More facts about the premium pension 2.0

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More facts about the

premium pension 2.0

April 2015

The Swedish Investment Fund Association’s pensions working group Contact persons: Pia Nilsson and Fredrik Hård

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Introduction

In January 2013, the Swedish Investment Fund Association’s pensions working group compiled a report entitled “Facts and myths about the premium pension”. A follow-up report entitled “More facts and myths about the premium pension” was published in 2014. We have now once again updated and complemented the facts presented in these reports and it remains clear both that the return on investments within the premium pension system has been very competitive and that the system is a cost-effective one. It is also clear that Swedes – and young

Swedes in particular – appreciate the opportunity to make their own fund choices when it comes to their premium pension. And that many people are exploiting this opportunity.

It is evident, not least from the premium pension review1_,

entitled “Vägval för premiepensionen, Ds 2013:35”, that the original objectives of the premium pension system have been achieved – savers have been given the opportunity to achieve better returns and risk diversification, and to take decisions based on their own wishes and preferences.

Summary of conclusions:

 Between the launch date and December 2014, the return on investments in the premium pension system has, several financial crises notwithstanding, outperformed that of the income pension, at an average of 6.4 per cent per annum compared to 2.5 per cent per annum.

 Over 99 per cent of pension savers had, as of 31 December 2014, seen a positive return on their premium pension investments.

 Differences in pensions will, in future, primarily be due to factors other than returns generated by the premium pension. The premium pension may, however, prove to be particularly significant and to offer

considerable potential for individuals with guaranteed pension in that the guaranteed pension is not affected by extra returns within the premium pension.

 There are no differences in terms of average premium pension returns between men and women.

 Savers are interested. Over half of all savers (55%) have made their own choices and those who have, account for 70 per cent of the assets under management.

1_{The premium pension review, Ds 2013:35,}_“_{Vägval för premiepensionen”,}

http://www.regeringen.se/content/1/c6/21/82/97/2e16b21f.pdf

Between the launch date

and December 2014, the

return on investments in

the premium pension

system has, several

financial crises

notwithstanding,

outperformed that of the

income pension, at an

average of 6.4 per cent

per annum compared to

2.5 per cent per annum.

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 70 per cent of people aged between 18 and 42 appreciate being able to make their own premium pension choices. Approximately 35 per cent of savers in their 30s and over half of those in their 40s have already chosen their own funds.

 There is a competitive, default alternative for those who do not want to make their own choices or who want the state to handle their entire pension for them.

 The average fund fee within the premium pension system is 0.28 per cent, after the equivalent of two thirds of the gross fee has been discounted. Saving in funds via the premium pension system may, therefore, offer the best value for money.

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What is the premium pension?

Pension savings as a whole can be divided into three parts – the national retirement pension, the occupational pension, and private pension savings. The premium pension comprises only a small part of the national retirement pension. Pension credits comprising 2.5 per cent of an individual’s pension base are allocated to the premium pension every year, in comparison with the 16 per cent credited to the income pension every year. Pension credit allocations are based on salaries and other pensionable income up to 7.5 times the income-related base amount, corresponding to SEK 435,750 for 2015.

The premium pension is the part of the national retirement pension that the individual saver can personally influence by choosing their own investment funds. Savers can choose up to five funds. If a saver decides not to choose their own funds, the capital is invested in the state management alternative, AP7 Såfa.

The premium pension capital is deposited in an individual account held by the Swedish Pensions Agency and is, unlike the other component of the national retirement pension (the income pension), credited directly to the individual premium pension saver.

Three overall objectives were formulated when the premium

pension system was set up:

 Improve the return. Offering access to capital market investments generates the potential for returns that exceed the economic growth (the growth in production value per capita).  Offer savers an increased risk diversification. The ability to

invest in economies other than the Swedish one enables the

premium pension to be disengaged from demographic and economic trends in Sweden.

 Enable investment decisions based on individual preferences. Allowing savers to take their own investment decisions with regard to their premium pension means that the decisions can be made in line with the saver’s personal preferences, e.g. with regard to risk level and risk diversification.

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Performance within the premium

pension system

The period since the introduction of the premium pension system has been an extremely turbulent one for the financial markets, but the system has still managed to deliver good returns on investments.

Since 1995, when the premium pension was introduced, the average per annum return within the premium pension system, several financial crises notwithstanding, has been 6.4 per cent, in contrast to the per annum return of 2.5 per cent that would have been generated if the capital had tracked the index, as the income pension does2_{. If the period from 1995 to 2000, when}

the capital was temporarily managed by the Swedish National Debt Office, is excluded, the difference is even greater at 7.1% per annum vs. 2.4%.

Viewed from the perspective of the individual savers’ returns, over 99 per cent of all premium pension savers had seen a positive return on their premium pension account investments by the end of 2014.

Source: The Swedish Pensions Agency: Monthly statistics, 31 Dec. 2014.

2_C_{apital-weighted return from start (incl. temporary management by the Swedish}

National Debt Office, 1995−2000) up to and including the end of 2014. Source: the Swedish Pensions Agency: Monthly statistics, Funds and Fund-based saving, 31 Dec. 2014.

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Costs within the premium

pension system

The premium pension system is cost-effective. Its administration is not tax-financed; instead, the system is financed through the administrative fee that the pension savers themselves pay. These charges totalled an average of 0.10 per cent, or a maximum of SEK 120 per saver, in 2014. The administrative fee is, over time, expected to halve from the current level as a consequence of the fact that the costs of setting up the premium pension system will be written off in 2018.

The selectable funds’ fees are, furthermore, heavily discounted in the premium pension system. The discounts are possible because the fund management companies have only one single customer within the system, namely the Swedish Pensions Agency, which

handles all contacts with savers and administration. The size of the discount is based on the amount of premium pension capital that is invested in a fund management company’s funds.

The average fund fee within the premium pension system is a mere 0.28 per cent per annum after the deduction of discounts equivalent to 0.59 per cent from the average gross fee of 0.87 per cent. It should also be borne in mind that the individual saver is completely free to choose their own funds from

an extremely wide range that offers funds with different orientations and fee levels, including at present, for example, funds that levy no charge at all within the premium pension system. If the saver makes no choices, the capital is automatically invested in a competitive fund with a charge that totals no more than 0.12 per cent per annum.

New fee cap, 2015

The Swedish Pensions Agency has also, as of 2015, introduced a fee cap for the funds in the premium pension system. This means that funds with a gross fee in excess of a given level will be obliged to offer a 100 per cent discount on the part of the fee that exceeds this level. As a consequence, no fund in the premium pension system can now levy a fee that exceeds 0.89 per cent after discounts. The maximum fees for balanced funds and fixed income funds within system are 0.62 per cent and 0.42 per cent,

respectively.

The average fund fee

within the premium

pension system is a mere

0.28 per cent per annum

after the deduction of

discounts equivalent to

0.59 per cent.

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It may be wise, within the premium pension system and in the light of the substantial discounts available within that system, to take a slightly different approach to fund charges than that normally adopted, in that the

construction of the premium pension discount means that funds with high charges outside the system are generally those that provide the biggest discounts within the premium pension system. As a result, some types of funds can be bought at a “huge discount”, within the premium pension system.

If one assumes, for example, that a person not only saves in funds through their premium pension but also has private fund-based savings, and that this person wishes, to some extent, to invest in emerging market funds (a type of fund characterised by relatively high fees), there are good rational reasons for that person to primarily use their premium pension savings for this type of investment in order to take advantage of the very large discounts offered. An emerging market fund may, for example, have a fee of 0.6 per cent within the premium pension system, but one of 2.5 per cent outside the system.

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Premium pension offers boost for

those with guaranteed pensions

Concerns are sometimes expressed that the state will be obliged to compensate people who have not succeeded particularly well in managing their premium pension investments. It is important to be aware, however, that the guaranteed pension is not affected by the return within the premium pension system in that the guaranteed pension is calculated as if the entire national retirement pension had been the income pension. The premium pension may hence also be particularly significant for individuals whose overall pension is partly made up of a guaranteed pension, since

they, via a positive return on their premium pension savings investments, can profit from the additional return, relative to the income pension, without lowering the level of their guaranteed pension. See below for an example.

Example 1: National retirement pension per month, calculated on the basis of the same return for the income and the premium pension, i.e. 2.5% per annum (SEK)

Income pension 8,400

Premium pension 1,300

Guaranteed pension 800

Income before tax 10,500

Example 2: National retirement pension per month, calculated on the basis of a higher return for the premium pension, i.e. 6.4% vs. 2.5% per annum (SEK)

Income pension 8,400

Premium pension 3,200

Guaranteed pension 800

Income before tax 12,400

For a person for whom credit allocations − which are assumed to have grown by the average annual rate of return to date for the income pension and premium pension (2.5% and 6.4%, respectively) − have been made to the national retirement pension for 40 years, the additional return within the premium pension system in Example 2 could give nearly SEK 2,000 more in pension per month at current monetary values.

An increase in income of this order is, particularly for pensioners with guaranteed pensions, of the utmost importance, not least in the light of the fact that sky-high marginal effects arise on other income for this group. Even taking into account taxes and any reduction in municipal housing

supplementary allowances, this means an increase in pension payments to a group in particular need of extra support. Around 40 per cent of current pensioners are covered by the guaranteed pension, including around 60 per cent of women and 15 per cent of men.

The premium pension

may be particularly

significant for

individuals with

guaranteed pension.

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0‐19 20‐24 25‐29 30‐34 35‐39 40‐44 45‐49 50‐54 55‐59 60‐64 65‐69 70+ Alla Share % 0,8 4,5 19,3 34,8 52,5 65,6 69,8 70,6 71,7 69,6 52,6 52,1 52,4 0 10 20 30 40 50 60 70 80 % Age group:

Percentage of premium pension savers who have

chosen their own fund portfolio, by age group

Activity levels within the premium

pension system

One figure that is often mentioned is that only around 1 per cent of new premium pension savers in recent years have chosen their own funds. This figure refers to the new savers, who are in their twenties and who have very little capital, and to whether they have actively chosen funds for the

premium pension during the first few weeks after they receive their first annual statements. But it is also a fact that a large

percentage of the premium pension savers who have been in the system for some time and who have put down stronger roots in the labour market move their capital from the default alternative, AP7 Såfa, to their own, personally structured fund portfolio.

In 2014, for example, the default alternative gained approximately 175,000 new savers as a direct result of the fact that over 99 per cent of the new savers did not make an active choice. In the same year, however, over

40,000 savers took the opposite route, i.e. they chose to leave AP7 Såfa, opting instead to choose their own portfolio of funds.

The graph below clearly shows that interest increases over time. 20 per cent of 25 year olds and 35 per cent of 30 year olds have chosen their own funds in the premium pension system. It should also be noted that none of these individuals were “in the system” when the first − and particularly attention-grabbing − premium pension choice was made in 2000. Over half of savers in their 40s have made their own fund choices.

Source: The Swedish Pensions Agency, 2015

35 per cent of 30 year

olds have actively

chosen their own funds

in the premium

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0 10 20 30 40 50 60 70 80 90 100 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 %

Percentage of premium pension savers who have chosen

their own fund portfolio and their share of the capital

Percentage of savers, own portfolio choice Percentage of capital, own portfolio choice

If all premium pension savers are taken into account, 55 per cent have chosen their own funds (2014) and this share has remained more or less constant for many years. These premium pension savers’ capital accounts, furthermore, for no less than 70 per cent of the total assets under

management3_.

Source: The Swedish Pensions Agency, 2015

3_{The fact that the percentage of total capital is higher than the percentage of savers is}

due to the fact that savers with larger amounts of capital in their premium pension accounts are more likely to make their own fund choices. (Savers with AP7 Såfa have an average total capital of SEK 81,800, while those who make their own portfolio choices have an average total capital of SEK 156,100.)

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A survey4_{conducted by TNS Sifo Prospera and commissioned by the Swedish}

Investment Fund Association has also shown that Swedes appreciate having the ability to choose their own funds within the premium pension system. The survey shows that six out of every ten Swedes like the fact that you can make your own choice of funds within the premium pension system. It is worth noting that the youngest age group (aged 18−42) share this belief to an even greater extent (70%).

Percentage who appreciate being able to make one’s own choice or who would prefer the state to handle it, %

Age: All 18‐42 43‐62 63‐76

Personal choice is good 60 70 51 57

It’s better for the state to handle it all 35 25 44 38

Don’t know/No answer 5 5 5 5

As regards the activity level among the premium pension savers, the 20145

Annual Report by the Swedish Pensions Agency states that approximately 10 per cent of savers who have made their own fund choices made at least one fund switch in 2014. Over the last three years, just over 30 per cent of this group have made at least one fund switch.

It should also be noted in this context that there is a completely acceptable alternative for those who would prefer not to make their own choice. If no active choice is made, the premium pension capital is, as noted above, invested in a state-managed, competitive fund with a low charge. It is important to realise, however, that the default alternative, AP7 Såfa, is not a low-risk alternative.

AP7 Såfa mainly comprises a global equity fund with leverage, which means larger rises and falls in line with stock market fluctuations, but which also offers the potential for a greater long-term return. In 2010, AP7 Såfa replaced the previous default alternative, the premium savings fund, which had a lower risk level. Savers were, at the same time, given the option of reverting to the default alternative after having previously chosen their own funds. AP7 Såfa cannot currently be chosen in combination with funds from the private range of funds, but savers may choose one of AP7 Såfa’s building block funds as a complementary component of a private fund portfolio.

4

http://fondbolagen.se/Documents/Fondbolagen/Studier%20-%20dokument/Fondspararunders%c3%b6kning%202012%20Fondbolagens%20f%c 3%b6rening.pdf

5_{The Swedish Pensions Agency’s 2014 Annual Report,}

https://secure.pensionsmyndigheten.se/download/18.c10f85e14bab3c830a6c3ac/14 27197744586/%C3%85rsredovisning_2014.pdf

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Inequities and risks

The premium pension system is sometimes described as a casino in which you risk “gambling away” your future pension. Another concern expressed is that the premium pension system entails significant inequities due to the fact that different premium pension savers achieve different balances in the premium pension accounts.

The premium pension is neither a lottery nor a magic trick. The premium pension accounts for only a small part of the national retirement pension – and an even smaller part of the total pension received. Taking a certain amount of risk in conjunction with premium pension saving does not, in other words, mean risking one’s entire future pension. The majority of the national retirement pension (the income pension) tracks growth, i.e. equates to a fixed income investment. It could, therefore, be argued from a risk diversification perspective, that the premium pension component should be exposed to the equity market, or at least that this opportunity should exist. Good long-term returns presuppose taking some degree of risk.

Minor differences between men and women

Gender differences within the premium pension system are, effectively, non-existent when it comes to returns. In 2014, when stock markets worldwide rose strongly, the difference in the average performance of men’s and women’s portfolios was extremely small at 22.2 per cent and 22.0 per cent, respectively. The average returns generated by men’s and women’s portfolios since the system was launched is the same, both for those who have chosen the default Såfa alternative and those who have chosen their own portfolios. This indicates that there is no difference between the genders in terms of their willingness to take risks within the premium pension system, which is particularly interesting, given that men are usually thought to be

considerably more willing than women to take risks in their savings in order to achieve better returns.

The fact that women generally have substantially less capital in the premium pension system than men is generally due to differences in the labour market resulting from women’s lower average wages. The opportunity for the individual to determine their investments’ orientation and risk level on the basis of their personal preferences and financial position is at the heart of the premium pension system’s structure. The premium pension system includes a very wide range of funds offering both low and high risk and those who do not wish to take the risk that exposure to the equities market entails already have the option of choosing a relatively secure, fixed income investment instead. This does, however, necessitate making an active choice. Equities are a means of financing companies. Equity funds offer the opportunity to own shares in companies all over the world and to share in the growth created. Their value can fluctuate substantially in the short term, but in the long term, equities have always generated higher average returns than risk-free fixed income alternatives.

The premium

pension is

neither a

lottery nor a

magic trick.

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The range of funds available within

the premium pension system

One common perception is that the number of funds available within the premium pension system is too large and that, as a result, many savers find making personal choices difficult.

A wide-open range of funds offers the potential for savers to fulfil different desires and, at the same time, the competition helps not only to increase pricing pressure, but also to enhance quality (increased value). A free product range has no predetermined optimal number of products, nor is the intention that everyone should be informed about every fund, but rather that the funds that different savers with different desires want should be available. It is, therefore, important that the premium pension system’s steering mechanisms are such that the range of funds offered comprises the funds that savers genuinely want and benefit from.

It is also very important that the choice of funds is facilitated by means of a well-structured product range and by the provision of high quality information and advice for the savers. To this end, the Swedish Investment Fund Association has, by means of, amongst other things, the “Fondkollen” project (comprising a website and an app), actively worked to increase savers’ knowledge and

involvement, e.g. with the help of practical tools that facilitate fund comparisons and evaluations.

Two-stage model facilitates choice

A two-stage model has been developed (see overleaf) which describes how the choice of funds can be facilitated. The starting point is that in the first stage, the saver chooses a type of fund. Only then, in the second stage, are specific funds compared with one another and this comparison is limited to the type of fund already chosen. These choices can then easily be ranked by preference in a number of different ways.

Historic performance is no guarantee of future performance, but sorting the funds based on the results they have previously achieved, e.g. over the past five years, does provide valuable information on how well the funds have been managed. Fund ratings and the size of the fund’s fees are other

parameters that should be taken into account in conjunction with choosing a fund. Those savers who wish to choose funds on the basis of specific

sustainability criteria can also, within the premium pension system, choose from funds that have a so-called “M/E-labelling” (environment/ethics). There are currently around 150 funds in the premium pension system with this labelling and hence an associated sustainability profile in which the fund’s sustainability work is described.

It is also of the

utmost

importance that

the choice of funds

is facilitated by

means of a

well-structured

product range

and the provision

of high quality

information and

advice for the

savers.

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All

funds

Stage 1

: Choose fund type Total number of categories: 35

Sampleof categories: Equity funds - Sweden - Nordic - Global Balanced funds Fixed income funds

Stage 2:

Choose fund Maximum number of funds within a single category: 2-87

Suport for making a choice:

1. Sort the chosen category by average returns over 5 years

2. Fund ratings 3. Management fees

Done!

Two-stage process for choosing premium pension funds:

The benefit that results from individual savers being able to choose their own funds in line with their own preferences also means that the returns on investments will differ from one saver to another. This does not, necessarily, have to be a negative thing. The fact that a person who has chosen to take a slightly higher risk in their premium pension savings reaps the benefits of so doing in the form of a slightly higher return than a person who preferred to save in a more secure investment with a more consistent return is not, necessarily, inequitable.

Differences in pensions will continue in future to be due, in the main, to factors other than the return on the premium pension investment: the most significant factors will actually be employment frequency, salary levels and age of entry to/withdrawal from the labour market. High marginal effects, i.e. the fact that increased earned income makes no tangible difference to the contents of the pension envelope, are a bigger problem for pensioners with low pensions.

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Premium pensions – a generation

issue

A wish to see credits transferred from the premium pension system to the income pension, primarily in order to stabilise pension disbursements to existing pensioners, has been expressed in a variety of contexts.

A transfer of this kind would, however, according to calculations by the Swedish Pensions Agency6_{, entail a substantial transfer from tomorrow’s}

pensioners to today’s, and for this reason, the appropriateness of any such transfer must be questioned, not least in the light of the demographic trend we currently face. The percentage of people who are gainfully employed will decline while the percentage of pensioners will increase, and at the same time, the increase in people’s lifespans will necessitate pension

disbursements over an extended period of time.

Extract from the Swedish Pensions Agency’s memorandum, “Switching contributions from premium to income pensions”6_:

“For those born in 1995, switching contributions in conjunction with a real return of 5.3 percentage points (a difference of 3.5 percentage points in relation to the assumed growth in income) would entail a reduction in the national retirement pension of SEK 2,190 per month, expressed in today’s wages and prices (ca. -18.8 per cent).”

The estimated effect shown above is based on switching contributions by 2.5 percentage points (i.e. the whole of the current premium pension share). The estimated effect, if the switch were, instead, to be one of 0.5 percentage points (a reduction in the premium pension component from 2.5 to 2 percentage points), is 20 per cent of that described above.

6_{http://secure.pensionsmyndigheten.se/download/18.732ffcac141a7450fb5cfe1/1379}

666209843/+Hur+den+allmanna+pensionen+paverkas+av+en+avgiftsvaxling+fr% C3%A5n+premiepensionen+130919.pdf

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Summary comments

The returns generated within the premium pension system have been substantially better than those that would have been generated if the capital had tracked the income pension performance instead.

Pension saving is, for the vast majority of people, a very long-term savings project and a project of this sort of duration should include the option of a certain exposure to the stock market and hence, to the possibility of reaping the benefits of the risk premium that this entails – for those who want it.

Having the ability to influence part of one’s own pension savings investment generates the potential not only for adjusting these savings in line with the

individual’s personal situation and preferences when it comes to risk and return opportunities, it also clearly helps give rise to a situation in which the individual is aware of and involved in their pension savings in particular and their overall savings in general.

In conclusion, it is clear that all three of the premium pension objectives formulated when the premium pension was launched have, to date, been met:

 returns have, on average, been better than the economic growth;  savers have been offered a greater risk diversification;

 savers have been given the opportunity to make their own investment decisions based on their own personal preferences.

More facts about the premium pension 2.0