PBSS Section Meetings, Session 3 DC Risks in Pensions and Social Security

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2 PBSS Section Meetings, Session 3 DC Risks in Pensions and Social Security

3 Shifting the Burden of Risk with NDC: The Swedish example Tuesday May 30th, 08:30 10:00 (Room 341) Jan Hagberg, PhD Chief Actuary, AFA Insurance Stockholm Sweden

4 Sweden's New National Pension System Contributions % Earned Income NDC system 16.0 Premium Pension 2.5 (Unit-linked private accounts) Total 18.5 Annuity Amount depends on earned pension rights, age of retirement, mortality risk for individual s cohort, survival bonus etc. Automatic balancing mechanism ( brake ).

5 ATP System Contributions Varied from year to year. Rate in final year (1994) was 22.3 per cent Pension Maximum benefit after 30 years of work; based on the 15 years with highest earnings

6 PAYG system vs. National Wealth SEK billions Annual report 2005 Assets 6490 Buffer Fund 769 Liabilities 6490 Surplus 28 National wealth 5406 Virtual Assets 5721 Pension Liabilities 6462 Stocks of fixed assets (net) 5406

7 Historical development and social objectives of Sweden's national pension system 1913 The first national pension system with universal coverage ( Folkpension ). Defined contribution, limited benefits The system was changed to provide a universal flat pension, independent of contributions made. PAYG system The basic benefit level raised to ca. one-third of the average earnings of industrial workers. Flat Pension. Widely regarded as inadequate ATP system launched to increase average benefit to ca. two-thirds of personal earnings. PAYG system with buffer fond NDC system plus private accounts. Reversers the social progress of the previous century.

8 Stated objectives of the new pension system Financial stability Insurance-like* Flexibility Freedom of choice Ownership *As defined by economists, not by actuaries, the most important consideration being the lifetime earnings principle.

9 Stated Principles From the 1993 government proposition. generally speaking, given the current life expectancy of the Swedish population, pensions from the reformed system will remain at approximately the same level as with the current system. The public pension system shall provide benefits as with today's system, i.e. somewhere between 55 and 65 per cent for an individual who works to a normal extent, provided that the national economy experiences average real growth of two per cent annually, along with certain other conditions.

10 Two key concepts relating to the adequacy of pensions Replacement rate the amount of pension benefits compared to some measure of the individual's earnings Relative pension level benefits for a category of pensioners compared to the earnings of the same or a comparable category of earners

11 Gross replacement rates from Sweden's national pension system for persons retiring at age 65 (NDC pension and Premium Pension combined) Earnings History Retirement Retirement /3 of average earnings during 40 years 62.5 % 40.4 % 30 years with earned income 49.6 % 30.3 % Constant earnings for 40 years 53.0 % 40.4 % (Example: industrial worker with average income) Source: National Strategy Report on Pensions, Swedish Ministry of Health & Social Affairs, July 2005, pp

12 Combined effect of demography and age of retirement Average Life Expectancy and Retirement Age Cohort reaches Forecast Effect of Retirement age Remaining life born in 65 in annuitization change in to neutralize expectancy divisor at 65 life expect- effect of life at 65, women and ancy on pen- expectancy on men sion at 65 pension years 18 years, 6 months % + 4 months + 6 months % + 8 months + 12 months % + 11 months + 17 months % + 18 months + 21 months % + 17 months + 25 months % + 19 months + 29 months % + 22 months + 33 months % + 24 months + 36 months % + 25 months + 38 months % + 26 months + 40 months Source: NSIO 2003 Annual Report, p. 46. A similar table is included in the 2004 Annual Report, p. 45.

13 Conclusions The experience of the new Swedish pension system to date indicates that: The original expectation that 40 years of work at average earnings and with a contribution rate of 18.5 % would yield the target replacement rate will not be fulfilled. More probable 44 years. The belief that an NDC scheme would automatically achieve approximate balance, provided certain rules formulated in 1994 were followed, is clearly false. The automatic balancing mechanism, which was originally introduced as an emergency brake for exceptional situations, will be activated more frequently than stated.