Forged by volcanoes and battered by the North Atlantic, Iceland really is a land of fire and snow, especially in the winter when temperatures drop to -10 and daylight is only glimpsed between 11am to 3pm. But in stark contrast to this natural turbulence, the island’s nearly 300,000 people display a pragmatic and tolerant approach to major issues.
And this consensual attitude extends to its pension system. “In Iceland we have survived because there has been a lot of solidarity,” says Össur Skarphédinsson, head of the opposition Social Democratic Alliance (SF), Iceland’s second-largest party. “It’s part of our ancestral history and heritage that we have social democratic genes, you even find it in a large strands of our conservative party, we are very different from, for example, the British Conservative Party. It says a lot about the pension system that in future the more prosperous section of society will be the elderly.”
“We are very proud of our system because it’s a fully funded scheme and its coverage is 100% of the workforce,” says Hrafn Magnússon, managing director of the National Association of Pension Funds.
But this enviable situation is the result of negotiations between the trade unions and employers, not of political foresight. “We are lucky that our predecessors made the decision to establish a funded pension system,” says Ari Edwald of the Confederation of Icelandic Employers. “The first was a fund for the commercial retail workers, which was founded in 1956, and agreement to establish the others followed in 1969.”
“There has been a consensus around the pension system here,” says Gylfi Arnbjörnsson, general secretary of the Icelandic Confederation of Labour (LO). “It’s a negotiated settlement as part of the collective agreements of 1969. Right at the beginning we decided to build the system on a very broad collective basis.”
It had an inauspicious start, as initially pension funds were only allowed to invest in bonds and mostly government bonds, and high inflation throughout the 1980s ate up what gains there were, resulting in years of negative performance. But the introduction of the European Economic Area (EEA) agreement a decade ago between the EU and three Efta states including Iceland ushered in the ‘four freedoms’ of movement of capital, goods, services and people and this triggered a gradual liberalisation of investments. From 1994 pension funds were allowed to invest abroad, and most began to do so in 1995, the same year that the Icelandic stock market opened.
“Since the 1990s pension fund money has been a major driving force in the Icelandic economy,” notes Tryggvi Thor Herbertsson, director of the University of Iceland’s Institute of Economic Studies and a member of the Frjalsi Pension Fund board. “The assets now amount to about 100% of GDP. And all that money flooding into the financial market helped it to deepen and for companies to finance themselves fairly cheaply. Consequently the pension funds, in effect, have created an Icelandic financial services industry, unlocked an Icelandic entrepreneurial spirit and financed Icelandic entrepreneurs’ inroads into the Nordic and British financial and retail sectors.”
But throughout this process there was little evidence of input from politicians. In the 1980s a law was passed requiring all working people to belong to a pension fund. However, this was merely giving legal form to the earlier social partners’ accord, as was a 1997 law which required everybody to pay into a second pillar fund from 1 July 1999, which coincided with a social partners’ agreement to pay 10% of salaries, 6% from the private sector employer and 4% from the employee, into the funds.
And despite the rapid development of a system that has had a dramatic economic and business impact and contributed to social stability political parties pay scant attention to pensions on their websites.
“That is very telling,” says Sigurdur Már Jónsson of the business newspaper Vidskiptabladid. “This is not a hot political issue. There was a national discussion a few years ago about how much should go to private saving but it was not a harsh debate.”
But this cosy situation is about to change. First Iceland is facing demographic pressures, although not to the extent of the rest of Europe. “We are having fewer children and the size of the generation coming into the labour market is smaller than the generation taking a pension,” warns Arnbjörnsson of the LO. “In 1970 there were 1.7 people in the 16-30 age group for each person in the 50-67 age group. Now the ratio stands at 1.2:1 and in 2030 it will be 0.8:1.”
And second, while until now the social partners have managed the system with minimal reference to politicians, pension funds face major issues that they cannot resolve alone. But because until now Icelandic politicians, unlike their colleagues elsewhere in Europe, have not had to focus on pensions, they appear ill prepared to handle the looming crises.
“As part of the 1969 agreement it was decided that pension funds should include disability rights,” notes Arnbjörnsson. “But over the past 10 years this burden has doubled. From actuarial principles we calculated that it would amount to about 13.5% of the overall pension burden but it appears to be about 25%.”
The level differs from occupation to occupation, with some traditionally having a higher propensity, he adds. Unskilled workers and seamen are among those most affected.
“The disability question came to our notice because of the due diligence undertaken as a result of our planned merger with the seamen’s pension fund,” says Bjarni Brynolfsson, managing director and CIO of Framsyn, whose members are unskilled workers. “The actuarial accountants are still doing their calculations but the impact is far greater than they had been expecting.”
The unanticipated rise in people claiming a disability pension is partly due to a change in culture, suggests Jónsson of Vidskiptabladid. “In Iceland we have traditionally had the attitude that ‘you’ve still got to work’ although you have a disability. But now this is changing and people are not as harsh on themselves in this respect as they used to be.”
Arnbjörnsson sees the cause as lying elsewhere. “We are seeing a change in the labour market. Previously, those who did not have full physical ability were tolerated in the workplace because the companies had social responsibility. Now that companies have been floated and are focusing on shareholder value and returns we are seeing a different management style. It’s not that people are not wiling to take a job, it’s that now there is not the opportunity for them to get one.”
But whatever the cause, the effect has been a lot of very worried pension funds. “The increase in longevity probably adds 3.5% to the liabilities of the pension funds,” says Jóhannes Siggerson, managing director of skilled workers’ pension fund Lífeyrir. “And the increase in disability pensions may add a further 1%.”
The social partners hoped that they had resolved the issue with a 2002 agreement to raise the 10% contribution rate by a further 2% from the employers – 1% from the start of 2005 and the rest from 2007. But the extent of the disability miscalculation suggests this will be inadequate. “The implications of the disability problem are massive,” says Edwald of the employers’ confederation. “I am on the board of the Framsyn pension fund. Today we are a positive situation. At the end of 2003 we were +1.5% towards all our total liabilities. The return on the fund for 2004 was in the region of 15%, so we are way in the black with the whole fund. But the size of the disability threat is of a magnitude that could threaten the fund’s ability to maintain its pension payments schedule.”
“We negotiated with employers to build up a system that would secure our members down the line,” says Arnbjörnsson. “But the government finances are better now than they were in 1969 so it’s payback time. The government should finance the second part of the generation consensus from 1969. If we manage to do that then Iceland will over one generation have solved the pension burden.”
This point is gaining support, says Jónsson of Vidskiptabladid. “The press is now asking whether the pension funds should carry this responsibility or whether it should be taken over by the state social security system,” he says. “I think that this will be the next issue on the agenda.”
But not necessarily on the agenda of a government pursuing a low-tax, free market policy. A right-of-centre coalition between the conservative Independence Party and the liberal Progressive Party that has been in office since 1991, it prides itself on its fiscal stringency. “We have been running budgetary surpluses for several years,” says finance minister Geir Haarde. “Our 2005 budget calls for a 1% of GDP surplus.”
And he shows little sympathy for the idea of the state taking over the disability burden. “There is some pressure from the labour market on us to change the current division of labour and press comment has suggested that the governmentreabsorb the disability payments so that the funds could pay more old age pension,” he says. “But then you could pay people more wages if you got the government to pay the overtime.”
However, Haarde is careful not to close any doors. “The disability issue is new and we are in the midst of figuring out how to deal with it. Up to now no decisions have been made with respect of a division of labour between the social security system and the pension fund.”
But what about the state taking on disability to the social security rolls? “Well, let’s say we’d be very hesitant to follow that direction,” he says. “This disability issue is two-fold. It is a problem for the pension funds because increasingly some of their members are applying for disability payments, and at the same time we are seeing a great increase in disability payments through our social security system. It’s a joint problem so maybe it needs some kind of joint approach.”
Edwald appears ready for some give and take. “Under the current system the government pays a certain amount per month as the state old-age pension. That will not decrease. But then there is a minimum total pension that the state has to pay if a person has no rights from the pension funds and that is falling as the pension funds get stronger and almost everybody has a reasonable pension from their pension fund. And I think that that is our negotiating chip.
One possible solution would be to define the disability and age participation by the pension funds and then have reinsurance by the state, for the state to guarantee disability beyond a certain level. So you could agree that pension funds not pay benefits beyond, say, a retiree’s 95th birthday, and the value of social insurance could be related to the decreased payments by the state in the coming decades because of the increased level of pension payments from the funds, which will keep growing until 2014.”
However, the second major issue centres on the perceived differences between the pensions paid to public sector workers and those in the private sector. And this will be even more difficult to resolve as it involves the state as an employer.
“Our pension system is better than the private sector system,” concedes Haukur Hafsteinsson, managing director of the Pension Fund for
State Employees. “Ours is a defined benefit scheme while others are defined contribution. So the disability and longevity problem here would lead to increased contribution from the government, while for the private sector it would lead to a reduction in the benefits.”
There has been some reform of the public sector system. “Traditionally the public sector pension fund was partly funded and partly built up through a PAYG system,” says Hafsteinsson. “Then in 1997 the old system was closed and replaced with a new fully funded system, with those already paying given a choice between the old or new and all new members paying into the new.”
“Currently the unfinanced pension burden of the state employees’ pension fund is something like 55-60% of GDP,” says Arnbjörnsson. “So this should be a political issue but politicians have managed to put it aside because these are large sums that are not comprehendible by the man in the street.”
In addition, the contribution of the employer is different. While employees in both contribute 4% of their salary, in the public sector the government pays 11.5%.
“Since 1969 we have been trying to close that gap,” says Arnbjörnsson. “But because of the state guarantee for the public sector fund, covering municipalities and central government, it’s very difficult. In 2000 we introduced a third-pillar scheme, called 2+2, where if the employee decided to save 2% into a supplementary pension scheme the employer was obliged to pay 2%, adding 4% of salary into a voluntary scheme. But then three months later the government negotiated the same scheme with its own employees on top of the 15.5% so we were back to baseline.”
“I was really unhappy with the government’s move, they pulled the carpet from under us,” agrees Edwald. “The government played down the consequences of its actions. It was just an easy way to increase payments to public workers without the macroeconomic effects by postponing the consumption effect.”
But Arnbjörnsson points out that although much of the focus has been on the different pension contributions made by the employer in the two systems the disparity is more fundamental. “The average annual rate of return on pensions in the private market was 1.4% but with the longevity and disability burdens we are going to face a reduction in rights, probably to 1.3% despite the fact that we negotiated a two percentage points increase from employers over the next two years. But public sector workers are earning a guaranteed 1.9%, so while we wanted to reduce the gap between the two systems the result is that it will widen because the private market system does not have any state and public guarantee.”
The government is unrepentant. “The situation with the public employees is complicated, they have long-standing rights and of course the fund has a government guarantee,” says Haarde. “We have been trying to pre-fund these public pension liabilities that are on the horizon and have paid some IKR70-80bn e850-980m into the fund which is now starting to accumulate. So we have pushed back the day of reckoning, the day when the fund would not be able to pay its obligations and the pensions have to come directly out of the treasury, from maybe 2014 to closer to 2030. That is not a measure to ensure that taxpayers don’t have to pay that through the treasury. But some people talk as if this was simply a gesture in the interests of the public employees.”
“I foresee a lot of turbulence in the labour market and a lot of pressure on the government if we have to reduce pension rights at the same time as the government has to increase taxes to pay for the increased longevity in the public sector,” says Arnbjörnsson. “It’s the same issue, civil servants are also living longer, but they don’t have to finance it. We have reached the stage where if the public organisations negotiate a 1% wage increase the total increase of labour costs including pension rights for the government and municipalities is 5% with those who are working getting only
one-sixth of the overall cost because under a decision dating from 1926 those receiving a pension will get the same increase. This now involves such large sums of money it’s beyond any reasonable expectation that it can continue.”
“State employees have always had relatively low pay compared with the private sector so a generous pension after retirement was seen as a quid pro quo,” recalls opposition leader Skarphédinsson. “However, the public sector is now demanding parity in salary as well as retaining their better pension rights. Within the next six months to a year the state and the public sector workers must finish negotiations on a new pay settlement and the union side is demanding hefty pay rises. It will be a difficult and a testing time for the finance minister as there has already been a settlement for teachers, and this may be taken as a benchmark for the rest of the public sector.”
“It’s very difficult for the government to decrease the public workers’ rights but I think that they will have to make some effort in adjusting the public sector pensions system towards that of the private market,” adds Edwald “If nothing else to make the pension fund DC and for it to live on its contributions. I also think that they will have to bring the contributions level closer to ours.”
“The right-wing parties want to introduce a similar pay structure, and we have been gradually moving towards that, and in the end to also strive for a pension that is similar,” says Skarphédinsson. “I wouldn’t say that this is the official policy of my party but this is my feeling.”
However, this is heresy to Ögmundur Jónasson, chairman of the federation of state and municipal employees’ union, the BSRB, a member of the Pension Fund for State Employees’ board and an MP for the Left-Green Movement.
“There are some people in our ranks who wanted to take the system entirely into our wage settlement process so that the pension arrangements would be part of our contract,” Jónasson says. “Others like me said let’s keep our rights protected by law. So we have a system now where the rights are protected. If the pension fund gets into trouble you raise the contributions and likewise adjust the contributions downward when the conditions improve for the funds. And we are, of course, quite happy with that system where the rights of the pensioners are protected in such a way and will not make any concessions on this at all. Attempts to change this would give rise to considerable conflict. What we are in favour of is to make the pension rights of other workers better, not ours worse.”
Arnbjörnsson disagrees. “Society cannot afford to transfer the public sector system to the private market,” he says. “Neither companies for competitive reasons nor the government have the ability to do that as we are talking about a sum that is double the national GDP. Obviously the government has to take difficult decisions and decisions that are unavoidable due to the extent of the burden and the huge gap between the public and private market.”
“I am not overly optimistic,” says Edwald. “It is of paramount importance we work with the unions to
preserve our long-term collective agreements. Most collective agreements made since the beginning of 2004 effective to 2008 have a clause allowing them to be reviewed in November 2005 and reopened at the end of 2005 if the annual inflation rate goes above 3% or if large groups have made agreements that are totally different from the collective agreements. And both these criteria are threatening. Inflation is currently 3.9% with the trend on the upside, although the forecast for the year is that it will moderate. And we must also look at the teacher’s agreement made last November. So if the labour unions walk away from a collective agreement or it is reopened, the pension fund issue would come very much into the picture. And I don’t think it’s likely that the government will write us a cheque but we expect it to help us solve this issue.”