Sweden’s PPM system is being overhauled. Mikael Nyman (pictured right) explains the reasons why and outlines the new landscape

The Swedish government has recognised that it has a problem with the premium pension (PPM) system that was introduced to give an element of individual choice as part of the reform of the country’s state pension system. The reform introduced a shift from an inflation-indexed flat-rate benefit (AFP) and a supplementary earnings-related pension (ATP) based on an employee’s highest 15 years of earnings to a notional defined contribution income pension financed on a pay-as-you-go basis. Under this, earned pension rights are linked to economic growth and to benefits that are determined by how much is contributed over an individual’s working life and indexed to life expectancy.

But in addition it established a second tier of funded benefits, the individual account, PPM.

The state pension system is funded by employers, who pay 18.5% of an employee’s salary. Of this, 16 percentage points goes to the basic pay-as-you-go income pension and 2.5 percentage points to the PPM, where the employee has the right to decide where to invest the money, choosing up to five funds.

However, the number of funds that employees can choose from mushroomed to an incomprehensible 800 and, in late 2005, some five years after the new system was introduced, a committee chaired by Stockholm School of Economics professor Karl-Olof Hammarkvist reviewed its progress. It reported that many pension savers felt unable to handle the system and that they were confused, did not know how to get relevant information about their pensions savings and needed better guidance. The Hammarkvist report also suggested that there were too many funds and that the number could be reduced to 100-200 without any deterioration in choice.

The report struck a chord with the government, which had become concerned that people were experiencing difficulties in understanding various elements of the pensions system, not only the PPM but how the whole framework fitted together, including the pay-as-you-go income pension and what the DC element was going to give them.

The requirement that people should play a role in determining to some extent what their pension will be by making investment decisions for a proportion of their contributions was included in the system at the insistence of the right-of-centre political parties during all-party discussions that led up to the reform programme.

They wanted individuals to take an element of responsibility for their own future and also to gain an understanding of the mechanisms behind the economy and the financial system and to realise that their pensions rely on the performance of the economy.

The debate on the Hammarkvist proposals has been closely followed by the public and over the past two years the media coverage has been extensive. We Swedes are a nation of fund savers; we have been saving in equity funds for the past 20 years or so as part of our regular savings.

And people have become used to choice, as it forms part of their occupational second-pillar pensions, which have grown substantially as employers have embraced DC. Their members have to tick a box to say that they want some of their contributions to go to this equity fund and some into another one or to traditional insurance and this has also made them aware of fees. The trade unions have put out tenders, and prices in union-backed second-pillar pensions are now something like half of what they were. The industry is not all that happy about this.

However, the pressure on fees began with the PPM, as fund providers that wanted to enter the system began giving kickbacks to individuals. And the kickbacks were quite substantial for a large fund, up to 96% of the fees going back to the savers. This led to price slashing in the PPM system that, in turn, has been transferred to the union pension systems. They have gone to tenders and the cheapest is around 15 bps. Of course, for such a low fee you do not need to get as good a performance as when the fees used to be 150 bps. So in 30 years’ time it will give better pensions.

The government’s PPM proposals encompass two ideas. One is to construct packages of assorted funds for the PPM to assist people to choose the asset allocation that is appropriate for them. For example, there might be a green package, another for people with a high tolerance for risk, and a low-risk package for people who are close to retirement.

The PPM website already contains a tool for deciding individuals’ investment profiles, called Lotsen - ‘the Pilot’. This enables individuals to enter their age and risk tolerance and receive a suggestion of mutual funds giving the corresponding investment profile. The recommended investment alternatives are ranked by cost, with funds with the lowest fees at the top of each list.

On an administrative level, the old age pensions elements overseen by the Försäkringskassan, which handles all aspects of state social insurance, will be taken away from its remit and merged with the PPM to form a new authority that is due to begin operating on 1 January 2010.

The intention is to bring together the different financial and administrative cultures, with the aim of reducing costs and increasing transparency. The idea is that the new old age pension authority should be able to give people a full picture of their first, second and third-pillar pensions to enable them to gain a better idea of what their future pension income will be. However, the industry has not shown much interest in supplying the data because the companies want to own the customers themselves.

Another proposal is for the rules governing the AP7 fund, which was set up as the default option for those who did not make a choice for their PPM, to be changed. The changes include the possibility of creating generational funds with differing risk profiles where the equity share of the portfolio decreases as the member’s age rises.

The government has so far not made any formal proposals but it is understood that the AP7 management is to submit proposals for a system where individuals can choose their own risk level for approval.

In addition, it is going to be possible for individuals to go in or out of AP7 whenever they please. Until now AP7 ran two funds, the Premiesparfond for those who made no choice and a smaller fund, the Premievalsfond, that people could choose as one of their five PPM choices. Presently a person who once made an active choice could not be part of AP7’s Premiesparfond - it was a window that was closed once a choice was made. Under the new proposals, people will be able to opt in or out of the Premiesparfond so there will be no need for the Premievalsfond. As a result the two AP7 funds will probably be merged.

This is a relatively controversial proposal. Those on the right of centre who promoted the idea of choice had insisted on restrictions being put on the AP7 because they did not want to see a state fund growing to a substantial size and are still not fully reconciled to the new architecture.  

Mikael Nyman is editor in chief of Stockholm-based newsletter Pensionsnyheterna

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