Lessons from the Great Swedish Pension Reform Should we move towards more funding and less PAYG?

Reform Reasons Financial instability A Unfair redistribution of income Significant work disinscentives C

according to new system Pension reform process - very long 1990 1991 1994 1998 2001 2003 1994 Parliament adopts principles of the new pension plan 1998 Main legislation of the new pension plan 2001 Legislation on the automatic balance mechanism 1992 Draft of a new pension plan 1991 Commission set up 2003 ”first” payments according to new system But transition rather quick i international comparison

Reform Objectives Financial stability (= Credibility?) A Transparency Maximize inter-generational fairness C Basic income security D

What Is a Notional Defined Contribution (NDC) Pension System?

Four basic design options Tie between contribution and accrued pension credit 0 % 100 % III IV I II Pay- as- you- go Defined Contribution Funded Theoretical or formal risk distribution 100 % insured 100 % insurer (= taxpayers) Defined Benefit 0 % 100% Degree of funding

Reform Strategy Defined Contribution Defined Benefit PAYGO Funded Premiepension Funded Inkomstpension “NDC” Contribution 16 % Contribution 16 % Defined Contribution I II D S G D = Disability pension S = Survivors pension G= Guarantee pension Defined Benefit Old pension scheme III IV PAYGO Funded

Pensinable income of insured Each crown payed during life result in the same amount of pension credit Pensinable income of insured SEK Funded 2,5 % 16 % Pay-as-you-go

Credited contributions Development of notional account and convertion to an annuity Life expectancy (65 =18,5) Interest rate 1,6% - The amount on the notional account, SEK Age 25 30 35 40 45 50 55 60 65 70 75 80 Net indexation Administration Survivors bonus Annuity divisor 15,7 Interest with change in average income Credited contributions = Pension

Pension as an annuity Pension Age Imputed interest 0,0 % growth 1,6 % 85 45 50 55 60 40 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 Age Pension Imputed interest 0,0 % growth 1,6 % ..interest 1,6 % growth 2,0 % ..interest 1,6 % growth 1,6 % ..interest 1,6 % growth 1,0 %

Individual information Micro level information

Why individual information? The change from a defined-benfit to (two) defined-contribution systems Harmonise the expectations of the insured with the economic and demographic realities Improve the insured’s opportunities for well informed decisions Create a relevant sense of confidence and trust between the system and the insured Make clear that: If life expectancy continues to increase you either will have to delay your retirement or accept a lower annual pension

Premium pension system Page 1 2 The development of the notional account 3 Pension credit earned last year The NDC system & Premium pension system Projection of the future pension 4 Premium pension funds 5 The development of the funded account 6 Explanations

Page 1 2 3 4 5 6

Page 2 1 euro 9 couronnes

Continuation ... The projection Page 1 Continuation ... The projection If you draw your pension from age: age 61: With growth 0 %: you receive SEK 7 321 per month 10 278 per month With 2 % growth you receive age 65: With growth 0 %: you receive SEK 9,374 per month 14 272 per month age 70: With growth 0 %: you receive SEK 13,270 per month 22 368 per month

The base : the last value of the virtual and financial accounts. Page 1 Continuation ... The elements of the annual individual projection The base : the last value of the virtual and financial accounts. A. The assumption made on the individuals future contributions to retirement: = 16 % + 2,5 % x last income + 0 % & 2 % B. Annuity divisor : projected life expectancy at 61, 65 and 65 for each birth-chohort C. Indexation / return: D. 0 % 3,5 % 2 % 6 % At age 61 : 7 321 9 374 13 270 14 727 22 368 10 278 At age 65 : At age 70 :

What are the ideas behind this complicated individual projection? Page 1 Continuation ... What are the ideas behind this complicated individual projection? The importance of economic development (Growth in average income and the return on capital) The importance of retirement age, and life expectancy development Age 61: 0.78 1.10 Age 65: +/-0 1.52 Age 70: 1.42 2.39

You may receive a pension from more than one source Page 1 Continuation ... You may receive a pension from more than one source In addition to the national pension, you may also receive pension benefits from other sources. This may be an occupational pension from your employer or perhaps a pension from your own private pension savings. Such benefits are not described here.

Here opinions differ wildly, at least in Sweden What is a fair pension system? Here opinions differ wildly, at least in Sweden

Some of many possible, definitions of a fair pension system: 1. Same pension for all 2. Same replacement rate for all 3. Same ratio of expected benefits over contributions for all Calculated at what discount rate? Discount with average income growth, always! Every contribution, for every insured, has the same expected value

Annual income euro Pension X 18.5 % White collar worker 50 000 X contribution rate 18.5 % White collar worker 25 000 Blue collar worker 20 25 30 35 40 45 50 55 60 65 70 75 Age of worker

Accumulated contributions= pension credits Euro 200 000 Accumulated contributions= pension credits 100 000 Accumulated interest (indexation) 20 25 30 35 40 45 50 55 60 Age of worker

Notional Capital, i.e. accumulated contributions & interest (indexation), euro 300 000 200 000 100 000 20 25 30 35 40 45 50 55 60 64 Age of worker

Credited contributions Remember this image? Life expectancy (65 =18,5) Interest rate 1,6% - The amount on the notional account, SEK Age 25 30 35 40 45 50 55 60 65 70 75 80 Net indexation Administration Survivors bonus Annuity divisor 15,7 Interest with change in average income Credited contributions = Pension

Annual income euro Pension White collar worker Blue collar worker 50 000 White collar worker 25 000 Blue collar worker Replacement rate 42 % Replacement rate 65 % 20 25 30 35 40 45 50 55 60 65 70 75 Age of worker

Fairness, etc Types of Pensionable Income 11% Sickness unemployment parental benefits, etc. Disability benefits 4% 2% Child years 83% Wages & incomes of self employed

Guarantee pension change the distribution of risks for those with low or no income-related pension The guarantee is a basic security financed with general tax revenue 140 000 20 000 40 000 60 000 80 000 100 000 120 000 42 000 Income-related pension Guarantee Earnings- related + guarantee pension Earnings-related pension

Pension age to neutralize life-span effect on pension Projected annuity divisor Birth cohort Gender neutral life- expectancy at age 65 Effect on pension from increased life-span ...turns 65 1940 2005 15,7 – 65 years 18 y. 6 m. 1950 2015 16,4 –4 % + 7 months + 11 months 1960 2025 17,0 –7 % + 13 months + 20 months 1970 2035 17,5 –10 % + 18 months + 28 months 1980 2045 17,9 –12 % + 23 months + 35 months 1990 2055 18,2 –13 % + 26 months + 41 months gdasjdghasdjj

Projected Compensation Rate at age 65, Cohorts 1938-1990 Average pension at 65 relative to average wage for those working at that time Procent 10 20 30 40 50 60 70 Garantipension Life-span effect Inkomstpension Premiepension Old Scheme gdasjdghasdjj Birth Cohort

Without balance mechanism Simulations of net contribution 2002-2077 in percent of total contributions 90’s Born in the 1940’s 60’s Without balance mechanism

Without balance mechanism Simulations of fund ratio, 2002-2077 Market value of buffer fund One year of pension disbursements Without balance mechanism

Four stylised policy makers – which one are you? The publics perception of the policy makers knowledge of the future 1 Trusted true prophet Mistrusted Accountant false Line of satisfied expectations Policy makers knowledge of the future 1

Distributed by: Riksförsäkringsverket (RFV), Stockholm The end