I. The Social Insurance System1
1. The National Insurance Scheme (NIS) and the Family Allowance Scheme (FAS) form an integral part of the Norwegian welfare and redistribution system. All persons residing or working in Norway are insured under the NIS and the system is financed on a pay-as-you-go basis through contributions and from general tax revenue. Benefits include old-age, survivors’ and disability pensions, disability, rehabilitation, and occupational injury benefits, medical and unemployment benefits and funeral grants. This chapter reviews the main elements of the NIS and FAS and provides projections of future pension expenditures. The paper demonstrates that indexing pensions to wages, in line with recent practice, would result in a large net liability by the year 2050 which could be reduced by indexing pensions instead to consumer prices. This could help make it possible for Norway to achieve a sustainable long-term fiscal position.
A. NIS Benefits
2. Old-age pensions consist of a basic pension, a supplementary pension, and/or a special supplement, and special supplements for children and domestic spouses (means-tested). The retirement age is 67 with partial deferment until the age of 70. If the insured person maintains an earned income which exceeds the basic amount, the pension is reduced by 40 percent of the income in excess of the basic amount.
3. Any person who has contributed to the NIS for at least three years between the age of 16 and 66 is entitled to the basic pension. The basic pension is independent of previous income or contributions paid. However, a full basic pension requires an insurance period of 40 years, with the pension reduced proportionally in the case of a shorter period. For a single pensioner, the full basic pension is equal to the basic amount for that year (Nkr 42,500 through April 30, 1998 and Nkr 45,370 thereafter). For a couple who are both pensioners, the full basic pension is 75 percent of the basic amount for each. A pensioner supporting a spouse who is not a pensioner is entitled to a 50 percent supplement of his basic pension and a pensioner supporting children is entitled to a 30 percent supplement for each child.
4. The supplementary pension scheme was introduced in 1967 and is provided for individuals whose annual income exceeds the average basic amount in any three years after 1966. The amount of the supplementary pension depends on the number of pension earning years and the yearly pension points. A full supplementary pension requires 40 pension-earning years, with a proportional reduction in the case of fewer pension years. Pension points are given for pensionable incomes up to six times the basic amount, incomes between six and twelve times the basic amount receive one-third credit with no credit for higher incomes. Pensionable income is the average income for the person’s twenty best income years in current prices. Pension points are computed for each calender year by dividing the pensionable income (up to six times the basic amount) less the basic amount with the basic amount. The maximum number of pension points is currently seven.
5. Given that the supplementary pension scheme was introduced only in 1967, older age groups have had no possibility to earn full entitlement. For these age groups special transitional provisions have been introduced that supplement their entitlement. In addition, an additional special supplement was introduced in 1969 for those who had no, or only a small, supplementary pension. This supplement was initially fixed at 7.5 percent of the basic amount, but has subsequently risen to 79.3 percent of the basic amount.
6. The full minimum pension is provided for anyone who has lived in Norway for over 40 years and to refugees with asylum status. The minimum pension consists of the basic amount and the special supplement. Prior to the new adjustments enacted earlier this year the minimum pension was Nkr 69,360.
7. When the new central coalition government came into office in the fall of 1997, it vowed to increase minimum pensions significantly to raise the standard of living for those people on the lower end of the income scale. In a bill that was passed in June 1998, the minimum pension was raised by Nkr 12,000 to Nkr 81,360 for single pensioners (about $10,800) by raising the basic amount by 6¾ percent to Nkr 45,370 and increasing the special supplement to 79.3 percent of the basic amount. These changes were backdated to May 1.
8. The relative improvement in the value of the minimum pension in 1998 has reinforced the distributional motive for offering pensions evident in recent years. Between 1991 and 1998 the ratio of the minimum pension to the maximum allowable pension under the system rose by 12 percent to 46 percent. Correcting for taxes the lack of differentiation between the minimum and maximum pension entitlement is even more stark with the minimum pension currently above 70 percent of the maximum pension. Moreover, the new minimum pension has resulted in a sizeable increase in the break-even point between receiving a pension based on 40 years work and the minimum pension, thereby transferring a number of people who were previously receiving pensions based on their own working incomes into the minimum pension scheme. The new break-even point is about Nkr 130,000 and up to 70,000 individuals are expected to transfer to the minimum pension scheme following this year’s adjustment.
Early retirement pension
9. An early retirement pension scheme (the avtalefestet pensjon-AFP) was introduced in 1989 allowing employees to retire at 64 years of age with benefits comparable to disability benefits. In the wage settlement for 1997 the social partners agreed to further reductions in the retirement age to 62 years effective from March 1998. Government workers and individuals associated with companies which have wage agreements with an early retirement pension provision are eligible for an early retirement pension. To receive an early retirement pension an individual must have earned at least 10 pension points between the ages of 50 and 62 and must be earning at least Nkr 85,000 each year. In addition, the early retirement pension cannot exceed 70 percent of the individual’s income during the three highest paying years between the ages of 56 and 60 and cannot be granted in conjunction with other special pensions such as the disability or widow/widower pension.
Occupational Pensions in the Government Sector
10. Pensions for government employees are calculated as the difference between two-thirds of the final pay level and the social security pension and are granted to those with 30 years of public service.
11. An insured person between 18 and 67 whose working capacity is permanently reduced by at least 50 percent due to illness, injury or defect, is entitled to a disability pension if he has contributed to the NIS for at least three years up to the contingency. The insurance condition is waived if the person has been a resident of Norway for at least 20 years. The structure of disability pensions is similar to that of old-age pensions; they consist of a basic pension and a supplementary pension. Special provisions apply to those born disabled or who become disabled before the age of 26—these persons are guaranteed an income slightly above four times the basic amount.
12. The NIS provides a variety of benefits including disability, occupational injury, rehabilitation, medical and cash benefits. Disability benefits consist of basic benefits and attendance benefits. Basic benefits are granted if the disability involves significant extra outlays; there are six benefit rates (up to about 70 percent of the basic amount) which are adjusted each year by Parliament. Attendance benefits are granted if the disabled person needs special attention or nursing; there are four benefit rates (up to 150 percent of the basic amount), which are also adjusted by Parliament each year. In the case of sickness, employees are entitled to daily cash benefits equal to 100 percent of pensionable income (up to six times the basic amount) for one year. The employer is responsible for the first 10 working days and the NIS the remainder. When on maternity leave, a woman who has worked six out of the ten months preceding confinement, is entitled to daily cash benefits of 100 percent of earned income up to six times the basic amount for 42 weeks, or 52 weeks at 80 percent of earned income.
13. Family allowances are provided for children residing in Norway under the age of sixteen. Prior to the new child allowance proposal adopted by the government (see below), the allowance for the first child between one and three years of age was Nkr 18,996, falling to Nkr 11,112 once the child reached three years of age. Slightly higher amounts were provided for each additional child.
14. In May a new child allowance measure was passed providing up to Nkr 36,000 for each child between one and two years of age depending on whether use is made of the government’s child care services. Families choosing to decline the government’s child care services would receive the complete allowance irrespective of whether the child was looked after at home or through a private agency; the allowance would be pro-rated for families using the government’s child care services on a part-time basis. The new measure came into force in August 1998 and would be extended to families with children between the ages of two and three in January 1999. The government also proposed to expand the coverage of government day care services to 75 percent of children aged between one and five years old; the current coverage is about 60 percent, up from 50 percent in 1995. To ofset some of the expenditure costs of the new child allowance scheme, the government lowered the basic child allowance for children between one and three years of age to Nkr 11,112 for those participating in the new scheme.
15. Unemployment benefits are provided to all insured persons registered at an unemployment office, able and willing to work, with an annual income of at least 1.25 times the basic amount the preceding calendar year or equal to the basic amount as an average during the three preceding calendar years. The calculation of benefits is based on the highest of the income of the preceding year or the average over the three preceding calendar years with income received from work, employment programs, periods of unemployment sickness and maternity included. The maximal benefit is six times the basic amount and the benefit rate normally gives an annual compensation of 62 percent of the calculation basis, and a delayed payment of an additional 6 percent, raising the replacement rate to 68 percent. The benefit period depends on earlier income from work. Labor income above twice the basic amount gives a benefit period of three years, labor income below twice the basic amount gives a benefit period of one and one-half years. When the initial benefit period has expired, a subsequent benefit period may be granted provided that the requirements concerning previous income are met. Persons over 64 are guaranteed at least three times the basic amount, paid without limitation until the age of 67. This could be considered an alternative form of an early pension provision.
Indexation and taxation of benefits
16. Since the introduction of the current pension system in 1967, the minimum wage has increased much more rapidly than the basic amount. Over the 1967-1990 period the real value of the minimum wage rose by about 80 percent, slightly higher than the increase in the real wage at about 60 percent, and much higher than the increase in the real value of the basic amount at slightly above 10 percent. Since 1990, the basic amount has increased at an average annual rate of about 4 percent, broadly in line with the average growth in wages. The minimum pension has risen even more rapidly over this period averaging over 5½ percent per annum, consistent with the objective of successive governments in narrowing the dispersion of incomes for retirees.
17. The NIS is a pay-as-you-go system that is financed through employee and employer contributions (70 percent) and from general government tax revenue (30 percent). Benefits from the NIS are taxed as earned income with the exception of family allowances and minimum pensions. Contributions from employees are based on pensionable income above Nkr 17,000. The employee contribution rate is 7.8 percent of gross wage income; the employer contribution rate differs according to the regional zone in which the employees reside (ranging from 14 percent for Oslo to 0 percent for the Northern region). The contribution rate for pensioners is 3 percent.
B. Calculation of Long-Term Pension Expenditures
18. As in many other industrialized countries the aging of the population poses considerable financing challenges to Norway. Between 1995 and 2050 the number of pensioners is expected to increase by 65 percent while concurrently the budgetary contribution of petroleum revenue is expected to fall from a peak of 10 percent of GDP in 2005 to 2 percent of GDP in 2050. In contrast to other countries which have been forced to legislate increases in social security contributions to cover the financing gap between revenues and future pension obligations, under reasonable assumptions Norway could be in a position to use its State Petroleum Fund (SPF) to cover these expenses.2 The purpose of this section is to describe in detail the assumptions which underlie the rapid projected increase in pension related expenditures over the next 50 years.
19. The calculations are based on annual demographic projections of the number of males and females at each age through 2050 and were provided by Statistics Norway. The figures take 1998 as a starting point and use the average basic and minimum pension amount for that year. The projections assume three categories of recipients of the national pension: supplementary pension earners, minimum pension earners, and individuals on disability pensions.
20. The basic expression for the calculation of the supplementary pension is as follows:
supplementary pension=(basic pension*pension-earning years*0.42)/40
The current average level of pension points for males and females (4.3 and 3.3) is used for all pensioners over 67 years of age. Male retirees in 1998 and beyond receive an increase in their pension points to 5.2; pension points for female retirees in 1998 and beyond are initially raised to 4.2 and gradually approach 5.2 to allow for the assumption about wage convergence over time. The choice of 5.2 for the number of pension points is based on the average number of pension points for individuals ranging from 47-67 years of age in 1995 (this is the most recent labor income survey data that is available).
21. Pension-earning years are assumed to equal 31 in 1998, corresponding to the difference between this year and its introductory year in 1967, and rise to a maximum of 40 in 2007. Since 1992 the value of pension-earning years has declined to 0.42 from 0.45 so that an individual turning 67 in 1998 will receive six years based on a pension value of 0.42 and the remaining 25 years based on the pension value of 0.45.
22. In the projection period the basic amount is indexed to average growth in wages which is projected at 6 percent over the next few years falling to 5 percent in 2003 and beyond. Nominal GDP growth is expected to average 5½ percent over the next few years, settling at 5 percent after 2001. Over the medium term wages and nominal GDP are expected to grow at the same rate because employment is projected to be broadly unchanged and workers are folly compensated for future increases in labor productivity.
23. The total minimum pension is indexed by nominal wage growth but the number of individuals receiving minimum pensions is expected to decline over time. This is because a large fraction of future generations will be eligible for the supplementary pension on account of the rapid increase in participation rates, particularly among females, over the past quarter century. In this analysis we take Fredriksen’s estimates of the projected decline in the share of those receiving minimum pensions relative to the total population of pensioners.3 From a current peak of 14 percent, the share of men on minimum pensions is expected to decline to 4 percent in 2050; for women, the current peak of 54 percent is projected to decline to 7 percent in 2050.
24. Since the mid-1980s the willingness of doctors to diagnose disabilities fairly liberally has resulted in a sizeable increase in the number of individuals on disability pensions and is partly responsible for the lowering of the age of eligibility for early retirement pensions to 62 years of age earlier this year, In this analysis the ratio of those on disability pensions to the population of 50-66 year olds is assumed constant at 35 percent, the projected level for 1999.
25. Putting the various components together indicates that the current ratio of pension expenditures to GDP at roughly 8 percent is projected to increase rapidly to about 17 percent of GDP in 2050 (Figure 1, Panel 1). The staff’s projection broadly corresponds with the profile developed by the Ministry of Finance using a much more detailed simulation model. The major differences occur at the beginning of the projection period. The slightly higher expenditure profile of the staff over the 1999-2015 period reflects a higher base level of expenditures and a higher wage growth forecast over the next few years of 6 percent compared to the Ministry’s estimate of 5 percent. The Ministry of Finance projection is fairly flat over the next five years because of the influence of the special transitional provisions made for those who were too old to be eligible for the current pension scheme which was set up in 1967.
FIGURE 1NORWAY: BASELINE PENSION PROJECTIONS
Sources: Ministry of Finance, and staff calculations.
26. In addition to providing pensions for all Norwegians over 67 years of age, the State also finances supplements to government employees if two-thirds of their final salary is higher than the national pension benefit and early retirement pensions (the AFP). Projections of the supplement to government employees are calibrated on the pension distribution of government employees in 1997 assuming that the future profile of pensioners previously employed by the government is comparable to the rest of the population controlling for the more rapid growth in the number of government-employed pensioners. The current differential between the supplement for government employees and the national pension is assumed to be maintained during the forecast horizon. Finally, for those on early retirement schemes, the current ratio of recipients to the stock of 65-66 year olds is maintained over the forecast horizon. The initial pension is based on the weighted average of the early retirement pension of government employees in 1997, which broadly corresponds to a standard national pension with 5.2 pension points.
27. Figure 1, Panel 2 indicates that the pension supplement for government employees rises over time to level out at slightly above 0.8 percent of GDP. In contrast, the early retirement pension peaks at about 0.2 percent of GDP in 2010 and remains at this level for the duration of the projection period. A major factor explaining the different profiles is that the ratio of 65 and 66 year olds stabilizes after 2010 and no increase in pension points is factored into the projection for early retirement recipients because they already receive maximum pension points. Combining the profiles for the standard national pension, the supplement for government employees and the early retirement pension reveals an increase in pension expenditures over the next 50 years of about 10 percent to 18 percent of GDP in 2050 (Figure 1, Panel 3).
28. Chapter II discusses the prospects for fiscal sustainability over the long term by assessing the speed at which requirements associated with the deficit on the non-oil budget operations, including pensions, will draw down assets accumulated in the State Petroleum Fund, under various assumptions. The paper demonstrates that the baseline pension expenditure scenario presented above is not sustainable over the long-term because the SPF is exhausted by 2038. As one way to help address this issue, the staff has suggested making the pension system less generous by indexing pensions to CPI inflation instead of to average wage growth. This form of indexing is currently operative in many countries and was broadly followed for the basic amount over the 1967-1990 period in Norway. Figure 2 indicates that indexing future pensions to price inflation lowers the ratio of pension expenditures to GDP by about 5½ percentage points to about 12¼ percent of GDP in 2050. This modification to the system would help to ensure fiscal sustainability in Norway (see Chapter II for more details).
FIGURE 2NORWAY: BASELINE AND SIMULATION PENSION PROJECTIONS
Source: Ministry of Finance, and staff estimates.
C. Recommendations of the Moland Committee on Financing the NIS
29. On July 2, Mr. Moland (the former central bank chief) presented the findings of a committee set up to consider various financing options for the current pension system. In its report the committee presented four financing alternatives but concluded that no system was superior to the others along all dimensions. The four alternatives considered are as follows:
- 1) maintaining the current system of accumulating assets in the State Petroleum Fund to cover future increases in social expenditures associated with the aging of the population but with no explicit earmarking of revenues for future pension liabilities;
- 2) setting up an independent pension fund which is fully funded but managed by the government;
- 3) setting up a private defined benefit pension fund which is fully funded with contribution payments based on the requirement to finance the future government mandated benefit. The fund would be managed by several private fund administrators; and,
- 4) setting up a private contribution-based pension fund in which individuals’ own contributions would determine their future pension benefit. This fund would also be managed by several private fund administrators.
30. The committee was unanimous on financing the minimum pension through the budget system but there was considerable debate on the relative merits of funding the supplementary pension privately or publicly. Moreover, within the public/private options there was a range of views on the relative merits of a funded system versus the continuation of the current unfunded system and on the merits of a defined benefit pension system versus a contribution-based system.
31. By not earmarking revenues for future pension liabilities, the current system is flexible regarding the financing of future expenditures which are unrelated to pensions and avoids giving the impression to the public that its future pension needs are completely covered, thereby implicitly raising the private saving rate relative to the alternative. On the other hand maintaining the current system could result in lower national savings than under a fully-funded system because without an implicit financing constraint decision makers are less conscious of the size of the future unfunded liabilities and therefore could compromise the future sustainability of the pension system by not setting aside sufficient funds now. An important issue in deciding between the current system and a folly funded system is how such a transition would affect Norway’s macro economy. One of the major arguments for investing the proceeds of the State Petroleum Fund overseas is that it moderates the effect of the current build-up of petroleum production on the Norwegian economy. If however, a fully-funded pension system is introduced, it is likely that there will be considerable demands for a large fraction of the fond to be invested in Norwegian securities because its obligations are in Norwegian kroner. This is a concern because the ability of the Norwegian authorities to neutralize the economic effects of a sudden increase in the demand for Norwegian securities is uncertain. A number of committee members recommend increasing the size of a fully-funded system gradually over time in order to minimize the potential for these effects.
32. The choice of a private versus public pension system involves comparing the benefit of higher expected returns through increased freedom of investment options against the increased administrative costs of private provision because of the absence of scale effects and the need for a long transition period. This is especially true of the contribution-based option because the availability of individualized investment plans will require offering each client the facility to monitor his own account. Moreover, in a contribution-based system, the size of the benefit withdrawal is highly uncertain because it depends on the success of the individual’s investment strategy during his working life. Therefore, if implemented, this system could only apply to new retirees, thereby lengthening the transition period. In a defined benefit system the size of the contribution needed to pay for the defined benefit in future is uncertain and depends on future wage growth and on the average annual return.
33. Norway’s pension regime has complex rules which only provide a weak link between contributions and payments because of the emphasis placed on distributional motives. The system could be simplified considerably by narrowing its focus to a basic pension funded through the budget system as recommended by the pension committee. A pension supplement based explicitly on contributions could then be added to the existing system which would allow individuals to choose their work pattens to influence their financial rewards in retirement. Provided that the basic pension was sufficiently generous, the variation between individuals in the size of the private pension supplement would not compromise the distributional objectives of the government. Moreover, the added administrative complexity of a contribution-based system would be partially offset by the paring down of the current system.
Prepared by Alun Thomas.
The SPF was set up in 1990 to insulate the mainland economy from developments in the oil sector by channeling expected budget surpluses associated with the peak in petroleum production into a large net foreign asset buffer available to be drawn on when petroleum production falls to much lower levels. In recent years the government has also noted that the SPF could well become large enough to pay for the rapid rise in pension expenditures associated with long-run demographic trends.
Fredriksen, D. (1998) “Projections of Population, Education, Labor Supply and Public Pension Benefits: Analyses Using the Dynamic Micro Simulation Model MOSART”, Social and Economic Studies, Statistics Norway.