Address to the conference European pensions organised by the Institute of Economic Studies at the University of Iceland at the premises of the Central Bank of Iceland.

Ladies and Gentlemen,

It is an honor and a privilege to have the opportunity to address this distinguished audience, and welcome you to Iceland. I am quite sure, just by looking at the conference schedule, that you have an interesting conference ahead of you. The range and quality of the speakers here today is very impressive and I congratulate the Institute of Economic Studies for being able to bring all of you together.

The topic of discussion, "European Pensions", is a very relevant one, and a particularly interesting one for us here in Iceland where we have been reforming our pension system in the recent years. The Icelandic pension system can now almost be viewed as a model for other countries, and I believe that we have been able to manage things in such a way that we can look to the future without much worry.

Most countries today face challenges in the years ahead as a result of demographic changes where the proportion of older people will increase. I think everyone agrees that this calls for action and reforms. Furthermore, since reforms take time, the sooner reforms are implemented the better. This will serve the dual purpose of, firstly, to give the people affected, i.e. those retiring, more time to prepare and adjust while they are still of working age. Secondly, if reforms are delayed they will have to be all the more severe and may lead to distortions in the economy and adversely affect the fiscal balance.

As I said earlier, in many ways the situation as regards the pension system in Iceland seems to be better than in most other countries. Already, in the beginning of the 1970s we established a private pension fund scheme and it is now becoming more or less fully funded. Two years ago, similar changes were made to the public pension fund system and as a result of these reforms, this system will in due course be fully funded. Finally, at the beginning of this year important changes were implemented in order to strengthen the financial position of the funds and ensure similar pension rights for all pensioners. Increased freedom of choice, i.e. greater emphasis on voluntary pension savings, is also an important element.

As a result of these changes, the pension system in Iceland will gradually move from being essentially based on two pillars, i.e. a public pension scheme and a compulsory occupational pension fund scheme, to a three-pillar system with the addition of a voluntary private pension scheme. In this context, it is worth noting that this three-pillar approach is in close conformity with the recommendations of both the OECD and the World Bank.

The first pillar is publicly managed providing a tax-financed means-tested basic pension from the age of 67 and a means-tested supplementary pension from the age of retirement, usually at 65-70 years. The public pension scheme guarantees a minimum pension of about 44 per cent of the average before-tax salary of a male industrial worker.

The second pillar is a mandatory, more or less fully funded occupational scheme. According to present rules, a typical pension fund may pay a pension amounting to 45-58 per cent of average earnings in the age group 40-60 years with the first pillar adding another 11 per cent which brings the total replacement ratio to 60-70 per cent.

The third pillar, a fully funded voluntary savings plan, is still relatively small in Iceland. But the recent reforms, including a special tax incentive to pay into a private savings scheme of up to 4 per cent of the total income, will serve to gradually increase their role in the overall pension system in the coming years.

The Icelandic case is in many ways special. For instance, as regards the retirement age, there has never been a serious discussion about whether it should be lowered. If anything, many older people have felt that they should be allowed to work as long as they are fit and there is a demand for their services. As a result, we have one of the highest retirement age in Europe, in effect at 70, even though the official retirement age is 67. This is very important in order to prepare for future demographic changes.

Furthermore, there is a built-in disincentive for early retirement in the pension system where the level of pension payment is reduced if you retire early and the recent reforms go even further in this direction.

Thirdly, high employment has always been one of the main policy issues in Iceland and, as a result, there have only been brief spells of serious unemployment problems in Iceland. Therefore, we have not been forced to introduce widespread labour policy measures, many of which are now felt to provide strong disincentives to work in other countries. Finally, as I mentioned earlier, we had the good fortune to introduce a funded pension system in the early 1970s. All these factors have helped us be better prepared for meeting the demographic challenges ahead.

I would like to mention a recent study that was done comparing the pension systems in the five Nordic Countries. The authors of the study are known to this audience, Tryggvi Þór Herbertsson, Michael Orszag and Peter R. Orszag, all speakers at this conference.

At a meeting of the Nordic Council of Ministers of Economic and Finance in November 1998, I proposed, as a part of the Icelandic chairmanship, that a study concerning the status and future prospects of financing the pension systems in the Nordic countries should be undertaken. This study is very interesting and provides us both with important information about the different systems as well as with policy recommendations for the Nordic governments. I will not go further into the findings of the study as I am sure that the authors will do so in their speeches later on, but I wanted to take this opportunity (on behalf of the Nordic Council of Ministers) to thank them for their good work.