Examination of Witness (Questions 480-499)
WEDNESDAY 22 JANUARY 2003
PROFESSOR EDWARD
PALMER
480. You paint a picture of people in thousands
of houses up and down Sweden discussing whether to invest in Japan,
in South-East Asia or in America. Was that the order of the day?
It was as broadly spread as you describe? (Professor Palmer)
Yes, it must have been like that, and the fact that people apparently
had discussions like this can be considered a positive externality
of the reform. The evidence that they deliberated on their decisions
is that they chose on average more than three funds per person.
Also, two-thirds chose actively, which I think surprised many
people. People in the north chose more actively than people in
the south, which surprised especially the experts. Also, the percentage
of women who made active choices was slightly higher than that
for men.
481. That is wonderful testimony to the spread
of people's capital in your country? (Professor Palmer)
Yes.
482. I was looking at the charges that were
allowed to be levied. I reckon they turn out at just under 1%,
about 0.95%, in total. In this country, we are having quite a
debate at the moment over our stakeholder pensions and whether
the capping of fees at 1% means that the promoters of these stakeholder
funds have not got enough resources to market them and sell them
in an individual way. What is your reaction to that? We are worried
that the 1% may curtail opportunities and some people may be worried
that it is still too high at 1%. What is your advice on that point? (Professor
Palmer) What Sweden has done is interesting in this sense.
If you manage a fund with a relatively small number of participants,
administration can cost more as a percentage of assets than if
you manage a fund with a relatively large number of participants,
and where new contributions are flowing in all the time. If you
have a large fund with a lot of participants, and with money flowing
into your fund because people have already chosen it you do not
have costs involved with the individual customers. First, the
public clearinghouse—the PPM—keeps all of the individual
accounts, takes care of customer questions and sends out statements.
Fund share information is published on a daily basis in the newspapers
and is available from the PPM. Large funds have only very marginal
cost increases as their asset base grows. In addition, they have
only minor costs for general advertising to solicit new customers.
For all these reasons funds should be able to charge less for
administration as they grow with new injections of public funds.
Eventually, many of the more popular funds will become very large
since assets for participants in their funds are augmented by
new contributions every year, and without any effort on the part
of the fund. The PPM has considered these facts and has constructed
a rebate system that says: the more money you get from us, the
public system, the less you can charge for administration of that
money, expressed as a percentage of assets held on behalf of participants
in the system. This means a fund can charge any cost to private
clients outside the public system, but must provide a rebate on
this fee to the PPM clients if their normal fee is too high compared
to the general rate schedule, based on their PPM asset holdings.
They had to agree to accept this schedule in order to participate
in the public system. In the paper I submitted there is a chart
that shows how this works.
483. Your paper makes clear, I think, that 0.65%
is the normal amount. (Professor Palmer) Yes, and as
the system gets bigger, the figures will have to go down; they
will be forced down because funds will have much more money from
the public system. This will cause charges to decline in accordance
with the PPM schedule. The public administration is also projected
to fall from 0.3% to 0.1% in the future within 10 to 20 years.
484. The final point I wanted to raise with
you is about regulation and the regulator. Could you say a word
or two about how the regulator deals with all these different
funds? Secondly, one thing we worry about here is that excessive
regulation may not protect the interests of the consumer but may
make it more difficult for the funds to be properly and most effectively
run. Can you give us a feel for how you ensure that regulation
is light and effective and not heavy and deadening? (Professor
Palmer) The regulation of these funds is no different than
the regulation of any other investment funds in Sweden. Even though
they may be owned and run by insurance companies, as many are,
they are still separate funds with their own fund management,
et cetera. There are no specific regulations other than the fact
that they have to report daily and electronically the value of
fund shares to the PPM, the public clearinghouse. Otherwise, there
is no more regulation of funds registered with the PPM than there
is for any other fund. Regulation is easier since the investment
phase is clearly separated from the annuity phase in the overall
system. For example, in a traditional insurance scheme, both the
investment and the pension phase are put together in a package
for the individual, often in the form of a defined benefit. These
schemes are not transparent. They require sophisticated actuarial
calculations and enough regulation and monitoring to be sure that
assets cover liabilities, given risks and using reasonable assumptions
for projections. In other words, regulation in this traditional
insurance environment requires more sophisticated regulatory procedures.
In a system where the investment and annuity phases are separated
and become two businesses you have an investment piggy bank, with
fund values at the end of the day, and then, when it is time to
become a pensioner, you cash in and you buy a pension annuity.
Monitoring the funds that invest participant money during the
accumulation phase occurs within a transparent environment, and
an environment in which funds have daily communication with the
public clearinghouse, which also provides a sort of monitoring.
Note that there is only a limited scope in designing the annuity
as long as we're talking about a mandatory scheme that is a part
of a country's social insurance system. In Sweden variable and
fixed rate individual or joint life annuities are possible. These
are provided by a public annuity provider, the PPM. If the annuity
products provided are the same, in principle, the difference between
private and public administration is only in the cost of administration.
Even though it isn't so today, it is conceivable that in the future
annuities will be provided privately in Sweden, in this case through
a bidding mechanism.
Andrew Selous
485. In the United Kingdom there has been a
lot of comment recently in our press about the number of employers
which have changed their pension schemes from defined benefit
to defined contribution, and most people have been concerned and
unhappy about that switch, not least our own trades union movement
here in this country. We were particularly interested to note
that the main Swedish blue-collar union actually supported your
switch to a defined contribution scheme. Was this a typical response
in your country and was it anything to do with the particular
type of defined contribution scheme which you have in Sweden? (Professor
Palmer) The group schemes for, first, all blue-collar employees,
second, civil servants and other state employees and, third, municipal
and county council employees—persons working largely in
health care, education and other care of children, the elderly
and the handicapped, and other municipal services—were all
converted to financial defined contribution schemes following
the reform of the public system in this direction. The blue-collar
union was the first to convert to defined contribution. I think
they wanted to get a financial rate of return, under the assumption
that is likely to be greater than the rate of return based on
the growth of the economy. This assumption is in line with historical
data for the period from 1950. The only group that has been reluctant
to change from defined benefit to defined contribution are the
white-collar, private sector business employees. The reason for
this I believe is because there are many employees who have benefits
that are not revealed to anyone, and that this is perceived as
being an advantage by both parties. Assume these benefits do not
come at the expense of business profits, and note that even this
group scheme has a ceiling that excludes from coverage the higher
earnings of top executives. Then implicitly, there is some redistribution
within these schemes from persons with lower career earnings and
longer careers to persons with higher earnings over a shorter
period of time, everything else equal. A change from defined benefit
with generous rules for full coverage and final salary benefit
rules to defined contribution makes everything explicit, including
who the winners are in the present defined benefit scheme. Of
course, with a conversion to DC, there is a clear option open
for employers to improve the take-home pay of so-called losers,
if it is the objective of employers to use remuneration to attract
and keep good employees, and these are for some reason among the
losers. The alternative, defined benefit schemes, with liabilities
on the books of companies also increases the risk that commitments
will not be met when liabilities have to be converted to annuities
in the future, and certainly creates a need for reinsurance where
pension capital is kept is only on the books within the company.
486. Stock markets have fallen very considerably
around the world in the last three years, particularly severely
here in the UK. We have had a 4% fall from the peak values in
2000. Do you think such volatile stock markets pose a serious
risk to the sustainability of an equity-based contribution system
like you have in Sweden? (Professor Palmer) This is
a very difficult question to answer. You would think that if it
did pose a risk, awareness would be high right now. So, in principle,
there should be a lot of backlash in Sweden today because the
Swedish markets, like the British markets, have gone down dramatically,
and the majority of assets in the system are in Swedish funds.
But, there isn't. Perhaps because the system is just getting started
and the level is so small to begin with, it has not been considered
by people to constitute such a great problem. Also, for persons
retiring now, the account values are so small anyway that it makes
no real difference for pensions what happened with the stock market
in the recent two years. It will be different in the future when
account values are higher. In addition, people have a substantial
part of their total public benefit coming from the NDC part of
the system, which is only related to the financial market through
the rate of return on its reserve fund. There has, in fact, been
a lot of discussion in the newspapers about how much people have
lost in the past year in the financial account system. It makes
good headline news in the financial section. So there has been
no absence of information, yet this has not caused much political
debate. This may be due to a feeling among the general public,
but even the financial experts including those writing for mass
media, that in the long run there will be positive growth.
Mrs Humble
487. Can I turn to the issue of pension forecasts?
Can you tell us if in the Swedish system there is a combined private
and state pension forecast and how reliable it is? (Professor
Palmer) There is not yet a combined forecast, although this
has been an objective of the National Social Insurance Board,
which is responsible for combined information on projections for
the NDC and public financial account schemes. There is a projection
for the public scheme based on assumed rates of growth of the
economy and the financial market return. I guess if you think
the assumptions are good, then the projection can be considered
a reliable enough forecast, in the sense that it provides a pretty
good picture of what the individual can expect, given these assumptions.
I should stress that you have to make assumptions to make these
personal forecasts, and that the assumptions have been a topic
of discussion in the newspapers. You can assume 2% real economic
growth for the NDC system and 4 or 5% for the financial system,
and these will be claimed to be both too high and too low by experts
with varying points of view. The closer you get to taking your
pension, of course the better the forecast is. If you are relatively
young, the information you receive on a yearly basis provides
a chance to get a picture of how each year's contributions and
capital growth enhance the outcome in the future. So it is informative
in this incremental sense. If you are, say, 55 or 60 years old,
with a relatively predictable earnings career then the information
in the statement can give you a picture that can help you plan
when you may want to retire. In fact, a major point of this exercise
is to illustrate for older workers the effect of postponing a
pension claim. Of course, there is no exact forecast, and you
have to take the responsibility yourself to evaluate what the
information means in your case. The new system has shifted more
responsibility explicitly to the participant in this respect.
488. Are you also hoping, by giving this information,
that people will look at those projections and think, "Oh,
dear, I must pay a little bit more"? (Professor Palmer)
Yes, some people will discover that they must make additional
provisions privately for themselves, depending on the standard
they may want as retirees. At the start of this system, account
values were created from information on contributions to the old
system. I think many people were surprised to see how small their
pensions would be, even though for older workers there was little
difference from the old system. Generally, the yearly information
contributes to the educational process.
489. Have you encountered any practical problems
in detailing all the different private pension schemes that people
have and then adding on the state pension, or have I misunderstood
you? My first question is: do you produce a combined forecast?
Does it actually list everything or not? (Professor Palmer)
No, there is still no combined forecast. This has been a goal
and is under discussion. The two public pensions are reported
together, as I've just mentioned. The idea was to put the occupational
group schemes on top in the same annual letter to the participant,
but this fell apart when some of the occupational schemes did
not want to communicate their results. Perhaps it will work in
the future. On top of the public system and occupational supplement,
you might have insurance purchased on the private market. There's
been no discussion to include this in the overall projection.
As it stands today, you get information of course from your private
provider, and your occupational group provider.
490. You might have several pieces of paper
but then you are trying to collate the information. (Professor
Palmer) You are still going to have three pieces of paper.
The idea was that you would have two, but the negotiations recently
fell through in Sweden to put the occupational results in with
the public results.
491. Are you also using the internet for people
to access that same information? (Professor Palmer)
Yes. I log into the internet and make my own personal calculations
if I want them, either for the NDC scheme or the financial account
scheme. My account includes my own history. Also, I can go into
the internet and look at my funds' performance in the financial
account scheme. I actually do this in practice. I have my personal
code, and can execute a transaction that moves my money from fund
X to fund Y.
492. Going back to your answer to my earlier
question about how difficult it is to project into the future,
especially for younger workers, are these forecasts guaranteed
or underwritten in any way? (Professor Palmer) No.
They are just information to help people to think about their
own future pensions. There is no guaranteed return. It is not
like in traditional insurance where you have a guaranteed X%,
usually 3 or 4% nominal return, and at least at present, after
the fall in equity prices, some Swedish insurance companies are
having trouble with this so-called guarantee. In the public system,
the internet information is to be interpreted as an example: "If
the rate of return is—" and we have a rate of return
that we use, say 5%, "then this is what the outcome looks
like", but there are other rates of return. It is just an
exercise to help the understanding of the participant of the economic
and financial risks involved.
493. Is that a projection of a cash amount that
you are going to get at the end of the day or is it a percentage
of earnings? (Professor Palmer) My yearly statement
tells me how much I will receive in kronor per month at the ages
of 61, 65 and 70 with zero and 2% real growth, and a 3.5% rate
of return on my financial account in the case with zero economic
growth and a 6% rate of financial growth in the projection with
2% real economic growth. The statement does not give me my replacement
rate, but since I know my income and can calculate with the same
rate of growth as in the example, zero or 2%, I can calculate
my replacement rate. The reason for showing zero growth in the
statements is so that people can understand this in terms of today's
values. We think that people have trouble understanding what 2%
growth is and what it will mean in 35 or 40 years.
494. Is there any chance that you could let
the Committee have an example of what one of these forecasts looks
like? You are talking about a lot of information being given here. (Professor
Palmer) Yes. As a few years have passed, we have been simplifying
the information. To begin with, there was too much. I can send
an example of a statement, yes.
495. That would be very useful. (Professor
Palmer) I should add that in the beginning there was an attempt
to educate people with a lot of information and that was a mistake.
People just need a basic amount of information. You can send out
a separate supplement with considerable additional information
that they can read at their leisure.
Mr Stewart
496. Professor, could you describe the mandatory
reinsurance scheme and assess how successful it has been todate? (Professor
Palmer) There is no reinsurance for the financial account
system because it is not designed as traditional insurance. As
I've mentioned earlier, the financial account scheme is really
just a savings scheme until you decide to retire and then you
convert the capital balance into an annuity. You are forced to
have a life annuity, and cannot convert your account balance into
a lump sum or, for example, into a five year phased withdrawal.
497. How does the guarantee benefit work for
low-income pensioners? (Professor Palmer) The guarantee
is provided outside the NDC and financial account schemes. It
is financed through general tax revenues. As I have discussed
earlier, it provides a certain amount which is price-indexed.
It is not enough to live on, I should say, and this is part of
the design of things. In order to get enough to live on, to get
up to what the social welfare board says you need to live on as
an old-age pensioner you have to have more, maybe about an additional
third more after tax. You get this through the housing supplement,
which as I have already mention is mildly means-tested.
498. Is means testing perceived as an issue
in Sweden? Secondly, what is the take-up rate like for means testing? (Professor
Palmer) I think that the general goal has been to avoid means
testing for the elderly. This is the purpose of the default guarantee
pension, which used to be the flat rate benefit. The question
is where you put the ceiling for the guarantee. If you put it
too high, then you are giving away some money to some people who
do not really need it. In principle the idea is to set the ceiling
lower than what people generally need and then to top it up, if
they need it, but this top up is something that they have to claim,
and in Sweden this is the housing supplement for old-age pensioners.
Since it is only mildly means-tested, you do not have to have
reached a financial rock bottom to claim this benefit, which you
have to do if you collect social assistance.
499. It is a gentler slope of means testing? (Professor
Palmer) Yes, it is a gentler slope. The real problem is, of
course, for people who immigrate from poorer economies to Sweden
when they are older. To qualify for a full guarantee you have
to have been in the country for 40 years. For example, with 10
years you get 10/40 of a guarantee, and this means that if you
have no other financial resources you are going to end up with
social assistance. Because of this a new benefit has also been
introduced to deal with older immigrants who have no financial
resources, so that they do not have to go to the social assistance
office every month for the rest of their life.
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