Competition drives down Swedish ITP fees
The move of Sweden's ITP scheme from DB to DC has had some unexpected consequences, finds George Coats
Earlier this year Sweden's employers' confederation Svenskt Näringsliv and the PTK, a confederation of 27 white-collar trade unions, reached an agreement on overhauling the second pillar industry-wide pension scheme, the ITP. The deal was more than 12 years in the making as it required the unions to accept that their members would shift from a DB scheme, with which they had generally been pleased, to a DC scheme. But the implications of the new arrangement extend far beyond a transfer of the risks from employers to employees and the level of contributions the employers had to offer to sugar this pill.
"The ITP covers some 23,000 companies nationwide and is the equivalent of a corporate pension fund," explains Mats Langensjö, newly appointed head of Nordic business at Pioneer Investments and former managing director of consultancy Aon.
"At the beginning it was DB and funded either on the balance sheet, secured at trade union insistence by credit insurance, or through an insurance company, Alecta. Most large companies took the balance sheet route because they wanted to keep the money in their business but in the early 1980s the credit insured part went from being an invisible factor to being very large and in the early 1990s a few corporates realised that the pension liabilities in the ITP sphere represented 35-45% of a balance sheet, varying from zero to 110%. In parallel a discussion began about the need to change the pension promise in the contractual ITP agreement. But it took a dozen years because the trade unions had no real incentive to agree. Every year they could sit back knowing they had a bigger pool of money to negotiate on because the liabilities were growing rapidly and exponentially. Then suddenly this spring the unions agreed on a new DC plan, with a very long transition period."
"When negotiations were taken up again in 2005 there was a different spirit on the union side," recalls Ingvar Backle, senior advisor at Svenskt Näringsliv. "We had all seen that many new companies did not want to become a member of Svenskt Näringsliv or sign an agreement with the trade unions because of the old ITP plan, which had the same basic structure as when it began in 1960, in other words it was constructed for a labour market that in many aspects no longer existed."
He adds: "The old ITP-plan will be in use for most salaried employees born in 1978 or earlier, and the new plan automatically just covers those born 1979 or later. This means that the new ITP-plan will cover all salaried employees from 2044."
The old ITP plan was administered by Alecta, a mutual insurer jointly owned by the PTK and Svenskt Näringsliv. Alecta also managed the contributions. A new body, Collectum, which is also owned by the PTK and Svenskt Näringsliv, was established to administer the new scheme and it opted to open the asset management to competition.
Under the new ITP plan, 4.5% of an employee's salary is paid to Collectum. The employee has to put a minimum of 50% of the contribution into a pension plan with a certain guaranteed return, the guarantee ranging from getting the contributions back up to an additional 2%. For this part employees can chose between AMF, Länsförsäkringar, Nordea, Skandia or Alecta. Alecta is the default option for those who don't make a choice. In addition, people can put a maximum of 50% of the contributions into unit-linked funds, and here they can choose between funds offered by AMF, Länsförsäkringar, Modernaförsäkringar, SEB or Swedbank. Collectum takes 1.3% for its administrative costs. What the insurers charge on top depends on what fund has been chosen, whether it's an index or something more exotic.
"We asked the market, the insurers, to give their best price and best conditions because we thought that would be the best way to give the employees good pensions with as much of the contribution going to pensions and not to the running costs," says Backle. "Under the old ITP part of the retirement pension with a premium amounting to 2% of the salary, is a DC plan known as ITP-K, with the ‘k' standing for complementary. So we have a yardstick against which we can compare the costs of the new DC plan. And we can already see that the new ITP has resulted in an average reduction in the administrative costs of 65%. So competition is driving down costs."
"The competition to get a part of this market was very severe and as a result there was an extreme downward pressure on prices, so much so that there have been queries in the market about whether or not this is sustainable," says Ellen Bramness Arvidsson, chief economist at the insurers' association, the Försäkrings Förbundet. "So one could expect that there will be significant changes in the market arising from this but it is early days yet and one cannot say what they will be."
"We had the lowest price on the market before the ITP bids and at the end of the process it turned out that we had the highest price of the companies that were accepted," says Jann Wiebols, segment manager at AMF Pension. "We really stretched it as far as we could in profitability terms so we wonder what the other companies based their calculations on. Maybe they saw it as a big ticket issue and felt that they had to be in the market regardless of profitability."
"There has been a lot of criticism of this process," says Länsförsäkringar CEO Håkan Danielsson. "But to be honest if I was representing all these white-collar workers and had the job of presenting them with the best pension I would of course make use of my buying power. And competition is healthy in the long run. Of course there is a lot of talk now about why this company or that was not chosen but that's the way all markets work."
And what are the implications for those companies that were not chosen? They included some big names, including SPP, Folksam and Handelsbanken, and their exclusion was seen as a shock.
"They are in trouble," says Danielsson. "But it should not be over dramatised because there will be a review of the providers on the guarantee side in five years and on the unit-linked part in three years, so the competition will be ongoing. However, I would have thought that those in from the start would have an advantage because there will be a number of customers who have chosen these companies, although that would not enough to cover up a failure to fulfil their promises."
Peter Salomon-Sörensen, head of corporate development at Nordea Liv & Pension, sees the possibility of a shuffle among the market players as a business risk but he adds: "We can't really see that there would be any benefit for the policyholders if every fifth year they were going to need to move their money somewhere else because, say, three companies are leaving the ITP and three new players coming in."
And Wiebols suggests that while those companies not chosen have received a setback, there are dangers for those that were chosen. "The process also threatens those companies that won because everyone can see the prices in the ITP area and so now wants them as well. So the cost pressures will spread."
"The price structure on the ITP offering is open and there to see for everyone and of course that's a problem," says Danielsson. "But the ITP terms were set for an electronic process. When we discuss with a company outside of this agreement, for example a small company with three employees that somebody visits to give advice and setting up their policy terms, it's a human touch process and therefore the price cannot be the same." Wiebols thinks prices may go the other way: "I'm not sure that in the next round the prices will go down, maybe they will even go up because you will come to such a low level that it will be difficult to find a profit. And this is a high-risk price model; it is only a percentage of the capital and of course in the beginning there is not very much capital accumulated. So, in the case of case Alecta, which takes 10 basis points, if you have SEK10,000 [€1,090] it has SEK10 in year one, and it is impossible to live on SEK10. And then the client can move all their capital at any point, paying a maximum SEK500 to do so, so you are not sure that you will be able to keep the customer. We pitched at 29 basis points, which is three times as much and still very low."
However, price pressures are likely to remain for some time as Sweden is currently undergoing a second selection process, this time for the wage earners' pension scheme, SAF-LO.
Svenskt Näringsliv and the blue-collar trade union confederation LO negotiated a switch to a DC scheme some years ago in a process that subsequently acted as a template for the Svenskt Näringsliv-PTK agreement. But the PTK's truculence meant that the ITP deal was better than the SAF-LO arrangement.
Fora, which is owned by the LO and Svenskt Näringsliv, administers the SAF-LO scheme. The assets were managed by AMF Pension, which is also owned by the LO and Svenskt Näringsliv. But now the asset management for the revised SAF-LO is being put out to competition. "Flora is now choosing the companies that will offer wage earners both funds and a traditional approach," says Wiebols.
"The difference is that the blue collar employees don't have a 50% minimum in traditional and a 50% maximum in funds. They can't split, they must choose to put everything in one or the other." And as with the ITP the key role is the provider of the default option. "It will be mandatory for everybody to do a new selection for future premiums so it is extremely important to be the default alternative because at least 50% will not make an active selection," says Wiebols. "So the company that gets the default will automatically get 50% or more of the market depending on how well the campaign to encourage people to make a selection works."
A similar assessment has brought the ITP default selection process under scrutiny. "We were looking to take the ITP default position but Collectum is an agreement between the employers and employees and there is a long history with Alecta, which is also owned by the social partners, so I don't think the decision was made on a purely commercial basis," says Torbjörn Callvik, COO Skandia Liv.
"It was not an open procurement so, for example, we haven't seen all the details of how the choices were made and how they picked the default alternative. We have asked for the information but have not received much yet."
But given that Sweden is a post-industrial society do the divisions between blue and white-collar workers have any relevance and if not why are there so many Svenskt Näringsliv-trade union entities with similar roles?
"That's a good question," says Salomon-Sörensen. "There has been talk of putting Alecta and AMF together but so far it has not happened."
And Collectum and Fora? "It's ridiculous, they should merge," says a veteran observer. "They could get together and make huge savings but it is political."
Wiebols agrees: "Sure, especially when the line between blue-collar workers and white-collar workers is not really there anymore with people switching between them throughout a career. But it is more a political factor within the unions, it has to do with who has power and is in control so that they can have a role in the future in this area. The blue and white-collar workers' trade union confederations want to keep their distinctive and separate identities."
"From time to time they look to merge them," says Callvik. "So perhaps in the future they will do so. But currently Collectum is doing everything to get the ITP system up and running and it would be too much at the same time to come up with another system for something like 1.1m individuals."
And would that change the nature of pension provision in Sweden? "There is no obvious benefit to having insurance companies involved," says the veteran observer. "This time round I don't think that the negotiating parties really thought about the details. They wanted to get a move from DB to DC, so they included insurance companies because insurance companies always work and they saw it as a risk control. One reason for choosing insurers could be to keep track of individuals, doing individual administration, issuing policies and so on, but Collectum is doing that and outsourcing the fund management to the insurance companies. So there are two administrative layers. Collectum could have set up its own collective platform and pension fund and saved a huge amount of money."
"From the beginning the entire system of collective occupational pensions in Sweden has been driven by mutual life insurers," says Callvik. "The social partners did look at other countries and perhaps thought that another model might be introduced next time. There was a debate on the unit-linked funds side of ITP, they were considering looking at having institutes directing funds instead of having the unit-linked companies doing it. I think that in the future, especially when it comes to fund managers, they will ask whether they need the insurance companies."
"We did discuss whether, instead of appointing fund managers, we could have created a platform through Collectum or something else where certain funds - not more than 50 alternatives - could be offered," says Backle. "That was an alternative to doing it the way we did when we signed up five fund managers. And in the future you never know. In five years we will have a new round, signing up new contracts, and we will analyse this alternative again."