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“The Swedish Pension Reform” Bengt von Bahr Sweden Summary

The former Swedish pensions system was established in 1960. It consisted of two parts – the National Basic Pension and the National Supplementary Pension. Guidelines for a pension reform were adopted by the Swedish parliament in the summer of 1994, and in June 1998 the majority of legislation constituting the reform was passed by the parliament. The decision was to replace the current defined benefit system with a defined contribution system consisting of two main types of pension: the Income Pension and the Premium Pension. The Income Pension comes under a pay-as-you-go system, while the Premium Pension is a scheme where contributions are invested in funds chosen by the insured (the pension saver), i.e. a premium reserve system (funded system).

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“Das schwedische Pensionsreform” Bengt von Bahr Sweden Zusammenfassung

Das vorige schwedische Pensionssystem wurde 1960 eingefuert. Es bestand aus einer Altersrente und einer allgemeine Zusatzrente, die vom Einkommen abhängig war. Die Richtlinien fuer eine Pensionreform wuerden von dem schwedischen Reichstag im Sommer 1994 angenommen. Im juni 1998 waren die vollständigen Gesätze fertig. Der Beschluss bedeutede dass das vorhandene System mit definierte Grösse der Rente mit ein System mit bestimmten Beiträgen ersetzt wurde. Das neue System besteht aus zwei Teilen: die sogenannte Einkommenrente und die sogenannte Premiumrente. Der erstgenannte Teil ist ein Verteilungssystem und der zweite ist ein System, wo die Einbezahlungen in Fonds investiert werden, die von den Versicherten selbst gewählt werden.

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Sweden’s new pension system Bengt von Bahr 1. The final decision on the new Swedish pension system was taken in our parliament in 1998. Before that, committees had been working with these questions for decades, but the main principles of the new system were laid down as early as in 1994. The first pension payments from the new system started last year, that is in 2001. The new system is introduced gradually. People born before 1938 get their entire pension from the old system, people born after 1953 only through the new system, and people born in between get a mixture. 2. The former Swedish pension system consisted of two parts, one basic pension, amounting to about US$ 4 000 per year for everyone, and one income related supplementary pension. Together, these two pensions could give the retiree up to 60 % of his salary before retirement. Both systems were of the type pay-as-you-go (PAYG) and defined benefits. The outcome of this system was determined from the average salary of the 15 best years, and you had to work at least 30 years to get full pension. 3. The reasons to change pension system in Sweden were the same, I think, as in all industrial countries. The system was not financially stable and would not be able to fulfil its promises in the future. The main reasons were: • The benefits were indexed by inflation, regardless of the strength in the economy and regardless of the income to the system. It was estimated that the system needed a persistent increase in the Swedish economy (GDP, gross domestic product) of 2 % annually. This worked out quiet well during the 50´s, 60´s and the beginning of the 70´s, but not since then. • Demographic factors. Longer expected life times and fewer persons in the active ages put hard pressure on the system. In the year 2000, 100 active persons had to support some 30 retired, but it is estimated that the corresponding number in 2025 will be 41. 4. The new system tries to handle these difficulties. It consists of three parts. First the Guarantee Pension, which is applied if the benefits from the two other parts don’t come up to a certain level. The two main parts are called Income Pension and Premium Pension. Both systems are of the type ‘defined contribution’, and you are granted so-called pension rights to these systems each year you earn a salary. The contribution to the system is defined as 18,5 % of your pensionable income: 16 % goes to the Income Pension and 2,5 % to the Premium Pension. People also get pension rights to both systems when having children under the age of four, when doing military service and when studying at university. 5. The Income Pension is a PAYG system, so no money is funded in this system. But nonetheless, everybody has an account in this system. Every year 16 % of your pensionable income is added to your account. This account imitates a real pension savings account, and every year, the balance of the account is increased by a factor, determined by an income index, which follows increase of income in the Swedish working population. In this way, the future pensions will follow the general income development. But also, the pensions, which are the output from the system, will follow the development of the input to the system, which is proportional to the total salaries earned in Sweden during the year. The system also imitates a real pension system by distributing the capital from the deceased to those living, as survivor bonuses. At retirement, the yearly pension amount is determined by the value of the account, through division by an annuity. The annuity can change over the years depending on the changes in expected remaining lifetime. It is

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calculated with an assumed rate of interest of 1,6 % annually. In this way, the system becomes less sensible to future changes in life times. The pension increases year by year according to the increase in the income index, after having subtracted 1,6 %. 6. People can retire at the age of 61 at the earliest, but there is no upper retirement limit. The later you retire the higher the pension. If you work and have income during retirement, you will earn new pension rights, which will increase your future pension. This goes for both the Income Pension and the Premium Pension. The Guarantee Pension, which I mentioned earlier, starts at the age of 65, if the contributions from the two other parts of the new pension system are too small. 7. I will now turn to the Premium Pension, which is more interesting for actuaries. This system works as a real unit linked pension system. A new special government authority, the Premium Pension Authority (PPM) has been set up to administrate this system, and it acts more or less like a mutual life insurance company. The flow of money goes as follows. Each month, all employers pay a certain percentage of the total salary sum to the tax authorities. One part of it, which is intended for the Premium Pension, goes further to the National Debt Office. There it stays until the tax authorities have determined the pensionable income for each individual. This takes place at the end of the year after the income year. During this waiting time, which is about 18 months, the money earns interest. After this, the money is sent to PPM, which invests the money in mutual funds determined by the pension savers. 8. Each fund that is accepted by the supervisory authorities on the Swedish financial market can take part in the Premium Pension system. PPM has contracted about 70 fund managers with about 600 funds. PPM acts as an intermediary between the pension savers and the fund managers. PPM is the formal owner of all units and the fund managers do not know which pension savers have units in their fund. When new money comes in to the system, when pensions shall be paid out or when pension savers wish to change funds, PPM sends a net order, either a buy order or a sell order, to the fund managers. PPM is a very large customer to the fund managers, and has negotiated quite large rebates of fund manager’s fees, so-called kickbacks. The rebate is higher the more money PPM has invested in a fund and the higher the normal fee of the fund is. 9. Each pension saver has an account in the Premium Pension system. He can chose at most five different funds. When he enters the system, that is when he has earned his first pension rights, at the age of 16 or later, PPM sends a catalogue with information about this pension system and with descriptions of all available funds that can be chosen. After having chosen funds, the pension saver can follow the development of his account using Internet or by telephone and he can also change funds free of charge using these media or ordinary mail. PPM sends out a yearly statement, which informs about what has happened to the account during the previous year. PPM takes out a yearly fee, at the moment 0,3 % of the balance per year, and distributes survivor bonuses and kickbacks. 10. The pension savers get 2,5 % of his pensionable income each year as contribution to his Premium Pension. This amounts to about 400 US$ per year on the average. The pension you can get from these earnings depends of course on the increase in the values of the funds. If you have earned this income over a period of 40 years, the monthly pension may be 400 US$ if the increase of funds is 4 % per year, but more than double if the increase is 7 % . This is not very much, but the Premium Pension constitutes only a minor part of the new Swedish Pension System. 11. It is possible to transfer pension rights for the Premium Pension between spouses. A husband can transfer what he has earned one year to his wife, and vice versa. A special actuarial calculation has been made in this respect. Three facts, or assumptions, lie behind this calculation. These are:

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It is assumed that more pension rights will be transferred from men to women than in the opposite direction. The reason for this is that men on the average earn more money than women, and thus get higher pensions, and that married couples may want to even out these differences. • It is expected that women will live longer than men. • The monthly pension amounts in this system are calculated using the same actuarial basis for men and women. It is therefore expected that transfers of pension rights between spouses will increase the pension payments from this system. According to the law that governs this business, this extra cost must be borne by those who use the possibility of transferring pension rights between spouses. To compensate the system for this extra cost, we reduce the transferred pension rights. Using certain assumptions on how much will be transferred in each direction, and on future remaining life times for the different sexes, we have decided that this reduction shall be 14 %. Thus, the receiving spouse gets only 86 %, and the rest is distributed over all pension savers as an extra survivor bonus. 12. At retirement, or later, the pension saver can choose between the following alternatives. He can decide to let his money stay in mutual funds, which probably will imply that the pension amounts will vary from year to year. In this case, there is no guarantee whatsoever concerning the size of the monthly amount. PPM calculates the monthly amount once a year by evaluating the balance of the account and dividing it by an annuity. The annuity is calculated with assumptions on future life length and 4 % rate of interest. The other alternative is to choose a traditional annuity, which guarantees lifelong payment of a fixed monthly amount. In this latter case, PPM sells the units corresponding to his account and invests the money in the same way as an ordinary traditional mutual life insurance company would do. In this case the guaranteed amount is calculated with a little more cautious assumption of future life length and 3 % rate of interest. If PPM´s traditional life insurance business yields a surplus, bonus will be added to the payable amounts. 13. There is one more option at retirement. For married persons, it is possible to choose a life long joint life annuity instead of a single life. In this case the pension is paid out as long as one of the spouses lives. Of course the monthly pension will be lower in that case. 14. Married persons thus have two extra options: to transfer pension rights during the savings period and to choose joint life pension at retirement. It will be interesting to see if in either of these cases adverse selection will occur. Will persons who expect a short life transfer pension rights to a higher extent than others? And will they choose joint life pensions? In a few years from now it will be possible to measure the mortality among those who have chosen these alternatives, and see if it is higher than normal. 15. Another survivor’s insurance than the joint life pension was also originally part of the Premium Pension system. It was an optional survivor’s pension, which the pension saver could chose before retirement. The premium for this insurance would be taken from the pension savers own account, and the benefit at death would be a temporary survivor’s pension of 300 US$ (or 600 US$) per month for five years. Since the Premium Pension is a part of the national social security system, any type of underwriting procedure like health assessment was excluded. To lower the risk of adverse selection a one year qualifying period was introduced, and also some restrictions concerning the right to sign up for it after the age of 50. The Swedish Actuarial Association advised strongly against this product, but nevertheless, it was decided. In the autumn last year, a few months before it would be launched, PPM sent a letter to our government and warned for a possible major loss in the economy for this product, and as a result, it was finally withdrawn. Not

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permanently, but for one year for further analysis. We are convinced that an optional risk product of this kind is impossible without health assessment. 16. In the letter to the government, PPM gave the following example. Suppose that 100 000 persons have signed up for this insurance product. The mean premium would be 40 US$ per year. This will yield a yearly income of 4 million US$. The mean mortality in the actual ages is 2,2 ‰ and the risk sum (amount at death) is 18 000 US$, so the expected death payments per year is also 4 million US$. Now, we know that about 12 000 persons die per year in Sweden in the ages between 20 and 65, and out of them, about 10 000 die as a result of a serious disease. Suppose that 1 % of those 10 000 persons, that is 100 persons, chose to sign up for this insurance more than one year before they passed away, and, naturally, chose the double amount, 600 US$ per year for 5 years. Then these 100 persons would cause extra death payments amounting to 3,6 million US$, comparable to the total ‘normal’ premium income. This would of course erase the economy of this product completely. I think that even the assumption of 1 % is too optimistic.