Swedes mass migrate to DC
The transformation of the Swedish pension system since the mid 1990s is perhaps the most comprehensive endorsement of the defined contribution (DC) scheme in Europe. More than two million people have been moved into second pillar contribution-based plans in the space of five or six years.
The first pillar has also been transformed into a partly funded contribution-based system. Under the new Inkomstpension, 16% of an employee’s salary is contributed towards a national account. In addition 2.5% of salary is contributed to a DC system, the premiepension (PPM), where employees can choose from more than 600 mutual funds where to place their investment
Björn Nilsson, the chairman of the Swedish Association of Institutions for Retirement Provision (SIRP), comments: “You could say that the social security part of the pensions system is now totally DC, and most of the occupational pension schemes are now DC.
“Inkomstpension is truly a DC scheme, though it is not funded. It is still PAYG, but pension level depends individually on contributions made. Premiepension is a DC scheme of a more traditional type, and is funded.
“The important thing about this reform is that this was a change from defined benefit (DB) to DC. Many people were impressed – and I am too – that we made such a swift change over in such a short time.”
In the second pillar, the bulk of the collective agreements that cover occupational pension schemes are now DC. Some 1.5m public sector employees and 1m private sector employees now belong to contribution-based schemes.
Jan Bernhard Waage, managing director of pension fund consultants Wassum Investment Consulting in Stockholm, says there is a strong move to homegeneity: “I think there is a tendency to move the whole system over to the same kind of structure. It’s quite powerful what is going on, with the whole thing that we have here, the whole collective agreement. It’s very powerful whenever an agreement is being changed which is moving a huge number of employees at just one pen stroke.”
This is largely because Sweden is strongly unionised. As a result, 95% of blue collar workers and 60% of white collar workers in the private sector belong respectively to the two main collective agreements, Avtalpension SAF-LO and ITP.
The changeover has meant more money flowing into the pensions insurance industry. Together PPM and the second pillar schemes are expected to produce between SKr45bn and SKr 50bn of new assets in 2003, and the country’s leading insurers have lined themselves up for their share
In particular, Folksam has come from nowhere to become Sweden’s third largest pensions insurer on the back of changes within the second pillar system. It has increased its market share by acquiring many of the companies that provide pension insurance societies for the members of the collective agreements.
Since 1997, Folksam has bought 60% of KPA, the insurer for the municipal and country workers scheme, PFA 98, a 51% stake in Folksam-LO, a joint venture with the Swedish trades union congress to provide pensions for the Avtalpension SAF-LO, and Förenade Liv which provides insurance for members of PTK trade union, partners in the ITP agreement.
Tore Andersson, Folksam’s managing director, says: “For Folksam it was important for us to position ourselves in these markets. We have been one of the big four non-life companies in Sweden, but the non-life market is not growing. So we took a strategic decision to grow our life business.”
The start of PPM doubled Folksam’s premium volume from SKr4.5bn to SKr8bn within a year.
Contribution-based schemes have brought investment choice with scheme members able to choose between leaving their contributions traditional pension insurance or making an active choice to inset them in unity-linked funds. The ITPK plan, where a 2% contribution is made to employees accounts within the ITP system, was the first to offer investment choice in 1990. After that, the PPM offered its members a choice of funds rather than fund managers.
The initial enthusiasm for fund choice has waned in the PPM, partly because of changes in the age structure of people entering the scheme, says Wassum’s Waage. “The initial active choice was somewhere around 70%. Today, new entrants, typically younger people reaching an age where they are able to get a pension with very small amounts, don’t really care about making an active choice. Only 10% are now making an active choice.”
Waage says that part of the problem is that the investment world is restructuring. Some of the largest insurance companies in Sweden have made major changes to their operations. Skandia and LF, for example, have sold their entire investment management businesses respectively to Den Norske Bank and ABN Amro.
“So not only are there a huge number of investment options out there but these are constantly changing as well which is making the whole selection process very difficult for an individual. That is one of the worries one might have with the DC system.”
SIRP’s Björn Nilsson, who is director of international pensions at Alecta, the pensions insurer for the ITP scheme, is also sceptical about investment choice: “Employees are supposed to make good choices between investment alternatives but they don’t know enough to be able to make good choices.”
However, he says they are learning fast, largely because of the downturn in the equity markets: “They have a chance to achieve better results with the DC scheme, but they can also lose money. This is actually a useful lesson because it tells people that things will not always be good on the stock market.”
However, Nilsson says that the balance between risk and return is something that barely concerns Swedes. “This is an ideological discussion which is not actually held in Sweden.”
What may engage employees is the suggestion that they should make some contribution to their DC schemes. Sweden is unusual in that employers in Sweden traditionally pay all the contributions into schemes, including contributions to social security.
The government now wants employees to pay some or all of the contributions to Inkomstpension and PPM. Nilsson says it will be difficult to introduce such a change. “If employees are to be able to afford the contributions they will need some increase in salary from their employer. This will be very difficult because employers say this will mean an increase in costs.”
However, one thing is certain. DC schemes are here to stay. “From an employers’ point of view DC is much easer to handle,” says Nilsson. “Mobility of labour between different companies is much easier if you have vested pension rights. And also it is useful internationally, although very few Swedes will move from country to country – maybe 1 to 2%. But in principle DC schemes are always going to be simpler.”