Technical provisions and their calculation

As concerns old-age pensions starting in the future, the provision for unearned premiums is calculated for the individual’s entire work history. The calculation is made at the individual level, i.e. for each insured person separately. The provision is calculated by adding the necessary capital value coefficient to the amount of the funded old-age pension. The provision corresponds to the sum that, considering the interest and mortality, is sufficient on average for paying the funded old-age pension throughout the whole period when the insured individual is on old-age pension.

As concerns future disability pensions, the provision for unearned premiums is not calculated at the individual level. Instead, a certain percentage of each insurance policy (insurance taken out by the employer/enterprise) is reserved for this purpose. The sum reserved for the provision corresponds to the percentage of disability pension contributions collected in the last two years that is sufficient to pay funded disability pensions during the next two years.

A pension insurance company’s provision for current and future bonuses is divided into two: provision for current bonuses and provision for future bonuses. Industry-wide pension funds only have provision for future bonuses.

The provision for future bonuses is used to even out fluctuations in the value of investments and to prepare for currency risks. The provision for future bonuses consists of the returns on investment and underwriting business. If the financial year generates a surplus, the transferable amount is transferred to the provision for future bonuses. Correspondingly, if the financial year shows a deficit, it is deducted from the provision for future bonuses. Thereafter, assets may be transferred from the provision for future bonuses to the provision for current bonuses, if allowed by the company’s solvency position.

Provision for current bonuses is an element of the provision for unearned premiums, specific to each insurance policy. Certain returns on investments and the loading profit are transferred to the provision for current bonuses. Pension insurance companies can use these assets for rebates given to their customers the following year.

An industry-wide pension fund transfers the return on investments to the provision for future bonuses, where it may also deposit the surplus from the fund department that grants supplementary benefits. After these transfers, the industry-wide pension fund can either cancel some of the provisions in order to reduce premiums or give rebates to the shareholders of the pension fund. If necessary, the industry-wide pension fund can also use the insurance premiums to increase the provision for current and future bonuses.

By using an equity-linked buffer fund, the earnings-related pension system in the private sector collectively bears some of the risk posed by stock market fluctuations. The amount of this buffer depends on the pension providers’ average returns on equity investments. On the basis of the pension providers’ realised returns on equities, this component of the technical provisions is either increased or decreased. If the equity-linked buffer exceeds the agreed upper limit, the excess is transferred to the old-age pension liabilities.

Assets for outstanding claims for old-age pensions commenced have already been reserved in the provision for unearned premiums during the individual’s working history. The calculation of the provision for outstanding claims for old-age pensions commenced starts when the individual retires on old-age pension. The provision corresponds to the sum that, interest and mortality included, is sufficient on average to pay the funded old-age pension for the remainder of the individual’s retirement.

The provision for outstanding claims for disability pensions commenced has assets reserved both for the disability pensions already granted (the ‘known’ pensions) and for the disability pensions where the pension contingency has already occurred but the pensions themselves have not yet been granted (the ‘unknown’ pensions).

The provision for known pensions is calculated at the individual level at the start of the disability pension. The provision is calculated by adding the necessary capital value coefficient to the amount of the funded disability pension. The provision corresponds to the amount of money that, recoverability, mortality and interest included, is sufficient to pay the funded part of the disability pension until the pensionable age.

The provision for unknown pensions is not calculated at the individual level. Instead, a certain amount of provision is reserved for these pensions from each insurance policy (insurance taken out by the employer/enterprise). The provision amount is obtained by reserving a certain percentage of the disability contributions paid during the past three years. This percentage is sufficient for paying the funded shares of disability pensions that have not yet been granted for pension contingencies already occurred.

The provision for pooled claims is a buffer fund for jointly paid pension components, such as partial old-age pension, years-of-service pension, survivors’ pensions and index increments. Pension providers pay jointly for the pooled components with the help of a cost distribution calculation made by the Finnish Centre for Pensions.

In the distribution of costs, each private-sector pension provider is assigned a share of the pooled components. If this share is smaller than the assets received from the pooled components of pension contributions, the provision for pooled claims increases. Correspondingly, if the share is larger than the assets received from the pooled components of pension contributions, the provision for pooled claims decreases.

The above share of the provision for pooled claims is calculated separately for each insurance policy, but the provision for pooled claims also includes a component stemming from the equalization of the equity-linked buffer among pension providers. This component is calculated separately for each pension provider. Each pension provider must cover the same amount of the equity-linked buffer in relation to the technical provisions used for calculating the solvency limit. When technical provisions develop at different paces from one pension provider to another, this is equalized through the provision for pooled claims.

A minimum value has been set for the provision for pooled claims. This is 20 per cent of the total amount of pooled components for the next year. The part exceeding the lower limit of the provision for pooled claims can be used, for instance, to supplement pension liabilities, to increase funding for old-age pensions, and to prepare for pension expenditure due to demographic development.

The provision for pooled claims also includes the EMU buffer. Its target level is 2.5 per cent of all wages insured. The EMU buffer can be used to even out fluctuations in pension contributions caused by cyclical variations.

The pension liability for future pensions comprises pension liability for future old-age pensions and future disability pensions. These components of the liability are calculated following the same procedure as when a pension insurance company or an industry-wide pension fund calculates the provision for unearned premiums for future old-age and disability pensions.

The pension liability for pensions commenced is divided among old-age pensions commenced and disability pensions commenced. These components of pension liability are calculated in the same way as when a pension insurance company or an industry-wide pension fund calculates the corresponding components of the provision for outstanding claims. A company pension fund’s pension liability for pensions commenced also includes the provision for pooled claims. This is determined in the same way as for pension insurance companies or industry-wide pension funds.

The provision for current and future bonuses corresponds to a pension insurance company’s provision for future bonuses. A company pension fund transfers the return on investments to the provision for current and future bonuses, where it may also deposit the surplus from the fund department A, i.e. from voluntary supplementary pensions. After these transfers, the company pension fund can either cancel some of the provisions in order to reduce contributions, or it can use contributions to build up the provisions.

The equity-linked buffer is the system’s joint risk buffer to offset fluctuations in returns on shares. Company pension funds determine it in the same way as pension insurance companies or industry-wide pension funds.