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Technical provisions and their calculation

The earnings-related pension system for private-sector employees is a partially funded system. This means that some pension contributions collected each year are placed into funds, i.e. saved and invested for pensions paid in the future. These assets deposited in funds constitute the pension provider’s technical provisions.

Funded pension components: an element of technical provisions

Partial funding in the private sector applies to old-age and disability pensions. Part of the annual earnings-related pension contributions collected from employers and employees is transferred to funds, where they wait until the employee retires on an old-age or disability pension. Funding is carried out according to the rules of each pension type, which are described in the Actuarial Principles of the Finnish Centre for Pensions Statute Service [in Finnish].

The pension provider calculates the technical provisions for each insured individual (employee) and pensioner insofar as assets have been funded in advance for their pensions. Technical provisions are determined so that they will be sufficient, on average, for paying the funded part of the pension. This takes into account both the return on funded assets and an estimate of how long the old-age or disability pension will be paid. With regard to the funding of old-age pensions, an estimate of life expectancy is taken into consideration. Disability pensions, in turn, are funded at the lowest old-age retirement age.

In addition to funded pension components, technical provisions also include various buffer funds. They are described in more detail in the relevant sections of technical provisions (companies and industry-wide pension funds) and pension liability (company pension funds).

It is essential for securing the earnings-related pensions that the pension provider’s technical provisions are constantly covered. The pension provider must therefore have at least the amount of assets corresponding to the technical provisions and the amount of solvency capital required by law. To ensure this, pension providers in the private sector are subject to the so-called solvency regulation, which is described in more detail on our Solvency Regulation page.

Components of technical provisions (companies and funds)

The technical provisions of pension insurance companies and industry-wide pension funds consist of the provision for unearned premiums and the provision for outstanding claims.

Provision for unearned premiums

The provision for unearned premiums consists of assets reserved for future pension contingencies. The provision for unearned premiums is divided into four parts, which are:

  • provision for unearned premiums for future old-age pensions
  • provision for unearned premiums for future disability pensions
  • provision for current and future bonuses
  • equity-linked buffer.

Provision for unearned premiums for future old-age pensions

As concerns old-age pensions starting in the future, the provision for unearned premiums is calculated for the individual’s entire work history. The calculation is made at the individual level, i.e. for each insured person separately. The provision is calculated by adding the necessary capital value coefficient to the amount of the funded old-age pension. The provision corresponds to the sum that, considering the interest and mortality, is sufficient on average for paying the funded old-age pension throughout the whole period when the insured individual is on old-age pension.

Provision for unearned premiums for future disability pensions

As concerns future disability pensions, the provision for unearned premiums is not calculated at the individual level. Instead, a certain percentage of each insurance policy (insurance taken out by the employer/enterprise) is reserved for this purpose. The sum reserved for the provision corresponds to the percentage of disability pension contributions collected in the last two years that is sufficient to pay funded disability pensions during the next two years.

Provision for current and future bonuses

A pension insurance company’s provision for current and future bonuses is divided into two: provision for current bonuses and provision for future bonuses. Industry-wide pension funds only have provision for future bonuses.

The provision for future bonuses is used to even out fluctuations in the value of investments and to prepare for currency risks. The provision for future bonuses consists of the returns on investment and underwriting business. If the financial year generates a surplus, the transferable amount is transferred to the provision for future bonuses. Correspondingly, if the financial year shows a deficit, it is deducted from the provision for future bonuses. Thereafter, assets may be transferred from the provision for future bonuses to the provision for current bonuses, if allowed by the company’s solvency position.

Provision for current bonuses is an element of the provision for unearned premiums, specific to each insurance policy. Certain returns on investments and the loading profit are transferred to the provision for current bonuses. Pension insurance companies can use these assets for rebates given to their customers the following year.

An industry-wide pension fund transfers the return on investments to the provision for future bonuses, where it may also deposit the surplus from the fund department that grants supplementary benefits. After these transfers, the industry-wide pension fund can either cancel some of the provisions in order to reduce premiums or give rebates to the shareholders of the pension fund. If necessary, the industry-wide pension fund can also use the insurance premiums to increase the provision for current and future bonuses.

Equity-linked buffer

By using an equity-linked buffer fund, the earnings-related pension system in the private sector collectively bears some of the risk posed by stock market fluctuations. The amount of this buffer depends on the pension providers’ average returns on equity investments. On the basis of the pension providers’ realised returns on equities, this component of the technical provisions is either increased or decreased. If the equity-linked buffer exceeds the agreed upper limit, the excess is transferred to the old-age pension liabilities.

Provision for outstanding claims

The provision for outstanding claims consists of the assets set aside for paying pensions that have already commenced. The provision for outstanding claims is divided into three parts, which are:

  • provision for outstanding claims for old-age pensions commenced
  • provision for outstanding claims for disability pensions commenced
  • provision for pooled claims

Provision for outstanding claims for old-age pensions commenced

Assets for outstanding claims for old-age pensions commenced have already been reserved in the provision for unearned premiums during the individual’s working history. The calculation of the provision for outstanding claims for old-age pensions commenced starts when the individual retires on old-age pension. The provision corresponds to the sum that, interest and mortality included, is sufficient on average to pay the funded old-age pension for the remainder of the individual’s retirement.

Provision for outstanding claims for disability pensions commenced

The provision for outstanding claims for disability pensions commenced has assets reserved both for the disability pensions already granted (the ‘known’ pensions) and for the disability pensions where the pension contingency has already occurred but the pensions themselves have not yet been granted (the ‘unknown’ pensions).

The provision for known pensions is calculated at the individual level at the start of the disability pension. The provision is calculated by adding the necessary capital value coefficient to the amount of the funded disability pension. The provision corresponds to the amount of money that, recoverability, mortality and interest included, is sufficient to pay the funded part of the disability pension until the pensionable age.

The provision for unknown pensions is not calculated at the individual level. Instead, a certain amount of provision is reserved for these pensions from each insurance policy (insurance taken out by the employer/enterprise). The provision amount is obtained by reserving a certain percentage of the disability contributions paid during the past three years. This percentage is sufficient for paying the funded shares of disability pensions that have not yet been granted for pension contingencies already occurred.

Provision for pooled claims

The provision for pooled claims is a buffer fund for jointly paid pension components, such as partial old-age pension, years-of-service pension, survivors’ pensions and index increments. Pension providers pay jointly for the pooled components with the help of a cost distribution calculation made by the Finnish Centre for Pensions.

In the distribution of costs, each private-sector pension provider is assigned a share of the pooled components. If this share is smaller than the assets received from the pooled components of pension contributions, the provision for pooled claims increases. Correspondingly, if the share is larger than the assets received from the pooled components of pension contributions, the provision for pooled claims decreases.

The above share of the provision for pooled claims is calculated separately for each insurance policy, but the provision for pooled claims also includes a component stemming from the equalization of the equity-linked buffer among pension providers. This component is calculated separately for each pension provider. Each pension provider must cover the same amount of the equity-linked buffer in relation to the technical provisions used for calculating the solvency limit. When technical provisions develop at different paces from one pension provider to another, this is equalized through the provision for pooled claims.

A minimum value has been set for the provision for pooled claims. This is 20 per cent of the total amount of pooled components for the next year. The part exceeding the lower limit of the provision for pooled claims can be used, for instance, to supplement pension liabilities, to increase funding for old-age pensions, and to prepare for pension expenditure due to demographic development.

The provision for pooled claims also includes the EMU buffer. Its target level is 2.5 per cent of all wages insured. The EMU buffer can be used to even out fluctuations in pension contributions caused by cyclical variations.

Components of pension liability (pension funds)

Company pension funds call the item corresponding to technical provisions ‘pension liability’. This includes the following parts:

  • the pension liability for future pensions
  • the pension liability for pensions commenced
  • the provision for current and future bonuses
  • the equity-linked buffer.

The pension liability for future pensions

The pension liability for future pensions comprises pension liability for future old-age pensions and future disability pensions. These components of the liability are calculated following the same procedure as when a pension insurance company or an industry-wide pension fund calculates the provision for unearned premiums for future old-age and disability pensions.

The pension liability for pensions commenced

The pension liability for pensions commenced is divided among old-age pensions commenced and disability pensions commenced. These components of pension liability are calculated in the same way as when a pension insurance company or an industry-wide pension fund calculates the corresponding components of the provision for outstanding claims. A company pension fund’s pension liability for pensions commenced also includes the provision for pooled claims. This is determined in the same way as for pension insurance companies or industry-wide pension funds.

The provision for current and future bonuses

The provision for current and future bonuses corresponds to a pension insurance company’s provision for future bonuses. A company pension fund transfers the return on investments to the provision for current and future bonuses, where it may also deposit the surplus from the fund department A, i.e. from voluntary supplementary pensions. After these transfers, the company pension fund can either cancel some of the provisions in order to reduce contributions, or it can use contributions to build up the provisions.

The equity-linked buffer

The equity-linked buffer is the system’s joint risk buffer to offset fluctuations in returns on shares. Company pension funds determine it in the same way as pension insurance companies or industry-wide pension funds.

Technical provisions are supplemented annually

Authorized pension providers must supplement the technical provisions (or pension liabilities for pension funds) annually in keeping with the fund interest rate, which is a technical rate of interest used for calculating the capital value of a pension. Its value is 3 per cent.

In addition, funded old-age pensions are raised annually by using a supplementary coefficient. The supplementary coefficient is determined on the basis of the average solvency of pension providers. The funds are supplemented with income corresponding to the supplementary coefficient, which targets the retirement pension liabilities of those over 55 years of age. The Finnish Centre for Pensions calculates the supplementary coefficient on a quarterly basis. If the value changes, confirmation is sought from the Ministry of Social Affairs and Health. Exceptions to the reference value of the supplementary coefficient may be made if there is a special reason. More information on the supplementary coefficient is available on the web page Supplementary coefficient of the Finnish Centre for Pensions [in Finnish].

The purpose of the supplements is to strengthen old-age pension funds, thus making it possible to curb the upward pressure on earnings-related pension contributions in the coming years. By targeting the supplements at those over the age of 55, the consequent benefits are reflected in the level of earnings-related pension contributions more quickly. The supplements also preserve the value and funding ratio of the funded units, since no index increments are made to the funded units in the same way as they are made to pensions already in payment.

The equity-linked buffer can also be increased or decreased by using an equity coefficient calculated annually. The equity coefficient is defined as the weighted average annual return on quoted equity investments of private-sector pension providers, less one percentage point. The coefficient is described in more detail on the web page Equity coefficient of the Finnish Centre for Pensions [in Finnish].

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