How having ‘too much money’ has become a headache for Iceland’s retirement system

Building one of the most successful pension systems in the world presented an unusual challenge for Iceland.

The volume of funds raised with contributions reached such a large volume that the country was faced with the need to discuss the best way to invest the money that finances Icelanders’ pensions.

With assets nearly twice the size of the island’s economy, located in the North Atlantic, the government led by environmentalist and ecologist Katrín Jakobsdóttir is touting the idea of ​​allowing companies that manage pension funds to make more investments abroad. Currently, legislation limits the percentage to 50%.

“The system has gotten too big,” Finance Minister Bjarni Benediktsson told a local press conference in December.

“It goes without saying that we cannot limit all investment opportunities to the domestic market,” he added.

‘Consequence of success itself’

With a sum of resources of around US$ 50 billion, equivalent to something close to 200% of GDP (Gross Domestic Product), “the system now faces the consequences of its own success”, says Hans van Meerten, professor of pension law from the University of Utrecht, in the Netherlands, in an interview with BBC Mundo, the BBC’s Spanish language service.

Iceland has a mandatory contribution pension system, explains the researcher, like many European economies. Participation, however, is compulsory even for self-employed workers, adds van Meerten, while in most European countries it is not mandatory.

Unlike countries like the Netherlands, the country also gives taxpayers more freedom when choosing a pension fund.

This type of characteristic ends up distinguishing the system from almost all others.

The country’s pension system became “the best pension system in the world” in October, according to the Global Pension Index developed by the Mercer-CFA Institute, a recognized measure that compares pension systems in 43 countries each year, representing about 65% of the world’s population.

The ranking assigns different score values ​​distributed among three main categories: system sufficiency (whose weight is 40% in the assessment), sustainability (35%) and regulatory environment (25%).

In 2021, Iceland scored 84.2 points, the top performer on the list, with strengths in what was considered a “relatively generous” public pension, a well-regulated and managed private pension system, and a high level of contributions.

Netherlands and Denmark occupied second and third places, respectively.

Iceland is “very well prepared for the ticking time bomb we see everywhere: aging”, says van Meerten.

“It has a unique combination of public and private pensions that largely avoids old age poverty for workers and non-workers alike.”

Source: OECD

how the system works

Briefly, the system operates under three pillars: a public pension system financed by the state, another to which workers and employers contribute, and a voluntary private pension system.

The public system, financed with taxes, has two modalities: a basic one, which includes the entire population, except for those with higher incomes, and a complementary one, which also has limits in relation to personal income.

The second pillar, labor, funded with social security contributions from workers and companies, provides for a minimum contribution of 12% on salary, with 4% paid by employees and 8% by employers.

Due to the work of labor unions, however, the most recurrent contribution is slightly higher, at 15.5%, with a rate of 11.5% for companies and the same 4% for workers.

The law establishes that, for those who have contributed over 40 years, the value of retirement must be at least 56% of the average income obtained in the years of work, with the benefit paid for life, according to data from the Organization for Economic Cooperation and Development (OECD).

The final value depends on the financial performance of the funds – by the rules, however, the income from the investments must, at least, be linked to the inflation index.

Workers in the private sector can retire at age 67 and those in the public sector at age 65. Most Icelanders, however, remain in the job market even beyond the age limit to try to achieve better benefit amounts.

Source: OECD

Protect yourself from big risks

With just 370,000 inhabitants and an economy heavily dependent on tourism, Iceland has not been immune to fluctuations in global economic cycles.

The 2008 financial crisis, for example, crippled its immense banking sector, nearly wiped out the national stock market and caused the pension system to lose more than 20% of its resources.

Because of this, the country decided to be more cautious and protect itself against a wave of international financial risks.

After more than a decade, however, many investment funds are approaching the limit of investment in assets abroad, and requests for legal investment limits to be relaxed have multiplied.

The Icelandic Pension Fund Association, an association that represents financial institutions, advocates the total elimination of the investment limit or, alternatively, the establishment of a ceiling of 60% to 65%.

There is an intense debate on the subject, since the greater the exposure to the international market, the greater the risk of the country feeling the effects and of a possible new crisis.

In this sense, the authorities have repeated that any increase in the internationalization of pension funds must be done gradually and in line with the evolution of the domestic economy.

Critics of the proposal argue that a major shift could destabilize the local currency at a time when Iceland faces a contraction in the tourism sector due to the Covid-19 pandemic.

At the height of the health crisis in 2020, the Icelandic Central Bank even signed an agreement with pension funds to suspend investments abroad for six months precisely in order to protect the exchange rate.