Since their inception in 1969, and in particular after the decision in 1986 to base contributions on total wage income, Icelandic pension funds have enjoyed spectacular growth. At the beginning of 2001 there were 54 funds boasting assets matching over 80% of GDP, the fourth highest level of EU and EFTA countries. The number of funds has fallen steadily over the years due to mergers, but pensions insiders believe what is in place now is a lean group of well-managed funds. No major plans for mergers have surfaced in the past few months, although some funds have closed down and are simply paying out while not receiving new income.
The picture for funds was not always that rosy. The government believed that the lack of comprehensive pension legislation was affecting standards, and that the poor performance of a few funds was affecting the industry as a whole. Although reforms began back in 1976, the Althing passed the centrepiece legislation in 1997 to become effective the following year. The government was keen, in 1998, to ensure that pensioners received equal treatment, and set a benchmark of a minimum benefit of 56% of monthly salary after 40 years contributions. After a few initial problems, virtually all funds are easily achieving this target. Overfunding and the prospect of higher returns should mean that benefits are significantly higher in the future, but as the funds are still relatively young there have been no problems in meeting the government target.
The industry as a whole has been keen to develop systems of self-regulation on investment, and believes that it is now doing a good job. The government seems to agree, as it has passed legislation aimed at facilitating the growth of the industry in terms of assets and membership. The assets of the funds have long since outstripped those of the banking sector in Iceland, and continue to grow in comparison with GDP. With the funds having locked high real returns into their portfolios, real interest rates are expected to be above GDP growth in coming years.
Meanwhile, about 20% of wage earners currently contribute to voluntary private pensions. Tax incentives have been a major influence here, and employers’ contributions are set to increase next year. Trades unions have long since argued those employers are not making a “fair contribution” to pensions, due to tax benefits. This argument is long-running and the
government looks set to address the issue when it reviews the 1998 Pension legislation next year. Already some employers are pre-empting any change by contributing more, the banking sector leading the way. Across the board, however, savings continue to grow in Iceland.
How and where the funds invest has also been the subject of debate by the Althing. The major issues were the development of the net foreign asset position, the prospective development of real interest rates and ownership and control of companies in Iceland. Until recently, the funds were mainly invested in domestic bonds, but the government has encouraged change. In spring 2000, the total foreign exchange risk exposure for funds was raised from 40% to 50%. Currently, the ceiling for equity holdings is 50%, as is the bonds limit. Funds may also hold 10% of assets in unlisted domestic equities. In common with most countries, Iceland has seen the amount of equity holding in its pension funds fall over the past six months. The industry average for such investment is around 30% of the assets mark. Nonetheless, this is a significant increase compared with the end of the last decade. When confidence returns to the world’s stock markets, expect Icelandic funds to be nudging that 50% ceiling for equities.
Another area of change is likely to be the fully funding requirement. Although guaranteed funds are exempt from the full funding requirement, only the government, municipalities and banks can guarantee funds. There is now a move to full funding even in these funds and all are expected to be sharing this quality in the near future.