Pension reform based on sound principles

Artikkelforfatter: Bo Könberg
E-mail: bo.konberg@d.lst.se
About:

Bo Könberg is Governor of the County of Söderman­land, Sweden. He was Minister for Health and Social Insurance 1991-94 and also Chairman of the Pensions Working Group that existed in the same years and that created the new Swedish pension system. He was a Member of the Implementation Group for the new system 1994-2005. He has been involved in the reforms of the pension systems in Latvia and Poland. He was Leader of the Liberal Party in Parliament 1998-2005. He has earlier written two articles in the NFT debate on the Swedish model.

* The articles can be found on www.forsakringsforeningen.se/nft (International and Swedish experts on Swedish Pen­sion Reform and related matters).


Udgave:
2, 2009
Språk: Engelsk
Kategori:

In this article the author responds to criticism of the pension reform, presented by Jan Hagberg and Ellis Wohlner in their article ”The Market for Social Insecurity”, published in NFT 4/2002. Bo Könberg claims, among other things, that: i) Resistance of the reform has decreased since its introduction and opponents, the Left Party and Green Party, have presented completely various options for the reform. ii) Lifetime earnings principle is more equitable than the old ATP-system. iii) The new scheme offers - at the same life expectancy - lower pension than ATP only if growth is lower than 2 per cent. However, at such low growth the contributions to ATP needed to be significantly increased. iv) The new pension system is based on clear principles, which was not the case with the ATP-system. This article was original written in Swedish and published in NFT, 2003/2, page 115-118.

The main principles of the reformed pension scheme

In January 1994, politicians representing 85 per cent of the electorate succeeded in reaching agreement on an extensive reform of the Swedish public pension system. The new rules have been introduced successively since 1995. The new pension earning rules apply fully to people born after 1953.

 

The reform does, of course, contain some compromises but is based largely on a number of principles:

 

* A universal system

* Distinction between old-age pensions and disability pensions

* Lifetime earnings principle (18.5% of earnings)

* Distribution policy supplements, primarily childcare years

* Taxable guarantee pension, not basic pension

* Indexation to wage development (with an advance upon retirement)

* Indexation to average life expectancy (until retirement)

* Flexible retirement from age 61

* Annual information to individuals about their pension

* Part of the contributions (2.5%) go to the premium pension

* Successive implementation

* Automatic balancing (“braking” and “accelerating”)

 

The reform has been implemented in stages. Most recently, the old basic pensions have been converted into taxable guarantee pensions, which replace the basic pension, the pension supplement and the special basic income tax deduction for pensioners.

Critique of the reform

If anything, there is now less opposition to the reform than there was in the summer of 1994 when the decision was taken. The only opponents in the Swedish Parliament today are the Left Party and the Green Party. But their alternatives to the reform are very different. The Left Party would like to see some kind of reformed ATP (national supplementary pension), rather like the system that Jan Hagberg and Ellis Wohlner (H&W) advocate in the Scandinavian Insurance Quarterly (NFT) 4/2002. The Green Party would like to see a system providing an equal basic pension for everyone. The differences between these two alternatives are greater than the differences between each of them and the pension reform.

 

The Swedish pension reform has, according to H&W, generated a great deal of international interest. They mention that countries like Latvia, Poland, Russia, Croatia and Mongolia are introducing pension reforms in line with the new Swedish model. They could also have included Italy, which decided on a similar reform as early as 1995, albeit with very long transitional periods. The changes that have now been decided in Finland will have a similar effect to that of the Swedish reform. Last autumn, the Norwegian Pensions Commission presented two alternatives for reforming the Norwegian ATP system – a basic pension system and the new Swedish model.

 

The Swedish reform is given positive coverage in a couple of foreign reports presented after H&W published their critical article.  The report on Member States’ pension systems that was presented to the European Council at the end of March is decidedly positive. In the same month a report was presented at a conference in Brussels on how 12 industrialised countries are expected to manage demographic changes up to 2040. Of the seven countries from mainland Europe that are included, Sweden is expected to fare the best. One reason is our pension reform.

 

H&W’s article contains much criticism of the reform. The changes they themselves say that pensions experts would like to have seen – presumably instead of the reform – are:

 

1) Indexing to economic growth instead of to consumer prices

2) An increase in normal retirement age

3) An opening for a reduction in pensions in response to demographic changes, as and when necessary.

 

Instead, H&W say it became “something very different”. Is this really the case?

 

The new system is indexed to wages, unlike ATP which was indexed to prices. Normal retirement age will probably increase as a result of indexation to average life expectancy, thus putting into effect the reduction in the (annual) pension to which the demography development will give rise.

 

It would appear that the only difference that exists here between the reform and the alternative which H&W advocate is that in the reform adaptation to demography takes place automatically and successively, and not through new political decisions. Such decisions would probably be taken more seldom and therefore with a correspondingly larger adjustment at each step.

Not much of a difference, you might think. No, but the biggest differences do not relate to these changes, rather to the introduction of the premium pension component and the lifetime earnings principle instead of the so called 15- and 30-year rules.  In addition, H&W assume the new system will provide reduced pensions to the great majority, and that there is an enormous transfer of power from society to special interests.

Lifetime earnings principle

In the new system, all contributions (up to the benefit ceiling of 7.5 times the wage base amount) will confer pension rights. In the ATP system, contributions paid in excess of 30 years were not included and the pension was based on the best 15 years. This meant that contributions paid into the system were transferred from people who worked for many years with a level income, to people who worked for relatively few years but whose wages rose steeply.  The latter could, in extreme cases, receive a full pension after having worked full-time for 15 years and 20 per cent of full time for 15 years, i.e. a total of 18 years full-time, which earned them a pension they received for 15–16 years.

 

Those who wanted to retain the ATP system, often people on the political left wing, have not been particularly clear in their argument as to why ATP was fairer than the new system. The relative silence is understandable. What is fair about people who work for many years on low incomes receiving a much lower pension per Swedish krona paid into the system than those on high incomes who have worked relatively few years?

Lower pension?

Will the (annual) pension be lower in the new system than in the ATP system? One crucial factor in this context is average life expectancy. In all probability, it will increase.  Then the annual pension will decrease – all other things being equal. But could a potential reform of the ATP system have avoided similar change? H&W do not seem so sure. Consider what they say about demography above. On this point, it appears to be the automatic element of the new system they dislike, not the effect.

 

The answer to the question, incidentally, is probably that if the growth rate is around 2% then the average pension in both systems will be the same. If the growth rate is lower, then pensions will be lower than in the ATP system – if it had been possible to retain ATP even at lower rates of growth. This does not seem particularly likely and would, in that case, have required significantly higher pension contributions.

Power shift?

The premium pension component means great freedom of choice for the individual. There are several hundred funds to choose from. In the coming decades premium pensions will increase, whilst we can expect the buffer funds to begin to decrease after 2010. When the strain on the pension system is at its greatest, the buffer funds will of course be at their lowest if the return on shares is not high.

 

What H&W criticise here is that there will more money in total in the many individually-selected funds and less in the former AP funds. We can certainly have different views on this. For me as a liberal, this is not a negative development.

Clear principles

One of the many advantages of the pension reform is that it is built on clear principles which provides a good opportunity to take a position on them. If you wish, you can go back to the beginning of this article, read the main points again and ask yourself: Do I think that every krona should be counted? Do I think that pension rights and pensions should follow average wage development for wage earners? Do I think that childcare years should confer pension rights? Do I think it should be possible to invest some of the pension contributions in unit trusts? 

 

This clarity is missing in H&W’s article. That they dislike the reform in the extreme is obvious, that they are critical of the Social Democrats’ support of the pension agreement is also obvious, but do they really dislike the fundamental principles of lifetime earnings and indexation?

 

We from the five parties that reached agreement in 1994 know what we think. The pension reform was both necessary and positive.