The connection between pension expenditure, pension assets and investment operations
Pension providers invest the funded components of earnings-related pension contributions as securely and efficiently as possible to make sure that there are enough assets when the accrued pensions are to be paid out in the future. The pension providers cover the pension expenditure that is not funded in advance with earnings-related pension contributions accumulated in the year that the pension is paid and state shares.
Successful investment operations that yield good returns also offer the opportunity to lower the insurance contribution level when pensions are financed with the investment return. For example, a change of one percentage point in the average investment return has the long-term effect of approximately two percentage points on the contribution under the Employees Pensions Act since the amount of current pension assets is roughly double the wage bill.
Investments come with many risks. As a rule, the risks correlate with the aimed for investment return. In part, the risks can be controlled thanks to the decentralized earnings-related pension scheme.
Solvency regulations steer investment operations
The investment operations of pension providers in the private sector are tightly regulated, since pension providers have accumulated technical reserves for future pensioners, calculated according to actuarial principles. In the public sector, pensions are not funded in advance per individual, complete with technical reserves. Instead, collective buffer funds for future pension expenditure are collected. The buffer fund are act-specific.
Private sector pension providers compete not only in efficiency but also in terms of investment profits and services for the policyholders. As a result, there are system-level conditions and limitations regarding the investment operations and related risks, as well as the solvency, of pension providers.
For example, solvency regulations require the private sector to have a sufficient solvency margin to cover any possible investment losses. In other words, the margin between pension providers’ assets and debts must be enough to cover any deficits caused by weak investment periods.
Obligation to transfer into funds
Pension providers offering insurance under the Employees Pensions Act and the Seafarer’s Pensions Act have an obligation to transfer assets into funds. This way, the investment return becomes part of the funding of pensions paid under these pension acts and, later, of the actual pensions paid.
Pension providers meet their fund transfer obligation with their investment return. If the investment return is not enough to cover the obligation, it must level the deficit from its solvency buffers. On the other hand, if the investment return exceeds the transfer obligation, the pension provider can increase its solvency and take bolder investment risks, since it is also better equipped to handle investment losses.
There are three crucial components to the obligation to transfer into funds:
- the discount rate,
- the pension liability supplementary factor, and
- the average returns of investments in shares.
The future payments are adjusted to current values with a discount rate of 3 per cent. The pension funds can be increased with the pension liability supplementary factor and the pension provider’s required average return of investments in shares and separate buffer fund.