Swedish Premium Pension: Safe and sound
Reform of the Premium Pension System aims to root out poor management practices and make the system sustainable
• Phase 1 of the Premium Pension System (PPM) reforms takes effect in November 2019
• PPM providers must meet new standards on capital and business history and follow best practice
• Phase 2 introduces a new government agency to officially select funds
This month tough new conditions came into force for fund providers to Sweden’s premium pension system (PPM) aimed at putting it on a safe and sustainable footing.
The PPM forms part of the country’s first-pillar system. Employees pay 2.5% per year of salary into a fund of their choosing, or the Seventh AP Fund (AP7 Såfa) by default, to build up an individual defined-contribution pot. Since its introduction in the late 1990s, the PPM has remained more-or-less the same.
But several problems persuaded policymakers that change was needed. First, there are now over 800 funds in the system, making it difficult for participants to make investment choices. Second, fewer people are actively making those choices.
Perhaps the most important reason has been the incidences of fraud, or suspected fraud, in the system. Some PPM asset managers have been accused of fraud against their customers, of breach of trust or bribery.
The PPM reforms are being implemented in two phases. The Swedish Pensions Agency – which operates PPM – is introducing changes to improve the quality of funds and asset managers, and to prevent misleading sales methods and fraud.
Phase 1 changes include:
• PPM providers must have capital of at least SEK500m outside the PPM system – this aims to prevent managers from starting up funds exclusively for the PPM system;
• PPM funds must have at least a three-year track record;
• PPM providers must have at least a three-year business history;
• Restrictions on sales and marketing – for example, telemarketing PPM funds is banned;
• No commission to be charged on the pension products;
• Maximum of 25 mutual funds per asset manager to be listed in the PPM market;
• A provision that fund managers must follow established best practice in the PPM market, act in the best interests of savers, and meet minimum requirements regarding (environmental) sustainability.
The deadline for providers to apply for registration is 28 December. But will these changes succeed in providing a more robust system?
They will certainly cut down the number of providers, although estimates vary. Press reports say that 20-50% of companies might be forced out or could leave by choice.
Jens Magnusson, household economist at SEB, says: “Most of the suggested reforms in phase 1 are well-balanced, and might help improve the public’s confidence in the premium pension system. It is completely unacceptable that pension savers are subjected to fraud or attempted fraud, and measures need to be taken.
And he says the new rules will bring potential problems. “Small fund managers can be genuine and hardworking, and just as good as the bigger ones. But many of these risk being excluded, because of the SEK500m minimum capital requirement.”
He says the same goes for many of the target funds (generationsfonder) that are specifically designed for the premium pension system.
Furthermore, one problem with the three-year track record requirement is that by definition it excludes newer and more innovative funds.
“In some areas, many pension savers – as well as government, pension providers and non-governmental organisations – think it’s important to move pension capital in a more sustainable direction, and developments along these lines are rapid,” he says. “With these rules, it will take at least three years before new, innovative, sustainable funds can be used in the premium pension system.”
Clarity and control
Jakob Mohlin, pension specialist at Mercer Sweden, says: “The obvious benefits of these new rules are that they clarify an opaque system and remove sub-standard mutual funds. Increased control of asset management companies will have a positive effect and hopefully prevent potential wrongdoing.”
He acknowledges that some investors will have to move their money to other funds, even though they might be perfectly satisfied with their first choice: “Limiting investors’ choices will always draw negative comments, but it might be a small price to pay to avoid the troubles of the past.”
But he cautions: “Over 500 mutual funds already live up to the requirements and are not affected by the reform. How effective the system will be is something we will have to look at when the reforms have been in place for a few years.”
While the first phase of reforms aims at repairing the existing system, the second phase will bring more radical change. The idea is to move from a system where every fund meeting the criteria can choose to participate in the PPM marketplace, to one where far fewer funds will be available for investors. These will be selected through an official procurement process by a newly created government agency.
Work on the practicalities has only just begun, leaving the final shape of the system difficult to predict. Magnusson says: “There are things in the PPM that need to be fixed and I think most features of phase 1 are reasonable. The reform has potential problems but I think it will do more good than harm.”
However, he says that if and when the second phase is implemented, that could be a different story. “Phase 2 will fundamentally change the PPM system, which so far has been very successful,” he says.
“Pension savers’ return on their money has been over three times higher in PPM than in the pay-as-you-go (PAYG) system, and it has helped with diversification and in offloading some of the pension burden for future generations.
“It would be a mistake to let the – unacceptable but rather limited – attempts at fraud that we have seen cause us to abandon a very effective part of the Swedish pension system.”
The recent elections in Sweden resulted in a hung parliament, which might, under other circumstances, have introduced political uncertainty to the pension reforms.
Stefan Lundbergh, director at Cardano Insights, says the reforms will go ahead, as they arose from an agreement by the cross-party Pensions Group, which still holds.
Mikael Westberg, the special investigator in charge of implementing the PPM reforms, is due to deliver legislative proposals by November 2019. The Pensions Group hopes to have the new system in place by the end of 2020. “The premium pension reforms are moving quickly,” says Lundbergh.
“They will significantly improve member protection, choice architecture and reduce fees. Following the package of reforms in the 2017 agreement, Sweden will have a more financially robust state pension system that is fair across generations and implemented well.”
But, he says, the main outstanding challenge for the Swedish state pension is that it does not match the payout expectations of today’s retirees.
He says the way to deal with this is to increase contributions, change the retirement age, and reduce costs.