Gearing up for changes
In an unguarded moment during a visit to New Zealand last year prime minister Göran Persson told a local interviewer that if the younger generation in Sweden really understood what the country’s new pension system meant in terms of a final pension they would not have accepted it. Although a long way from home his comments were picked up and reported back.
But although the next general election will be held in September and the Social Democrat government is coming under attack on a number of fronts, notably for failing to reduce unemployment, the right-of-centre opposition parties have failed to capitalise on Persson’s New Zealand gaffe.
In the late 1990s, the Persson government had overseen the passage of legislation that transformed the state pension system from an inflation indexed flat-rate benefit (AFP) and a supplementary earnings-related pension (ATP) based on an employee’s 15 years of highest earnings to a notional defined contribution (NDC) income pension financed on a pay-as-you-go basis where earned pension rights are linked to economic growth and benefits, which are determined by how much is contributed over the lifetime, and indexed to life expectancy. In addition, it established a second tier of funded benefits, an individual account premium pension.
“Research due to be published later this year will show that from an historical perspective and assuming that we still live to the same age as now, the state pension may be halved on average, and if life expectancy is extended by four years the situation will be even worse,” says Mats Langensjö, managing director of Aon Consulting. “To preserve stability, the system assumes a GDP growth, expressed as income index growth. If that is too low or there are changes to life expectancy, the work participation ratio, migration and so on, pensions will be lower.”
But the opposition parties’ have been reluctant to exploit Persson’s discomfiture because the measures that his government implemented were based largely on their initiatives.
That something had to be done to make the existing system sustainable had been clear for some time, says Ingela Thalen, a former Social Democrat social affairs minister. “We had had comfortable GDP growth in the 1950s and 1960s, but by the 1970s this was threatened by the oil crises, changes in the labour market and to industry, the growing service sector and so on,” she says. “And we had changed the rules of the pension system many times, for example we had lowered the average age for pensions from 67 to 65.”
In the early 1980s the government established a parliamentary committee, including labour market representatives, to examine the system, Thalen adds. “But after 10 years of discussions there were as many opinions as there were groups in the committee.”
In the spring of 1991, with a general election coming, the then Social Democrat premier Ingvar Carlsson agreed with the leaders of the other major parties that the pensions issue should not be raised in the campaign and that the next government would set up a working group to take the matter further.
In the event, the Social Democrats were defeated and replaced by a minority four-party centre-right coalition led by the conservative Moderate Party, with Bo Könberg of the liberal People’s Party as minister for social affairs. As agreed with Carlsson, Könberg formed an all-party working group to hammer out pension reforms through consensus.
“As minister of social affairs I chaired the pension working group from 1991 until 1994,” recalls Könberg. “There were three main reasons for transforming the old ATP system – to design a system that was more sustainable, to make it fairer, and to introduce incentives on the basis that what would be good for the individual would also be good for society as a whole and vice versa. Like many other defined benefit systems, the old system transferred money from people who worked many years with a rather steady income to those who worked a shorter period but had a steeper income rise during those years.”
The most controversial element of the reform was the creation of the premium pension. The state pension system is funded by employers, who pay 18.5% of an employee’s salary. Of this, 16 percentage points goes to the basic PAYG income pension and 2.5 percentage points to the funded individual account, with the employee having the right to decide where this money is invested. Employees can choose up to five funds from more than 700 on offer.
“The proposal originated with the coalition_member Centre Party, their argument being that people should have the possibility to invest in local companies,” recalls Thalen. “But the liberals adopted it very quickly.”
In fact the idea fitted in with the centre-right parties’ ideological support for individual choice and the need for people to take responsibility for their future. “We wanted part of the future pension benefits to be based not only on some kind of wage index but on what is happening in the capital market,” says Könberg. “We thought that people would get a higher pension in the future if they had some part of it based on the markets, and it would be boosted by not having all the eggs in the same basket.”
But why did the Social Democrats agree to the proposal? It was part of a trade off, says Peter Norman, executive president of AP7, the default fund that manages the premium pension money of those who do not make a choice of fund. “A compromise between five parties is a give-and-take situation, so although the Social Democrats were not in favour of all the changes they had to swallow them because they were getting something else, including a low percentage that people could decide for themselves.”
In addition, notes Könberg, they got agreement to establish Norman’s default fund.
The debates were enlivened by allegations of skulduggery. Initially, the working party included all seven parties then represented in parliament – the four centre-right governing parties, the Social Democrats, the formerly communist Left Party and the right-wing populist New Democracy.
“In 1994 I discovered they had a secret group that I was not allowed to be in,” says Ulla Hoffmann, Left Party spokesperson on social insurance. “I learnt there was a secret pension group consisting of the five parties that met without me. Suddenly I understood why I got quite complicated material on a Saturday that I was supposed to discuss with my party before a meeting on Monday. There was not a chance, of course. They had agreed all this before.”
Könberg dismisses accusations of underhand behaviour. “In 1994-95 I was accused of this before the Swedish constitutional committee and was acquitted,” he says. “What happened was that in the autumn of 1993, as chairman I sent a list of the 16 or 20 points that I wanted to have in a final agreement to all the six other parties. They had a few weeks to consider whether they wanted to continue negotiations on that basis. The Left Party and New Democracy parties said no. While the official seven-party committee continued its work, negotiations moved ahead with the five parties that had signalled that they were trying to reach an agreement.”
Hoffmann says the Social Democrats miscalculated in accepting the five-party compromise. “The new system was presented in the spring 1994 and elections were due in the autumn,” she recalls. The Left Party had formed an electoral alliance with the Social Democrats. “I told Ingela Thalen we were going to win the election but she said she was not sure about that.”
The Social Democrats were indeed re-elected later that year and true to the five-party agreement began the implementation of the reforms despite having reservations about key elements. The new system was passed by parliament in 1998, by which time Persson had succeeded Carlsson, and the first round of premium pension choices were made in 2000, on the eve of the market downturn. “It was really bad timing,” says Langensjö. “People thought they had SEK10,000 in their account and then it was worth SEK3,000. This has engendered passivity and new people coming in to the system are not making a choice and instead their money is going to AP7 as a default fund.”
Whereas in 2000 only one-third of first-time choosers opted for the default fund the total reached 92% in 2005.
“My target is to beat the 700 private funds we compete with, and to do this we calculate the average chosen fund in the system which becomes our benchmark,” says Norman. “And we have beaten that by 7% for the past five years, and at a substantially lower risk. My success is the system’s worst enemy.
The politicians foresaw this when designing the system. “They put some sand in the wheels for us,” says Norman. “Although people can choose up to five funds, those defaulting have to default with all their money, and people making active choices can never return to the default fund. But when they realised that some people might want us to manage their assets even though they have made some choices they forced us to open a new fund, the Premievalsfonden, just for them.” Nor is AP7 allowed to advertise.
But change may be on the way. In October, Stockholm School of Economics professor Karl-Olof Hammarkvist reported the findings of the committee he had been chairing on the first five years of the premium pension system. He found that many pension savers felt unable to handle the system and that they needed better information and guidance and that the number of funds could be reduced to 100-200 without a deterioration in choice. It recommended that the Premievalsfonden be phase out and merged into the main AP7 fund which should then be treated as other funds in the system.
The Hammarkvist proposals together with responses from interested parties are now with the government which is expected to propose any legislative changes in the spring of 2007, after September’s general election.
Könberg sees little reason to change anything. “Many eggs were broken during some of the worst fall in the capital market that we’ve had for two generations,” he concedes. “But nevertheless, very few people have lost money in the sense that it reduced the amount of pensions paid out today. Only a very small amount was based on the new system, and since the collapse it has changed to the positive for almost all people.”
And does the drastic fall in people making an active premier choice matter? “The new people who have the right to choose are on average very young and have very little money so I’m not surprised that they don’t make an active premium pension choice due to what happened to the stock market,” says Könberg.