Nicholas Barr
London School of Economics http://econ.lse.ac.uk/staff/nb
Evaluation of the Finnish Pension System
Helsinki, 7 January 2013

1 The backdrop
2 Strengths of the system
3 Weaknesses
4 Recommendations
5 Topic for discussion: age-related accrual rates
6 Conclusion
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• It is essential to think of the different parts of a pension system as a system
• There is no single best system for all countries
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• The primary objective: income security for all elderly people
• Four elements
• Consumption smoothing
• Insurance
• Poverty relief
• Redistribution
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• A smaller pension, i.e. lower average monthly pension
• A later pension, i.e. an unchanged monthly pension from a later age
• Higher contributions
• Higher national output
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• Successive reforms in Finland have
• Contributed to the achievement of the main objectives
• Been timely
• Have commanded consensus
• Thus discussion of improvements can be reflective rather than crisis response
• Most of the discussion below is of potential problems but – to repeat – the system is functioning well and is not in crisis
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• Consensual: the system is run consensually
• Unified: earnings-related pensions operate within a unified national framework
• Constrained choice: workers choice is limited, both over how much to save and over pension provider; these features comply with lessons from information and behavioural economics
• Compatible with labour mobility because the pension systems of workers in the private, public and municipal systems are all basically the same
• Adequacy: the system scores well for most people
• Coverage is high
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Though the system is not in crisis, a number of features create pressures that over time will compromise its ability to achieve its objectives
• Tunnel vision, i.e. a failure to consider adequacy and sustainability together
• Inadequate adjustment for a delayed start to pension
• Inadequate account of changes in family structure
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• In many countries the Ministry of Finance worries about sustainability and the Ministry of Social Security about adequacy, with little dialogue between the two departments
• Though institutional arrangements in Finland are different, the outcome is similar
• Life expectancy has been rising, which is great good news
• However, if the present system remains unchanged, the result will be
• Diminishing adequacy, and/or
• Declining sustainability
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• Diminishing adequacy
• If nothing changes, people will retire at 63 with a lower and lower earnings-related pension via the longevity factor
• After (say) 25 years, more and more people will receive the national pension but little earnings-related pension
• Declining sustainability
• Alternatively, contributions could rise as life expectancy increases; but contributions are already fairly high by international standards, so the scope for increase is limited
• Sustainability matters not only for Ministry of Finance reasons, but also to protect pensioners and older workers from shocks
• Declining sustainability is undesirable because it threatens the ability of the system to provide old-age security
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• More flexible retirement is desirable for its own sake
• It also facilitates a second policy direction – later retirement – whose purpose is to promote adequacy and sustainability simultaneously
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• Benefits should
• Either start at a given age without requiring an end to work
• Or increase significantly for a delayed start
• The way earnings-related pensions are adjusted for a delayed start (discussed below) is faulty in a number of ways
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• Social policy in Finland, as in many other countries, was based on an assumption that people got married and stayed married
• Neither is as true today as in the past, so that family structures are more fluid
• In addition, the individual basis of pension benefits is a partial cause of the fact that the incidence of poverty for single pensioners is strikingly higher than for pensioner couples
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• Maintain the current consensual approach
• Retain a clear focus on the primary objectives and the weights accorded to each; a narrow concentration on instrumental objectives, e.g. the status of pension funds, may blur focus
• Retain constrained choice for workers about how much to save and about pension provider.
These features are useful, and should be protected from naïve arguments that increased choice necessarily increases welfare
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• Why? To preserve adequacy and sustainability simultaneously
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• Mandatory full retirement made sense historically, but no longer
• Increased choice about when to retire, and whether fully or partially is desirable
• To promote output growth
• As a response to individual preferences
• More flexible retirement is desirable for its own sake, and would be part of good policy even if there were no problem of financing pensions
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• Longer healthy life + constant or declining retirement age creates problems of pension finance
• The problem is not that people are living too long, but that they are retiring too soon
• The solution: pensionable age should rise in a rational way as life expectancy increases
• Most work is less physical than in the past
• The ‘lump of labour’ fallacy
• Another way of sharing risk; if they have to bear some of the cost, many pensioners would prefer a shorter duration of retirement to lower living standards in retirement
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1987
2010
2050e
1987
2010
2050e
0
18
19
20
Life course for men and women in Finland
19 38 13.7
70.7
21
22
39
41
16.7
22.9
76.7
85.9
39
42
21.7
22.2
43
20 40 60
Education Activity Retirement
27.2
80
78.7
83.2
90.7
100
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• Partial deferral, e.g. option to draw 25%, 50% or 75% of pension, while deferred element continues to grow
• Avoid fixed costs of employing a worker, which create an incentive against part-time employment
• Review employment law to reduce transactions costs and legal uncertainty where a worker wishes to downshift at his/her existing employer
• Provide access to training for older workers
• Policies to change attitudes: gradually increasing earliest eligibility age is important not only for fiscal reasons but because of the signal it gives
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• Instead of reducing pensions at earliest eligibility age as the only adjustment to rising life expectancy, there is a good case for adjusting at least in part by gradually increasing the earliest eligibility age without any compensating increase in pension
• Why? International evidence, explained by behavioural economics, shows that many people retire as soon as they are allowed, even if not in their best interests or that of their family (next slide)
• Instead of talking about standard retirement age and later retirement, it would be useful to talk about the earliest eligibility age and normal retirement age
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• Changes should be announced a long time in advance
• Rules should relate to date of birth, not date of retirement
• Changes should be made annually (or monthly), to avoid large changes across nearby cohorts
• The rules should be explicit
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• There are different ways of raising pensionable age
• Perhaps the simplest: suppose policy makers regard it as appropriate that on average retirement should be half of working life
• This would be achieved by raising pensionable age by 8 months for every increase in life expectancy of one year, or pro rata
• Thus pensionable age is adjusted to relate the number of expected years receiving benefit to the number of accrual years.
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• National pension should continue to be increased broadly actuarially for a delayed start
• Adjustment of earnings-related pensions for a delayed start should be applied to the pension a person has accumulated till age 63 rather than as a higher accrual rate of 4.5 per cent on the flow of earnings after age 63
• The current system may be roughly actuarial for an average case but takes no account of the variance around the average, for example, over-compensating a delayed start to pension for someone whose post-63 earnings are high relative to the earnings-related pension he or she has accumulated at age 63
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• The problem
• In 2009, over 30 per cent of single pensioners in Finland were poor, compared with 4.3 per cent of couples
• The introduction of the guarantee pension in 2011 will improve matters, but is not a complete solution
• Individuals and couples: these findings suggest a need to review benefits for single pensioners
• Is the relative size of the national pension and guarantee pension for single people and couples the right one?
• There is a good case for making the taper in the withdrawal of earningsrelated pension more generous, or otherwise ensuring that the pension of a surviving spouse or partner is adequate
• Divorce: given the frequency of divorce, there is a good case for an option to transfer earnings-related pension rights between partners at divorce or retirement
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• The higher accrual rate of 1.9 per cent for workers aged 53-62 gives greater weight to earnings in later years, which benefits those whose earnings rise faster later in their careers, typically higher earners
• If a higher accrual rate at some ages is retained, thought should be given to transferring it to earnings in earlier years
• Such a move would benefit lower earners (who have high labour-force participation in early years) relative to higher earners (who are more often in education or training when young and, at least in the past, have had more options to continue working at older ages)
• The move might be a useful political balance to raising eligibility age over time
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• No single best system for all countries
• Four and only four policies to fix problems of pension finance
• Reform strategically and with a long time horizon
• Addressing demographic change: any solution that does not include later retirement over the medium term will fail
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On Finland
Barr, Nicholas (2013), Evaluation of the Finnish pension system: Part 1: The pension system in Finland: Design , Helsinki: Finnish Centre for Pensions
Ambachtsheer, Keith (2013), Evaluation of the Finnish pension system: Part
2: The pension system in Finland: Institutional structure and governance ,
Helsinki: Finnish Centre for Pensions
For a summary of the issues
Barr, Nicholas (2012), The Economics of the Welfare State , OUP, Ch. 7
Barr, Nicholas and Diamond, Peter (2009), ‘Reforming pensions: Principles, analytical errors and policy directions’,
International Social Security
Review , Vol. 62, No. 2, 2009, pp. 5-29 (also in French, German and
Spanish)
For broader discussion
Barr, Nicholas and Diamond, Peter (2008), Reforming pensions: Principles and policy choices , New York and Oxford: OUP.
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