Transcript The new Swedish Pension System

A review of the Swedish Pension
Reform
Strengths and Weaknesses
Contribution to the 10th International Pension Seminar in Tokyo,
Japan, organised by the International Pension Research Institute,
November 22, 2005
KG Scherman
1
Problems
• A normal pensionable age that had been unchanged for
decades, in spite of a raising life expectancy
• The “baby boom” generation approaches retirement
• Too generous a benefit formula, requiring only 30 years for
a full pension, the amount of which was based on average
earnings during the 15 best years
• Many of these problems originated from the fact that the
system was designed at a time when the expectations about
economic growth were much more optimistic than today
2
The Aim for a new Public Pension
The public pension system shall give a
pension at approximately the same
replacement rate (old age pension as
percentage of final salary) as in today’s
system, i.e. somewhere between 55% and
65%, for a person who works to “a normal
extent”, provided there is a 2 % real growth
in the national economy.
3
The New System
• Earnings related part with two subsystems
• PAYG, Notional Defined Contributions, 16%
• Premium reserve, fully funded, 2,5%
• A guarantee for those who have no or only a
small pension
• Various supplements, especially for housing
4
The minimum pension
5
Minimum pension
(reduced against public earnings related pension but
not against any other earnings or income or wealth)
• Today:
– Minimum pension: around 8 800 Euro for a person
without any earnings related pension at all
– Max. earnings related pension around 19 800 Euro
• Tomorrow (2% real growth, 35 years):
– Minimum pension: Still 8 800 Euro for a person
without any earnings related pension at all
– Max. earnings related pension 39 600 Euro
6
18, 5 % of covered earnings
• Ceiling around 33 800 Euro, indexed to average
earnings
• 11% is paid by the employer, 7% by the employee
• Certain periods (social security benefits, child
care, military service, higher education) give
pension rights for which the individual and the
state pay the contributions
• The contributions are split between PAYG-scheme
(16%) and fully funded scheme (2,5%)
7
The PAYG, Notional Defined
Contribution (NDC) part
8
The PAYG, Notional Defined
contribution part : Contributions and
covered earnings
•
•
•
Contributions, 16 %, unchanged
indefinitely
Benefits based on all earnings over an
individual’s full working career
it is the contributions paid to the system
on behalf of each individual that
constitutes the pension rights;
9
The PAYG, Notional Defined
contribution part: Pension calculation
•
•
•
•
pension rights are indexed according to average
wages and accumulated during the entire career;
the retirement age for an individual is flexible
after age 61;
the pension amount is dependent upon a cohort's
average life expectancy and on the individual
age of retirement;
pension benefits are indexed in relation to
growth in average wages minus 1.6 per cent;
10
The NDC pension is dependent
on life expectancy and a
”norm”
./.
notional account
Life expectancy at
the time for
retirement
Adjusted for the norm= Amount of
old age pension
11
Basic ideas behind the calculation
• Reduce pension drawn at a certain date, for
later cohorts when life expectancy increases
• with the aim to maintain financial balance
• Use the ”norm” in order to
– Increase first years pension
– By reducing the yearly revaluation
as compared with a straight wage
indexation
12
The yearly revaluation is wage
increases- 1,6%
Growth = norm
High
growth
Low growth
%
%
%
Average rate of
nominal wage
increase
4.7
5.4
3.7
Rate of price
inflation
3.1
3.1
3.1
Average rate of real
wage increase
1.6
2.3
0.6
Deviation from the
norm 1.6%
0
0.7
-1
Pension adjustment
= economic
adjustment
index
3.1
3.8
2.1
13
Pension as compared to wage for
people who remain in employment
pension
earnings of
people
remaining in
work
replacement
rate
Average wage
increase:
Average wage
increase:
Average wage
increase:
1%
2%
1%
2%
1%
2%
at the year of
retirement
100
100
167
167
50
50
10 years
later
94
104
184
204
43
43
20 years
later
89
108
204
248
37
14 37
The Automatic Balancing
Mechanism and the Buffer fund
• In spite of all restrictive measures the
system can loose it’s balance
– Average wages - sum of wages
– Continuous increase in life expectancy even
after 65
• The baby boom generation approaches
retirement and
– large recourses needed to meet obligations
• A very big fund was in fact available and is
a prerequisite for the reform
15
The PAYG, Notional Defined
contribution part :Financial stability
•
•
there is an automatic balancing
mechanism that sees to it that the financial
stability is always maintained;
there is a buffer fund to counter variations
in the flow of contributions as compared
to the flow of pensions.
16
The Balance number
• New calculation methods for assets and
liabilities
• If assets exceeds liabilities the Balance
Number is above one
• If the Balance Number is below one;
pension rights and pensions in payment are
reduced
17
Balance Number
( Assets/Liabilities )
1,4
Optimistic
1,2
Base
1,0
Pessimistic
0,8
The yearly revaluation of pension rights
and pensions is reduced in order to
restore the financial equilibrium
Pessimistic without
balancing
0,6
2010
2020
2030
2040
2050
2060
2070
18
The size of the Buffer fund=
Fund/yearly pension payments
År
10
Optimistic
8
6
4
2
0
2010
2020
2030
-2
-4
The Balancing Mechanism is activated
2009
-6
-8
-10
Base
2040
2050
2060
2070
Pessimistic
Pessimistic without
balancing
This difference is
eliminated by the
balancing mechanism
19
Basic scenario is fairly optimistic
• Growth in average wages is assumed to 2%
p.a.
• Real return on investment is assumed to
3.5% p.a.
• Much higher immigration than ever before.
• Fertility, 1.8 is high compared.
• Assumed increase in life expectancy stops
around 2050
20
Reduction of PAYG pension as a result of the
automatic balansing mechanism in the pessimistic
scenario
0%
Reduction %
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
1940
1950
1960
1970
1980
1990
Birth cohort year
21
The Premium reserve part
22
The fully funded part; contributions
• contributions 2.5 per cent
23
The fully funded part; administration
• a State Insurance Authority is fully responsible for
all functions in the scheme, with the exception of
the investment funds;
• All contacts with the funds on behalf of insured
• Concludes agreements on fees, dissemination of information
etc.
• contributions are accumulated in one or several
funds which the individual chooses;
• there are both private and State funds, today
nearly 700 funds!
24
The fully funded part; pensions
• the amount in the funds increases by the
investment yield on the savings which are
deposited;
• the pension is determined by conventional
private insurance principles.
25
Why a premium reserve subsystem?
• Many arguments
• Spread the risks between the capital market
and the sum of wages
• Political compromise
26
Problems
• Too many funds
– Causes confusion
– High costs in spite of special arrangements
• Uncertainty
– What about return on investment?
– Room for manipulation with forecasts for
amount of pension
• No minimum guarantee on investment yield
27
The Result: Work more and up to a
higher age
• Longevity effect
• Further reductions
28
Demography and time of retirement
Cohort
born
...reaches
65
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
The
annuity
factor is
15,7
16,1
16,4
16,8
17,0
17,3
17,5
17,7
17,9
18,1
18,1
Life
expectancy
reduces the
pension
–
–2 %
–4 %
–6 %
–8%
–9 %
–10 %
–12 %
–12 %
–13 %
–13 %
Pension age
to
compensate
for higher
life
expectancy
65 years
+ 4 months
+ 8 months
+ 11 months
+ 14 months
+ 17 months
+ 19 months
+ 22 months
+ 24 months
+ 25 months
+ 26 months
Remaining life
expectancy at 65,
men and women
18 years 6 months
+ 6 months
+ 12 months
+ 17 months
+ 21 months
+ 25 months
+ 29 months
+ 33 months
+ 36 months
+ 38 months
+ 40 months
29
Further reductions
• Manipulations with the old system
• Work ”to a normal extent” has become
”work at a stable wage for 42 years”
30
Replacement rates
Case:
2005
2050
“Model case”: Constant earnings for 40 years as an
average production worker
53.0% 40.4%
2/3 of average earnings during 40 years
62.5% 40.4%
Concave earnings profile, from 75 to 105% of average
earnings with retained life time earnings
49.7% 35.2%
Rising earnings from 80% to 120% of average with
retained life time earnings
48.0% 33.0%
Rising earnings from 100% to 200% of average
36.1% 25.9%
Broken career (30 years of seniority at retirement at
average earnings)
49.6% 30.3%
31
Replacement rates
• The replacement rates are reduced
significantly over the time period studied.
• The outcome falls far short of expectations
and is much lower than should have
followed from the objectives, formulated in
1994.
32
A sustainable system?
33
Core questions
• Financial stability and adequate pensions?
• Coherent old age policy and social justice?
• Are work careers expanded and
employment improved?
• Can the system be understood and has it
been carried out in an open and transparent
manner?
34
The earnings related pension system
is financially stable, …
Item
Finances of earnings related
pensions
Present
Stable
Future
Stable
Contributions from the state
budget for social security
benefits and certain other
periods
High
??
Amount of minimum pension
Fairly high
Costs of minimum pension
Modest
Successively
lower in the
face of
economic
growth
Diminishing
35
….but the replacement rates are not
adequate
36
…and the need for a coherent old
age policy is not met
Item
Availability of benefits in kind
Cost sharing for benefits in kind
Public costs of benefits in kind
Availability of adequate health care
Cost sharing for health care
Present
Future
Comprehe ??
nsive
Low
??
High
Good
Low
??
??
??
37
…hence important changes are
needed
• The automatic balancing mechanism must
be rescinded
• The contributions must be increased
• Further changes are also needed in order to
meet the need for social justice
38
Far-reaching risks are transferred to
the individual and further changes
are needed for social justice
• The minimum pension is faced out and that
can not be accepted
• Risks of not being able to find a job at an
advanced age is transferred to the
individual, therefore the safety net must be
extended to higher ages
39
Expand work careers and raise the
retirement age
• The generational contract is all about
mutual solidarity
• The national economy need people working
• People’s behavior need to be influenced in
an effective and transparent way
• The state becomes involved in providing
jobs
40
..and improve employment
opportunities
Item
Employment opportunities for
people age 55-67
Employment opportunities for
people age 67-75
Present
Future
Comparati Probably
vely good enhanced
but much
to low to
meet the
need
Non
??
existent
41
Transparency and democracy
• A ”paradigm shift” has occurred, but only
gradually
• The information to the public is inadequate
• The financial balance of the new system and the
ensuing reduction in replacement rates is poorly
understood
–
–
–
–
Manipulation with the old system
42 years of stable earnings needed to break even
Longevity effect
All this comes to the surface only gradually, due to the
effect of the transitional arrangements
42
Conclusions (1)
• The request to work more and up to a higher age
for a decent pension is a realistic approach
• A financially stable earnings related pension
system is a valuable result
• But the new system does not offer
– neither adequate pensions,
– nor social justice,
– nor transparency.
• And therefore it must be thoroughly revised
43
Conclusions (2)
• The introduction of a NDC system– that is a
system designed to keep the contribution rate
unchanged –means that, with a continuously aging
population, pension levels will fall.
• Hence, a NDC system, whatever kind it is, does
not offer any way out of the hard questions on
how to balance pension ages, contributions and
benefits, today and in the future.
44
Conclusions (3)
• The belief that a “paradigm shift should add
clarity and consistency to reform” is not backed by
practical evidence. Instead, confusion becomes the
result.
• The deficiencies of the Swedish reform might at
least to some degree depend on a lack of
understanding of the true meaning of the reform.
• In the end democracy itself is at stake .
45