Norway
compiled by Allianz Global Investors
Pension System Design
The Norwegian system consists of a public pension system, a mandatory occupational pension system and personal pension saving arrangements.
Even Norway faces the demographic shift resulting in a higher old-age-dependency ratio in the forthcoming decades and has to prepare its social security system that it remains sustainable in the long term. The growing demographic pressure induced the government to make several proposals for reforming the pension system, although Norway is in a relatively strong position compared to other European countries because of its considerable oil revenues. With broad political agreement proposals were made in a government white paper. Some elements have already been implemented; others are proposed to be gradually phased in the forthcoming years.
In October 2006 the Norwegian government presented a white paper on a new pension scheme, in whose main features should become effective from 2010.
The main reform measures are the following:
- Pension guarantee scheme
Irrespective of former employment income, a minimum pension is paid, which is at least equal to the minimum pension.
- Closer correlation between income and pension
The pension entitlement will accrue at a rate of 1.35% of annual earnings from employment up to ceiling of EUR 54,390 (2007).
- Automatic adjustment to life expectancy
The amount of future pension payments will hereafter be linked to the evolution of life expectancy. Thus, an increase in life expectancy would consequently lead to lower pension payments or to extended participation in the labour market.
The advantage of introducing this element into the calculation formula is that the governmental budget, and the social security respectively, will not be affected by changes in life expectancy.
- Change of pension indexation
Pension payments will be indexed to the average annual growth in wages and prices. This indexation method assures full purchasing power for beneficiaries, but the pension payment increases at a lower rate than the income of wage earnings and therefore lags behind real wage growth.
The Norwegian pension market is a small market dominated by insurance products. About 75% of private pensions in the Norwegian pension market are funded by insurance contracts. The market is oligopolistic with the top 5 insurance companies controlling about 94% of the market. We expect the pension market in Norway to grow at a rate of 6.3% compound annually to approximately EUR 188 billion by 2020.
Public Pensions
The state pension scheme provides a satisfactory pension level based on a flat-rate basic pension and an earnings-related supplement that covers all employed and self-employed persons. In Norway, the entire social security system is operated by the National Insurance Scheme (NIS). People employed in Norway or who have been living in the country for more than one year are required to join the system.
Employee contributions amount to 7.8% of income whereas the employer pays 14.1%. In contrast to most European countries a maximum earnings ceiling does not apply, consequently total income is charged.
The statutory retirement age is 67. Estimates by the OECD state a gross replacement ratio for average earners of approximately 60%.
In 1966 Norway established the National Insurance Scheme Fund (NIS Fund), which was intended to be the funding vehicle for reserves stemming from a surplus in the social security system. To further strengthen Norway’s financial position to meet future pension liabilities, the Petroleum Fund was established in 1990.
Both funds merged on January 1, 2006 to the Government Pension Fund that consists of two parts, the Government Pension Funds - Global and the Government Pension Funds - Norway. The latter reflects the old NIS Fund.
The assets of the fund amount to EUR 230 billion, the largest part fall upon the ‘global’ section. The bulk of assets, approximately 78%, is managed internally by the Norges Bank on behalf of the Norwegian finance ministry. The remaining assets are outsourced to external asset managers.
Occupational Pensions
Since January 1, 2006 occupational pension provision is compulsory in Norway under specific conditions that are related to the number of employees and their working hours. Within six months all employers were obliged to provide occupational pension contracts at work being effective on July 1, 2006. The new legislation led to a strong increase in sales of mandatory pension products, thus encouraging new providers to enter the market.
Traditionally, defined benefit schemes were the prevailing form of occupational pension provision. Large employers predominantly offer them. The benefit level is quite generous with an average replacement ratio of 60% to 70% of final salary. However, defined contribution schemes are becoming increasingly popular since their introduction in 2000. With the introduction of the defined contribution legislation, a number of banks and investment funds have entered the market as potential providers for such schemes. But insurance schemes are still the dominating financing vehicle.
Occupational pension schemes can be funded through a group insurance arrangement or a pension fund. Insurance is the dominating financing vehicle for occupational pension plans although the number of pension funds is growing rapidly.
1. Pension funds
There are no special regulations regarding the appointment of an investment manager for pension funds. The market is open for external financial service providers located and licensed in other EEA countries.
According to the 2001 pension legislation, defined benefit schemes have to be fully funded at all times.
Tax treatment of contributions and benefits
Employer contributions towards an approved defined-benefit pension plan are fully tax deductible with no limit on the level of contribution. However, total benefits from both first and second pillar pensions are limited to 100% of salary up to six times the basic amount plus 70% of salary between six times and 12 times the basic amount. In order to receive an approved status, a defined benefit plan must not provide pensions on a pensionable salary in excess of 12 times the basic amount.
For defined contribution plans the contribution rate is limited to 5% of salary between two and six times the basic amount plus 8% of salary between six and 12 times the basic amount. These contributions are fully tax deductible.
Benefits paid from a tax-qualified pension plan are treated as taxable income of the recipient.
Investment regulation
The following quantitative investment limits apply:
- Max. 35% in equities;
- Max. 30% in interest-bearing securities;
- Max.30% in retail investment funds;
- Max. 7% in private equity, hedge funds, infrastructure and emerging markets stocks; but single investment into each of the asset classes is limited to 1%
- Max. 1% in non-secured loans;
The IORP Directive is currently being implemented. A transition to the Prudent Person Principle is expected, changing the regulatory environment for pension funds.
Investments have been conservative so far: in the past, domestic bonds and real estate have been the main investments. However, equity investment, particularly in foreign companies, is becoming increasingly popular, although legally restricted to 35%.
2. Group Insurance Contracts
Insurance is the dominant financing vehicle for occupational pension plans. About 75% of private pensions are funded through insurance contracts.
Tax treatment of contributions and benefits
Tax treatment of contributions and benefits is the same as for pension funds.
Investment regulation
The same investment regulations as for pension funds apply.
Since 1989 insurance companies have had to keep separate accounts for each contract (allocated funding), offering the traditional investment strategy of the insurance company. The 2001 legislation improved the flexibility of the investment strategies offered for insurance-backed defined benefit schemes. The employer now has the possibility to open a separate account and is able to choose from a range of investment vehicles. Employer contributions to a defined benefit plan and funding levels of the plan are calculated in such a way that the promised benefit level can be provided if the plan achieves a return of 3% a year. If the plan achieves a higher return, the excess usually goes to the employer.
For defined contribution plans an investment account will be opened for each employee, who is free to choose the investment strategy of the underlying assets.
Outlook
The introduction of mandatory occupational pensions gave impetus to the pension market. Nevertheless, it remains small compared to other countries. The reform of the pension system, probably coming into force in 2010, will give additional impetus to the pension market through an increasing need for additional benefits as a consequence of lower social security benefits.
The Norwegian pension market has no technical barriers to market entry and the market is open to insurance and asset management providers located and licensed in other EEA countries.
In recent years, changes to Norway’s pension market have mainly been driven by the emergence of mandatory occupational pensions. Since 2001, many of these new plans have been of the defined contribution type. In terms of asset volume, the pension reserve fund is clearly dominant, as it is one of the biggest funds in the world. The fund has evolved gradually, especially with regard to the scope of investments. Mandatory occupational plans and the reserve fund have made funded pensions the focus of pension provision in Norway, eben though this form of funded pensions differs form most other European countries.