Sweden
compiled by Allianz Global Investors
Pension System Design
The Swedish pension system consists of a public pension pillar that is unique in Western Europe. Part of the social security contribution is paid into individual investment accounts and a funded pension is build up with independent fund management companies responsible for the asset management.
In addition, mandatory occupational pensions schemes are in place for employees working in industries covered by nationwide collective bargaining agreements. Employers who are not part of collective agreements may offer plans on a voluntary basis. Voluntary individual pension savings complement the pension landscape in Sweden.
The Swedish retirement system has been subject to major changes in the past. Formerly, the first pillar consisted of a flat-rate basic pension supplemented by an earnings-related pension (ATP). The current system in place has been fully operational since January 2003.
Characteristic for the pension market is the strong position of insurance companies. About two-thirds of pension assets are invested with insurance companies. As Sweden is highly supportive of occupational pension schemes, we expect the pension market to grow substantially at an annual rate of 6.8% to approximately EUR 481 billion by 2020.
Public Pensions
The public pension system, which is fully operational since 2003, consists of three elements:
1. The income-based pension
2. The premium pension
3. The guaranteed pension
Contributions to the system amount 18.5% levied on total income up to a certain ceiling. The lion’s share is used to finance current pension payments; the remaining 2.5% is allocated to individual accounts that build up a funded pension.
1. The income-based pension
The major component of the state pension system is the income-based pension. It is financed on a pay-as-you-go basis, the contribution rate amounts to 16%, which is recorded in notional accounts. At the time of retirement the virtual account balance is basis for the calculation of pension benefits. An annuitisation factor that is predominantly based on the statistically remaining average life expectancy divides the pension account balance into annual pension benefits. A balancing mechanism assures that the balance in the notional accounts is adjusted to reflect changes in average wages. The income pension is paid for life. The retirement age is flexible and retirement benefits can be claimed from the age of 61 at the earliest.
The pension system is autonomous from the national budget and income-based pension contributions are transferred to the system’s buffer funds: the First, Second, Third and Fourth AP (National Pension) Funds. Each fund receives a quarter of the contributions and is responsible for a quarter of pension payments. At the end of 2007, the system had a surplus of SEK 18 billion (EUR 1.9 billion). In case liabilities exceed assets there is an automatic balancing mechanism that reduces the value of pension entitlements as long as assets and liabilities have returned to a new equilibrium. Automatic balancing means the pension system regulates its own finances and avoids the government having to intervene by raising contributions or borrow money to fund pensions.
2. The premium pension
The premium pension is the funded part of the earnings-related old-age pension. The premium pension system is administered by the state Premium Pension Authority (PPM).
2.5% of pensionable income is paid to the funded pension scheme, which is compulsory. The money is deposited in individual investment accounts with individual choice. Employees can choose to have their premiums invested in up to five funds out of more than 700 mutual funds offered by independent fund managers. In addition, the government has set up a special investment fund for individuals who do not want to make their own investment decisions; their contributions are automatically invested with the Premium Savings Fund, which is managed by the Seventh National Swedish Pension Fund (AP7). The individual is free to change the chosen fund at any time and free of charge. The premium pension can be drawn at the age of 61 at the earliest, but it is also possible to postpone withdrawals from the pension account, which requires that the assets are invested in security funds.
The value of the fund holdings of pension savers as of December 31, 2007 was SEK 308 billion (EUR 32.7 billion). SEK 90 billion or 29% of total premium pension assets is managed by AP7, making the fund by far the largest in the premium pension system. The bulk of assets are invested in global equity (~50%) and Swedish equity (~20%). External asset management companies manage the lion’s share of AP7 assets.
The investment risk lies with the individual. A minimum guarantee does not exist, neither on the part of the Premium Pension Authority nor on part of the independent fund manager.
The Premium Pension Authority is responsible for the operation of the premium pension system. It collects contributions and invests them in the individually chosen investment option; thus, there is no relationship between the individual and the fund manager. This is the distinguishing criterion to most pension systems in Central and Eastern Europe (CEE). In CEE countries the employer contracts directly with the financial service provider.
In order to qualify as a fund provider within the premium pension scheme, fund managers must meet certain requirements:
- An agreement on practical cooperation and on the price of management services must be concluded;
- The provider has to supply requested information to the private individuals even though they are not formally the holders of the mutual funds;
- The provider is not allowed to charge withdrawal fees;
- Substantial reporting to the Premium Pension Authority on costs charged to the funds must be supplied.
Once the pension-saver applies to receive his premium pension he is obliged to opt whether to withdraw fund insurance or to convert his account into a traditional insurance. In case the individual chooses the fund insurance he will maintain his account and the benefit payments vary according to the funds’ performance. It is still possible to switch between funds and also opting for the traditional insurance at a later point of time. Converting the account into a traditional insurance implies selling the fund holdings and transferring the management and the implied risk to the Premium Pension Authority. The traditional insurance guarantees life-long retirement payments at a fixed rate.
3. The guaranteed pension
In addition to the income-based and premium pension, the guaranteed pension, a means-tested benefit, provides a minimum pension for persons older than 65 with low or no income and at least 40 years of residency in Sweden. It is financed by the government’s budget.
Occupational Pensions
Second pillar pension benefits for almost all blue-collar and white-collar employees are determined by nationwide collective bargaining agreements. Permanent employees automatically belong to an occupational pension scheme. These schemes are known as ITP for white-collar employees and SAF-LO for blue-collar employees.
Some industries (e.g. banking, insurance) have other pension schemes than ITP, but the benefit provisions are more or less the same. Employers who are not part of the collective agreements may offer plans on a voluntary basis. These also often follow the range and level of benefits provided under ITP. As a result, pension plans in Sweden are extremely standardised.
There are 4-4.5 million active employees in Sweden. The ITP plan covers about 16% of them. Effective July 2007 the ITP switched from a defined benefit plan to a defined contribution plan. After 12 years of negotiations between employer and employee unions an agreement was achieved to switch to a defined contribution plan. The old ITP plan will be closed to new participants.
The key elements of the new DC pension plan:
- Decrease of entry age to 25;
- Employers will make monthly contributions of 4.5% of an employee’s salary;
- More flexibility in the payout phase – length of the benefit payout period must be at least 5 years;
- Requirement to invest at least half the contributions into a qualified insurance chosen by the employee with a guaranteed return; the remainder may go into a variety of investment vehicles.
Employees earning more than a certain salary (ten times the income base amount, SEK 44,500/month, in 2007) have the choice to opt out of the ITP system to some extent and use a scheme of their own choice. In addition to the opt-out system there are special regulations for early retirement provision (ITPK), which allow the use of individual arrangements for this purpose. Individual or group insurance contracts are used to fund these benefits. The most common schemes for alternate ITPs are defined contribution plans, which means that the traditional ITP scheme has already been replaced to some extent. The employer decides if the company offers an alternative ITP.
The SAF-LO pension scheme was introduced in 1996 and is DC in nature and covers about 1.8m blue-collar workers. Differences in the benefit level between SAF-LO and ITP were perceived as unfair. Therefore it was agreed that employer contributions will increase stepwise until 2012. The rate is adjusted from 3.5% today to 4.5% in 2012.
The pension plan for civil servants is a defined benefit plan, which covers 700,000 employees. The pension plan for employees of Swedish municipalities is mainly a defined contribution plan and covers about one million employees.
Pension funding
There are three methods available to companies to fund pension benefits: pension funds, pension insurances and book reserves. However, their use is influenced by the type of plan concerned (whether it is ITP or SAF-LO), and in some cases, even specific providers have to be used. Book reserves and pension funds are most frequently used for a defined benefit system, whereas for a defined contribution liability pension insurance is the usual choice. Risk benefits are typically fully insured, even if the company uses a pension fund or book reserves for financing its pension plan.
Pension insurance is the most common form for financing pensions in smaller companies and it is also the dominating form for financing occupational pension for blue-collar workers. Larger companies typically participate in the ITP plan and use book reserves in combination with credit insurance for securing the pension liability. Still, pension foundations are proving to be increasingly popular vehicles, especially among larger companies.
1. Pension funds
Pension funds are most commonly used to finance ITP plans and other defined benefit plans. They are set up as separate legal entities but are affiliated with the company. Pension funds have to participate in the credit insurance system, which guarantees the pension payments. The Act on Safeguarding of Pension Obligations provides that a national pension plan must contain rules that safeguard the pensions, for example via the credit insurance system provided by FPG (‘Försäkringsbolaget Pensionsgaranti’). FPG guarantees the pension if an employer becomes insolvent and is no longer able to meet his obligations, and then redeems the pension liability through the insurance company Alecta – previously known as SPP. The insurance premium, 0.2% of pension liabilities, is paid to FPG.
Law does not require to appoint an investment manager; however, external asset managers are increasingly becoming market practice.
There are no legal requirements regarding minimum funding levels.
Tax treatment of contributions and benefits
Employer contributions of up to 35% of the plan member’s salary are tax deductible. However, a ceiling of 10 times the price base amount applies. Employer contributions are not considered taxable income to the employee.
Benefits paid from occupational pension schemes are taxed as ordinary income.
Investment income on pension assets held by insurance companies or pension fund is taxed. The basis of taxation is not determined with regard to the actual return of the plan assets but by a standard method using the average interest on government loans in the preceding year to determine the investment income.
Investment regulation
There are no specific investment restrictions besides the Prudent Person Rule and a solvency requirement.
2. Group insurance contracts
Insurance contracts can be used for all types of plans, i.e. ITP, SAF-LO and voluntary plans. However, for the collectively bargained plans (ITP, SAF-LO), there is no free choice of provider. ITP plans have to be insured with the insurance company Alecta. This will change with the launch of the new ITP-defined contribution scheme where employees have to opt for a provider receiving their contributions.
SAF-LO plans have to be insured with the insurance organization AMF (‘Arbetsmarknadförsäkringar’). The insurance company AMF had a monopoly before 1998 for blue-collar pensions, but their share has dropped to around 70% after the market opening.
AMF administers the scheme, collects contributions and distributes them to the investment vehicle (bank or insurance company) chosen by the employees. If the employee does not make a decision, contributions remain automatically with AMF.
It is also possible to use endowment insurance contracts. They are regarded as a legal form for securing a pension promise if the contract is pledged to the employee. For the investment of assets, the same principles apply as for pension insurance.
Pension insurance is the most common form for financing pensions in smaller companies and it is also the dominant form of financing occupational pensions for blue-collar workers.
Tax treatment of contributions and benefits
The same tax treatment as for pension funds applies to pension insurances.
Investment regulation
The assets invested in a traditional pension insurance are managed by the insurance company. In the case of a unit-linked insurance, the insurance company invests in its own funds (domestic or foreign) or in other external funds.
3. Book reserves
Book reserves are in principle only applicable to defined benefit schemes. Thus, retirement pensions under the ITP plan can also be financed through book reserves. In this case, participation in the credit insurance system provided by FPG is obligatory. The administration of book reserve schemes is done by a special institution called PRI (‘Pensionsregistreringsinstitutet’), which administers pension payments and calculates pension liabilities. Due to the connection with these two institutions, this system is also called the FPG/PRI system.
Larger companies typically participate in the ITP plan and use book reserves in combination with credit insurance for securing their pension liabilities.
Book reserves can also be used to finance pension promises outside the collectively bargained schemes.
Tax treatment of contributions and benefits
The same tax treatment applies as for pension funds and pension insurances.
Investment regulation
It is not common under book reserve systems to earmark any assets for pension purposes (asset backing).
Outlook
The Swedish pension market is medium-sized compared to the rest of Europe and is highly dominated by insurance companies. The fact that in 2007 insurance assets make up almost 90% of pension assets under management in Sweden demonstrates the strong position of insurance companies in the pension system. Although the use of an external investment manager is not legally required, it is increasingly becoming market practice and foreign asset managers are gaining market share.
The nationwide collective pension schemes are of high importance in Sweden and high inflows into these pension products are expected.