The pension system in Finland: Institutional structure and governance Keith Ambachtsheer Adjunct Professor of Finance, Rotman School of Management, University of Toronto Director, Rotman International Centre for Pension Management January 7, 2013 Keith Ambachtsheer Adjunct Professor of Finance, Rotman School of Management, University of Toronto Director, Rotman International Centre for Pension Management January 7, 2013

Comprehensive and robustAdequate pensionsCovers entire workforceFacilitates labor mobilityEffective integration of system components Page 2 FINNISH RETIREMENT INCOME SYSTEM The Pension System in Finland, Ambachtsheer, January 2013

How is the system financed? Institutional structure and ‘value for money’? Institutional governance? Investing outside vs. inside Finland? Page 3 FOCUS FOR REPORT – PART 2 The Pension System in Finland, Ambachtsheer, January 2013

Current finance sources: 75% pay-go, 25% pre-funding How should this ratio be steered? Do the PIC solvency rules foster unnecessary ‘short-termism’? Move the 150B Euros asset mix from to 80-20? The Pension System in Finland, Ambachtsheer, January 2013 Page 4 RETIREMENT INCOME SYSTEM - FINANCE ISSUES

Total annual investment costs: ½% of assets...or about 700M Euros/yr Similar to cost experience of an international peer group Bulk of costs (2/3rds) relate external fees for private markets and hedge fund investing Finnish internal oversight/executive/control functions under-resourced The Pension System in Finland, Ambachtsheer, January 2013 Page 5 ‘VALUE FOR MONEY’ FACTS – INVESTMENTS

The Pension System in Finland, Ambachtsheer, January 2013 Page 6 Table 1

The Pension System in Finland, Ambachtsheer, January 2013 Page 7 Figure 1. FPF investment costs vs. global larger and smaller fund peer group investment costs

The Pension System in Finland, Ambachtsheer, January 2013 Page 8 Figure 2. Benchmarking investment function compensation

Aggregate Finnish fund marginally outperformed its benchmark ( ) Benchmark included 1/3 rd inside-Finland weighting Finnish equities performed poorly during Finnish funds underperformed intl. peers by 1.5%/yr ( ) The Pension System in Finland, Ambachtsheer, January 2013 Page 9 ‘VALUE FOR MONEY’ FACTS – INVESTMENTS

The Pension System in Finland, Ambachtsheer, January 2013 Page 10 Figure 3. Global policy returns – quartile rankings

Aggregate per member Finnish ben. adm. costs: 107 Euros/yr (440M Euros total) Aggregate international peer group experience: 60 Euros/yr Finnish costs higher because: 1. Scale (63%), 2. Complexity (23%), 3. Other (14%) 55% of Finnish costs (59 Euros) related to serving employers vs. only 10% (6 Euros) for international peer group Major cost offset: Finland combines Pillar 1 and 2 ben. adm....other countries do not Aggregate Finnish Member Services ranking: 70 vs. 75 for international peer group The Pension System in Finland, Ambachtsheer, January 2013 Page 11 ‘VALUE FOR MONEY’ FACTS – BENEFIT ADMINISTRATION

The Pension System in Finland, Ambachtsheer, January 2013 Page 12 Figure 4. Total pension administration costs per active member and annuitant

The Pension System in Finland, Ambachtsheer, January 2013 Page 13 Figure 5. Total service scores, score out of 100

Significant ‘economies of scale’ opportunities (inv. and ben. adm.) On inv. side: 1. In-source high-cost mandates, 2. Strengthen internal oversight/executive/control functions Value of PIC competition questionable. Collaboration strategies likely offer better prospects. The Pension System in Finland, Ambachtsheer, January 2013 Page 14 ‘VALUE FOR MONEY’ – CONCLUSIONS

Investment policy shift from to 80-20: € 1.5B/yr ‘Value for money’ shift in investment structures: € 300M/yr ‘Value for money’ shift in benefit administration structures: € 100M/yr Total of € 1.9B equals 1% of Finland GDP The Pension System in Finland, Ambachtsheer, January 2013 Page 15 POTENTIAL ECONOMIC GAINS

Global pension governance debate: “Representation vs. Skills/Experience” Resolution: not “either-or” but “and-and” Practical convergence strategy: build collective requisite skills/experience matrix involving all stakeholders The Pension System in Finland, Ambachtsheer, January 2013 Page 16 INSTITUTIONAL GOVERNANCE

Close historical connection between Finnish economy and pension system Increasing outward focus...but investments still 1/3 rd Finnish Health of 75% pay-go part of system already relies on Finnish economy Accelerating outward-looking focus would move pension assets further away from the reaches of Finnish government and corporate sectors, and increase exposure to international best practices The Pension System in Finland, Ambachtsheer, January 2013 Page 17 FROM LOOKING INWARD TO LOOKING OUTWARD

Accelerate ‘looking outward’ momentum in pension asset management? Raise governance quality by combining representation and skills/experience requirements? Shift incentive structures in pension system from competition to collaboration basis? Exploit significant ‘economies of scale’ opportunities in inv. and ben. adm.? Rethink role of pension assets and implications for investment policies? Adjust retirement income system financing strategies? The Pension System in Finland, Ambachtsheer, January 2013 Page 18 SUMMARY OF REPORT – PART 2 SIX SUGGESTIONS/RECOMMENDATIONS