Pension Financing – Principles
In Finland, earnings-related pensions are financed according to the pay-as-you-go (PAYG) principle and the partial funding principle. For the main part, the pensions paid out in a given year are financed with the pension contributions paid that year. The remaining part is financed with the investment return of the funded pension components.
Employers, workers and the self-employed pay insurance contributions which are used to fund pensions. In addition to pension assets and their investment returns, the Unemployment Insurance Fund and the State contribute to the financing of pensions.
The earnings-related pension provider that insured the worker before their retirement grants and pays out the earnings-related pension when the worker retires. If the worker has worked for several employers during their working life, the pension may have be funded in different pension providers.
The pension provider that pays out the pension will collect the components that the other pension providers are responsible for according to a division of costs calculated by the Finnish Centre for Pensions.
The State finances national pensions.
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Cost of division and partial funding
Public sector earnings-related pensions are financed under the cost of division principles, backed up by act-specific buffer funds. The pensions of the self-employed and farmers are financed with the insurance contributions paid in the year in question. The State pays the part of the annual pension expenditure for pensions paid to the self-employed and farmers that the insurance contributions do not cover. The State also contributes to the financing of sailors’ earnings-related pensions under the Seafarer’s Pensions Act.
The earnings-related and disability pensions of private sector wage earners are financed according to the partial funding principle. The earnings-related pension providers fund a certain share (per pension benefit) of each worker’s pension contribution to finance these pensions. The actuarial principles confirmed by the Ministry of Social Affairs and Health define the financing principles in more detail.
The pensions of state employees are paid by funds set aside for the purpose in the state budget. Assets collected in the form of pension contributions are transferred each year from the State Pension Fund to the state budget (40% of the pension expenditure). The remaining 60 per cent of the paid pensions are financed directly from the state budget for each year.
In the municipal sector, pension contributions are collected each year to cover the pension expenditure. Part of the contributions are also funded to form a buffer for future pension expenditure. The funding helps curb the rise in pension contribution rates. In addition, by monitoring how well the structure of pension contributions works in the municipal sector, structural changes in the municipal sector can be predicted.
So far, the earnings-related premium income in the municipal sector have exceeded the annual pension expenditure. Now the net income has turned negative and, in the future, the pension expenditure will exceed the premium income.
Financing methods from an intergenerational standpoint
In the PAYG scheme, as a rule, the working population finances the benefits of the retirees. That means that the pensions of each generation are financed by later generations. A sufficient number of working people is needed to pay the pensions of earlier generations. For this system to work, employment rates and the age structure of the population play a crucial role.
The number of retirees is continuously growing in Finland, and people are retired for a longer time than before. The number of working-aged people is shrinking and, as a result, the number of persons financing pensions is also decreasing. The life expectancy coefficient that is linked to life expectancy will also affect the pension amounts of the younger generations. The life expectancy coefficient will reduce an individual’s pension amount if they don’t work longer than before.
Partial funding eases the contribution burden of future generations since the funded assets and their long-term investment returns can be used to pay for future pensions and to uphold the system. For its part, the partial funding protects the pension promised made. If our earnings-related pensions system was fully funded, each generation would finance its pensions on its own.