Insurance risks

The Finnish earnings-related pension system functions on a partially funded basis with respect to the Employees Pensions Act (TyEL). Around one fifth of the pensions paid each year is previously funded, while the remaining part is a pooled component, which is covered by annually collected insurance contributions. The funded parts of the pension are the responsibility of individual pension institutions, while the pooled components are the joint responsibility of all the pension institutions.

The provision for pooled claims contained in the technical provision acts as a buffer for jointly managed insurance business. The amount of the provision for pooled claims in the entire earnings-related pension system is estimated to correspond to nearly 80% of the following year’s PAYG pension expenditure. The clearing system eliminates the effects caused by the varying development of the number and age structure of employees insured by different pension insurance institutions. Thus the cost of the pooled components presents no risk for the individual pension institution.

Basic pensions under the Self-employed Persons Pensions Act YEL are financed in full by the insurance contributions collected annually in accordance with the pay-as-you-go system and by the State’s contribution and do not present a risk for the individual pension institution.

The level of earnings-related pension cover is based on a defined benefit pension scheme, and is therefore not based directly on the return on funded pension assets. Earnings-related pension benefits are secured for the insured and pensioners by a statutory joint and several liability for bankruptcy that applies to all earnings-related pension insurance institutions. The costs of pension provision are borne by employers and employees together. The Ministry of Social Affairs and Health annually confirms the common calculation bases concerning the technical provisions for earnings-related pension insurance companies. The calculation bases include issues such as actuarial assumptions used in the calculation of technical provisions, for example, mortality and disability incidence rate. Under the TyEL act, the calculation bases must be secure and, should the base for technical provisions prove insufficient for all earnings-related pension insurance institutions, the technical provisions can be supplemented with a clearing system. An example of this is the adjustment of the mortality model which will increase old-age pension liabilities at the end of 2016.

The risks of Varma’s insurance business are linked to the sufficiency of the insurance contributions collected and the technical provisions accumulated from them in relation to the pensions that are the company’s responsibility. Because common calculation bases can be changed annually, and the clearing system acts as a buffer for all insurance risks concerning earnings-related pension insurance institutions, the risk for the individual pension institution lies in its deviation from the average of the pension system.

The equalisation provision, which contains a risk-theory-based lower and upper limit, helps the companies to prepare for fluctuations in their annual insurance business results. Varma’s equalisation provision under TyEL was approximately EUR 1,171 million at the end of 2015, which is about 6.4 per cent of the total payroll of the insured. The corresponding risk components included in TyEL contributions totalled approximately 3.7 per cent of the total payroll in 2015. As of 2017, the equalisation provision will be incorporated in other solvency capital, and it will no longer be monitored as a separate item. Insurance risks will then be carried by the provision for future bonuses, which is a component of the solvency capital.

The greatest fluctuation in the insurance business relates to disability pensions. In terms of the disability pension component, the amount of Varma’s equalisation provision corresponds to nearly four years of funded pension expenditure under Varma’s responsibility.

All supplementary pension insurances under YEL ended years ago, and pension liabilities related to these were transferred to the joint liability system on 1 January 2014. Supplementary pension insurances under TEL will also end on 31 December 2016, and the pension liabilities will be transferred to the joint liability system on 1 January 2017.

Technical provisions are calculated per person and insurance during the spring following the financial year in an annual calculation, after employers have provided the required earnings data. The Finnish Centre for Pensions carries out the clearing in the autumn following the financial year, at which time the remaining components of the technical provisions can be calculated. The calculation of the technical provisions in the Financial Statements is based on estimates.

According to the calculation, the structure of Varma’s technical provisions on 31 December 2015 was as follows:

€ million%
TyEL basic insurance
Provision for unearned premiums
Future pension liabilities15,16547.6
Provision for future bonuses-1,083-3.4
Provision for current bonuses1150.4
Equity-linked provision for current and future bonuses1,4024.4
Total provision for unearned premiums15,60049.0
Provision for claims outstanding
Current pension liabilities14,55445.7
Equalisation provision1,1713.7
Total provision for claims outstanding15,72549.3
TyEL basic pension insurance, total31,32598.3
TEL compliant supplementary pension insurance, total5191.6
YEL basic pension insurance, total200.1
YEL compliant supplementary pension insurance, total20
Total technical provisions31,866100.0
Of payroll,
€ million%
TyEL equalisation provision, 31 Dec. 2015
Old-age pension component200.1
Disability pension component9775.3
Contribution loss component1730.9
Lower limit for the equalisation provision276
Lower limit for the equalisation provision1,397

Neither the age structure of the employees insured by Varma nor the employers’ size or lines of business deviate significantly from the average for all earnings-related pension institutions, and the company’s equalisation provision is somewhat higher than the average. Thus Varma carries little risk relating to an atypical insurance portfolio.

Risk management in insurance business applies insurance technique analyses. Insurance risks are analysed using, for example, a risk assumption analysis (mortality, disability intensity), financial statements and business result analyses (insurance technique, distribution of responsibility) and, e.g., by compiling statistics on contribution losses and disability pension expenditure. In drawing up the financial statements, in particular the estimate of the insured’s payroll may deviate from the final sum. This is reflected in the company’s premium income and in the amount of technical provisions, but has little effect on the company’s result.

The risks involved in technical provisions and the assets covering technical provisions, i.e. insurance and investment risks, are provided for by the solvency capital, which for this year still includes the above-mentioned equalisation provision as a separate item. The amount of solvency capital is monitored in relation to the technical provisions and to the solvency limit calculated on the basis of investment allocation. The calculation of the solvency limit also takes into account the insurance risk. Thus, solvency capital provides the company with a buffer especially for years in which the return on the assets covering the technical provisions is below the interest credited on technical provisions. The calculation of the solvency limit will be renewed as of 1 January 2017. All investment and insurance risks will be taken into account in the calculation more comprehensively than before. At the same time, the separate regulation on technical provisions will be abolished.

A part of the interest credited on technical provisions (10%) is determined retroactively and is based on the pension insurance companies’ actual equity returns. An equity-linked provision for current and future bonuses, which is between -10 per cent and +5 per cent of the technical provisions, helps the insurance companies to carry the risks involved. If a pension institution’s equity returns differ from the average, it must employ its solvency capital to carry the risks that this involves. When the average equity return is calculated, the weight of the largest pension institutions is limited to 15 per cent. In conjunction with the pension reform, the labour market organisations agreed to raise the equity-linked provision for current and future bonuses to 20 per cent as of the beginning of 2017. At the same time, the limits for the equity-linked provision for current and future bonuses will be raised.

The following table presents the allocation of investments and certain other items according to solvency group at year-end.

€ million%
Money-market instrument2,3395.6
Bonds and obligations9,02621.6
Real estate6,87916.5
Miscellaneous investments3,9449.4