Key Concepts of Technical Provision Calculation
One key assumption when calculating the new technical provision generated in connection with pension accrual, that is, in the discounting of the future funded pension compensation, is the nominal discount rate of three per cent. Accordingly, the technical provision is adjusted at least annually by a three-per-cent discount rate. The discount rate has been set at a fairly low level. Thus, it is achieved in investment operations in most years.
However, one consequence of the low discount rate is that, in most years, investments would generate large surpluses if no additional measures were taken. To solve the problem of fluctuating investment returns, annual increases to the funded old-age pensions are made. The increases are targeted exclusively at persons who have turned 55, with the aim to achieve a steady development in earnings-related pension contributions.
The size of these increases is determined by the adjustment factor. It is defined on the basis of the average solvency of all authorised pension providers. The adjustment factor as a percentage of the technical provision is generally received by multiplying the general solvency ratio by 0.18 and by deducting the discount rate from the result.
A collective equity-linked buffer fund acts as a buffer against fluctuations in share returns. The buffer fund may be either positive or negative. The equity-linked buffer fund is, at maximum, one per cent and, at minimum, -20 per cent of technical provisions. On the basis of pension providers’ realised share returns, this component of the technical provisions is either increased or reduced.
Assets exceeding the upper limit (1%t) are transferred to the old-age pension liability at the individual level by increasing the size of the funded pension components. Falling below the lower limit (-20%) is prevented by dissolving the pension providers’ solvency margin.
Thus, each pension provider must adjust its technical provision with a three-per-cent discount rate, the adjustment factor and a change in the equity-linked buffer fund, that is, with an investment return rate. The rate is defined as the weighted average of the realised investment returns. The investment return rate in percentage of the technical provision is approximately one tenth of the pension providers’ average realised investment return rate, from which one percentage point from the return figures is reduced on an annual level.