The current Norwegian pension system is to be replaced by a new system in 2011, but will it solve the problems, or create new ones? Alison Swersky reports
Where were you when the volcano erupted in Iceland?
If you had any vested interest in Norwegian pension funds, you would have been at the Sandefjord hotel near Oslo hobnobbing with the great and good in the industry.
The government will not want to upset the pension market, so any major changes will not be applicable in the first round of reform to be introduced next year
There were more than 300 delegates at the Norwegian Association of Pension Fund’s annual conference in mid-April, the highlight of the year in the pensions’ calendar.
Certainly most of them will testify that the keynote speeches from legislators, university professors, actuaries, and sponsors were far less explosive than Eyjafjallajoekull, but still there was a sense of anticipation of an eruption of a different kind.
On January 1 next year, the government pension system in Norway will be replaced by a brand new system.
It is the outcome of almost a decade of negotiations between the government, opposition parties and the countries’ powerful unions and it is designed to address the challenges of increased longevity and rising pension fund costs that is a financial noose around the neck of many developed nations.
The new rules will affect how Norwegians earn a pension through the government’s national insurance scheme, at what age they can start drawing a pension and how the pension is adjusted.
“The fundamental idea is to offer a greater degree of choice to people over when and how they receive their pension and at the same time motivate people to work longer to create a sustainable pension framework,” explained Ake Flintull, a partner at Stockholm-based consultants HRS.
A time for reform
Without major reform, pension expenditure as a share of gross domestic product in the Nordic country is expected to more than double by 2050.
Under existing rules, the retirement age is 67 and only those in employment in the public sector or in the private sector where the company offers an early retirement pension scheme, called AFP, are entitled to pension income from ages 62 to 67.
A pension is calculated from an individual’s 20 best income years. It takes 40 years to earn a full retirement income.
The biggest change is that from January 1, 2011 the fixed retirement age will be scrapped.
From then, Norwegian residents and employees will be able to start drawing a state retirement pension at age 62, but will also have the option of continuing to work and accrue pension rights until age 75.
Retirement pension will be adjusted according to average life expectancy in the country – a mechanism to cope with an ageing population.
So, the earlier pension income is applied for, the lower it will be and vice versa.
In addition, for those born after 1962, the 20-year rule will no longer apply.
Norwegians will be able to build up pension in every year they are in work or receive other pensionable income, like certain welfare benefits, until the age of 75.
One innovative measure is that under the new system, there will be the opportunity to draw down all or part of the pension entitlement at age 62 while continuing to work, full or part-time, and thus continuing to accrue pension rights.
“What was a classic pension system has been transformed into a banking institution,” said Christian Fotland, a director at Norwegian pension advisers Gabler Wassum.
“The decision to retire and the decision to access the cash flow from pension income have been split into two decisions: ‘do I retire?’ And ‘do I draw on my pension and continue to work’?”
Pension adjustment has also come under the knife in the government’s cost-cutting reform agenda.
Up until this year, the annual increase in a pensioner’s income would rise by the same amount as wage growth.
But from 2011, the indexation will be equal to the percentage of salary growth minus 0.75%.
What is still to be ironed out is how occupation and other public-sector pension schemes will be affected by these seismic changes to the state system.
Adapting to reforms
Already, the insurance company and municipal pension fund KLP, which manages billions of kroner for local authority plans, is in the midst of working out how to adapt.
KLP department for industrial framework and analysis director Roy Halvorsen said: “Plans for civil servants are gross schemes. When you add the National Insurance scheme and the municipal plan, the public sector employee is guaranteed an annual pension of at least 66% of their salary on retirement.
“As the municipal plan is so closely linked in with the state scheme, it is necessary for KLP to make changes to the municipal occupational pension plans and this is something we are working on at the moment.”
The main changes will be to the indexation of pension rights, longevity adjustment, and how to calculate municipal pensions for people who take out their state pension before the age of 67, suggested Halvorsen, who indicated that these will not represent major changes to how the plans are structured currently.
“So, from next year, if a municipal employee decides to draw their National Insurance scheme entitlements before the age of 67, which will result in a proportionate drop in pension income from that scheme, the shortfall will not be supplemented by the municipal scheme,” he said.
Meanwhile, changes to the state system may have a ripple effect on company plans. The industry will get a clearer steer on the government’s intentions for the occupational sector at the end of April.
On April 30, the Bank Law Commission – set up by the Ministry of Finance and led by professor Erling Selvig to look into making the provision of pension rights in the private sector more sustainable – will offer its initial proposals to the Storting, the Norwegian parliament.
The Storting will have to react to these proposals by the end of the year.
“The big question is whether it will be up to the company to decide when an employee is allowed to retire, or whether the employee will have the right to decide when they want to retire and when they want their pension like it is with the national insurance scheme,” said Gabler Wassum’s Fotland.
“But it is generally thought that the legislation for company plans will follow the methodology of the new state system,” he added.
Mercer market business leader Bengt Olav Lund says it is waiting to find out what the Bank Law Commission proposes before advising clients on their next move.
But he doesn’t believe there will be any big changes in the first round of recommendations because of the short time frame of implementation.
“The government will not want to upset the pension market, so any major changes will not be applicable in the first round of reform to be introduced next year,” he said.
“The easiest way out will be for them to keep the same actuarial formulas to calculate benefits, just allow for lower income for those wanting to retire before 67.”
Once there is a solution to how employer plans will coordinate with state reforms, the commission will then start work on other changes in the laws governing defined benefit and defined contribution schemes.
“In Norway there are specific laws governing DB and DC schemes and the talk is that new laws will create an alternative, possibly a hybrid between the two,” said Lund.
He expanded: “It could be that the commission proposes increasing DC contribution levels, which would be attractive for employers looking to move away from expensive defined benefit provision.”
Alternatively, a new type of DB scheme could be created where pension calculations are not connected with the public scheme to offer a basic guarantee of two thirds of final salary, suggested Norwegian Association of Pension Funds secretary general, Rolf Skomsvold.
“Also on the agenda is whether, as people live longer, all pensions should be life-long, not just DB schemes, or if the required minimum pension time should be increased beyond 10 years,” he said.
“This would benefit people in DC schemes, which currently tend to give a pension for 10 to 15 years after retirement,” he added.
So some big changes are on the horizon for the five million or so Norwegian population and Fotland suggests that they could have an unintended effect on certain lines of business.
“For example, what would happen in certain businesses and professions if suddenly you had a mass of people retiring? Because, you would assume that those in poor health will,” he said.
“Also, you could see certain classically female occupations, such as teaching and nursing, shrink as low salaries drive people in these jobs to retire when their husbands reach 62 and can start drawing on their state pension while continuing to work.
“There is bound to be some unforeseen event with a system designed to please everyone,” he added.
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