mast image

Impact Investing

IPE special report May 2018

Sections

Rebuilding the pillars

Sweden’s pension system is undergoing fundamental changes at almost all levels. The changes are aimed at:
q increased funding of existing and future liabilities;
q decentralisation of decision-making on the individual’s choice of insurer and on premium reserve investments;
q gradual conversion from defined benefit to defined contribution schemes, and
q increased surveillance of local asset managers.
The basis of the Swedish pension system continues to be a national basic pension, introduced in 1947 and developed to include various additional benefits, depending on individual overall financial and physical conditions. The basic pension is only partly financed by mandatory employer contributions, but should be regarded as a pay-as-you-go scheme. Benefits are inflation-indexed.
The second public pillar of the system is a mandatory national supplementary pension introduced in 1960. This is an occupational scheme based on the income compensation principle. The pension is to be regarded as a postponed wage for work already carried out, not as assistance. The scheme was designed as a pay-as-you-go system.
To build up a buffer fund, contributions paid in the first years were higher than required for payment of pensions. The surplus was injected into the National Pension Insurance Fund – in Swedish, Almänna Pensionsfonden or just AP-Fonden. Benefits are indexed and the individual pension depends on the seniority of life-time occupation with a maximum pension when reaching 30 years of occupation. Combined, the national basic pension and the national supplementary pension cover up to 75% of the income before retirement for the average Swedish employee.
From 2001 the supplementary system will gradually change to reflect the present imbalance between underlying trends in outlays and revenues, caused by slow real wage growth, a greying population and longer life expectancy. The pension reform being implemented aims at linking current costs to economic growth, thus creating consistency with overall resources of the national economy. Employer contributions totalling 18.5% of an individual’s lifetime earnings provide basic financing of the system, with a small percentage to be withheld for a premium reserve fund in individual pension accounts.
Since 1996, two percentage points have been channelled into an account with the Swedish finance ministry in preparation for the reform. From 1999, contributions are raised to 2% of wage income (roughly $2bn in the first year). This, together with accumulated capital of $5bn, will be channelled through a new state-operated reserve system, the Premium Pension Authority (PPM). PPM, in accordance with the choice of the individual, will place premium reserves in unit trust certificates issued by unit trust organisations complying with its requirements. Domestic as well as foreign asset managers may apply for inclusion in PPM’s universe. PPM will front all investments, disguising beneficial ownership of the unit trust certificates vis-a-vis the asset managers, and PPM is also responsible for trading associated with individual freedom to allocate and switch between unit trusts.
As switching between unit trust funds is intended to be free of charge for the individual, the costs so incurred by PPM will have to be covered by reimbursement of – possibly a large portion – of annual management fees, charged by participating asset managers. Should an individual not opt for a unit trust solution, his assets will automatically be placed with a new (seventh) sub-fund under AP-Fonden. Assets managed under the existing system by AP-Fonden (funds 1–6) – the buffers – are being reduced substantially between 1999 and 2001. A total of Skr245bn (e28bn) is being channelled back to the exchequer, reducing public sector consolidated gross debt, the so-called Maastricht debt, by approximately 4% of GDP. The six funds will be converted into four mutually competing funds by January 1 2001. The funds will have equal buffer amounts, at present four times Skr125bn, and equal placing rules, for example, minimum 30% in prime quality bonds, listed securities only and a maximum unhedged currency exposure of 40%. Additionally, the legislation also calls for a minimum of 10% of assets to be outsourced to external managers. This is in marked contrast to the existing regulations, which require assets to be invested almost entirely in Swedish domestic instruments, as evidenced by the present allocation of assets totalling approximately e100bn (see Table 1)
The new objectives for the four funds are higher asset returns at ‘acceptable’ risk levels, requiring regular policy reporting to the authorities, including outlining of ethically and socially responsible guidelines for investment programmes.
The third level of the Swedish pension system comprises mandatory occupational, primarily defined benefit, schemes for four sectors of society, originally established and managed by the relevant labour market parties:
q central government employees;
q local government employees;
q private sector salaried staff (white-collar) or ITP.
q private sector wage-earners (blue-collar) or STP.
Central government pension schemes are by far the smallest arrangements, and continuously based on a pay-as-you-go system. Local government schemes comprise 288 municipalities and 24 district authorities, covering roughly 1m wage-earners. Hitherto, pension liabilities have been partly funded by book reserves and insured with KPA, the municipalities insurance company. A sharp expected rise in municipalities’ book reserve pension provisions over the next decade – a doubling from the present 1.5% of the annual budget, tantamount to a tripling of pension liabilities from the present e5bn to e16bn in 2010, has triggered a reform with several elements.
First, new accounting rules from 1998 meant that municipalities had to reveal new pension liabilities on their balance sheets. Second, municipalities are required to address the question of funding and management of assets, the latter so far being freed from placing restrictions. Third, contributions at the rate of 3.4% of annual salaries have been initiated, of which one percentage point from 2000 will be channelled through the PPM (see above) and thus will be freely available for investment by individual employees, for example through unit trust certificates. Finally, KPA has lost its monopoly on insuring the pension schemes, and will have to compete on equal terms with both other suppliers of insurance, such as private insurance groups, and asset management services, including foreign organisations.
In consequence, roughly 7% of Swedish municipalities have already chosen to consolidate all or part of their pension liabilities by transferring assets from their balance sheets to a separate pension account or foundation. These have a typical asset mix of 70% bonds and 30% equities, largely domestic, and are typically outsourced to external managers. It is estimated that roughly 50% of all local authorities will form independent foundations, representing roughly 150 new funds, although with modest assets. Some municipalities have pooled their funds to achieve economies of scale and international diversification. On behalf of the present members and future retirees, one may hope for further cooperation between the new funds to secure adequate returns – net of costs!
Recapitalising on assets involved from the local government sector, the new contributions will bring about new money of roughly e1bn annually. Consolidations may free an additional e1bn–2bn annually for asset managers to pitch for.
The private sector salaried staff scheme, also called ITP, is the main Swedish occupational pension arrangement. It provides final salary benefits to about 1m white-collar employees of member companies of SAF, the employers’ federation. For many years, companies had two choices of how to provide members’ ITP retirement pensions: by making provisions on the company balance sheet, backed by mutual credit insurance at Försäkringsbolaget Pensionsgaranti (FPG), or by purchasing deferred annuities from SPP, an insurance group owned by the relevant labour market parties, and exercising a monopoly in its field. Over the past few years, a third option has become available. This is to establish a legally separate ITP entity called a pension foundation, jointly controlled by employer and employees. Companies such as car maker Volvo, telecom operator Telia and the Swedish Post Office are examples of new pension foundations with most of their respective assets outsourced to external managers.
At year-end 1998, pension assets with the ITP system totalled e50bn, of which two thirds was still with SPP, e11bn kept in book reserve/credit insured, and the balance of e4bn with individual company pension foundations.
SPP, managing assets of around e30bn including a surplus over liabilities of around e8bn, has recently announced an agreement to pay back roughly half of the surplus to its member employers, as the surplus retained may not exceed 15% of liabilities, according to a recent bill passed by parliament. Pending discussions on a further withdrawal of money from SPP, in case member employers should decide to establish a separate pension foundation, may further erode SPP’s position.
Private sector wage-earners (blue collar workers) have for decades been obligatory members of the STP occupational and supplementary pension system, administered jointly by labour and employers’ unions. This counterpart to white collar workers’ ITP, comprises more than 1m Swedish privately employed workers, and is this year converting from a defined benefit to a defined contribution system. Annual premiums totalling 4% of salaries will be equally divided between employer and employee. Formerly, the scheme was insured with AMF-Pension, an insurance company also jointly owned by the labour market parties and also exercising a monopoly in its field.
Although AMF-Pension will continue to administer contributions and pension benefits, individual employees may now choose whether to leave their premium reserves with AMF-Pension, transfer them to another insurance group offering better terms, or place them in unit-linked, UCIT-recognised products. AMF-Pension manages about e18bn, and has reacted to the end of its monopoly by setting up and marketing a large unit-linked programme.
Parallel and complementary to the comprehensive and mandatory pension systems, there are about 700 small individual pension foundations and funds in Sweden, with total assets of roughly e12bn, compared to life and pension insurance assets of e135bn.
Hasse Nilsson is chairman of Alcifor Associates in Denmark

Have your say

You must sign in to make a comment

IPE QUEST

Your first step in manager selection...

IPE Quest is a manager search facility that connects institutional investors and asset managers.

  • QN-2436

    Asset class: Real Estate - Core Open-ended Real Estate Equity Fund (non-listed).
    Asset region: Asia Pacific.
    Size: Approx. CHF 70-100m per investment.
    Closing date: 2018-05-25.

  • QN-2438

    Asset class: High Yield Bonds.
    Asset region: US.
    Size: USD 300 million.
    Closing date: 2018-05-25.

  • RE-2441

    Closing date: 2018-05-31.

Begin Your Search Here