Stockholm (Ekonamik) – Given the demographic and financial challenges facing pension systems in developed countries, NordSIP was keen to reach out to Pensionsmyndigheten – the Swedish Pension Agency – to understand how one of the most advanced pension systems in the world works in practice.
Pensionsmyndigheten and the AP Funds
The Swedish Pension Agency carries out several functions in the management of the various parts of the country’s pension system. “Our mission is to administer and pay public pensions on behalf of the Swedish state. Pensionsmyndigheten is responsible for the central part of the national pension, the earnings-related, the essentially pay-as-you-go financed inkomstpension, as well as the premium pension. This is the part of the national pension that savers can place themselves on the Pension Authority’s fund marketplace,” Johan Andersson, press secretary at Pensionsmyndigheten tells us referring to the 2.5% of their pension contribution that people can allocate themselves since 2000. “We also administer and pay out a guaranteed pension which provides a basic level of income for people with low pensions.”
Naturally, Pensionsmyndigheten has a close relationship with the rest of the pension system, particularly the buffer funds of the inkomstpension, the AP Funds. “The first four AP funds are buffer funds for a smaller part of the income pension system,” Andersson explains. Sweden’s first, second, third and fourth AP funds exist to cover deficits in the inkomstpension system in years during which contributions to the income pension system are less than the year’s pension disbursements. Between 2009 and 2018, AP1-AP4 paid out SEK51 billion to the pension system because the large cohort of people born during the 1940s began retiring. However, not all AP funds are alike. “The Seventh AP Fund manages AP7 Såfa, which is the default public fund to which contributions to the premium pension scheme are allocated.”
Demographic & Economic Assumptions and Expectations
According to Andersson, Pensionsmyndigheten uses the Swedish statistical office’s population projections to inform its expectations of future demographic trends. “The projections are reviewed and updated every year in April and are published in the Pension System’s Annual Orange Report. Every three years, Statistics Sweden makes a slightly more extensive forecast and also includes two alternative scenarios. The last such deep dive was published in 2018.” Pensionsmyndigheten uses a base scenario as well as an optimistic and a pessimistic scenario to inform its decisions.
“According to the 2019 Orange Report, the natality rate is expected to stabilize at 1.86 children per woman born in Sweden. This number falls to 1.65 and rises to 2.05 children per woman under the pessimistic and optimistic scenarios, respectively. The average life expectancy of men in Sweden is forecasted to increase from 80.9 to 85.2 years between 2018 and 2050, while for women, the expectation is for an increase from 84.2 to 87.5 years during the same period. Under the pessimistic scenario, the average life span for men and women increases to 87.3 and 89.7 years by 2050, respectively.”
Pensionsmyndigheten uses an inverted measure of the oldage dependency ratio, the ‘Support Ratio’, which divides the number of working-age people by the number of retirees. From this perspective, unsustainable demographic dynamics take the form of a continued decrease in the support ratio. “The Support Ratio is currently below three and is predicted to fall further in the base scenario but the introduction of the target age can make it level out,” Andersson explains, discussing the 2019 Orange report.
According to Pensionsmyndigheten, the difference between the three main scenarios for the Support Ratio is motivated by more or less generous assumption about the number of births and immigration rather than about any significant shifts in longevity. A fourth scenario considers the case where parliament realises current plans to extend the retirement age from 65 to 68 years, which causes the support ratio to stabilise above 3.
Beyond demographics, the Swedish pension authority also takes into account the path of macroeconomic variables. “In our base projection of the pension system, we assume a real income increase of 1.8%. This assumption has been constant for a long time,” Andersson explains. “The assumption is 1.0 percent under the pessimistic and 2.0 in the optimistic scenario.” Return, in real terms, on buffer fund and capital is assumed to be 3.25, 1.0 and 5.5 percent in the base, pessimistic and optimistic scenario respectively. The premium pension real return on capital is assumed to be 3.9 percent in the base scenario, and 1.0 and 5.5 percent in the pessimistic and optimistic scenario respectively.
“One reason we have chosen to be frugal in adjusting assumptions such as returns and real wage increases is that it facilitates our scenario analysis of the dynamics of other parameters. If actual income increases are systematically different from our assumption over time, we need to review whether these should be changed,” adds Andersson.
“Given that income pensions are indexed to the income trend with a 1.6 previously credited deduction, wage developments affect both the system’s liabilities as well as its assets. Therefore, the assumption is not as crucial as it could otherwise have been for the system’s financial position,” Andersson says.
“Inflation assumptions are also constant across scenarios at 2%. The rate of inflation is irrelevant to the pension plans finances as well as for real pensions,” he explains.
The Pandemic Path Ahead
While the ongoing disruptions caused by the COVID19 pandemic didn’t significantly affected the work of Pensionsmyndigheten, their assumptions may be challenged. “As a result of the Coronavirus, most employees have had to transition towards working from home. Fortunately, we can largely carry out our assignments without interruption,” says Andersson.
The effect on the structure of the pension system and the market returns available may not be as plain to sail. “We have already seen that the fall in value in assets in the financial markets in the wake of COVID19 has affected the premium pension and the performance of Pensionsmyndigheten’s fund market. In the longer term, the income pension is likely to be affected by a change in society’s income trends. Our message is that people should see pension savings as long-term savings and that, for example, the default option AP7 Såfa is adapted for longterm pension savings,” Andersson concludes.
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For more articles about the demographic challenges facing the global economy and Scandinavia in particular, please click here to read Ekonamik’s Longevity report.