A Victim of Success?- why is Finland a laggard in extending pension age?

Mikko Kauttofirst draft, 6.8.2012

A paper to be presented at the 10th Espanet Conference in Stream 15: Increasing the Normal Retirement Age: A Difficult Exercise?

Mikko KauttoHead of Research Department, PhD Centre for Pensions, Finland Kirjurinkatu 3, 00065 Eläketurvakeskus mobile: + 358407408095 mikko.kautto@etk.fi

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Abstract

The paper addresses pension policy in Finland using Kingdon’s (1995/1984) “problem” perspective, where selection of agendas and alternatives occupies an important role. It is argued discrepancy between pension promises and financing has been seen as a major problem in Finland, not legal retirement age as such.

In Finland the share of pension expenditure is approximately 43 per cent of all social expenditure and a fourth of all public expenditure. Due to the important role of pension protection and given the ageing process, the socioeconomic challenges the Finnish pension system is facing have been addressed since early-1990s, when first cost-containing and consolidating pension reforms were introduced. In 2005, the biggest reform so far was carried out in the history of employment pensions, aiming to modernise the scheme, curb rising expenditures, and extend effective retirement by three years in the long run.

First, the paper describes the reforms, and with the help of long term projection model, illustrates the cumulated effects of these reforms for projected pension ex-penditure and contribution rates. The main argument is that the reforms have been successful in curbing down pension expenditure and contribution rates, and have helped to increase effective retirement age.

In the second part of the paper we discuss the latest sustainability challenge and how during last three years raising of old age pension age has been discussed as a key solution. Retirement ages have been lifted in most European countries, and so far, Finland is one of the few European countries that has not decided such a re-form. We ask why is a country with an impressive track record of pension reforms reluctant to consider such an obvious advice? We argue past success in reforms af-fects willingness to implement new reforms, and with the help of Kingdon’s (1995) toolbag, offer possible explanations for why this reframing of the problem so far has not been very successful.

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Introduction

In his classic treatment on public policy, John Kingdon was interested in “why some subjects rise on governmental agendas while other subjects are neglected, and why people in and around government pay serious attention to some alternatives at the expense of others” (Kingdon 1995, 196). His main answer was that an issue needs to be defined as a problem, and politicians need to want to do something about it to enter government agenda.

This paper addresses pension policy in Finland using Kingdon’s “problem” perspect-ive, where selection of agendas and alternatives occupies an important role. It is argued discrepancy between pension promises and financing has been seen as a major problem in Finland, not legal retirement age as such. When policy makers want to do something about pension finances, they have many possible alternatives in their hands. Raising the retirement age is just one of the alternatives, or para-meters that affects pension finances.

By presenting the many pension policy amendments, the paper first shows there have been many different ways to improve sustainability in pension finances. With the help of long term projection model, we illustrate the cumulated effects of these reforms for projected pension expenditure and contribution rates. The main argu-ment is that the reforms have been successful in curbing down pension expenditure and contribution rates, and helped to increase effective retirement age.

The second part of the paper starts from the fact that even after reforms, with continuously increasing life expectancy, and due to employment rate drops and problems in the financial markets since the 2009 financial crisis, the financial sustainability of the pension system is once more challenged. In this situation, raising the old-age retirement age has been lively discussed during the last three years to counter rising costs. The discussion has been fuelled by the advice from the OECD and the European Council to tie the retirement age to longevity trends. Retirement ages have been lifted in most European countries, and so far, Finland is one of the few European countries that has not decided such a reform.

Why is a country with an impressive track record of pension reforms reluctant to consider such an obvious advice? We argue past success in reforms affects willingness to implement new reforms and with the help of Kingdon’s (1995) toolbag, offer possible explanations for why this reframing of the problem so far has not been very successful.

Pension schemes can be changed

Much of welfare state research tries to account for change. Since literature on wel-fare state crisis, and doom forecasts of welfare state withdrawal and retrenchment, considerable energy has been devoted to understanding welfare state resilience (Pierson 1994, 1996) and explain reasons for and forms of adaptation and trans-formation. A main explanation to resilience Pierson gave, was ‘lock-in’: past policy commitments narrow present options. Decisions that were taken decades ago fall upon the shoulders of present policy makers, and seriously hinder other options. This point of view has been later elaborated as ‘path-dependence’ in mature pen-sion schemes (Myles & Pierson 2000).

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Pension policy is the classic example of ‘lock-in’ and path-dependence. PAYG fin-anced schemes rely implicitly on a generation contract, and explicitly on today’s workers financing the pensions of present pensioners. Pensions are treated as ‘earned income’, ‘deferred wage’, or ‘property rights’. Such notions give powerful messages for today’s decision-makers to honour previous commitments from fore-gone governments. Pension recipients (present, but also future!) are also a strong interest group (policy-takers), a power resource comparable to mobilised labour at the time of welfare state expansion.

Comparative research has shown full-scale retrenchment does not happen for a number of good reasons, and there is some path-dependence in social policy. How-ever, this doesn’t mean a situation of no change. Rather, path-dependent adjust-ment can be interpreted as making changes within the room-to-manouvre. Some issues are more prone to be addressed than others. As pension schemes do evolve over time, and policy-makers operate in this policy area, too, the two interesting questions are how to find the “movable objects”, and how to overcome resistance to changes?

John Kingdon (1984/1995) has addressed the first question. In his view, there are two major predecision processes that he calls agenda setting and alternative spe-cification. An agenda-setting process narrows the set of subjects that could conceiv-ably occupy the attention of policy makers to the list on which they actually do. The process of alternative specification narrows the large set of possible alternatives to that set from which choices actually are made. By analysing these processes, King-don concluded actors, or participants certainly are one key to determining the agen-das and alternatives. But the other answers were related to processes, of which he identified three crucial streams: recognizing problems, generating proposals for changes, and politics. His main conclusion was that reform happens when an issue is widely seen as a problem, when there exists ready alternatives to solve then, and when time is right.

Paul Pierson has been more interested in finding answers to our second question. He has elaborated three adjustment strategies, all of which take time to show ef-fects. First, change can be brought by decrementalism, with slow changes that do not alter the year-to-year situation much, but that make up a significant change in the long run. Second, such a major change in the long run can be achieved also by making the decision now, but implement it later (the ‘grandfather-clause’). Pierson’s offer for a third strategy - blame-avoidance, or blame-sharing – refers to a strategy where key parties are able to reach a common position, or a compromise, and avoid political backlash. Rhodes (1998) has described the coalitions between govern-ments and social partners as ‘competitive corporatism’. Such coalitions extend blame avoidance options for key parties. Blame avoidance strategies take time, but reduce opposition and hindsight criticism once a reform alternative is reached. Hin-richs & Kangas (2003) and Hinrichs & Jessoula (2012) have addressed the long term consequences of pension reforms and showed how small step-by-step amendments could amount to significant changes and even system shifting. Palier (2007) in turn taking development in France as an example, has described in detail how such a process may evolve.

Korpi and Palme (2003) have argued retrenchment can happen in a visible way, and that it mostly happens when countries confront deep economic problems or large deficits. Governments can then cut social expenditure for a higher cause, e.g. to re-store competitiveness or fiscal balance. A higher cause can also be a social one, in

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pension policy e.g. a generational reason, or a distributive fairness reason. The im-portant thing is not the cause in itself but to find the justification that is acceptable among key actors and citizens.

Pension policy in Finland has happened very much along these lines. As will be shown later, Finland is a good case for Korpi and Palme: pensions were adjusted sig-nificantly in crisis years. One could even argue the alternative simply did not exist (see also Kangas 2006). Non-action in the event of financing problems in the situ-ation of an economic and employment crisis would have jeopardised the continuity of the employment pension scheme. The crisis explanation however does not ac-count for why reforms were continued after crisis years. Here the decision making structure may provide the explanation. The way policy reforms were made is along Rhodes’s suggestion: political parties in the government united, and ordered reform from social partners, who were in charge of crafting an acceptable alternative. After years of Kingdonian “alternative specification”, a consensual reform proposal was reached, and it could be endorsed both in the employers’ and employees’ organisa-tions but also in different parties. The end-result fits Pierson’s frame: blame for cuts was avoided, and as will be seen, many of the reforms included decrementalist fea-tures and grandfather-clauses that helped their acceptability.

Pension finances as a problem, and its measurement

According to John Kingdon (1995), policy change necessitates identification of prob-lems. Different kinds of issues rise to political agenda only when they are defined as problems, and when policy makers believe we should do something about them. But how does an issue become a problem? Kingdon’s answer is that one needs first the means to learn about conditions, and then have ways in which these conditions be-come defined as problems. The means may be several, and they include above all indicators, events and feedback.

In pension policy, all these means are relevant. While events may be haphazard, there is constant feedback from the running of the pension scheme. Also, the use of statistics, accounting, forecasts and research is regular practice and provides the base for a variety of indicators. Pension expenditure and pension contributions are arguably the key indicators in all pension schemes. For judging the situation or de-velopment problematic, magnitude and change are decisive.

As in so many other welfare states, also in Finland pension expenditure is the biggest source of social protection expenditure. In 2010, the share of pension expenditure was approximately 43 per cent of all social expenditure, and accounted for a fourth of all public expenditure. In relative terms, the expenditure was close to 13 % of GDP, and in relation to the wage sum, the share of pension contributions was almost 23 per cent. (FCP Statistics; THL 2012.)

All long term projections on how pension expenditure and contributions relative to GDP are going to develop have prognosed growth. The historical reasons for expenditure growth can be traced back to decisions extending pension rights, but also to structural reasons such as changing age structures, labour market participation and wage development. The future development is uncertain, but register data on current paid and accrued pensions, coupled with population scenarios and employment and productivity patterns point to an increasing number

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of pensioners with higher pensions at a time of slower economic growth. Pension expenditures thus continue to grow while their financing remains uncertain.

Thus, in comparative terms, the magnitude of pension costs is not negligible. There is no doubt growth trends catch the interest of policy makers. On both criteria pension costs can be labelled as a “problem”. In the following we intend to measure these “problems” in pension finances with two key indicators. We use pension expenditure, and contrast this not to GDP but to the financing base, that is the wage sum. The motivation for this is that in the Finnish PAYG pension scheme expenditure defines the level of contributions needed, and these are collected from wages. Our second indicator is pension contributions as percentage of the wage sum for the private sector. There may be objective limits to what pension expenditures and contributions in relation to wage sum can be, but that level is probably more a matter of time-bound value judgements. Thus in judging these indicators, it is above all change that may be more important than the level itself. Here again, it is difficult to postulate an exact objective threshold of how big a change (and over which time period) is needed for defining it as a problem (see also Hinrichs & Kangas 2003). The employers’ organisation sees an increase of a decimal in contributions as a problem, so we could heuristically say an increase of one percentage unit in our measures with all likelihood is seen as a problem among policy makers.

The long term projections model as a yardstick for measuring change

Since 1970s, an important tool in assessing financial sustainability in the employment pension scheme has been the FCP’s LTP (long term projection) calculation model (see appendix 1 for a fuller description). Building on existing registers on the population, all pensions and pension insurances, and employing Statistics Finland’s population forecast, this model provides baseline scenarios for pension expenditures, pension contributions and average pensions. By alternating the assumptions, the model offers sensitivity tests and alternative projections, but here we will make use of only the baselines.

As all deterministic long term models, the results depend heavily on the starting level and different assumptions about future development (e.g. population, retirement and employment, wage development, returns from financial markets). The correctness is hard to assess, as in the real life developments tend to be different than the assumptions already in the short run, and besides, pension policy measures intervene. Due to these reasons and to keep the policy-makers informed, new calculations are provided every three years. The model is above all a regularly updated tool for policy makers to assess whether the projected future is acceptable. In case the expenditures, contributions, or pension levels turn out to be undesired, policy intervention is likely to occur. The next forecasts then have the new rules as starting point.

Here we make use of the almost symbiotic relationship between reforms and forecasts. Due to constant evolution in important factors, and in assumptions, different LTP model projections cannot be compared in the strict sense. Nevertheless, a key concern in pension policy is to achieve a balance between contributions and expenditure. So for the purposes of assessing development in sustainability, it may be argued the results from LTP models from different periods of time do provide interesting points of reference. The interest in this paper is to contrast different projections and pension policy adjustments. In Finland, the long

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term projections have been so bleak, that policy makers haven’t been willing to accept the scenario, and thus made changes to pension policy to generate a more acceptable future. If adjustments have been able to make a difference, growth in expenditure levels and required increases in contributions should be lower.

Two waves of pension reforms

Between 1990-1993 Finland experienced the most severe economic recession in its recorded economic history. The crisis years included a macroeconomic crisis with three consecutive years of negative growth. This resulted in a massive employment crisis, as unemployment rate rose from 3,5 % in 1990 to 16,5 % in 1993. The col-lapse of the economy and employment led to a fiscal crisis characterised by budget deficits and a surge of debt. Years 1992-97 aimed to restore the competitiveness of export industry and development at domestic markets. They were also marked with consolidation measures including cuts in social benefits and tax raises.

The export industry recovered by 1993, and employment started slowly to improve. As a result, the situation improved in the mid- and late-1990s, and fiscal balance was achieved. Since then, Finland has followed a “restrictive expenditure policy” to keep general government finances sound and to prepare for the ageing society.1

Pension policy reforms have been part of these consolidation measures. There have been almost yearly changes in pension policy, but still, pension reforms in Finland may be grouped in two waves.2 In the 1990s, reforms were geared at solving acute financial problems. In the 2000s, the employment pension system was subject to more thorough modernisation.

Pension reforms 1990-1999

In 1993, employees’ pension contribution was introduced to help contain wage costs, and to enlargen the funding base and lift some of the pension funding pres-sure from the employers, who until then had been solely responsible for pension financing. It was also decided all future raises will be split 50/50 between employers and employees. To help correct public finances, the pension accrual period, target replacement level and retirement age in the public sector were changed to corres-pond to those of the private sector.3

In 1994, the lower age limit for the individual early retirement pension4 was in-creased from 55 to 58 years. The age limits for the part-time pension were syn-chronised so that in the private sector the limit was lowered to same age as in the public sector, i.e. from 60 years to 58 years. Accelerated accrual rate of 2.5 per cent for persons who had reached the age of 60 was introduced to motivate continuing at work. One measure with long term consequences was to deduct the employees’ 1 The latest review laying out the fate of public finances is Finland’s Public Finances at a Crossroads, 2010.2 In this paper we discuss only the cost-containment oriented measures. From the 1960s until the end of the 1980s pension rights were expanded.3 Historically, public sector pensions had higher target replacement rates. This change started a gradual unification of pension rights that were finalized in the reforms between 2005-2007. However, the financing of public and private pensions still have a different logic, and purse.4 The individual early retirement pension was a special disability pension targeted for elderly workers with less strict medical criteria, i.e. one could apply for it e.g. for social reasons or due to threat of redundancy.

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pension contribution from the wage before calculating the pension (the Act took ef-fect in 1994, and the practice started from 1996, and is still in place).

Instead of a liberal criteria of ‘residence’, the national pension and the survivors’ pension paid by the Social Insurance Institution were made proportional to the time of residence in Finland, and a minimum of five years residence was introduced. As an immediate relief for pension finances, index adjustments of earnings-related and national pensions were not carried out in 1994.

In 1996, the pensionable wage concept was changed, and was gradually calculated on the earnings of the 10 last years of each employment contract (instead of two middle ones out of the last four years). Persons of working age and old age pension-ers got their own indexes. The index for valuing pension accrual continued to take into account half of the real-term change in earnings, while the other half was based in consumer price index. The index for pensions for pensioners over 65 was weakened. The earlier index thus was a 50/50 index, but the new one weighed earnings by 20 % and consumer prices by 80 %. In disability benefits, the accrual rate for projected pensionable service was weakened from 1.5 to 1.2 between the ages 50 and 60, and to 0.8 between the ages 60 and 65. The time-limited disability pension was changed to rehabilitation benefit to promote return to work. Rehabilita-tion services were to be promoted instead of granting disability benefits.

The national pension was made proportional to the earnings-related pension. This was a big change in principles, although one that did not markedly affect the level of pensions paid out (Kautto 2012). As a compensation, levying of national pension contribution from the insured and from the pension recipients was terminated.

From 1997, the age limit for a right to unemployment tunnel (unemployment bene-fit plus extra days plus a special early unemployment pension) was lifted by two years from 53 to 55 years. In 1998, after a series of cost-cutting reforms, three years of positive economic development, improving fiscal situation and before na-tional elections year, it was decided that employment contracts of shorter duration than a month or with low wages became covered by pension provision (and needed to be insured). The age limit for the part-time pension was temporarily lowered to 56 years.

Pension reforms 2000-2009

In 2000, the age limit for the individual early retirement pension was raised to 60 years. In 2003, the age limit for the part-time pension raised back to 58 years (the temporary age limit was not continued). Same year, the Parliament approved the biggest pension reform package in the history. The reform in the earnings-related pension scheme took effect in 2005. There were three key goals.

The first was to lengthen working careers by 2-3 in the long run (later ex-plained as 2 years by 2030, 3 years by 2050). The main method for lengthen-ing careers was to prune out early exit possibilities. The unemployment pen-sions and individual early retirement pensions were abolished. Also flexible retirement age was introduced.

Secondly, the reform aimed at unifying and simplifying the pension system. The pension accrual was made more equitable by basing benefits on lifetime earnings and harmonizing benefit rules. The link between benefit calculation

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and employment contracts was abolished, and only earnings per year now affect the level of pension.

Thirdly, the reform aimed at reducing pressures on pension contributions (fin-ancial sustainability). Increasing life expectancy is a challenge to all pension systems, and to this end Finland crafted an automatic stabiliser. The life ex-pectancy coefficient takes into account changes in life expectancy and adjusts the starting old age pension accordingly.

After the pension reform all employees have to be insured between ages 18 and 68, and since 2005, the pension is calculated on the earnings for each year. The pen-sion rights were calculated according to the old legislation until the end of 2004, and the new accrual rates took effect from the beginning of 2005.

The accrual rates were changed. From 19 to 52 years, the accrual is 1.5 per cent of earnings, between ages 53 and 62 1.9 per cent and from the age of 63 4.5 per cent for earnings. The retirement age is flexible between ages 63 and 68.5 Accrued pen-sion rights and pensionable wages are adjusted since 2005 with the new wage coefficient, where the real-term change in earnings is taken into account to 80 per cent. Increment for deferred retirement can be paid from the age of 68 (0.4% per month) and reduction for early old age retirement can be made at the earliest from the age of 62 (0.6% per month). The 20 (wage)/80 (price) index is applied to all pen-sions in payment. Thus also early retirement pensions were now touched by the new index.

The unemployment pension was abolished for persons born after 1949 and the indi-vidual early retirement pension for persons born after 1943. The unemployment pension was replaced by extra days of unemployment benefits, and the age limit was raised by two years from 55 to 57 (the extra days can start at the age of 59 after two years on normal unemployment benefit). The criteria for the individual early retirement pension were included in the rules on disability pension. The life expectancy coefficient was part of the reform, but has been applied after an interim period from 2010.

In 2006, the reform continued, and second phase changes took effect. Also other types of pensions than old-age pensions are calculated in the new way. In disability pensions, the calculation of the pension for projected pensionable service was changed in its entirety, so that from the age of 50 the accrual rate is 1.3 per cent to the termination age 63 years for the projected pensionable service. The earnings for projected pensionable service are (after a transition period) calculated from earn-ings for the five years which precede the pension contingency.

To finalise the reform, all Pension Acts were rewritten in 2007, and their contents were harmonised. In the private sector old TEL, LEL and TaEL were merged into TyEL. Public sector pension Acts were also rewritten. In the same year, new invest-ment rules for private sector pension companies were passed in the Parliament. They allowed pension companies more risk taking on order to gain higher returns.

5 In the national pension scheme the retirement age remained at 65, and the increments for postpon-ing retirement and the reductions for early retirement remained. Due to the new flexible retirement ages, the age limit for the early retirement reduction was changed to 62.

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In 2009, pension adjustments continued. Some corrections to the disability benefits were made. The accrual rate for projected pensionable service until the age of 63 was lifted back to 1.5. Further, after five years on disability benefit, a lump-sum in-crease of 25 per cent (decreases by one percentage point per year) for those under the age of 32 was introduced. To further correct the cuts by life expectancy coeffi-cient, it is not applied to the projected pensionable service, or when the disability pension is converted into an old-age pension. In the part-time pensions, the age limit was lifted by two years to 60 years. It was also decided that the decrease in income of part time pensioners does not accrue pension (as it did before). In the unemployment tunnel, the age limit was raised by one year to 58 years.

In sum, access to early retirement schemes has been significantly restricted in the past twenty years. Part-time pension can be paid from the age of 60. The unemploy-ment pension is abolished (phased out altogether by 2014) but the “unemployment tunnel” with additional days of unemployment allowance still enable older people (currently from age 60) to stay on unemployment benefits until retirement. The indi-vidual early retirement scheme has been abolished. As a result, only the disability pension scheme now provides a path to early retirement. At the same time the in-troduction of flexible old age pension age has given more choice to wage earners on when to time old age retirement. Improved accrual rates and the life expectancy coefficient were meant to give better incentives for continuing at work. In turn, the life expectancy coefficient also plays the role of an automatic stabiliser. It reduces strain caused by increased life expectancy, but with the flexible retirement age, this effect can be compensated by working longer.

Consequences of reforms for financial sustainability

How have these changes affected the sustainability of pension financing? Figure 1 presents the frame to assess the financing situation with expenditures. On the hori-zontal axle we have the past and future year, while the vertical axle measures pen-sion expenditure in relation to the wage sum, thus contrasting the value of ex-penditures with the financing base for pension insurance. The expenditures are shown for the whole history, i.e. from 1962. As explained, we use this grid for fol-lowing the future development in pension finances. It should be remembered each projection represents the baseline estimate at the time (affected by the economic situation, legislation and expectations) they were done.

As can be seen, pension expenditures grew rather systematically the first 30 years. The oil-crisis in mid-1970s affected the economy and employment, thus a twist in the graph can be detected. The broken line shows LTP estimate for future expendit-ures, as prognosed in 1990. As can be seen, expenditures were projected to grow at the same rate until around 2010, whereafter especially the changing age structure was foreseen to drive expenditure growth at an even faster pace. As can be seen, the projection was made for 50 years forward, and in 2040s, the expenditure growth was still continuing (from a level of 42 %). Thus in fifty years, pension ex-penditure in relation to wage sum was estimated to triple.

The forecast model was done and published before the economic crisis between 1990-1993. The consequences of the economic and employment crisis for pension financing were twofold. First, due to lower employment and poor chances of wage growth, the wage sum got smaller. Second, due to increased lay-offs, and retire-

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ment, pension expenditures grew. As a result, the actual development in expendit-ures as % of wage sum shows a remarkable increase from around 15 % to 22 %. It took just three years to reach a level that was supposed to come about in fifteen years.

Figure 1. Pension expenditure growth 1962-1989, projection for 1990-2040, and actual growth 1990-1993.

As can be understood from both magnitude and growth pace, this was the time for making adjustments in pension policy, described in the previous section. Figure 2 shows how both the recovery in the economy and the adjustments made in 1993 and 1994 helped to curb down the relative expenditures. The LTP forecast made in 1996 took into account the altered economic situation and pension policy changes. As a result, the expenditure development had to continue from a higher level than what was envisaged in 1990, but due to the reforms, expenditure growth was not projected to be as fast as in 1990. Compared to the level of over 40% foreseen in 1990, the peak in expenditures was to be reached around 2030, at 33 %.

Figure 2 includes the projection from LTP model from 1999. As can be seen, the re-covery of the economy and the enacted reforms made the starting level to remain at around 22 % in the 1990s. This model gave even more positive results concern-ing expenditure growth in the mid-term. A curve in the growth trend was localised for around 2010, whereafter growth was prognosed to be faster than in the projec-tion of 1996. A major explanation for this is the new population scenario that was used. It showed more pressing ageing of society. Besides, better employment and wage development also drew the level of pensions, and thus the expenditures higher.

Figure 2. Pension expenditure as % of wage sum growth 962-1994, and projections made in 1996 for 1995-2045 and in 1999 for 2000-2050.

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Actual Projection 1990Projection 1996 Projection 1999

(in red colour)

If the 1996 projection was followed by small changes in pension policy, the same cannot be said for the 1999 projection. The expenditure growth was deemed to be too fast. The expenditures would exceed 35 % of wage sum, and remain at a high level. The preparations for more considerable reforms got strong support, and the early-2000s became the period of intensive negotiations for reforming the employ-ment pension system.

Figure 3 shows how the projections made after reaching the compromise (pension reform was passed in 2003) and immediately after reform (reform took effect in 2005) changed the projections. The first thing to note is how the expenditure level had remained around 22 % since the early 1990s. Although time has passed, all projections since 1990 have started from a more or less comparable level. This rel-ative stability testifies that the employment and wage sum development, and re-forms since 1990s, have strengthened financial sustainability. The actual develop-ment can be compared to the prognosis from 1990, that pictured a spending level of 27 % by 2010.

Compared to the projection made in 1999, later projections from 2004 and 2007 show a much lower peak in expenditures, remaining in both projections at the level of 33 %. Moreover, both of the projections estimated a downturn to happen in ex-penditures after 2030. This downturn was a new result in projections. To a great ex-tent, the downsizing effect can be attributed to the life expectancy coefficient, that cuts starting pensions depending on how life expectancy develops and to a declin-ing expenditure path with the public sector pensions6.

Figure 3. Pension expenditure growth 1962-2005, and projections made in 2004 for 2005-2055 and in 2007 for 2008-2060.

6 Due to the age structure of public sector workers, to the reforms unifying pension rules, and to the privatization of some functions, the role of public sector pensions will decline from around 2030.

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10152025303540

Actual Projection 1999 Projection 2004Projection 2007

In DB schemes, pension expenditures determine the funding base needed. In the Finnish pension system that is partly funded, pension funds play a role in the finan-cing. Thus although pension expenditures are projected to rise to a level of over 30 per cent of wage sum, pension contributions do not rise to that level.

Figure 4 shows explicitly the calculated effect of the 2005 pension reform on private sector’s employment pension contributions7. The base line describes projected con-tributions with the old pension legislation, and the one after 2005. As can be seen, the pension reform cut the growth trend considerably. Without the reform, contribu-tions would have grown year by year, with no stabilising trend, and would have reached over 30 % of wage sum after 2030. After the reform, the growth rate in pension contributions is much more moderate. The rate of contributions would reach 25 % level by 2025, and remain at around 26 % after 2030.

Figure 4. Projection of development in private sector employment pension contri-butions before and after the 2005 reform.

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Base line

Reform 2005

We can summarise the effects of reforms for pension expenditures in the following way:

in the short term, the reforms in the 1990s (together with gradual improve-ment in employment and wage development) stabilised expenditure growth.

in the long term, the reforms in the 1990s curbed down expenditures by 3-7 percentage points, from over 40 % level to 33-37 %.

in the short term, the 2005 reform helped the stabilisation of expenditure trends, above all by limiting early exit possibilities.

in the long term, the 2005 reform managed to further lower the expenditure levels (to 33 % and less), and to curb down expenditure development after 2030. This effect is to a great extent caused by the introduction of the life ex-pectancy coefficient.

7 We show only the private sector’s contributions as the financing rules with the public sector pen-sions are different.

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taken together, reforms have helped to alter the LTP prognosis on future ex-penditures by 10 percentage points, or in relative terms by 24 per cent (measured as the difference between the 1990 and 2007 LTP model results for expenditure level in 2040).

The latest sustainability challenge

However remarkable the results from previous pension reforms are, pressures for reform have continued. First, according to latest population scenarios, ageing hap-pens faster than expected. The age dependency ratio, currently at 26,5 % is pro-gnosed to increase to 48 % in 2050. The number of people expected to live very long will be larger than expected in the future. In the population projection carried out for Finland by Eurostat at the beginning of the 2000s, the life expectancy of a 62-year-old in 2050 was estimated to be 23.35 years. In the latest projection by Statistics Finland, that expectancy has been calculated as 28.53 years. That makes a difference of more than 5 years compared to the time when 2005 reform was planned, a dramatic difference when it comes to arranging pension provision finan-cing.8

The second challenge to sustainability comes from employment rates. In 2007, the employment rate was approximately 71 % according to Statistics Finland, whereas the employment rate in 2009 was approximately three percentage points lower, and still in May 2012 less than 70 %. Worse than expected employment situation and poor prospects in the development of the wage sum affect the financing base.

A third sustainability challenge stems from the global financial markets. In the Finnish partly-funded earnings-related pension scheme, pension expenditure and yearly returns from pension funds together determine the size of the pension contribution that is needed. The capital in pension funds amounted in 2011 to approximately 140 billion euros, or 160 per cent of the total wage sum. The stock market crash of 2008 brought investment losses (overall, companies reported a loss of 18 %). In 2009 and 2010, the returns were high and the previous drop was repaired. Year 2011 again proved to be a difficult year for investors, and 2012 has been volatile. The past and present problems in financial markets have resulted in playing down the expected yearly return from funds, and this affects the pressure to raise the pension contribution.

In sum, dark clouds over the financing of employment pensions haven’t vanished. Consequently policy makers have resorted to making further reforms. A first com-promise after 2005 reform was made in January 2009 between the employers’ and employees’ organisations. The amendments included raising of age limits by one year in unemployment ”tunnel” and in part-time pensions. The social partners also agreed on a timetable to raise the pension contributions. They agreed on a yearly increase in contributions of 0,4 % (0,2 % for the employer, 0,2 % for the employee) for 2011-2014. As the contribution level was 22 % in 2010, it will increase to 23,6 % in 2014.

Figure 5 presents the projected growth in relative expenditures before (projection 2007) and after the financial market crisis (projection 2011). As employment de-

8 Thus if the 1990 LTP model would have had the same population scenario, the expenditure growth probably would have been even more impressive.

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creased abruptly and as year 2008 was a record in new pensioners because of the age structure, expenditures in relation to wage sum grew from 2008 to 2009 from around 23 % to 25 %. From their current level of around 26 %, expenditures are projected to reach 34 % in around 2030, and thereafter decline to a level of around 31 % from 2050 onwards. The difference with the projections are to be found in the expenditure levels for the next ten years. As they will start from a higher level, costs will be higher the next decade. Thereafter, expenditure trends are very much the same as projected in 2007.

In the private sector pensions the level of contributions has exceeded that of ex-penditures until the present. In other words, there has been a surplus during the whole existence (fifty years) of the employment pensions in Finland (Risku et al. 2012, Figure 5.5). The early 2010s is characterised by expenditures gradually over-taking contributions. The financing gap that emerges will be filled from returns from pension funds, underlining the importance of this revenue source. In LTP model, the assumption concerning yearly real rate of return is set at 3,5 %. If the returns turn out to be lower, the level of contributions has to be increased. Higher return in turn would help to ease pressure on contributions. Provided expenditures and returns from pension funds develop as the model suggests, private sector pension contribu-tions are projected to increase from their current level to around 26 %, and stay on that level from 2030s onwards.

Figure 5. Pension expenditure growth 1962-2010, and projections made in 2007 for 2008-2060 and in 2011 for 2012-2070.

1962 1969 1976 1983 1990 1997 2004 2011 2018 2025 2032 2039 2046 2053 2060 20670

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Actual Projection 2007 Projection 2011

Source: data from FCP statistics and projection 2011 from Risku et al. 2012, table 5.1.4.

The expenditure growth after the financial market crisis in 2008 is as visible in the expenditure curve as the aftermath of the oil crisis in the mid-1970s and the eco-nomic crisis of the early-1990s. Yet, at least so far, the effect has been somewhat milder. Moreover, the effect does not produce a totally differing scenario on future expenditures, partly because of the more actuarial pension system operating since 2005: employment drops will in the future yield lower pensions. In other words, the sustainability gap remaining in private sector’s pension financing from the current level is still of an order of 4 percentage units rise in contributions. The current level of contributions will not suffice to pay for future pensions, even after the reforms in the 1990s and 2005.

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Since the publishing of the latest LTP model, the social partners have in May 2012 agreed on lifting the age limits of unemployment tunnel and part time pensions by one year. They have further agreed on abolishing the possibility for early old age retirement (i.e. the possibility to take the old age pension at the age of 62 instead of 63 years at a reduced pension). Moreover, they have agreed on lifting the contri-butions for 2015-2016 by 0,4 percentage units by year (split 50/50). This means pension contributions will be 24,4 % in 2016. They further agreed that they will con-tinue to negotiate and reach an agreement on further reforms, that will take effect in 2017.

In sum, Pension expenditure is projected to reach 34 % of wage sum in 2030. This is

about the same level than what the 2004 and 2007 projections estimated. The reforms of the 1990s and 2005 haven’t solved the financing problem, but

the expenditure increase has declined from 45 % of wage sum diagnosed in 1990 for year 2030 to 34 % estimated in 2011, or in relative terms by 25 %.

Compared to the baseline projection before the reform (Figure 4), where the contribution rate was prognosed to reach over 30 %, sustainability has strengthened markedly, by 6 percentage units, or in relative terms by 20 %.

Taking into account the agreed increases in contributions between 2011-2016, the financing gap that remains in 2016 will be less than two percentage units.

Why was the old age pension age limit decreased rather than increased in the 2005 reform?

More than one hundred years ago when the first pension schemes emerged, 65 became the age threshold for old age pensions. When the national pension scheme started in 1956, old age pension age limit was 65 years. When the private sector employment pension scheme was launched in 1961, the same age limit was applied. That same age limit prevailed in both schemes until 2005, and continues to do so in national pension scheme.

Interestingly, one of the results of the 2005 reform was a reduction in old age pension age, from 65 to 63 years. Contrasted to how life expectancy has increased and how rapidly it is expected to develop in the future, such a decrease was against all odds. According to basic pension mathematics, allowing retiring earlier rather than later extends the time pensions are paid, and thus expenditure. How could such a costly decision be passed in the context of cost-containment we have described?

Following Kingdon’s (1995) logic of public policy making, we propose three reasons for this apparent paradox. First, raising of the old age pension age limit was not framed as the problem to be solved. In other words, in the possible reform agenda, it occupied a secondary place. Second, nor was it chosen as the alternative on how to fix the problem that was chosen as the one to be addressed. Third, decreasing pension age did not mean turning a back to expenditures: cost-containment was addressed by another mean, by introducing the life expectancy coefficient, that hits the level of pensions through a sophisticated automatic stabilizer.

Before the reform, the average retirement age was 58 years. More people retired on different early pensions than on old age pensions (see Figure 7). The acknowledged

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problem was early retirement - not the time for old age retirement – and the agenda was to raise effective retirement. 65 years age threshold had not proved to be an effective gate keeper in the first place. First, over the years, several other pension types had been invented (unemployment pension, early individual pension, early old age pension, part time pension, plus several forms of early retirement pensions for the agriculture-dependent population). Second, such different early retirement paths were widely used for restructuring the economy, and their wide use in turn supported their acceptance in the eyes of the large public. Third, even with old age pension age limits, there were several exceptions for different occupational groups (e.g. seamen, miners, firemen, ballet dancers …) and rules between the public and private sector varied. Fourth, such paths meant the employment rates were low among the 55+ population, an issue that slowly became to be recognized as a problem.

In other words, the problem was the early retirement culture, not the old age pension age as such. Early retirement had become costly for the employment pension system and for the State. By decreasing the old age pension age limit to a more realistic 63 years, the legislated age was brought closer to reality. It was seen as a way to motivate continuing at work especially in those groups who retired much earlier on other pensions. It should be remembered this was the majority of new retirees. A further motivation for decreasing the age limit was related to disability pensions: many unions representing especially physically demanding jobs had for years seen old age pension age limit as too high. For them, decreasing the age limit was a step towards acknowledging the reality in work life.

While early retirement was recognized as a problem, means to address it had to be sought elsewhere than from old age pension age limits. As was explained before, the main alternatives for fixing this problem were to abolish early exit pension types, or if this was not possible, at least to raise the age limits of early retirement schemes in order to limit the flows to pension. A particular example in this respect is the combination of unemployment benefits and unemployment pension, which in the beginning of the 1990s allowed an uninterrupted path to retirement if one became unemployed at the age 53, i.e. 12 years before the old age pension. At the time of writing this paper, this path has been shortened with a series of reforms by six years, and through the decrease of the old age pension age by two years, so the “tunnel” is today four years long.

By stressing early retirement as a problem, we don’t pretend it was the only problem, only that it was more important than the old age pension age question. As we have earlier shown the increases in pension expenditure forecasts was seen a major problem, we should try to account for why expenditure growth was not dammed by raising the old age pension age? The answer we propose is derived from the expenditure equation. Pension expenditure is a function of average pensions and the time they are paid out. If you want to affect expenditure, you should play with one of them, if not both of them. We argue the level of pensions was chosen as the alternative because addressing the problem of early retirement did not allow, or at least was not compatible, with raising the old age pension age limit. So, the life expectancy coefficient was introduced to take care of the projected increase in pension expenditures arising from longer time on pensions. Retiring at the age of 63 is since 2010 punished by a reduction in the starting old age pension level. An individual’s decision to postpone retirement in order to avoid this cut will increase his/her monthly pension, but at the same time, the overall payment period will decrease. Either way, the coefficient is helpful. As was visible in forecast Figure

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4, the introduction of life expectancy coefficient eased the growth of pension expenditure.

The life expectancy coefficient was of course not the only way to fiddle with expenditures. There have been many other ways in which future expenditures have been affected. The list of these measures has been presented earlier and contains contributions, indexation, accrual periods, accrual rates, coverage rules etc. So, (almost all) other alternatives to restricting expenditure were prioritized over the retirement age.

How successful were the reforms in raising the effective retirement age?

It is of course hard to tell to what extent changes in early retirement culture, measured as employment rates among elderly workers and retirement trends, are accounted for by the pension reforms, and how much by other factors. By presenting some labour market and pension register data we do not want to imply that positive development is solely due to pension reform. They certainly have an important role, but also other factors have of course contributed to the trends.

Figure 6 presents the development in employment rates for the 55-59-year old, and for 60-64-year old groups before and after the 2005 reform. Compared to 2000 employment rate was in 2011 15 percentage units higher in the first mentioned group, and almost 20 percentage units higher in the latter group. While employment rates in the total population decreased between 2008-2010, employment rates in the elderly groups continued to improve or at least did not deteriorate. In fact, employment rate in the 55-59 –year old group is currently higher than in the population 15-64 years. For the 60-64 –years group, it has doubled, although there is still room for improvement.

Figure 6. Employment rates for the 55-59-year old, and for 60-64-year old groups, 2000-2011.

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Source: LFS data, Statistics Finland.

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Figure 7 shows the share of the population in the same age groups on different pensions or unemployed. This is to a great extent a mirror picture for employment rates. As can be seen, being on a pension increased during the economic crisis years. In the early-1990s, close to two thirds of the 55+ population were receiving some kind of a pension. Since pension reforms the rates have been gradually declining. The figure also illustrates the relative importance of different pensions, and how some of the pension forms slowly have become extinct. The blue column for 60-64 year olds shows also old age pensions played a role in the total picture of retirement in the early-1990s, despite the legal retirement age of 65. Coming to 2010, its role has increased as one can take old age pension from the age of 62. In 2010 two out of three new retirees retired on an old-age pension. The rest is above all disability pensioners, although part time pension (yellow) also still figures a role. Other pension types have become an exception rather than the rule.

Figure 7. The share of the population in age groups 55-59-year olds and 60-64-year olds on different pensions or unemployed, 1992-2010.

Source: FCP Statistics, Työpoliittisen aikakauskirjan tilastot.

Figure 8 shows the development in retirement age since 2002 until 2011. It portrays retirement with three indicators, all of them pointing to the same direction of increasing retirement ages. All indicators show a pronounced increase after 2005. Especially the median retirement age has increased a lot, from around 60 in the early-2000s to the current 63. The average retirement age was less than 58 years before the pension reform. It is now close to 60 years. However, these two indicators hide the differences in age structures. Late 2000s has been marked with the baby boom cohorts reaching old age pension age limits. Therefore, Finnish pension policy is rather followed by the expected effective retirement age, an indicator that takes into account the different sizes in age cohorts and thus gives a comparable figure on the year-to-year development. The expectancy indicator has risen as well, from below 59 years in 2002 to 60,5 years in 2011. We can safely conclude that during the last decade the retirement age has increased by more than a year.

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Figure 8. Expected effective retirement age, average retirement age and median retirement age in Finland, 2002-2011.

2002 2003 2004 2005 2006 2007 2008 2009 2010 201155

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Source: FCP Statistics: Effective retirement age in the Finnish earnings-related pension scheme. Statistics reports 02/2012.

How an effort to raise old age retirement age failed and got banned until 2015

The idea of raising old age retirement age was of course discussed when preparing pension reforms. It was again listed in an expert group’s report in January 2009 (Ageing report 2009). The analysis suggested age limits should be lifted for consid-eration in the near future given increasing life expectancy, but the immediate policy concerns it listed were related to the existing means of early retirement. The ageing report presented a realistic reform agenda for next step reforms, and included the question of retirement age to be approached after them.

Just a month after the publishing of the report Prime Minister Matti Vanhanen pro-posed to raise the age limit of the old-age pension from 63 years to 65 years. This proposal came out of the blue, without prior contacts with the social partners, and apparently without much discussion in the government, and without any prepara-tions or ideas concerning the timetable or technicalities. The trade unions immedi-ately reacted with strong opposition. After two weeks long strong criticism, strike threats and constant media attention, meetings and settlements, the Prime Minister and trade unions finally came out with a joint statement in March 2009. Vanhanen’s idea of raising the old retirement age was abandoned. Instead, the partners stated their joint will to lengthen working careers by three years by 2025. The goal was operationalised with the expected effective retirement age indicator. The means to achieve this goal were left to be suggested by working groups.

The sudden proposal and the dispute that followed started a series of working groups, assessments and planning work that is still going on. After the change of government in June 2011, the government programme explicitly states it will not raise old age retirement age while it is in office. Its aim is to lengthen working ca-reers (“in the beginning, in the middle, and at the end”) by three years by 2025, so the goal is the same that was agreed in March 2009. As the goal is larger, the ways

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include also other measures than pension policy. The programme also states pen-sion issues are prepared in cooperation with the social partners. 9

Following Kingdon (1995) we could list a number of things that went wrong with the idea to raise old age retirement age. First, the Prime Minister failed in framing the problem. In a way, he went too fast for the solution by explicitly picking up one pa-rameter from the pension policy toolbox. In other words, the problem had been seen with other lenses, and his view of the problem was not widely shared. Kingdon has also concluded, that to be successful, the alternative has to be ready when its time comes. In this case, the alternative was by far from ready. On the contrary, the biggest pension reform had been launched just a few years before, including a new flexible retirement age, new accruals, new calculation of pension wage, and their technical implementation. All of these constituted important parameters that should have been thought about beforehand were the old age limit to be changed, but were totally ignored by Vanhanen. Also along Kingdon, the policy stream and partic-ipants were wrong in the sense that the proposal was not tested among the political parties, it did not have the backing nor the involvement of the social partners. Nor was there an input from specialists.

What happened when the government changed? First, the problem was reframed. The problem is the too short length of working careers, a problem description that is largely shared. Age limits instead have been put back to their place in the toolbox, as possible alternatives for solving the problem. The policy stream now involves the social partners, who have been given free hands to negotiate on the next pension reform. Finally, the timing of the next reform is scheduled for 2017. Thus the present or the next government (from Spring 2015) will get a negotiated proposal package on how to lengthen working careers with the help of pension policy. When the next political window opens, and if the problem remains, the alternatives (pos-sibly including the retirement age) to solve it will be there. According to Kingdon, all crucial elements may be at place, and the different streams could be coupled.

Conclusion: raising old age retirement age after a series of successes

This paper has had a dual focus. It has first presented the different pension reforms introduced in Finland over the past twenty years and shown how they have managed to improve financial sustainability of the employment pension system. The second aim of the paper has been to discuss why raising of legal old age retirement age has not featured in the reform story, at least so far.

9 From the trade unions’ perspective, reforms have been difficult. They have involved cutting of pensions (changes in pension wage concept, indexation of pensions, life expectancy coefficient), a new and increasing role in financing pension contributions, and serious limits to pathways to early retirement. From the employers’ perspective, all these changes have helped to contain the costs and contributions. Their concessions are related to the recent agreements on raising contributions. From the government’s perspective, the changes have promoted not only sustainability in general government finances in the long term, but fiscal balance in state finances, too as longer working lives have generated higher tax incomes for the public sector. The employers and the Ministry of Finance are pushing for further reforms, whereas the trade unions are reluctant to continue weakening of pensions. Instead, trade unions have directed attention towards working life, arguing bad conditions in the work place, poor management and neglect of working capacity lead to ill-health and disability pensions. Thus their recipe for further lifting the retirement age is related to the work place, and involves the employers. In their view, continuing at work is not just the employee’s decision and is not solved by merely lifting the old age retirement age.

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We first showed how the Finnish employment pension system in the early 1990s was facing a very rapid expenditure growth: the level of expenditures in relation to the wage sum was prognosed to triple in 40 years time. The economic crisis of early-1990s hastened reactions and a reactionary reform path started. The Finnish reform path shows a variety of different ways and means to cut future pension expenditure. As a result of these reforms, the sustainability gap today is much less pressing than it was some twenty years ago. We have further shown how the reforms have helped to generate higher employment rates among elderly workers, less early retirement and later retirement. Although it is difficult to measure financial sustainability in pensions over the long run and in different schemes, the changes that have happened in Finland are not minor.

Nevertheless, it has been argued pension finances still face a sustainability gap as the expenditure increase is prompting a pressure for contributions to rise. In this situation raising of old age pension age limits has again entered the discussions. After a series of reforms attacking the early exit culture and targeted at the different early exit routes, the old age retirement age now presents itself as a more important parameter.

Why haven’t policy makers so far extended the retirement age? The answers we proposed is first, that other agendas and alternatives have been preferred. Second, their implementation has improved pension finances plus helped to raise effective retirement age. Third, this success may be one good reason for why raising the old age retirement age now isn’t perceived nor framed as the main problem to be solved, nor seen as the most effective alternative. Instead of raising the retirement age, the agenda is to lengthen working careers, and the alternatives to do that have shifted attention to also other than pension policy alternatives, to improving work places, working conditions and working capacity. Extension of policy measures may bring about further good development in effective retirement age. Yet, as was also discussed, the present policy landscape may well contain the crucial elements for making changes also in the retirement age, but only after 2015.

All in all, past reforms have achieved cost-containment and continuing positive development in employment and retirement indicators. This success has paradoxically inhibited further reforms. As has been shown, so far progress has happened without raising the legal old age retirement age. In fact, the legal age was decreased in the reform process and yet the effective retirement ages have increased.

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Appendix 1: The long term projection model of the Finnish Centre for Pensions

The calculation of pension expenditure covers both the earnings-related pension acts of the private and the public sectors, as well as the national pension and SOLITA (soldier, traffic and accident insurance) pensions. Projections concerning the financing are only made for the private-sector earnings-related pension acts. The different employment pensions Acts are modelled as if they were managed by only one pension provider. This way the model handles data on the system level. The LTP model consists of several interconnected modules. The population forecast determines the number of people of a pensionable age and has an impact also on the employment forecast which, in turn, determines the size of future pensions as pension accrues from earned income. Together, the number of pensioners and the size of the pensions determine the pension expenditure.

The earnings-related pension expenditure is calculated separately for each earnings-related pension act. Financing calculations, such as the determination of the contribution under the Employees Pensions Act, are also made. The number of people receiving earnings-related pensions and the average pensions are calculated once all act-specific calculations have been completed. An average technique by age and gender is applied in the projection. For example, all working men aged 48 receive an equal salary. Although the model cannot forecast the distribution of pensions, the average technique yields the same result for the combined pension expenditure as would the computationally more difficult individual-based technique.

Register data and assumptions

The age and gender source data for the projections are available from the registers of the Finnish Centre for Pensions, the Social Insurance Institution, Keva and the State Treasury. Based on these, the LTP model progresses according to given assumptions. The key assumptions concern demographic development, employment rates, growth in earnings and the development of inflation, retirement risk and return on pension assets.

The population forecast is published by Statistics Finland. If this forecast does not go far enough into the future, the Finnish Centre for Pensions extends the projection period. In the most recent projection, the population forecast of Statistics Finland covers the time period until 2060. The most important assumptions are the following:

total fertility rate 1.85 net migration 15,000 persons per year the observed decreasing mortality rate will continue in the future.

The Finnish Centre for Pensions extended the projection in question to also cover the period 2061-2080 according to the same assumptions, apart from the mortality rate, which is expected to be halved after 2060.

The assumptions concerning the employment rate and the development of the earnings level and inflation in the near future are taken from short term economic forecasts. For the period after the near future, the parameters are fixed as constants. In the most recent projections, the employment rate has been fixed at a constant 70-71 per cent and the unemployment rate at approximately seven per cent. The real growth in the earnings level has been assumed at 1.6 per cent and inflation at 1.7 per cent.

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