Pensions in early March 2020. His report is due for publication in early 2021.
The previous external evaluation of the Finnish pension system was done in 2013 by Nicholas Barr and Keith Ambachtsheer.
Finland in top third
PENSIONS AT A GLANCE, published by the OECD in late autumn 2019, puts Finland among the top third OECD countries in terms of replacement rate. The rate depicts the ratio between the gross pre-retirement earned income and pension received (for a 22-year-old who has just entered working life).
The replacement rate in Finland is 56.5%. The highest rate is found in Denmark (75%), where the ambitious theoretical retirement age for a 22-year-old is 75 years.
According to senior advisor Antti Mielonen (Finnish Centre for Pensions), the strengths of the Finnish pension system are its transparency and easiness, particularly for atypical work. Short employments are insured and the pensions of the self-employed are statutory.
Recently, the OECD published a summary titled “How does Finland compare?”, the first of its kind for Finland. It summarises the strengths and weaknesses of the Finnish pension system (see OECD.org).
Low interest rate distorts
THE RETURN ON INVESTMENTS is an important component in the financing of earnings-related pensions in Finland. The historically low interest rates have benefited pension investors so far. However, in the long run, negative interest rates are likely to increase the upward pressure on pension contributions to a larger extent than previously projected.
This is one of the findings of a report by doctor Jukka Rantala, retired managing director of the Finnish Centre for Pensions. He estimates that the current average investment allocations of Finnish pension providers will yield a real return of less than two per cent (or three at most), which is below the solvency regulation requirement.
In his report, Rantala suggests ways to improve earnings-related pension financing in Finland. For example, the solvency regulations should be changed to better support countercyclicality in the economy. That way, pension providers would not be forced to sell when share values plunge temporarily.