Pension sustainability is more than liabilities and assets
Is the Finnish pension scheme in debt as only 29 per cent of its liabilities are covered by investment assets? Looking at it from another angle, the funding balance is 98 per cent. How can the figures be so different?
When measuring the financial sustainability of a pension scheme, we should naturally be aware of the scheme’s liabilities and future expenses and compare them with its available assets and resources. Eurostat published in December 2018 new statistics on accrued-to-date pension entitlements as a part of the European System of National and Regional Accounts. The Finnish data was published in advance by Statistics Finland on 7 March 2018, based on projections made by the Finnish Centre for Pensions.
Meeting the liability for pension entitlements at a particular point in time means that the scheme has enough money to cover the future expenses accrued by that particular point in time.
At the end of 2015, Finnish earnings-related pension providers had a pension liability of 632 billion euros and pension assets worth 183 billion euros. By definition, the funding ratio of Finnish earnings-related pensions was then 29 per cent. Does this mean that we are unprepared to cover 71 per cent of our pension liabilities? Fortunately, no.
Pension obligations covered by intergenerational agreement
Estimating the accrued pension entitlements at a certain point in time sheds light on aspect of how the pension scheme is financed, but it does not give the whole picture. The pension scheme continues to be governed after that date as new generations are entering the scheme and new contributions are paid each year. The Finnish pension scheme is only partially funded. Those who are of working age pay their share and trust that the future generations will pay when it is their turn.
Another way of looking at the financial sustainability of a pension scheme is to take into account not only current liabilities and assets but also future accruals and contributions. At the Finnish Centre for Pensions, we calculated that the value of all liabilities, including future accruals, is 1,750 billion euros and that the value of future contributions at the current contribution rate was 1,530 € billion at the end of 2015. Our calculation uses the same projection as in the estimate published by Eurostat and a 3-per-cent real interest rate. Comparing financial assets (€183 billion) and the value of expected contributions (€1,530 billion) to liabilities (€1,750 billion) gives a funding balance of 98 per cent. Error margins considered, the scheme can be said to be almost fully balanced.
No single figure gives the whole picture
The ISAP 2 standard for Financial Analysis of Social Security Programs suggests that partially funded programs should be analyzed using an open group methodology, under which contributions and benefits of both current and future participants are considered. However, the established interpretation of the Finnish constitution strongly protects accrued pension entitlements. Future accruals and contributions, however, can be far more easily adjusted.
So – which is the right percentage? Has the Finnish pension scheme covered 29 or 98 per cent of its obligations? When a complex subject matter is forced into a single figure, problems are bound to arise. As professionals, we have to emphasize the various aspects of the matter.
A beneficial special feature of pension insurance is that liabilities can be estimated and communicated transparently, at least on a satisfactory level. Society’s future expenses relating to some other commitments are much more difficult to grasp, and their estimates are influenced more by subjective assessments.