The big picture of pension investing

2020-08-10 at 14:05 Timo Löyttyniemi

Pension investing is an interesting field of activity. It pursues important social goals while at the same time being at the heart of the financial markets. Pension investing affects all citizens. Even if it is often perceived as a black box, the details of which people do not necessarily understand or do not want to understand. Complexity puts people off. However, a steady flow of pension income is highly appreciated when the time comes.

Recently, the Finnish Centre for Pensions issued a report entitled “Investment activities within the Finnish employment pension system”. The report provides an overview of pension investing in Finland. The over 300-page report offers a wide range of perspectives by several authors. Professionally drafted, the report gives a comprehensive presentation of pension investing from a number of angles.

Here I will make an attempt to crystallise Finnish pension investing into a few key observations on which pension investing has been – and will continued be – based.


1.The Finnish pension system works

The Finnish pension system is ordinary on the one hand and extraordinary on the other. It is ordinary in that it is a national, defined benefit based system with a foreseeable pension income. The pension system covers nearly all employees and the entire working career. The fact that the system is separated (private sector employment pensions and public sector separately) is a mere curiosity from an ordinary pensioner’s point of view. What matters is the amount of pension accrued over the entire working life. The merits of the system have even been recognised internationally. In the Mercer Global Pension Index comparison, the Finnish system was ranked fourth.

The existing system has proved itself in crises. Past experience demonstrates that decision making within the Finnish pension system works. In the face of crises, it has been possible to make changes to the system. It is fair to say that the system is stable from the pensioner’s point of view but at the same time, dynamic enough for long-term investment purposes.


2. A partially funded system is the golden mean

The Finnish pension system is partially funded. Total pension funds amount to over EUR 200 billion while the total private and public sector pension liabilities are EUR 660 billion (Statistics Finland, 2017). The funding ratio is about 30 per cent. Of total liabilities, the public sector accounts for a little over EUR 200 billion, of which some EUR 80 billion are covered by existing investment assets.

In terms of pension investing, a separate, distributed and partially funded system means that private pension institutions need to be monitored, and they have to maintain the required solvency relative to liabilities, i.e., sufficient buffers. This helps maintain adequate certainty of the ability to meet pension obligations despite the fact that private actors seek to outdo one another in terms of performance and size.

A partially funded system provides a sound basis if the population grows. When population growth stagnates, many believe that the funding ratio should be raised. If, by contrast, the population grew at a fast rate, the funding ratio would be of less importance. It appears that societies are not capable of such a systematic, long-term approach. Consequently, the Finnish system may be seen as a compromise between these two extreme positions – the golden mean. Most likely, the system is a result of negotiations and the relative weights ascribed to costs and benefits.


3. Determining the right level of risk is difficult

A pension system is a mirror image of the existing social and economic order. In hindsight, it is far too easy to say which asset classes would have generated the best returns over the decades. In simplified terms, the risk level of a pension system can be measured by means of equity weighting. For a long time, the weight of equities (and comparable instruments) in the Finnish employment pension system used to remain below 20 per cent, a level that was not exceeded until the late 1990s. The next level, over 40 per cent, was not achieved until 2007 just before the financial crisis. Last year, we were approaching the 60 per cent mark. However, it needs to be pointed out that up to the early 1990s, more than 50 per cent of the assets were re-lent to companies.

One wonders if the returns would have been different if the investment portfolio had been different. Even so, timing would have made all the difference. Crises in which returns are low recur every 7–10 years. Naturally, the outcome would have been different if the risk level of the portfolio had been raised at the wrong or at the right time.


4. Who bears the risk?

The party who bears the real risk within the pension system is not the pensioner. If there is not enough money to pay for the pensions, pension contributions may be increased or the employment rate or investment returns improved or pension benefits adjusted. In some systems, there is a degree of automatic interdependence between these elements. Such an element of automation can be introduced by making pension benefits responsive to returns on investments (up or down). This is not something that Finland wanted because the thinking within the system is that a steady pension income is preferable.

The Finnish system is committed to the defined benefit principle. Another alternative could have been a system in which the amount of pension would have partly been determined by investment returns, or at least the link between the two would have been more direct. Globally, there is a trend towards defined contribution pension schemes in which the risk is increasingly shifted to pensioners. Sound investment decisions could affect the amount of pension. Sweden took a cautious step in this direction long ago.

By increasing the weight of equities over the years, countries have sought to earn higher returns. While doing so, they have shifted part of the systemic risk (up and down) to future pensioners. If things work out as planned, it will be possible to keep the future pension promises, and if not, some future generations will suffer.


5. Sound real returns on investments

The returns earned by the Finnish pension system have exceeded the level foreseen in the calculations made by the Finnish Centre for Pensions. As a result of healthy returns, the pressures to increase pension contributions or lower pension benefits have remained under control. Over the long term, investment returns have major implications for society.


6. Finland and pension investment returns

At the time when the pension system was built, its link with the Finnish society and economy was strong. Over the decades, the added value created by pension investors for Finland has shifted towards the investment contribution approach. High returns are of growing importance. Company ownership, construction investments, company re-lending and financing have always played an important part in pension investing. However, they have declined in importance as the world moves on. While the capital may come from any source, pensions are paid out of returns on investments.


7. Lower expected returns

The calculations of the Finnish Centre for Pensions extending up to 2019 foresee that returns on investments may fall over the next few years. The real return assumed in the Centre’s calculations was 2.5 per cent over the following ten years and 3.5 per cent after that. The current low interest rates do not promise high returns. The same conclusion can be drawn from the returns on government bonds. Many of them are safe investments but offer negative returns for the next ten years. Fortunately, there are other asset classes.


8. Sustainability and pension investing

Future returns will be increasingly based on sustainability. It appears that the integration of sustainability into investment strategies is facing a major transition. Pension investors are not do-gooders but their actions may have a healing effect on the world. Sustainability considerations need to be incorporated into investment activities wisely.



The Finnish pension system has survived storms and tempests. It enjoys widespread support among citizens and decision-makers. This support creates a strong basis for pension investing. At the system level, moderate competition is welcome as it helps keep costs under control and encourages pension companies to seek high returns. The Finnish pension system is not necessarily the best there is, and it could have been constructed better. However, it has served its purpose well and is good enough.


The writer is VER's CEO Timo Löyttyniemi.


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