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Pension systems in different countries

Throughout Europe, pension systems have become very different. When pension systems are developed, balance is sought between risk-sharing and individual responsibility. More and more countries are leaning towards the latter.

The Finnish earnings-related pension differs from its counterparts in several respects: its social security character; its scope; its nature as a defined benefit system with a basis in earnings; and the financing and administration of pensions. Finland fares well when pension systems are compared in terms of sustainable financing and the adequate level of pensions.

Each EU country has its own pension system

No two pension systems are alike. Pension provision has been created from the premises of each individual country, and its principles are deeply rooted in the structures of each country’s economy, labour markets and culture on the whole.

An established international technique for examining pension arrangements and decision-making is to divide pension provision into pillars. The simplest practice is to have three pillars:

  1. statutory pension;
  2. occupational retirement pension based on employment; and
  3. private savings.

As concerns their status in EU law, Finnish earnings-related pensions are social security pensions under the first pillar.

The Finnish system is a unique combination of statutory social insurance and implementation managed through pension insurance companies in the private sector. In the private sector, earnings-related pensions are managed in a decentralized manner by several competing pension insurance companies, company pension funds and industry-wide pension funds. The public sector has its own institutions for pension provision.

Pensions are secured against the possible insolvency of pension providers through joint and several liability among the insurers. In accordance with the principle of joint and several liability, other private-sector pension providers would assume responsibility in a problem situation, should one actor face financial difficulties.

Trade-specific occupational pensions have major role in many EU countries

Since the earnings-related pension in Finland has provided comprehensive earnings-based pension insurance without a pension cap, i.e. maximum pension, employer-specific or trade-specific occupational pensions under the second pillar have played only a minor role in Finland. In many other EU countries, earnings-based pensions are employer-specific or trade-specific occupational pensions, i.e. outside social security. In this case, the statutory pension and the occupational pension based on employment are managed through different systems.

In many European countries, these occupational pensions produce a considerable part of the earnings-based pension provision. The level and coverage of pension provision may vary depending on the occupational sector, the labour market status and organization. It is common to have shortcomings in pension coverage. The role of private supplementary pensions, i.e. the third pillar, may be highlighted in situations where the level of pensions provided by the first and second pillars in relation to wages is low.

In Finland, earnings-related pension is the principal source of income during retirement years. Supplementary and voluntary pension arrangements are meant to supplement statutory pension provision, not to replace it.

Supplementary pensions emphasize the individual’s responsibility, for example in terms of investment risks, and, in general, the individual’s responsibility for preparing for retirement. It is therefore harder to ensure that population groups vulnerable on the labour market have adequate livelihood during retirement years. On the other hand, in the case of statutory pensions, too, risks have been shifted to individuals in various ways in Europe. From the viewpoint of pension provision, statutory or mandatory arrangements and extensive coverage are good things.

Towards defined contribution pensions

Depending on the way in which pensions are determined and financed, pension systems can be divided in a simplified manner into two categories: defined benefit and defined contribution systems. In a defined benefit system, the benefit level is set beforehand or is determined on the basis of the earnings level and the length of the work history. In a defined contribution system, in turn, the benefit level depends, for example, on investment returns or financial balance. The pension sum is determined on the basis of the contributions paid into the system and the consequent investment returns.

In Finland, the goal was to create a pension system that brings stability and security to a vulnerable phase of life, when the possibilities of influencing one’s own income have weakened. An earnings-based, predetermined, lifelong and untouchable pension meets these criteria.

Elsewhere in Europe, the trend in the development of earnings-related pensions is that the promised defined benefit pensions are abandoned while defined contribution pensions gain more ground. Investment risk is passed on to the individual and the cost risk for instance to public finances or companies decreases, but old-age income may become more insecure than in the Finnish model.

Funding helps to prepare for aging of the population

When pension systems are compared, attention is often paid to the adequacy of pensions and the sustainability of financing. On both indicators, the Finnish model does fairly well in European and global comparisons. An earnings-related pension is the primary source of income for pensioners. Its purpose is to maintain a reasonable consumption level while Kela’s guarantee pension and national pension provide a minimum income.

With respect to the financing of statutory earnings-related pensions, Finland is better prepared than many other European countries The skewness of Finland’s age structure poses its own challenges to the financing of pensions, but Finland has also made more provisions for ageing of the population than most other EU countries by placing pension assets in funds. At present, Finland is leading the way in ageing, but many other countries will pass it in the future.

The returns on invested assets ease the pressure to raise pension contributions and serve as buffers for future pensions. Thus, pension contributions remain permanently lower than what they would be without funding.

In most other EU Member States, social security pensions do not include funding, and their costs are covered by taxes and fees collected annually. In consequence, economic crises have put the sustainability of pension systems to a real test in many EU Member States, especially as the population is ageing at the same time as life expectancies are rising. Under these financial pressures, pension systems have been revised in all countries, for example by raising retirement ages.

Finland will also need longer careers than at present in order to maintain the current level of pensions. The underlying factors are the increasing life expectancy and the rising target retirement age. For its own part, the earnings-related pension system supports longer work histories. In addition to the pension reforms carried out, rehabilitation plays an important role within the earnings-related pension system. Its objective is to improve the opportunities to work when a person can no longer continue at his or her former job for health reasons.

Finnish pension provision is at the average level

The pension reforms achieved in Finland have secured both the sustainability of financing and the adequacy of pensions. The earnings-related pension reform that entered into force at the start of 2017 has been regarded at the EU level as a model of how the longer life expectancy can be taken into account in pension reforms (see the 2017 edition of the review Employment and Social Developments in Europe (ESDE)). In the EU countries, the reforms have focused mainly on how to secure financing.

When looking at the adequacy of pensions, the Finnish pension provision is at the average European level. In measurements of relative poverty (i.e. how many pensioners have a net income that is under 60 per cent of the population’s median income), Finland is in the middle category, alongside Sweden and Germany. Deep poverty among pensioners is virtually non-existent in Finland. However, Finland has been criticized by the Council of Europe for the level of the minimum income (including the guarantee pension).

The earnings-related pension of the Finnish type is egalitarian when compared against many other earnings-related pensions. The statutory pension accrues and is maintained irrespective of the sector, duration of employment or job changes. In many countries, people pay pension contributions but are entitled to an earnings-related pension, for example, only after several years of work, or may even lose a supplementary pension when switching jobs. When it comes to supplementary pensions provided purely by the employer, the rules vary.

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