In his Others' Views commentary May 13, James H. Smalhout discusses the history of the credit insurance business run in conjunction with the Finnish pension scheme and calls it a cautionary example and a fiasco.
This criticism could be justified, at least to some extent, if the business had been run by a normal commercial credit insurance company. However, he fails to appreciate this was not at all the case.
The primary purpose of the credit insurance was to support the recovery of the country's economy and to create employment in a period when emigration was a serious problem.
Mr. Smalhout's writing gives a totally erroneous picture of Finnish credit insurance and - still worse - of the skills of the Finnish experts to manage their profession. Hence, the subject necessitates a reply.
Post-war Finland experienced a dramatic and rapid transformation from an agrarian to an industrial society, leaving the agrarian population redundant on a mass scale.
Finding jobs for them posed an enormous problem for a country that was just recovering from the hardships of war. Unfortunately, this task was, to a large measure, beyond the resources of the country.
As a consequence, some 300,000 to 400,000 persons in the prime of their working life left the country and moved abroad, mostly to Sweden. This was about 10% of the population younger than 60; it caused Finland's future irreparable damage.
Therefore, in the design and introduction of the pension scheme, the main investment strategy of the assets was the support of business activities and job creation in order to rescue as many people as possible from being lost as emigrants.
In order to be successful, the strategy required that assets also could be invested in sound and promising companies that had not enough conventional capital, which is often the case in newly started enterprises.
Just as the supply of capital was important to these operations nationwide, a credit insurance business was established and incorporated into the employment pension scheme in the custody of the Central Pension Security Institute. For it to be of real use, it was reasonable and purposeful to substantially relax the conventional conditions applied within the commercial credit insurance business. Failing this, many a perfectly viable and promising business undertaking would never have materialized for want of capital.
In addition to the lack of capital, the high premium rates of the bank guarantees and credit insurance available had been another obstacle to raising investment capital. Rates of 2% to 3% of the liability sum had been required even in the case of sound entities.
Expert analyses commissioned by the Central Pension Security Institute indicated this current rate could be substantially reduced. This was, of course, associated with a risk, but the idea of indirectly subsidizing operations explicitly justified risk taking when it meant improved chances of attaining employment goals. The CPSI caused premium rates to plummet to 0.5% to 1%.
The investments took off well and were successful for 30 years, CPSI's credit insurance being an important reason. There are estimates showing the scheme helped create at least 200,000 new jobs. Taking into account the family members concerned, at least some 300,000 to 400,000 persons were rescued from emigration.
The architects of the credit insurance business of the CPSI were, of course, well aware of the risks associated with indirectly subsidized credit insurance. In fact, such risks might not, by normal standards, be insurable at all.
This is why the credit insurance was linked to the nationwide statutory pension scheme that was to act as the final guarantor. This deliberate risk taking was, no doubt, justified regarding the aims of the scheme.
To reduce the risk involved, a massive equalization reserve was built up, made to withstand a depression as severe as the Great Depression that shook the world in the 1930s. However, in the early 1990s, Finland witnessed a depression that was twice or three times as disastrous as that of the 1930s.
This new depression was caused by several unfortunate coincidences and developments, including the near extinction of trade between Finland and the Soviet Union. This trade had represented around one-fifth of Finland's foreign exports and it took time before the loss could be compensated for by trade to Western economies.
Considering that not even Henry Kissinger could predict the collapse of the Soviet Union, how could the credit insurers of the Central Pension Security Institute be expected to have been prepared for it or for the simultaneous occurrence of the other unfortunate developments?
It is - or should be - well known that the normal insurance safety idea of broadly diversifying risk does not work in credit insurance. A recession, and much more a depression, triggers claims far over what they would be according to the conventional "law of large numbers."
The outcome was that the equalization reserve was not high enough to cover the losses, but an additional loss of 2 billion Finnish markkaa was to be credited from the guarantor and, eventually, to be covered by a tiny, temporary increment in the pension contributions.
Considering there are estimates to show the employers who were granted loans at the lower rates maybe saved around FIM 4 billion to 6 billion (and probably more) in credit insurance premiums and bank guarantees over a period of 30 years, I would hardly call it unreasonable, and certainly not a fiasco, if they now have to repay some of their savings.
Mr. Smalhout wanted to show how "enormous" the loss was by translating it into a U.S. dimension by arriving at $50 billion. If we use the same scale for the rescued part of the population, it would amount to 50 million persons.
Mr. Smalhout's comparison with the corresponding Swedish credit insurance scheme for the labor market is totally out of place. The business concept adopted in Finland was entirely different from the Swedish one, as are its organization and working environments.
In expressing amazement at the Finnish borrowing scheme, Mr. Smalhout has perhaps failed to appreciate that in Finland, pension insurance companies and pension funds compete in an open market. Because the funds can freely "loan" the reserves to the host employer (which cannot easily be forbidden by law or otherwise) the insurance companies have had, in order to preserve market neutrality, to offer the same advantage.
All things considered, the project was a success story. The balance between the final loss against the savings by the employers is still strongly positive. But above all it helped expand the Finnish economy and create abundant new job opportunities at a time when the war had left the country short of capital. The rescue from emigration turned out to be great (in the country's total dimensions). The fundamental aims of the credit insurance were achieved, in fact beyond what could have been anticipated when the venture was established.
Recently, the Central Pension Security Institute chose to close the credit insurance based on the original concept and moved it to a specialist company, Garantia. This was motivated by the fully changed circumstances of the country, but that is another story.
Professor Teivo Pentikainen, Ph.D., was chairman of the committee responsible for the design of Finland's employment pension scheme and credit insurance, overseen by the Central Pension Security Institute, Elaketurvakeskus, Helsinki, Finland.