Comments on Financial Stability of Swedish Pension system

1. Comments on Financial Stability of Swedish Pension system for Urban Institute Conference by Estelle James February 2006

2. Main points • Swedish system is very clever • Gets close B-C link without transition costs • Very generous— • high replacement rate and minimum pension • Automatic stabilizers for system: • unexpected outcomes reduce benefits, • increase outlays from general state budget • Different starting points limit relevance to US: • our benefits start much lower • using general budget as shock absorber likely means making large deficit still larger

3. Very clever • NDC gets labor market benefits of close benefit-contribution linkage without high transition costs of FDC—NDC is PAYG • NDC is PAYG, therefore has low implicit return, doesn’t increase national saving, not automatically sustainable as population ages. Financial stability achieved in other ways. • NDC is not redistributive—this is achieved by separate minimum pension guarantee (interferes with benefit-contribution linkage at bottom end)

4. Very generous: benefits • Replacement rate now 65%, expected to be 55% in future, of which 2/3 from NDC, 1/3 from FDC • Minimum pension is 30-40% average wage. May fall due to price indexation, but authors expect wage linkage to continue; many retirees receive it. • Also, recipients of minimum pension get housing supplement (90% of rent paid by government) • Generous minimum permits risk-taking, high expected return, in FDC • Minimum benefit in Sweden is higher than our average benefit

5. Very generous: generosity costs • Contribution rate = 16% for NDC + 2.5% for FDC up to ceiling + 8% paid without benefit for all wages above ceiling • + 3-4% quasi-universal occupational pension • + govt budget pays for guaranteed pension, housing allowance, disability and survivors insurance, pension credits for those on parental or sickness leave, childcare years and unemployed—costs equivalent to 12-14% wages?? (unclear) • Total cost—35% of payroll?? • (++medical insurance and long term care)

6. Built-in stabilizers: mechanisms • If people live longer than expected, annuity factor on notional accumulation rises so annual benefit falls for new retirees • Notional account is indexed to wage growth (g) so future benefits fall if g is low. If g < 1.6%, benefits fall for current retirees also. • ABM (automatic adjustment mechanism): if (notional assets+buffer fund)<pension liabilities, due to falling fertility or lf participation rates, notional accounts and current benefits fall • Note: no automatic adjustment for guaranteed minimum, housing supplements, disability insurance, and other expenditures from govt budget. In fact, these will probably increase.

7. Built-in stabilizers: where does risk go if not borne by NDC? • Brunt of unexpected outcomes is borne • mainly by present and future benefit cuts, except that bottom is protected by minimum pension • secondly by increases in general government spending • No automatic increase in contributions— • starting point is high benefit & contribution rate • No rise in retirement age, fall in minimum pension • Most uncertain items put into govt. budget but no calculations of costs under alternative scenarios • Authors claim that some of government spending will increase national saving, but this won’t happen if financed by larger budget deficit

8. Relevance to U.S.—in principle but limited in practice • In principle we could have automatic adjustment when life span increases, growth decreases or expected PDV of revenues < PDV of liabilities • But we are starting with much smaller benefits and no minimum—not clear we want benefits to bear most of brunt of unexpected events • We could have a formula that splits adjustment between benefits, contributions, & retirement age, and specifies distribution of cuts by income class • but we would have a hard time agreeing on this (long term commitment on income distribution) • We could shift uncertain spending items into govt. budget—but this would be difficult given deficit