Policy Update 023 Pre-event Interview No.2

Evaluating the History, Future and Lessons of Pension Reform in Sweden

Director of the Department of Pensions of Sweden's Social Insurance Agency

The 2004 reform of Japan's pension system presents a paradox in that most of the Japanese public is still skeptical of the pension system's sustainability, while economists abroad and major international organizations such as the World Bank have given the reform high marks. The significant difference in assessing the 2004 reform may be attributed to the fact that the basic principles of the public pension system have become blurred and increasingly difficult to understand. At the RIETI policy symposium "Japan's Pension System -Evaluating the 2004 Reform and Establishing Clear Principles for Further Reforms-" on December 15-16, RIETI will present the interim research results of its social security projects including the analysis based on a newly developed simulation model (RIETI Model) and bring together a broad panel of Japanese and overseas economists. The purpose of this symposium is to jointly evaluate the 2004 reform by clarifying the basic principles and provide insight into the directions of future reforms. In advance of the symposium, RIETI interviewed Mr. Ole Settergren, a presenter on the Swedish pension system about Sweden's own implementation of reforms and what potential it created for informing Japan.

Ole Settergren is Director of the Department of Pensions of Sweden's Social Insurance Agency1. In his previous capacity a pension expert with Sweden's Ministry of Health and Social Affairs, Mr. Settergren was responsible for developing the automatic balance mechanism at the heart of Sweden's mid-1990s pension reforms that created the first automatically financially balanced pay-as-you-go (PAYG) pension scheme in the world. Prior to his roles in the Swedish government, Mr. Settergren worked in the private sector as a financial controller, underwriter, and financial advisor. He holds an MBA from the Stockholm School of Economics.

REITI: Sweden's pension system (the inkomstpension) is quite attractive in that it is pay-as-you-go and allows the individual to track his/her balance like a savings account. The system's maintenance also requires strong social governance. How were the 1990s Swedish pension reforms presented/"sold" to the public initially and how were they received?

Settergren: I share the judgment that one of the attractions of the inkomstpension is that it can be presented like a savings account and that it requires a strong social governance to be maintained.

You would probably get different answers to the question of how the reform initially was presented to the public depending on who you ask. This is, naturally, my version.

From the pension reformers' point of view the basic argument for the reform was one of financial sustainability. The reform implied a change from a pension scheme that in normal to pessimistic assumptions was judged to be going bankrupt, to a pension scheme that regardless of economic or demographic assumptions would be financially sustainable. This was the number one selling point.

However it was of course obvious that this change would imply lower pensions in normal to pessimistic scenarios -- this was the negative side of the "sustainability argument." This presented pension reformers with perhaps their most difficult task, convincing enough people that still the change should be made.

In this context one must admit that Swedish politicians and perhaps also their experts had a relatively enviable situation when compared with other countries that need to reform their pension schemes. The Swedish demographic projections are not as troublesome as those of many other countries. This is due to slightly higher experienced and projected fertility rates, roughly 1.8, than many other OECD countries and high experienced and projected immigration2. Contributing to the relatively easier situation in Sweden was also the large buffer fund of the old pay-as-you-go pension scheme which increased the financial and political space for maneuvering the reform3. In this last respect -- a large buffer fund -- Japan and Sweden have a similarity. Thirdly, Swedish politicians gave themselves an advantage as they started relatively early with their grand reform.

The less tough than average demographic projections, the better than average financing of the old pension scheme, and the relatively early start gave reformers an opportunity, a selling argument that most other legislators do not have.

Swedish reformers could rightfully claim that the new scheme would on average give the same pension benefits as the old pension scheme would have given under reasonably good conditions: an average work life of 40 years, a real growth of 2% and a life expectancy that corresponded with the one measured in 1992. This I believe has been very important, and it is an argument that most other countries cannot rightfully claim.

RIETI: Looking to the future, what further reforms are necessary for the Swedish pension system?

Settergren: None are financially necessary. This is one big difference relative to the pre-reform situation. However there are always ideas and sometimes the need to change social constructions as society changes. But in some sense the idea (some would say the illusion) of the Swedish pension reform is to construct a system that need not and should not be changed.

The issue that is most debated right now is the design of the premium pension system. It has over 700 participating funds and some find this to be a disturbing number both for making informed choices and for securing low administrative costs. A government commission has looked into this issue and made some suggestions for reducing the number of funds. This is a much more difficult issue than one might first think. My view is that Sweden should not do anything radical right now. It should only push costs to their minimum and gather more experience from the scheme.

One disturbing fact to me in the public Swedish pension system is that the ceiling, i.e. the highest income that is insured by the system, is only some 150% of an average pensionable income. At the same time the guarantee pension is not completely reduced to a level quite close to that of an average pension. Thus the space between the floor and ceiling is very limited. This implies high marginal effects for both low income earners and high income earners. There is a means tested housing allowance that increases the marginal effects substantially, pushing the high marginal effects to also include normal income earners.

Unfortunately I have difficulties in seeing how this situation could be improved. In Sweden it is politically unpopular to decrease benefits to low income earners, thus high marginal effects will probably remain.

In the reform the design of the guarantee pension implies that it will be price indexed, thus it will fall in value relative to expected increases in incomes. In consequence the marginal effects will fall. It is however unlikely that the guarantee will remain unchanged and thus drop in relative value for a very long time.

REITI: Japan's major concern is its aging population (28% of which is projected to be over 65 by 2025). Sweden also has one of the world's highest populations of people over 65, which should continue to rise. In terms of the pension system what measures are taken to accommodate this rise?

Settergren: In the new scheme if life expectancy continues to increase, benefits for new retirees will drop if they retire at the same age as their predecessors did.

Thus the hope and ambition is that the insured will postpone their retirement. To aid this, the age at which employers have the legal right to terminate the employment contract has been changed from 65 to 67. (There are of course other reasons than age for terminating an employment contract.)

RIETI: The Swedish pension system, particularly in regards to its automatic balancing mechanism, seems to have provided an example for the Japanese pension reforms of 2004. What other aspects of the Swedish pension system might be adaptable to the Japanese reforms? In what ways do the countries explore partnership opportunities?

Settergren: I wish I could give a good answer to this question. Sweden is a small country, Japan very large when measured by population and size of the economy. Pension reform is a process where economic and political aspects move each other in a dynamic way, extremely difficult to project even for local experts. I am a foreigner -- a gaijin.

In some sense my uninformed opinion is that Japan should essentially do what it is actually doing in the area of pension reform. Gathering expert knowledge from around the world, bringing it home to Japan and seeing what might be good solutions for Japan. The 2004 pension reform seems to me to be a very substantial reform -- the indexation of benefits is very tough. It will be interesting to follow how Japanese politics will deal with its consequences -- just as it will be to follow Swedish politics in the "post-reform" era. No democracy has yet experienced the political and economic dynamics that supposedly will follow from the implementation of an automatically financially stable public pension scheme.

One area where there might be opportunities to exchange experiences is in the way we inform the insured individuals and also in how we analyze the financial development and position of the pension scheme. In both areas I think Sweden has made substantial progress. Another might be in the area of collecting contributions, where I think the Swedish tax authorities are quite good.

A further possible area for cooperation would be projection methods and to analyze if it would be possible to calculate a "balance ratio" for the Japanese system in a similar way as we do in Sweden.

Another area that is a bit outside "core pension politics", but still related, is whether there are good products in the market for elderly people to convert real estate capital to income. In Sweden this market is not well developed.

Interview conducted by Adam Goulston, online editor, on December 9, 2005.

  1. Previously The Swedish National Social Insurance Board, which changed its name as of January 2005 when it merged with the 21 regional insurance offices.
  2. In the projections immigrants are, with some delay, assumed to have similar labor force participation as others in the Swedish population. At present this seems not to be the case as the immigrant population, even after many years in Sweden has a significantly lower labor force participation.
  3. The fund is at present some 25% of the Swedish GDP or four times annual pension payments. The fund was larger before the reform but the increased government payments to the pension system were balanced by "one-time" transfers that still have not been permanently settled.

December 9, 2005

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