Jaakko Tuomikoski 7.1.2013

1. Comments on the report by Keith Ambachtsheer: “The Pension System in Finland:Institutional Structure and Governance” Jaakko Tuomikoski 7.1.2013

2. General remarks • A thorough and well-informed report, by a first-rate expert, on a robust system. • There is no need for a complete overhaul of the system…… • ….. which does not mean that there is no need to improve certain features! • My comments concentrate on private sector occupational pensions. • Disclaimer: maybe I am too much of an insider to avoid a certain bias.

3. The one and only goal • Fulfilling the pension promise is the one and only goal of the design and operations of the system. • Somebody must provide a guarantee in case of failure of a pension institution. • No tax money enters the system (some slight exceptions). • Neither is any tax money wanted, as the social partners regard occupational pensions as a part of the total remuneration of employees. • Hence the guarantee must be provided by other pension institutions, and finally by those who pay the premiums. • Thus, common rules are needed to furnish a level playing field. • This is not to say that the present rules are the only possible ones, or even the best ones.

4. The premium level as the sustainability indicator • The affordability of the system depends on the ability of the Finnish economy to carry the “burden” of the TyEL premium. • The burden relates to both the (estimated) maximum level in the future and the future path of the premium level. • Better investment returns lead to more moderate premium levels. • Risk-taking leads to higher expected returns. • Disappointments follow at times when actual returns do not measure up to expectations (an all too frequent experience in recent times). • The risk is borne by those who pay the premium. • Thus, their risk appetite must decide the risk level adopted.

5. The present solvency rules • Furnish the needed level playing field. • Safeguard the assets, as they cover liabilities instead of being just a heap of money. Insurance, not savings! • Can be calibrated to match the risk appetite of the social partners. • This has been done in 1997, 2005 and 2007. • Also the confidence level can be calibrated. • This resembles the idea in the report of not guaranteeing the whole pre-funded part of the pension. • True that the solvency levels corresponding to market interest rates would be lower than those reported. • However, the reported solvency levels are mainly used to regulate risk-taking. • Divergence from market-based rates is not a problem, as temporary lowering of the funding rate provides a tool at times of distress.

6. Partial funding • A strength. • In my mind a strength which is further enhanced by the evolutionary, not pre-determined, funding ratio. The funding ratio is a consequence, not a target. • This allows dynamic response to changing projections of the premium level. • Remember the projected premium level as the main indicator of sustainability! • Special case: in times of exceptional stress (i.e. 2008-) temporary reduction in funding was an efficient tool. • However, if such reductions become permanent, they endanger the pension promise.

7. The discount rate • Market discount rates are fine in a system that aims to be fully funded. • A volatile discount rate brings greater volatility to solvency levels unless matching instruments are used. • These are necessarily instruments with modest expected returns. • Wouldn’t market rates thus reduce the return-seeking possibilities? • The 3% (subject to infrequent ad hoc changes when absolutely necessary) rate may demand changes if low interest rates are there for decades. • The problem is not fatal, as in such a case the 1997 trick may be replicated.

8. Costs: a general comment only • Two cost drivers: 1) Costs that are consequences of the overall system design. 2) Costs that are consequences of inefficiency. • Also the latter exist and should be diminished. • When assessing the former, it is relevant to bear in mind, as the report does, that the system covers Pillars I & II and also long-term disability insurance. • The lack of a pension ceiling reduces also the need for Pillar III arrangements. • Whether this is a good thing overall depends on preferences as regards social policy. It is definitely an asset as regards administration costs.

9. The identity of the PIC:s • The main aim revisited: fulfilling the pension promise is the one and only aim of the design of the administration system. • Quoting the July KPA Letter: “Never underestimate the role of mission clarity in powering organizational success.” • Thus the most successful institutions are those that have only their mandate in mind! • For PIC:s, the mandate is administrating the TyEL and YEL, and nothing else. • They should not imagine that they have any other identity than that! • Competition vs collaboration: the question is extremely profound and should be revisited with the mission in mind.

10. Recommendations • Pay careful attention to the recommendations in the KPA report…. • …. and doubt my comments. • The roadmap for achieving both representativeness and skill on the Boards is extremely important, and can be fulfilled within the present legislation. • It is probably not possible to achieve at the same time also the third goal, i.e. reduce the size of the Boards. • Strengthen the Internal Investment Oversight function and the Boards’ position in relation to senior management. • Revisit the question of investing domestically. • Appreciate intergenerational fairness and get to the sustainable premium level quickly.