Guest Comment: A return to austerity in Finland casts a shadow over pension reform

The newly elected right-wing coalition government in Finland is planning a major pension reform, which is framed by the need to balance the Finnish economy. Prime minister Petteri Orpo´s government has inherited a chronic deficit and a steadily growing level of public debt; this situation is common to many ageing societies in Europe.

This being said, the state of public finances is not as dire as in many other EU member states. Nevertheless, voters in the general election held last spring sent a message on economic policy and they wanted a shift to a more frugal stance, after a so called period of pandemic economics.

Public discourse on the need to balance pension system finances after the last pension reform in 2017 had been minimal until now; Orpo´s new government took many by a surprise. Not only does it have a numeric sustainability goal for the next pension reform, but it also offers a means on how to achieve it.

It is worth noting that private sector earnings-related pensions (TyEL) are not financed from the state budget. Previous governments have in the past kept at arm´s length from the decision-making on pension reforms. But the present government views all the different sectors in the public economy as one body, including the state, regional government, municipalities and social security funds.

The government’s austerity goal for the whole economy is quite considerable and the fundamental idea is to cut earnings-related pension benefits in the long term, in order to create space for more public spending. The new government programme has a wide range of pension reform ideas, which have now converted into a tripartite pension reform negotiating process.

Social partners have for last 60 years negotiated pensions reforms for the earnings-related I-pillar pension system, and they also take part in the governance of pension funds. They have managed to negotiate major structural pension reforms every 10 years and political parties have succeeded in passing those into legislation accordingly.

A working group has now been set up by the Ministry of Social Affairs to figure out a concrete design for the next reform. The actual bargaining process will however be a bipartite project between the social partners. The timetable for the negotiations, including impact assessments, is very tight and the government expects results at the end January 2025.

Orpo´s government has set two conditions for the pension reform, or else it may take its own action, which would be unprecedented in the decision-making of the Finnish pension system. The next pension reform should strengthen the public economy for its part by 0.4 per cent of GDP in the long term. This is quite close to the adjustment needed to stabilise private sector earnings-related pensions system by the latest calculations of Finnish Centre for Pensions.

The second condition is far trickier. The pension reform must also find a way to stabilise the pension contribution level in the long term by a rule-based balancing system. The stabilisation mechanism should kick in if economic shocks affect the financing of earnings-related pensions in the near future. The latter goal of the permanent stabilisation of the contribution level is unprecedented and could change the whole nature of the current defined benefit pension model in Finland.

Furthermore, the government programme also focuses on mitigating the investment rules imposed on private sector earnings-related pension funds. A significant part of the needed adjustment (first condition) could possibly be done by loosening nationally defined and supervised solvency rules. There are limitations as to what can be achieved by this taking into consideration current portfolios of pension funds and overall changes in the interest-rate environment.

It is easier to find €1bn worth of parametric adjustments within the current system than to change the whole risk-sharing mechanism between employers, employees and pensioners. A stabilisation mechanism based on a fixed contribution level would in practise introduce current and/or future pensioners to financial risks stemming from economic shocks and uncertainty.

The direction of occupational pension reforms in Europe has been away from traditional defined benefit models and towards various defined contribution models. What makes the Finnish case stand out is that the I-pillar earnings-related pension is crucial for retirement income and other pensions have only a residual role. There is also no compulsive need for a rule-based balancing system.

Pension policies in general should always be planned and assessed in the long term, rather than in political cycles. It remains to be seen what kind of results the bargaining process will produce and will it be enough for the government. Orpo´s government would play a risky game if it would in the end try to overpower social partners. You cannot “put the genie back in the bottle”, so meddling with earnings-related pensions would probably be attractive for future governments as well and not necessarily based on financial stability.

Share Story:

Recent Stories

Podcast: The benefits of private equity in pension fund portfolios
The outbreak of the Covid-19 pandemic, in which stock markets have seen increased volatility, combined with global low interest rates has led to alternative asset classes rising in popularity. Private equity is one of the top runners in this category, and for good reason.

In this podcast, Munich Private Equity Partners Managing Director, Christopher Bär, chats to European Pensions Editor, Natalie Tuck, about the benefits private equity investments can bring to pension fund portfolios and the best approach to take.

Podcast - The power of three: Using Common Contractual Funds to improve tax outcomes for investors
Large asset owners are still investing in equities in a way where they are taxed on their income. The implication is that they get a poorer return. They need to, and can, improve this, but how?

In this podcast, AMX Head of Client and Manager Development, Aaron Overy, and AMX Product Tax Specialist, Kevin Duggan, discuss with European Pensions Editor, Natalie Tuck, about three options to help ensure good withholding tax outcomes for institutional investors.

Mitigating risk
BNP Paribas Asset Management’s head of pension solutions, Julien Halfon, discusses equity hedging with Laura Blows