In Sweden, pension problems are so 1989
TheGlobeandMail.com – ROB/economy/economy lab
Posted on Friday, January 21, 2011. Naomi Powell – Stockholm
There’s no shortage of pension woes in Europe these days.
Everywhere, it seems, governments are hiking retirement ages, cutting benefits and quelling protests from outraged workers.
Not in Sweden.
It isn’t that the Swedes escaped the troubles now facing many of their European neighbours, they were just forced to deal with them a long time ago. Still, the economic crisis presented the first real test of the country’s pension reform, one it weathered relatively well.
In the late 1980s, the government realized that without a major overhaul, the public pension system would be bankrupt in about 20 to 25 years. The reasons are familiar: a rapidly aging population and a defined benefit system that would collapse without consistently strong economic conditions.
“You had this big tanker of pensioners who were going in one direction and you had pensions that had to be paid by law,” said Edward Palmer, a professor of social insurance economics at Uppsala University who helped design the system. “But you had an economy that could do anything. We had to get a system that would be resilient to both economic and demographic shifts and we had to get people to work longer.”
In a radical change, Sweden scrapped its traditional defined benefit pension for what’s called a “notional defined contribution” plan (NDC). The notional account recorded each individual’s contributions and a rate of return tied to the national per capita real wage growth. There was no “real money” in the account – as in traditional pension plans, contributions fund current retiree benefits – but the system provided a way of keeping score.
Swedes contribute 18.5 per cent of their pay to the system: 16 per cent to the NDC and 2.5 per cent to a private account where money is invested in mutual funds of their choice. The public pension is a significant portion of retirement income – responsible for 75 per cent of the average monthly benefit for men at 17,000 Swedish kronor ($2,562 U.S.) and women at 12,000 kronor. The rest comes from occupational pensions negotiated between companies and unions.
When workers retire, their annual benefits are calculated by dividing the account balance by the life expectancy rate and rate of return based on the growth of the economy. Benefits are adjusted each year taking into account changing life expectancies, inflation and the rate of return.
Workers can retire as early as 61, but the longer they stay in the work force, the higher their benefit upon retirement.
The bottom line? When the economy is strong, pensioners receive more than they might have under the old structure. But when the economy is weak pension payments automatically drop to ensure the fund’s stability.
The system was designed in part to take difficult decisions regarding benefit cuts out of politicians’ hands by allowing them to refer to a formula.
That was the theory anyway. No one really knew how well the system would perform until the global economic crisis.
Pensioners, who had enjoyed years of higher payments following the changeover to the new system in 1999, suddenly faced a cut of 3 per cent in 2010 and 4.3 per cent in 2011.
The government stood behind the system, though eventually politics did get involved. Taxes for pensioners were slashed to make up for the shortfall.
“The positive side is that Sweden now has one of the few public pension schemes that is in good shape after this crisis,” said Ole Settergren, head of research and development at the Swedish Pension Agency. “But one of the points was to isolate public finances from what happens in the pension arena. That didn’t happen.”
Perhaps the most controversial aspect of the plan is that it shifts the burden of fund shortfalls onto pensioners – though there is a basement for how low benefits can fall, at 7,000 kroner a month. And as the crisis proved, that burden can be significant.
Not a perfect system then, but sustainable. And one that many countries, including Egypt, Poland and Brazil have considered as they try to fix their own pension schemes.
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