Finnish pensions too small – pension funds waste

The Finnish pension funds have seldom been very honest with pensioners. Their boards, their senior management and the over 100 of their administrative representatives from the employee and employer unions all know that the funds under their management are small in relation to most similar pension funds around the world. They also know (or should know) that they are relatively inefficient when compared to the pension funds in Norway and Singapore, 2 countries with populations of similar size.

Three big funds like to call themselves “private funds” have been playing games with pensioners for years, even though they are implicitly guaranteed by the government.

These three big ones are called Ilmarinen, Varma and Elo, and they exercise a lot of power in the Finnish economy:

  1. They have commercial and political power through their board positions, and connections in many of Finland’s biggest public companies and banks. Their network is almost perfectly impregnable unless you are fro the “right” organisation.
  2. They have political power through their relationships and connections with the main political parties, in addition to their very effective lobby organisations and related think tanks. 
  3. They have very close relationships with the employee and employer unions, bodies that also have strong connections to the biggest political parties, with the exceptions of the Greens.
  4. They also have strong connections with civil servants in the various ministries that are meant to oversee and supervise their activities, A revolving door keeps this supervision muted because who knows what high paying job you could be prevented from receiving if you are too assiduous in exercising your supervisory duties.

The whole pension system in Finland is covered by one set of complex and protective legislation that forces employees and employers to make joint payments each month of some 25% of gross salaries into the pension funds. Current pensions to retirees are paid out of these funds, while a remaining amount is invested for future payments when working folk eventually retire. Ordinary pensioners currently around 50% to 60% of their last salary as a pension for life after they retire from their lifelong jobs.

The whole system is nicely closed up and works smoothly with the above mentioned boards, senior management and the over 100 administrative representatives from the employee and employer unions all enjoying rather generous benefits.

In fact, it is so well organised that there are no foreign-owned pension funds operating in Finland. Foreign pension managers must set up a fund in Finland as a domestic operation and the current laws here and the state of competition has stopped all efforts to enter this market.

The whole system is so cleverly constructed between the three big funds that even the biggest foreign pension funds see no opportunities to enter such a closed market. 

These three funds, together with the state and municipal pension funds, largely replicate their investment strategies. The differences are minimal and their results are similar. Their asset allocations are also similar – they say that they must diversify their funds into several asset classes but the results are similar since they all use the same consultants.

They have large equity and bond investments which are separately managed at home and abroad with their annual investment costs, they claim, below 1% of the amount managed. The world’s largest funds make do with one-tenth of that amount. The impact of the claimed 1% annual cost reduces pensioners’ pensions by quite a large amount. The actual costs are challenging to measure because but judging from the results there appears to be leakage above this figure…

If you can invest at 3% real rate of return over 40 years, (this is the rate they claim they want to achieve open average each year), that means 6% assuming inflation is 3% on average over such a long period during which people work, then you would only need to invest 12% to 13% of your gross salary every year to receive most 100% of your last salary. 

In today’s pension system you must invest together with your company 25% of your gross salary and receive around 50% or 60% of your last salary as a pension.

The calculation can be made on an Excel spread sheet relatively easily. The assumptions are valid for such large groups because this pension system includes all workers and retired pensioners in Finland by law. 

It is estimated that around 30% of today’s payments into the pension funds goes out as pension payments to current retirees. Thus using that percentage, you can assume that 16% should be sufficient for much better pensions for current and future retirees – something close enough to the last salary as a pension!

There are three truths about investing over the long term that every fund manager knows:

  1. The bigger the fund in absolute terms, the easier it is to demand and receive lower management costs. Smaller funds pay higher management costs to third parties.

  2. The lower the costs in percentage terms, the higher the return.

  3. Smaller funds, bigger fund management salaries, and higher administration costs mean  lower total returns for the portfolio, which means that they eat up what pensioners should be receiving!

But you will never hear the above three stories from Ilmarinen, Varma and Elo because of truth number 3…

… and no matter how many times this column repeats these three statements, you can be sure that not one fund manager or other “Stakeholder”, or should we say “Steakholder”, will open their mouth because number 3 is where the beef is!

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