Switching the pension system for public employees in Iceland from defined benefits to defined contributions

Abstract

In 2016 and 2017, radical changes were made to the pension system for public employees in Iceland by transitioning from defined benefits (DB) to defined contributions (DC). These changes were said to be desirable to align the pension benefits of public employees with those of other workers. However, they were controversial and imposed through legislative amendments, despite opposition from labor unions and without the consent of fund members. This article examines the premises and effects of these changes, with a particular focus on the actuarial calculations related to the A division of the Pension Fund for State Employees in Iceland, LSR. Under the previous DB system, the state was the guarantor, ensuring specific pension rights for fund members regardless of economic and demographic developments. In the DC system, fund members now bear the risk associated with these factors. Despite promises that pension rights would be equally valuable after the transition, fund members have experienced significant reductions in their benefits due to the changes. Actuarial assumptions were incorrect and the government’s financial contributions to support the transition were insufficient to maintain the value of the original pension entitlements. The article also discusses international standards for similar pension transitions, which typically emphasize that employees should be given the choice to retain their previous system or switch to a new one. The conclusion is that the reform was flawed, both in its structure and execution. Fund members have suffered substantial financial losses as a result that the government may ultimately need to compensate.