'IKEA of pensions insurance
The pension insurance society for Sweden’s central government employees, commonly known as Kåpan, is currently at the centre of a switch from DB to DC systems.
Kåpan, whose official name is FSO, was started 10 years ago to provide pension insurance for 220,000 members of three leading trade unions. In the current DB system, the pension is based on the average of the last five annual salaries before retirement.
However, under a new collective agreement, known as PA-03, the scheme will move progressively from the DB system into a DC-based system. Government employers will make a contribution corresponding to 2.3% of the employees’ salary. They will also increase the percentage of pay set aside for the administration of the scheme from 1.5 to 2%. The new system will come into force on I January 2003.
Members of the scheme are free to choose among life companies other than Kåpan. They may either invest their contributions in a traditional life insurance policy or in a unit-linked mutual fund. If they make no choice, their contributions will go to Kåpan as the scheme’s default fund.
Sven Benestam, president of Kåpan, says the aim is to keep the menu simple and the costs down. “We will only offer life insurance. We have no mutual funds and we have no plans to start some here. To make it work in a cost effective way you need larger volumes than we can create here. We have calculated that it may take up to 10 years before we can reach a break-even level. It’s better to let the employees choose another alternative.”
Benestam is wary of investment choice. “The people who want to go outside are in a minority. So far, from what we have learned from the PPM system, it is impossible – even if you are professor of finance – to make the maximum portfolio choice. You have to be a professor of the future to do that. It’s absolutely impossible to foresee everything. We can also see nothing from the first PPM rally – the people who made their choices still have their position. Very few have changed their positions even if they have gone bad, that was one thing the journalists said. Don’t be afraid of choosing badly – you can always change.
“If people try to switch from one fund to another to increase the value of their positions, perhaps 1% will be successful. But most likely they will all fail. You shouldn’t play games with your pension. If you put them into decent hands with a low cost then the chance of a good pension is much greater than trying to be active and jumping from one fund to another.” Kåpan concentrates on costs rather than performance, Benestam says. “You can never guarantee the outcome of your performance. The only thing you can guarantee is your cost levels.” He is proud of Kåpan’s low costs. “You could think of us as the IKEA of the Swedish pensions insurance market,” he says. “We have some of the lowest costs in the business. We are improving every single year, because our volumes are increasing but we have more or less the same cost. Our total cost for last year was 0.20%. Mutual funds are ten to 15 times more expensive and that will have a strong impact on the pensions paid out.
“Because I have the monopoly I can achieve very low cost of sales promotion. I am not competing with others, so we have no salesmen.”
Kåpan also concentrates entirely on investment management. It has outsourced all other activities to the National Government Employee Pensions Board (SPV), one of Sweden’s largest pension administrators. In the new DC scheme, SPV will act as an information exchange for scheme members. “They will collect the information about the members’ investment wishes and if the members don’t make any choice they will direct the money to us.”
Kåpan also has exclusive use of the 2% component of the contribution. “There are no options for employees to choose another manager for that money. It is a safety belt for the pension fund member. This is a brave decision by the social partners, even if it’s not fashionable today when there has to be freedom for everybody to choose whatever they want.”
Investment strategy is as adventurous as the regulations allow. Like life insurance companies, Kåpan may invest no more than 25 % in equities. Nor may premium income be directly invested in equities. “By law, I can’t just take the premiums coming in and buy equities. I have to create values in the bond portfolio and then transform that to into equities as time goes by.”
Kåpan’s strategy is to allocate between 35% and 55% of the portfolio in equities, he says. “In March 2000, we were very close to 45% of equities. Currently, it has fallen to 30% because of the poor performance of the equities market during the past two years. It could take us five years to reach that again, because to reach that I have to trade surpluses.
“We are strong believers in getting a good yield from the money we have. We don’t agree with the concept of Boots in the UK going into bonds. We think you should have a third of your portfolio invested in equities.”
Kåpan is unusual among pension insurers in excluding real estate from its portfolio. “We go instead for government bonds indexed linked to the CPI. It’s more liquid, it’s good value, and during the last three and a half years it has outperformed the ordinary bond by far. We have up to 15% of our holdings in these bonds,” Benestam says.