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Decentralized system

The administration of the Finnish earnings-related pension system is decentralized. This means that there are many pension providers of different types and numbers. Decentralization is closely linked to the basic function of the earnings-related pension system, which is to secure current and future earnings-related pensions.

Decentralization helps risk management

The basic function of the earnings-related pension system is to secure the pensions of current and future pensioners. The aim is to perform this task with the minimum pension contributions so that the cost of earnings-related pensions would be as low as possible for payers.

Some of the pension contributions collected annually are placed in funds and invested for future pensions. The aim is to obtain the highest possible return on the invested assets while keeping the risk within permissible limits. Thanks to the returns, the level of the pension contributions can be kept lower than it would be on the basis of the pension expenditure.

In a decentralized earnings-related pension system, risks associated with investments are managed better when the investment of assets does not depend on the views of a single operator. The investment strategies of pension providers differ from each other, as do the returns they achieve from one time to the next. It is impossible to know in advance which investment method will yield the best returns during each period.

Without decentralization, the investment of earnings-related pension assets would depend on the investment vision of only one organization. This would increase the risk of failure at the level of the whole system.

Thanks to decentralization, our pension assets are largely separate from the State Budget, unlike in many other countries. The state pays part of the pensions of self-employed persons, state employees, farmers and seafarers. However, most Finnish pensions are financed by pension contributions paid by employers, employees and self-employed persons.

Decentralization makes it impossible for the state to intervene in pension assets in situations where general government finances face difficulties. In many other European countries, this has been done, for example, during economic crises. In Finland, owing to decentralization, pension assets are also protected from political cycles. Pension assets cannot be used, for example, to pay off state or municipal debt.

More versatile investment thanks to decentralization

By law, pension assets must be invested profitably and securely. In practice, this means that the assets must be invested in different targets and different geographical areas.

In the private sector, solvency legislation also sets frameworks for investment activities by classifying the risks of various investment instruments and by regulating investment in them. However, pension providers have much freedom in formulating investment strategies, and they weigh different investment instruments and geographical areas in a variety of ways in their portfolios.

If, for example, the investment of earnings-related pension assets were the responsibility of only one actor, this operator would be a major user of economic power when deciding where to invest the assets. The targets could also change from the current ones so that they would be sufficiently diversified between various targets and geographical areas. For example, investing in Finland might shrink from the current level.

Decentralization benefits both employers and employees

It is the employer’s responsibility to take out earnings-related pension insurance for the employees. In the decentralized model, the employer has more leeway in deciding the form in which pension insurance is arranged: whenever possible, the employer can set up a pension fund for the company, join a pension fund already operating in the same industry or become a customer of the selected pension insurance company.

Thus, authorized pension providers in the private sector compete with each other for customers. One of the means of competition is the quality of customer service and various service solutions, targeting both customer companies and the employees insured. In addition, some pension providers may specialize in earnings-related pension insurance in certain sectors, enabling them to offer their special expertise to customers.

The benefits of decentralization and competition are also reflected in the level of pension contributions. The customer companies of pension insurance companies may be granted a discount on the pension contribution through company-specific customer rebates. Customer rebates are a surplus distributed among the customers of pension insurance companies. The rebates accumulate from efficient operations and investments.

As a result of customer rebates, the pension contribution may remain lower than the average level. Customer rebates are taken into account in pension contributions collected from both employers and employees.

Co-responsibility for bankruptcy secures accrued pensions

In the private sector, pension providers annually take some of the pension accrued to the insured and put it into a fund in advance. Each actor uses its own assets to vouch for these funded assets.

The decentralized system has ensured that no harm is caused to the retired person should an individual actor fail in his or her task. In the private sector, pension providers have joint and several liability for accrued pensions: should one operator go bankrupt, the pension assets and liabilities for which the provider was responsible would be divided among the remaining providers.

Decentralization has a long tradition

Since its inception in the early 1960s, the Finnish earnings-related pension system has been built according to the decentralized model. The roots of decentralization go even deeper.

As early as the 19th century, relief funds were set up in connection with factories, while certain occupational groups (e.g. civil servants) had their own relief funds. Some of them also granted pension benefits.

The decentralized implementation in its current form has its background in the general policy disputes of the late 1950s between the agrarian population and wage earners over income distribution. The committee planning the pension system at the time stated that the earnings-related pension provision should be based on a decentralized organization.

When the Employees’ Pensions Act came into force in 1962, it provided for decentralization: according to the Act, an employer could obtain earnings-related pension insurance by setting up a company pension fund or an industry-wide pension fund, or by acquiring earnings-related pension insurance from a pension insurance company. The first pension insurance companies were established in connection with life insurance companies.

An administrative reform was carried out in 1991. As a result, pension insurance companies became independent of insurance companies and established their own independent administration. The social partners acquired a key role in the governance of pension insurance companies. This role was also confirmed by law.

The need for pension insurance companies to become independent was linked with Finland’s EU membership. In the early 1990s, Finland was already a member of the European Economic Area EEA and negotiated on full EU membership. The European Commission required that private pension insurance companies had to be clearly independent actors, providing only statutory pension insurance. Otherwise, the Finnish earnings-related pension system could not have been kept as a national system.

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