Speaker(s): Ismo Vesa Antero Risku (Finnish Centre for Pensions)
Combining historical data and results of long-term projections, our study explores the lifetime pension benefits and contributions under the Finnish private sector earnings-related pension system.
The real internal rate of return on earnings-related pension contributions for persons born in 1940 is 6.5 per cent. In this birth cohort, the rate of return for women is approximately eight per cent and for men six per cent. The internal rate of return will decline steadily across generations up to those born in the 1970s, for whom the figure will stabilise at approximately 2.3 per cent.
The net present value is the difference between the present value of lifetime pension benefits and the present value of lifetime pension contributions. The net present value is positive for people born in the early 1950s and earlier. For those born after the late 1960s, it will be negative.
Our analysis shows that the youngest generations' declining internal rates of return and negative net present values are due to the increase in the earnings-related pension contribution rate. On the other hand, lifetime pension benefits relative to lifetime earnings are relatively stable across generations. Sensitivity analysis reveals that lower future interest rates imply a smaller loss to younger generations in terms of net present value. Furthermore, a faster decline in mortality would not materially affect cohort specific net present values.
The Finnish private sector earnings-related pension system combines features of occupational and social security pensions. It is mandatory and partially funded. Pension benefits are linear in wages and there is no pension ceiling. Consequently the role of other occupational and individual pensions is minimal. The system is run by private pension insurance companies and pension funds.