sou · GTB387d3 · 2006-01-01 00:00:00 — In its decision on 23 2004, the Government authorised Minister to assemble a committee to evaluate the function of the premium pension system (directive 2004:77). Backed by the same authorisation, Professor was appointed special commissioner on the same day. To assist the committee in the capacity of experts, the following individuals were appointed as of : acting Chief Economist , , Managing Director , Department Director , Professor , Director , Managing Director and Managing Director . was discharged from the committee as of 13 January 2005. , MSc in economics was appointed secretary of the committee as of 15 2004. , PhD, assumed the position as of 1 October 2004. , PhD took over as secretary on 1 January 2005. was released as of 13 January 2005, when she was appointed committee expert. Division Manager was appointed secretary as of 21 2005. was granted maternity leave as of 1 2005. , PhD was appointed secretary as of 1 2005. has acted as committee assistant. , which assumed the name (Fi 2004:13), hereby submits its report Svårnavigerat? Premiepensionssparande på rätt kurs (SOU 2005:87). (Difficult waters? Premium pension savings on course). This completes the assignment. Specific statements made by some of the experts have been enclosed in the report. The Riksdag decided in 1998 to adopt the new pension system con- sisting of guarantee pension, income pension and premium pen- sion. Pension rights are earned annually as 18.5 per cent of the sum of earned pension-qualifying incomes and amounts – with a ceiling of for 2005. Of the 18.5 per cent, pension rights for income pension are 16 percentage points while 2.5 percentage points are premium pension. The Premium Pension Authority (PPM) was founded to admin- ister the premium pension system. PPM is to keep an individual premium pension account for each pension saver that shows the development of the savers holdings in the system. The Sjunde AP- Fonden () was also set up to manage the Premiesparfonden (the ), where money was invested for those pension savers who opted not to choose. Sjunde AP-fonden also manages Premievalsfonden, which is a state fund alternative among the systems elective funds. The premium pension system is funded, which means it is possi- ble for pension savers to receive a higher pension given that the return in pension investments exceeds the growth of labour income in the society. It is also possible to spread the risks internationally since pension savers can invest in the financial market. The distin- guishing feature of the premium pension system is that pension savers themselves carry investment risks and make investment de- cisions. Savers can thereby adjust the risk levels for their premium pension savings to their specific life situation. In its operations, PPM acts as a unit linked insurance company, where asset management is conducted in investment funds that have applied to PPM for registration and are handled by independ- ent fund managers. The unit linked insurance model means that PPM is owner in investment funds where the money is invested. Pension savers can opt to invest their money in as many as five funds on the PPM fund market. The basic requirements for regis- tration stipulate for instance that the fund manager must have a permit to conduct fund business in accordance with the Invest- ment Funds Act and is subsequently monitored by the Swedish Financial Supervisory Authority () or compa- rable authorised foreign agency. A fund can be registered if the fund fulfils requirements corresponding to those in the UCITS Directive. If the pension saver does not select a fund, the money is invested in Sjunde AP-fondens Premiesparfonden (the default alternative). Furthermore, a saver is entitled to at any time request that PPM transfer all or parts of the savers holdings to one or more different funds. Pension savers do not currently incur fees or tax conse- quences when they switch funds. However, a pension saver who has at one point selected funds at the PPM fund market cannot thereafter actively opt for the Premiesparfonden. Premium pension can be drawn starting the month the pension saver turns 61. There is no set time when pension must be collected at the latest. Premium pension is lifelong and calculated equally for women and men. Pension is calculated based on the balance in the premium pension account. When drawing pension, the pension saver has the alternative to keep his/her account balance invested in securities funds. The saver can also receive his/her premium pen- sion in the form of a life annuity as a guaranteed amount. According to the official document for appropriations, PPMs operations are to gradually be covered by fees extracted from the pension savers premium pension accounts. year PPM invests considerable amounts (over billion in 2005) in funds for 5.4 million pension savers. PPM handles a large part of the admini- stration and information that otherwise would befall fund manag- ers. PPM negotiates with fund managers registered in the system for discounts on fees for manager services. PPM receives rebate on the management fees extracted by fund managers which are based on the size of the funds fees and PPMs total holdings in the funds. The rebates that fund managers repay to PPM are reinvested in full in each respective fund on behalf of the pension savers. The committees assignment entails identifying any problems asso- ciated with actual and expected difficulties in supporting individual savers decisions to choose and switch funds through information and guidance. is also to assess to what extent more detailed information and guidance can improve the results and reduce the risks for systematic poor outcomes and propose related measures. is also to review the design of the system in re- spect to the scope of the fund selection and how it is compiled and propose measures that facilitate the selection process for individual savers and reduce the risk for systemic poor outcome. Furthermore, the committee is to assess the systems costs in the form of fees for participating fund managers and assess the conse- quences of the proposals submitted for the systems collective ad- ministration costs. Finally, the committee is to consider and propose improvements for the individual in conjunction with transferring to life annuity. The basis for the committees work The first round of choice in the was in 2000 and it was preceded by a period of very strong growth on the stock exchange, which was followed by a period of dramatic de- clines in share prices after the first round. The committees assign- ment should be viewed against this background. At the same time, it should be noted that the premium pension system does function well and is reasonably cost effective. The basis for the committees work has therefore not been to create a new system but to propose improvements in the current premium pension system. Based on the guidelines given to the committee, the committee has concluded that the premium pension system will continue to be a unit linked insurance system where asset management is carried out in investment funds administrated by independent private or public fund managers. Public managers must comply with the same terms and conditions and in full competition with the private man- agers. will also continue to be de- signed as an open system. This means that a fund manager that ful- fils the requirements is in principle free to register its funds in the system and that PPM when registering the fund will not make any assessment as to whether it is appropriate that the fund is in the system. PPM will instead take market-oriented and transparent measures. understands that PPMs ongoing activities are governed by the pension savers needs. One guideline should be that pension savers have a better chance to manage their invest- ments so they receive a high premium pension. has as its basis chosen to propose as few changes in the regulations as possible and allow PPM to utilise the discretion already at the au- thoritys disposal. Pension savers management results Since new pension rights are earned and new money deposited each year, the fall in the stock exchange that occurred at the start of the period becomes less significant. In 2005, the fund capital value for the first time exceeded the combined deposits and the increase in value totalled billion at the close of . Accumulated deposited amount and fund capital, SEK billion At the close of , 89 per cent of the pension savers were on the credit side of their premium pension accounts. Pension savers time-weighted return, which shows the return on one in- vested krona, is however negative and about nine per cent. This means about () remain of one average krona in- vested at the start. This does however not consider that returns have been more favourable when the accounts balance was the greatest. The capital-weighted return in the form of internal rate of return does consider this factor. The systems internal rate of re- turn has been positive since mid-year 2005 and was about 21 per cent on . Internal rate of return can be com- pared with interest that would have been ascribed the current balance if the amount corresponding to earned pension rights had been deposited in a bank account instead of in the premium pen- sion system. Pension savers average outcome, 2000-2005, internal rate of return (internränta) and time-weighted return (tidsviktad avkastning) A comparison with other pension systems reveals that the Swedish premium pension system has a large portion of savers. In the first round of choice in 2000, two-thirds made an choice and money for 33 per cent of collective amount was invested in Pre- The level of activity in the system has however dropped over time. Share of first-time choosers that invested in Premiesparfonden Both pension savers with money in the Premiesparfonden and those in the fund market have to a large extent refrained from changing their choices. There is however a tendency for greater activity. During 2004, almost 6 per cent of the pension savers had switched funds. At the close of , a total of 12 per cent of the pension savers had switched funds at least once. The number of fund changes is increasing which to a certain extent is influenced by the occurrence of advisory firms that continuously switch funds for pension savers. Pension savers have primarily invested in shares. Up until 2003, those that made choices invested almost three-quarters of their pension capital in share funds. Among those savers that made a choice, the risk profile in the strategic distribution of assets as of the 2003 election has changed in respect to the distribution be- tween interest and shares. Savers have gone from a 90/10 per cent distribution between shares and interest respectively to a 70/30 per cent distribution respectively. The transition to a greater share of interest-bearing investments among first-time-choosers occurred a few years after the negative stock market trend began and in con- junction with again rising share prices. The allocation between shares and interest at an aggregated level does not however reflect the entire distribution at individual levels. half of the first-time choosers chose to only invest in interest or shares. 20 percent of the first-time choosers in 2005 chose only interest-bearing funds. Among these, more than two-thirds chose only long-term interests and about one-fifth only short-term interests. Distribution of portion in shares at individual level, first-time choosers 2005 An analysis of which decision-making criteria pension savers use reveals that criteria such as past returns and fees are relevant. In the first round of fund choice, 44 per cent that chose their own port- folios stated they did so based on the funds earlier returns. Com- parable figures for the following years (2001-2004) are around 30 per cent. At the same time, many pension savers stated they chose funds based on low fees; 46 per cent in the first round and just over an average of 30 per cent the following years. An analysis per- formed by PPM of the choices made by first-time-choosers in 2005 shows that pension savers consider both the funds returns and fees when selecting funds within a specific category. However, analyses also reveal signs that simple decision-making rules apply when pension savers distribute their premium pension money between various funds – such as equally distributing money between the possible categories. It can be difficult for pension savers to evaluate various fund managers. Subsequently, pension savers have a tendency to choose well know fund companies, which can for instance mean that do- mestic fund companies are chosen ahead of foreign fund companies and fund companies that have an established brand name are se- lected ahead of fund companies with a weaker brand name. has compared the popularity of Swedish and foreign fund compa- nies and notes that only about 8 per cent of the total capital is in- vested in funds managed by foreign fund companies. At the same time, the analysis shows funds managed by Swedish fund compa- nies on an average to a greater extent show lower growth compared with the relevant index than foreign fund companies funds. Lack of knowledge and participation According to a survey presented by in , only 6 per cent fully agree with the statement that they have sufficient knowledge to manage their premium pension savings. A further 11 per cent rate themselves a 4 on a scale of 1-5. than the ma- jority (52 per cent) state they have far from sufficient knowledge to handle their premium pension, while 3 of 10 rate themselves in the middle, indicating they are not satisfied with their knowledge and would like to know more to feel secure in handling their pre- mium pension. Pension savers perceived knowledge I have sufficient knowledge to handle my premium pension savings. Source: 2005. 5=Agree completely 3=Dont know 1= Disagree completely In a comparison with other systems, the Swedish premium pension system has a high portion of savers. Increasingly fewer first- time-choosers tend today to make an choice. This need not be a problem in itself but instead confirms the situation in an in- ternational perspective. Many factors indicate a low interest in and insufficient knowledge about pension issues among first-time choosers in general and young people in particular. Evaluation of the premium pension systems costs The average investment management fee for the funds in the pre- mium pension system (including Premiesparfonden) is currently 0.39 per cent of the managed assets after rebate. Costs for PPMs administration (PPM fee) in 2005 correspond to a fee of 0.22 per cent. At present, the collective withdrawal for fees for the average saver is just over 0.6 per cent of the managed assets. Administra- tion fees as a portion of the managed assets will drop over time as the assets in the system grow and the cost levels for PPMs activi- ties stabilise. In the same way, average investment management fees can be expected to drop in time. The combined annual withdrawal for fees in relation to managed assets is expected to fall to about 0.3 per cent in 2020, of which 0.25 can be attributed to investment management fees and 0.05 to PPMs administration costs. Forecast of fees in the premium pension system Average management fee after rebate An international comparison shows that withdrawal for fees from savers in the premium pension system is low overall. The assess- ment is based on a comparison of, in part the systems withdrawal of fees from future pension and, in part the systems fees in rela- tion to managed assets. However, there are systems that rank even better. Relation between total fees and assets in various systems : "corporate" UK: "personal" : "industry-wide" UK - "stakeholder" UK - "personal" : "trust" Source: Whitehouse (2001), (2005) and ATP Portion of fees withdrawn from future pension Australia-"industry-wide" -"corporate" UK - "stakeholder" UK - "personal" Australia-"trust" Source: Whitehouse (2001), (2005) and the committees own calculations There are several different ways of organising a funded pension system. One alternative is that the state acts on the institutional market and procures the management for all pension savers at wholesale prices with quantity discounts. Pension savers then select a risk level (asset allocation) but not a manager. The other extreme is that pension savers each individually select investment funds at consumer prices and without quantity discounts. The premium pension system is somewhere in the middle. PPM serves as a clearinghouse where pension savers and participating fund managers meet. Pension savers choose the managed invest- ment funds but PPM is the owner of the fund units. Since PPM is the only owner of the funds in the system, PPM is in a position to demand a quantity discount from the participating fund managers. The international comparison between the premium pension system and other systems with individual accounts shows the pre- mium pension system has low costs, even when compared with systems that provide more limited freedom of choice in respect to investment alternatives. At the same time, the comparison shows there are systems with more limited freedom of choice and there- fore lower costs compared with the premium pension system. With the price reduction model adopted by PPM, the fee after rebate that PPM pays on the fund market resembles the possible whole- sale price. The premium pension systems discount model therefore fills a central function as a cost-limiting measure. This model is de- signed in such a way to give pension savers a reasonable share of the profits from the economies of scale in investment management, which is a prerequisite if the system is to be considered cost-effec- tive in international comparisons in the future. Design of the premium pension system The premium pension system is said to consist of two parts: the information pension savers require for their investment choice and the systems investment alternatives, i.e. the funds participating in the system. Pension savers face as first-time choosers a choice be- tween Premiesparfonden (the default alternative) and the funds available on the PPM fund market. The participating funds in the system guarantee a certain diversification and facilitate the pension savers situation to the extent that it is not necessary to choose between individual securities on the financial market. Present premium pension system Based on their knowledge and participation, pension savers can be divided into three different groups that each constitutes the pri- mary target group for one of the following management solutions: 1.Pension savers that feel they have neither the knowledge nor the commitment to design and manage their own fund portfolio are the primary target group for Premiesparfonden (the systems de- fault alternative). 2.Pension saves that feel they have the commitment to design and manage their own fund portfolio but insufficient knowledge to do so are the primary target group for choosing and switching funds on the PPM fund market but with guidance. 3.Pension savers that feel they have sufficient knowledge and com- mitment to design and manage their own fund portfolio are the primary target group for choosing and switching funds on the PPM fund market without guidance. The premium pension system can be analysed from this division. The system provides two choices in the initial phase – to actively choose funds on the PPM fund market, or to consciously or unconsciously refrain from making a choice with the consequence that premium pension money is instead invested in the Pre- miesparfonden. As is evident, the fund markets primary target group (target group 3) should be pension savers that feel they are knowledgeable and committed. Premiesparfonden should therefore presently fulfil the remaining investors needs (target groups 1 and 2), a consider- able target group. We see that these investors probably have differ- rent needs depending on their level of knowledge and commitment in respect to managing their premium pension savings. is of the opinion that sufficient consideration has not been given to the need for decision-making support evident in target group 2, which is comprised of pension savers that feel they have the commitment to design and manage their own fund port- folio but that they lack sufficient knowledge. The situation for this group can be alleviated by providing in-depth decision-making support for managing premium pension money. Draft for a future premium pension system PPM fund market without guidance The premium pension systems default alternative The premium pension systems default alternative should have a generation fund profile, which means risk levels decline as the pen- sion saver gets older. The entire collective general pension, includ- ing income and guarantee pension, should be considered when risk levels are determined in the default alternative. The default alterna- tive should be an choice option. As a result of this proposal, Sjunde AP-fonden has been com- missioned to set up the funds needed to cost-effectively manage the money and so investments can be adjusted to pension savers ages. Premievalsfonden should be shut down and the money man- aged in the fund transferred to funds as decided by Sjunde AP-fon- den. The low-risk management demand for Premiesparfonden should be replaced with a person principle for Sjunde AP-fon- dens activities. An investment decision cannot be considered non- in itself. The person principle is not result ori- ented but more a quality specification concerning the processes that precede the investment decisions made. Furthermore, the Swedish Financial Supervisory Authority is not responsible for en- suring the Sjunde AP-fonden complies with the person principle. This is an issue that should instead be addressed when the government annually is evaluating AP-fondens activities. PPM should in its traditional life insurance operations have the option to invest in funds on the market and in Sjunde AP-fondens funds. Sjunde AP-fonden should not be able to provide its services other than to the . Limitations regarding Sjunde AP-fondens use of voting rights should be revoked. Current limitations in which Sjunde AP-fonden may own a maximum 5 per cent of the votes in an individual com- pany should be revoked. Instead, we propose the same influence limitations that apply for investment funds in general should apply. Range of funds in the The range of funds in the system has increased heavily since the start. In the first round of fund choice in 2000, over 450 funds were registered in the system. At the close of , about 82 managers had registered 705 funds in the system. ager had an average of 8.6 funds registered and the fund manager with the most funds had 36 funds registered. feels there should be a range of funds that pro- vide a good return after investment fees and rebate. While it is in principle impossible to comment in advance on the funds returns, fund investment fees are set in advance. This means it is possible to influence the investment fees. A reasonable objective for PPM is therefore to keep the investment fees in the system at a low level. One basis for the committees assessment has been that PPM will receive tools that mean the range of funds can be reduced to about 100-200 funds. This is not an absolute objective, more an interval based on to what extent pension savers chose to use the range of funds. The interval can subsequently change over time. The balance between costs and freedom of choice should be left to PPM. It is however important that the government emphasise to the authority the prerequisites for a good premium pension and the importance of down costs.