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Krona jewels

Swedish independent consultant and former director of fund analysis for Morningstar Europe, Niklas Tell on how Sweden’s reformed pension system is keeping costs down.

Around seven years have passed since Sweden reformed its pension system, going from defined benefits to defined contributions. Today, Sweden has a three-pillar system, where the state pension (the first pillar) is divided into income pension, premium pension and guarantee pension.

Part of the pension reform was the introduction of a funded part – the premium pension – where individuals select how their money should be managed through investment funds. A committee appointed by the government recently presented a report on the premium pension.

The Premium Pension Authority chief economist Daniel Barr says that among the key findings and comments of the report was that the PPM should introduce investment guidance for investors and a web-based allocation tool will be introduced on the PPM’s home page in the next couple of weeks. Another comment was on the number of funds in the system (currently about 706 funds), which many have said needs to be reduced.

When asked about the main benefits of the centralisation of the premium pension, Barr says it is the ability to keep costs down.

He says: “There are two benefits with our system of a centralised clearing house for the premium pension. First, our admin is very cost-effective and I have not seen anyone with lower costs. One of the explanations is the high internet penetration, where some 95 per cent of all contacts are online. We have also been able to keep the costs of asset management down. The average cost in the system is 0.8 per cent which we, thanks to our rebate system, have been able to reduce to 0.4 per cent.”

Putting this in perspective, Barr says a person aged 25 will see assets in the system reduced by about 11 per cent due to fees over the course of his or her life compared with a private unit-linked system, where fees reduce assets by about 45 per cent.

With the introduction of the premium pension and the PPM system, smaller fund groups and international fund groups gained access to an alternative distribution channel in Sweden, at least on paper.

Barr says: “They have not been very successful as international fund groups have some 60 per cent of the funds in the system but only 8 per cent of the assets. But the international fund groups do have significantly better performance in their international funds compared with international funds managed by Swedish-based fund groups.”

When ranking the funds in the system by assets under management, the first 50 are managed by Swedish fund groups.

Barr says: “As for all consumer goods and services, brand name seems to be important in how people select funds in the PPM system.”

When looking at how people have selected funds, it is clear that the average investor has taken on a big equity exposure.

Barr says: “If this was the only pension portfolio investors had, it would be too risky as people on aggregate hold more than 90 per cent in equities. But if you look to the whole system, you can view the income pension as an inflation-linked bond. In that scenario, individuals may today hold 97 per cent of their pension assets in an inflation- linked bond and the PPM account sits on top of that. In that scenario, it is rational to hold a lot of equity in the PPM account.”

One of the main benefits and key reasons behind pension reform was to make the system financially stable over the long term by moving from a defined-benefit system to a notional defined-contribution system also in the pay-as-you-go system, including automatic balancing if assets and liabilities are temporarily out of balance.

It is the internationally well known AP funds which play a significant role in preventing the automatic balancing from kicking in. The AP funds are so-called buffer funds for the pay-as-you-go system and manage about 10 per cent of the total pension assets. The four funds currently manage about 685bn krona and the performance of that money is critical in situations of temporary imbalances between inflows (from today’s workers) and outflows (to today’s pensioners).

AP3 head of communication Christina Kusoffsky Hilles石ays: “One of the unique points with the Swedish system is that the assets have been divided among four different funds. That creates risk reduction as we have all interpreted the investment guidelines slightly different and have invested in different mix of assets. This is evident in performance as well and the difference between the best (AP3) and the worst (AP4) performer is some 10 billion krona for the first 4.5 years.”

She says the pension reform and the law that govern the four AP funds have created an environment where the funds can act long term. “It is a very stable system. It was five political parties who agreed on the pension reform and all five need to agree again if anyone wants to make changes. In that sense, it is a long-term and stable system, regardless of which political party is running the country at any one time.”


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