O. Settergren 2004 Should we move towards more funding and less PAYG? Lessons from the Great Swedish Pension Reform.

O. Settergren 2004

Should we movetowards more funding

and less PAYG?

Lessons from theGreat Swedish

Pension Reform

O. Settergren 2004

Unfair redistribution of incomeB

Significant work disinscentivesC

Reform Reasons

Financial instabilityA

O. Settergren 2004

1994Parliamentadoptsprinciplesof thenewpension plan

Pension reform process - very long

1990 1991 1994 1998 2001 2003

2003 ”first” payments according to new system

1991Commissionset up

1992Draftof a new pensionplan

1998Mainlegislationof thenewpension plan

2001Legislationon the automaticbalancemechanism

But transition rather quick i international comparison

O. Settergren 2004

TransparencyB

Maximize inter-generational fairnessC

Basic income securityD

Reform Objectives

Financial stability (= Credibility?)

A

O. Settergren 2004

What Is a Notional Defined Contribution

(NDC) Pension System?

O. Settergren 2004

III IV

I IITie betweencontributionandaccruedpensioncredit

0 %

100 %

0 % 100%

Degree of funding

Four basic design options

Defined Benefit

Defined Contribution

Pay-as-

you-go

Funded

Theoreticalor formal

riskdistribution

100 % insured

100 % insurer(= taxpayers)

O. Settergren 2004

III IV

I II

DefinedBenefit

Reform StrategyContribution 16 % Contribution 2.5 %

PremiepensionFunded

Inkomstpension“NDC”

Contribution 16 %

D

S

G

D = Disability pensionS = Survivors pensionG= Guarantee pension

Old pensionscheme

DefinedContribution

PAYGO Funded

O. Settergren 2004

0

25 30 35 40 45 50 55 60 65

Age

Each crown payed during life result in the same amount of pension credit

16 %Pay-as-you-go

Funded2,5 %

Pensinable income of insuredSEK

O. Settergren 2004

Administration

Survivorsbonus

0

Development of notional account and convertion to an annuity

The amount on the notional account, SEK

Annuitydivisor15,7

Net indexation

Credited contribution

s =Pension

Age

25 30 35 40 45 50 55 60 65 70 75 80

Interest with change in

average income

Lifeexpectancy (65

=18,5)

Interest rate1,6%

-

O. Settergren 2004

..interest 1,6 %growth 2,0 %

..interest 1,6 %growth 1,6 %

Imputed interest 0,0 %growth 1,6 %

Pension as an annuity

85

45

50

55

60

40

65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84

Age

Pension

..interest 1,6 %growth 1,0 %

O. Settergren 2004

Individual information

Micro level information

O. Settergren 2004

Why individual information?

The change from a defined-benfit to (two) defined-contribution systems

Harmonise the expectations of the insured with the economic and demographic realities

Create a relevant sense of confidence and trust between the system and the insured

Make clear that:If life expectancy continues to increase you either will have to delay your retirement or accept a lower annual pension

Improve the insured’s opportunities for well informed decisions

O. Settergren 2004

Page1

Projectionof the future

pension

5

Thedevelopmentof the funded

account

2

The development

of the notionalaccount

3

Pension creditearned

last yearThe

NDC system&

Premium pension system

4

Premiumpension funds

6

Explanations

O. Settergren 2004

Page1 2 3

4 5 6

O. Settergren 2004

Page2

1 euro 9 couronnes

O. Settergren 2004

Page1

Continuation ... The projection

If you draw your pension from age:

age 61: With growth 0 %: you receive SEK 7 321 per month 10 278 per month With 2 % growth you receive

age 65: With growth 0 %: you receive SEK 9,374 per month 14 272 per month With 2 % growth you receive

age 70: With growth 0 %: you receive SEK 13,270 per month 22 368 per month With 2 % growth you receive

O. Settergren 2004

Page1

The elements of the annual individualprojection

The base : the last value of the virtual and financial accounts. A.

The assumption made on the individuals future contributions to retirement: = 16 % + 2,5 % x last income + 0 % & 2 %

B.

Annuity divisor : projected life expectancy at 61, 65 and 65 for each birth-chohort

C.

Indexation / return: D. 0 % 3,5 % 2 % 6 %

At age 61 : 7 3219 374

13 27014 72722 368

10 278

At age 65 :

At age 70 :

Continuation ...

O. Settergren 2004

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What are the ideas behind this complicated individual projection?

Age 61: 0.78 1.10The importanceof retirement age,and life expectancydevelopment

The importance of economic development(Growth in average income and the return on capital)

Age 65: +/-0

Age 70: 1.42 2.39

1.52

Continuation ...

O. Settergren 2004

Page1

You may receive a pension from more than onesource

In addition to the national pension, you may alsoreceive pension benefits from other sources. This maybe an occupational pension from your employer orperhaps a pension from your own private pensionsavings. Such benefits are not described here.

Continuation ...

O. Settergren 2004

What is a fair pensionsystem?

Here opinions differ wildly, at least in

Sweden

O. Settergren 2004

Some of many possible, definitions of a fair pension system:

1. Same pension for all

2. Same replacement rate for all

3. Same ratio of expected benefits over contributions for all Calculated at what discount rate? Discount with average income growth, always!

Every contribution, for every insured,has the same expected value

O. Settergren 2004

0

25 000

50 000

20 25 30 35 40 45 50 55 60 65 70 75

White collar worker

Blue collar worker

Age of worker

Annual incomeeuro

Pension

Xcontribution rate

18.5 %

O. Settergren 2004

0

100 000

200 000

20 25 30 35 40 45 50 55 60

Accumulated contributions=pension credits

Age of worker

Euro

Accumulated interest(indexation)

O. Settergren 2004

0

100 000

200 000

300 000

20 25 30 35 40 45 50 55 60

Notional Capital, i.e. accumulated contributions & interest (indexation), euro

Age of worker

64

O. Settergren 2004

Administration

Survivorsbonus

0

Remember this image?The amount on the notional account, SEK

Annuitydivisor15,7

Net indexation

Credited contribution

s =Pension

Age

25 30 35 40 45 50 55 60 65 70 75 80

Interest with change in

average income

Lifeexpectancy (65

=18,5)

Interest rate1,6%

-

O. Settergren 2004

0

25 000

50 000

20 25 30 35 40 45 50 55 60 65 70 75

White collar worker

Blue collar worker

Age of worker

Annual incomeeuro

Replacementrate 65 %

Replacementrate 42 %

Pension

O. Settergren 2004

Disability benefits

4% 2% Child years11%

Sicknessunemploymentparental benefits, etc.

Fairness, etcTypes of Pensionable Income

83%

Wages &incomes of self employed

O. Settergren 2004

Guarantee pension change the distribution of risksfor those with low or no income-related pension

The guarantee is a basic security financed with general tax revenue

Earnings-related pension

140 000

0

20 000

40 000

60 000

80 000

100 000

120 000

0 42 000 100 000

Income-related pensionGuarantee

0

20 000

40 000

60 000

80 000

100 000

120 000

0 42 000 100 000

Income-related pensionGuarantee

Earnings-related

+ guaranteepension

O. Settergren 2004

1940 2005 15,7 – 65 years 18 y. 6 m.

1950 2015 16,4 –4 % + 7 months + 11 months

1960 2025 17,0 –7 % + 13 months + 20 months

1970 2035 17,5 –10 % + 18 months + 28 months

1980 2045 17,9 –12 % + 23 months + 35 months

1990 2055 18,2 –13 % + 26 months + 41 months

Genderneutral

life-expectancyat age 65

Birth cohort

...turns 65

Projectedannuitydivisor

Effect on pension from

increasedlife-span

Pension age to neutralize

life-span effect on pension

O. Settergren 2004

Procent

0

10

20

30

40

50

60

70

Inkomstpension

Old Scheme

Premiepension

Life-span effect

Birth Cohort

Garantipension

Projected Compensation Rate at age 65, Cohorts 1938-1990 Average pension at 65 relative to average wage for those working at that time

O. Settergren 2004

Simulations of net contribution 2002-2077in percent of total contributions

90’s

60’sBorn inthe 1940’s

Without balance mechanism

O. Settergren 2004

Simulations of fund ratio, 2002-2077

Without balance mechanism

Market value of buffer fund

One year of pension disbursements

O. Settergren 2004

Trustedtrue

prophet

Mistrustedtrue

prophetAccountant

Trustedfalseprophet

Policy makersknowledge of the future

0 1

The publicsperception ofthe policymakersknowledge ofthe future

0

1

Line of

satis

fied e

xpec

tatio

ns

Four stylised policy makers – which one are you?

O. Settergren 2004

The end

Distributed by: Riksförsäkringsverket (RFV), Stockholm