sou · H7B344 · 2019-11-04 00:00:00 — However, the view of the Inquiry is that this is an expensive form of freedom of choice, in part because the costs of managing the system rise if many funds must be controlled. Since the procurement is intended to select the best funds, a fund marketplace without funds that are too similar ideally means that worse funds are not selected. There can, admittedly, be reasons to have several similar funds so as to attain a functioning fund market- place and to avoid the State becoming too big an owner in individual funds. The Inquiry is aware that always being able to select the best funds is an idealised picture, but a procurement professional is nor- mally in a better position to examine and compare funds than most pension savers. Section 5.4 on behavioural economics describes the global prob- lem that competition theory is decoupled when consumers are not capable of rejecting the worst and most expensive funds. But simply weeding out the funds that have the poorest of offering a good saving product increases the possibility that the fund market- place will contribute to achieving the objective of the premium pen- sion system. By establishing a procured fund marketplace, the com- petition aspect of the premium pension system can become relevant again and create sound price pressure and relevant innovative power in the fund market. In section 6.5 the Inquiry describes how insurers in occupational pension schemes make selections of funds for their fund marketplaces. The existence of and methodology for the selection of funds in the occupational pension system is likely to be able to serve as a model for the design of the selection of funds for the fund marketplace of the premium pension. In practice the cost aspect will greatly limit the number of funds compared with today. How many funds a procured fund market- place will ultimately contain will thus be a trade-off between what is required to achieve real freedom of choice and what can be managed and controlled at a reasonable cost. For that reason, the Inquiry does not consider that an objective should be set for the number of funds. Section 5.5.1 about choice architecture sets out the Inquiry’s pro- posal of how to interpret real freedom of choice in terms of fund categories and of procured funds. Should the risk in the fund marketplace be limited? The Inquiry’s assessment: There should not be any prior limita- tions on the fund marketplace regarding the risk level and invest- ment approach of the funds. Instead it ought to be left to the new agency to ensure that the risk level and investment approach of the funds procured are suitable for premium pension savings. It ought to be the choice architecture, and not any constraint on freedom of choice, that deals with the potential negative effects of too high or too low risk in individual funds by support- ing conscious choices; and it should do so by making it possible to compose diversified portfolios on the basis of savers’ wishes. Reasons for the Inquiry’s assessment Given the overall objective of a secure and stable pension, the question arises of what risk can be accepted in a state fund marketplace pro- cured by the State. On making their choice, the savers who choose to invest their premium pension assets in funds in the fund market- place do indeed take over responsibility for how their assets are managed; yet in a choice environment within the social insurance system, which is intended to provide a secure and stable pension, it is still relevant to consider whether there ought to be limits for how risky the choices available should be. It goes without saying that the risk in funds at the fund marketplace should be able to be both higher and lower than in the default option, but surely the risk in a social insurance system ought not to deviate manifestly from it. Since the default option will be the basis for the system and since there will, in the longer term, probably be a more limited number of savers in the fund market place, those who actually are there ought to be sufficiently aware of their own responsibility and the risk they have taken. In the Inquiry’s assessment, this indicates that the legislator does not need to be restrictive regarding the riskiness of funds that can be accepted in the fund marketplace. A fund marketplace without any actual restrictions regarding risk means that it is possible for savers to design portfolios only contain- ing risky funds during both the saving and the payment period. This manifestly increases the risk of a both low and volatile pension, which could conflict with the objective of a pension with low volatility. However, the choice architecture proposed in section 5.5.1 contains monitoring, information, guidance and confirmation steps. This means that savers who choose to move to the fund marketplace will, in the Inquiry’s assessment, generally have sufficient knowledge and under- standing of what their own choice entails. This does not exclude the possibility that there will, nevertheless, be savers who make directly inappropriate choices in the fund market- place. It is even less the case that it excludes the possibility that some savers will get low pensions even though they have made considered choices; the fact that investments are risky means that they will give poor outcomes in certain cases and periods. However, introducing restrictions in risk to prevent a small number of savers from making bad or risky choices means, in the view of the Inquiry, excessive constraints on savers who choose to make use of the right to free- dom of choice. At the same time, the risk of inappropriate choices is limited by the proposed choice architecture and information about the consequences of leaving the default option and instead choosing funds on the fund marketplace. Moreover, it is part of the mission of the new agency to ensure through relevant categorisation and relevant requirements in pro- curements that only funds that are suitable for premium pension saving are offered; for more information see section 11 on the regu- latory framework for procurement of funds for the fund marketplace. Freedom of choice: both opportunity and risk The procured fund marketplace will probably contain considerably fewer funds than at present. The funds will have undergone a com- pletely different quality control through the procurement and the funds offered will be examined continually in order to control that they always meet the requirements specified in the fund agreement. This does not, however, entail any guarantee that the return from the funds will always be good. Even though the funds in the fund marketplace will have been selected by the new agency on profes- sional grounds so as to be the best funds in each category represented, this will, in retrospect, turn out to not always have been the case. So, the fact that the fund marketplace is procured is no guarantee against poor outcomes also occurring in the future in funds chosen by savers. It can be noted that this also applies to the default option, just as it does all investments in the capital market. This is an unavoidable effect of the characteristics of the capital market. Against the background of the responsibility of the State for social insurance provision, the importance of fostering knowledge of the risks and opportunities of freedom of choice ought to be stressed here. Savers who choose funds by themselves should there- fore be given clear information and confirm specifically that, on choosing funds in the fund marketplace, they take over the full respon- sibility for the management of their portfolio and also the responsibility for maintaining it throughout their lives, which is of particular impor- tance ahead of and during their retirement. Measuring achievement of the objective New role for the The Inquiry’s proposal: Based on the objective of the premium pension, the Government or the agency designated by the Govern- ment should continuously formulate key figures and measure the achievement of the objective of the system. This should include measuring the degree of freedom of choice for savers in the fund marketplace. The Government should give this role to the . Reasons for the Inquiry’s proposals The objective proposed by the Inquiry for the premium pension system is set out in section 5.2.3. According to the Inquiry, the objective of the premium pension system should be stated in a law. For that reason, the objective should have a long-term character that is not altered as a result of more or less temporary changes in the financial market. For this and other reasons the Inquiry’s proposal of an objective is not expressed in figures. Another weighty reason for not formulating quantified objectives for returns and volatility in the premium pension system is dealt with in section 5.2.4 on the tension between freedom of choice and quantitative objectives. The freedom of choice in the system gives more unpredictable objective achievement from the outset, and the relevance of setting up quantified objectives therefore decreases con- siderably. The return for the pension savers who compose their own portfolios will be able to be both higher and lower than the return objective proposed. The return objective should therefore be aimed at the default option in the first place and should also act as a com- parative value for the return in the fund marketplace. There is also a risk in the case of premium pension payments with low volatility of a different objective achievement in the fund market- place on account of savers own choices. However, it should be part of the State’s responsibility to take action, chiefly through the choice architecture and a special payment product, to avoid excessively volatile choices. ought therefore also have the task of providing information about choices and the consequences of choices and of thereby contributing to greater objective achieve- ment, even for those who make their own choices, see section 5.5 on choice architecture. ought to be responsible, as the insurance provider of the premium pension, for continually monitor- ing whether the objective has been achieved and presenting monitor- ing information in, for instance, the annual publication the Report, which is the annual report of the pension system. The Inquiry has not formulated freedom of choice in the pension system as an objective. Instead the Inquiry has proposed viewing free- dom of choice as a right in the system that individuals can choose to, but should not feel obliged to, use. Even though it is not an objec- tive, the degree of freedom of choice should be measured and eval- uated continually. Variations in outcomes regarding returns and volatility can be an indicator that the fund marketplace offers real freedom of choice. Of course, another important indicator of whether the fund marketplace offers real freedom of choice is savers’ own views on the matter, i.e., whether savers consider that the range of funds is broad enough. This should therefore be studied regularly through focus groups and surveys, for instance. ought also to be responsible for the task of measuring the degree of freedom of choice in the fund marketplace. Ought the objective of the premium pension system to be considered as part of the annual evaluation of the ? The Inquiry’s assessment: The objective of the premium pension system ought not to be considered as part of the annual evalua- tion of the . Measuring the objective is part of the task of the to evaluate the impact of the pension system on individuals and society. Reasons for the Inquiry’s assessment The work of the is examined each year by the Govern- ment. This examination is compiled in an annual report that is delivered to the Riksdag by 1 each year. The report includes a compilation of the annual reports of the for the year concerned and an evaluation of the activities of the since the evaluation started in 2001. has the role of evaluating the impact of the pension system on individuals and society. presents analyses and evaluations of this continually in various reports and annually in the Report, which is the annual report of the pension system. The Inquiry considers that the most natural arrange- ment is for the analysis and monitoring of the objective of the pen- sion system to be presented in one of the ’s reports, since the system perspective is the essential point, not the performance of the . Behavioural economics research casts light on deficiencies in the design of the premium pension system Individuals’ behaviour and long-term pension saving In recent decades a new branch of academic studies has emerged in the borders between economics and psychology: behavioural econo- mics. Alongside this, twenty years of Swedish premium pension sav- ing have provided considerable insights into individuals’ behaviour in financial matters. To realise a design of the premium pension system that is adapted to how people behave, it is therefore relevant to take account of research results in behavioural economics in general, and Swedish experience specifically. Even though research in behavioural economics has grown strongly in recent years, significant parts of this research were already well- established when the pension system was introduced. The fact that, despite this, the legislator did not take more account of research results in behavioural economics when designing the premium pension system can presumably be attributed to the spirit of that period, which was characterised by strong confidence in the capital market following record rises in financial markets. Ideological reasons were also prominent; given the deregulation in other markets, it became natural to also introduce freedom of choice in the pension system. The general conclusion of behavioural economics – that, for various reasons, individuals are not as rational as many economic models assume – is of particular relevance for pension saving. Pension saving is a recurring example of a complicated decision situation in which individuals either save too or too much, seek or are offered advisory assistance that is not always economically rational or take investment decisions that are seldom economically rational either. The first premium pension choice in 2000 was unique in many ways. The marketing was extensive, the message one-sided (“Choose!”) and the outcome distinctly different from choices in other pension systems. The experience of other pension choices is that the share staying in the non-choice option is usually higher than the share making their own choices. In contrast, in the first premium pension choice the share creating their own fund portfolio was 67 per cent, which can be seen as a result of the message presented. Compared with previous studies, there were also considerable differences in terms of which individuals made choices: women were more than men and younger people were more than older people. After the first choice, activity in the fund marketplace fell, partly because the message and marketing were changed. It is, however, not relevant to compare the first choice with the first-time choosers in the coming years, who will often be young individuals who have received their first pension credit and therefore have a small sum to invest. But the choice frequency was also low among other savers. In recent years, as of 2014, the share of savers switching funds has been around 5–6 percent. It is possible to object here, pointing out that in long-term saving there is no need for savers to review their holdings and make switches on an annual basis – perhaps savers are invested in exactly the funds they want and their low activity should, instead, be seen as a sign of this. However, around 40 per cent, or over a million savers, have retained the same fund choices they made in 2000, a sign of the status quo bias in behavioural economics, i.e., an unwillingness to change decisions made previously. Even though a certain proportion of these fund choices are generation funds (11 per cent) and could therefore be regarded as rational since such savers do not need to maintain their choice to the same extent, there are reasons to assume that many fund choices are not rational. Many savers probably had difficulty designing a well-diversified, efficient investment portfolio adapted to their own balance sheet (own human capital, other assets includ- ing future valuation of real property, for instance) and their own risk capital, and reviewing the portfolio regularly. Several of the phenomena identified as risks by behavioural economics can be identified when non-professional investors have to take investment decisions in the context of individual pension saving. do professional investors avoid making equivalent incorrect decisions in their activities. Premium pension and behavioural economics A concept that sheds light on why individuals’ decision-making often deviates from what is most rational on the basis of financial theory is naive investment strategies. This means, for instance, that decisions are steered towards the fund categories that dominate the selection. If the majority of funds in the fund marketplace are equities funds, savers tend to choose those specific funds since savers expe- rience their dominance in the range as an indirect recommendation. In the premium pension system 68 per cent of funds in the fund marketplace are equities funds and 64 per cent of the capital (exclud- ing AP7 Såfa) has been invested in them. Another expression of naive diversification is the use of various rules of thumb due to a lack of time, energy or ability to make a deeper analysis. One example is the 1/n rule, which involves allocat- ing equal shares of capital to the funds chosen. If, for example, a saver has chosen five funds, they allocate 20 per cent of their capital to each fund without a deeper analysis of whether this partitioning creates the most efficient portfolio. Out of the savers who chose funds in the first premium pension choice in 2000, 74 per cent of those who chose two funds invested 50 per cent of their holdings in each of them. The corresponding shares for four and five funds were around 40 per cent of savers. Many pension savers have considerable difficulty in analysing their financial situation as a whole. For most people, evaluating their human capital, their other pension saving, their other saving and their other assets and liabilities – and forming a view of their specific risk preference for premium pension saving on that basis is a difficult task. This is due to factors including lack of interest, lack of analytical knowledge and lack of knowledge about actual assets and liabilities, but probably also to fundamental factors such as genuine uncertainty. One closely-related phenomenon is considerable investments by individuals in their home market or neighbouring area, which is called home bias. This means that savers do not make use of international diversification to spread their risks efficiently. In the premium pension system about 45 per cent of the capital in the fund marketplace is invested in assets traded in , which can be compared with ’s share of the world economy, which is about 0.7 per cent measured as GDP. Furthermore, apart from the buffer fund’s for- eign investments, the income pension is linked to the growth of the Swedish economy, and especially its income growth. Even though there may be good and rational reasons for savers to invest their assets in their home market, which they probably know most about and have most faith in, they risk not spreading their risks suf- ficiently. Behavioural economics research also shows that savers often have difficulty assessing the quality of different fund managers and funds and the probability of different outcomes. As a result, savers often invest in funds that have had high historical returns in the belief that these funds will continue to have them. Another result of the diffi- culty of assessing the quality of fund managers is that savers tend to choose brands known to them: national rather than international and established rather than more unknown managers. To take a well-founded investment decision savers need to make an analysis of a number of historical facts such as return, risk (volatility), return in relation to risk (the Sharpe ratio), fees such as the TER (total expense ratio) and TKA (ongoing charges including commissions) and so on, combined with a qualitative analysis of the fund management. The latter includes taking account of the manage- ment team and the strategy and objectives of the fund management in order to assess the ability of the management team to deliver a good return. In combination with a menu of financial choices with a large range of funds, this tends to make savers passive and paralysed and to result in them sticking with the default option or their first choice. When a choice is overwhelming, it is also common to take short-cuts such as choosing funds based on brands and advertising or simply taking one of the funds presented first; it is, for example, much more common for funds beginning with A to be chosen when the alternatives available are presented in alphabetical order. One event that has often been used as an example of irrational choices in the premium pension system is the alteration of the form used when drawing premium pension. During the saving period, savers’ assets are invested in fund insurance in the default option or in funds in the fund marketplace chosen by savers. When they draw premium pension, savers choose whether their assets will stay in the fund insurance or be transferred to the traditional insurance managed by the . Up until 2009 the form was designed with fund insurance as the default option, i.e. sioner was forced to make an choice of traditional insurance if they wanted to have it. Then around 20 per cent chose the tradi- tional insurance. As of January 2010, the form was designed without a default option, i.e. the prospective pensioner was now forced to give consideration to both alternatives: fund insurance and traditional insurance. The share choosing each product then became around 50 per cent. In 2011 the form was changed back to its original design and the share choosing traditional insurance fell back to the previous level: around 20 per cent. The example has frequently been used since then as support for the view that the default option has a strong effect on individuals’ behaviour and that savers are steered implicitly in their choices by the ‘framing’ of the choice architecture, in this case the design of the form.43 To sum up, special difficulties are associated with individuals’ behaviour in long-term pension management. This is due, in part, to the requirements for dynamic decision-making and the difficulties of compose an efficient portfolio and of valuing the funded pension in relation to other assets. It is also due to the fundamental difficulty savers have in determining their own risk preference and choosing a combination of funds that matches it. Moreover, savers need to understand and apply diversification in their portfolios, for instance, to realise which assets covary, to evaluate the quality of their fund manager and to consider the need to rebalance their portfolio in the light of both market changes and age. There are, of course, a con- siderable number of savers who have made conscious, informed and rational choices in the management of their pension capital. How- ever, the Inquiry has not been able to find support in behavioural economics research for the great bulk or even a majority of savers having done so or having the capacity or even the wish to do so. 43See, for example, the Audit Office’s report Retiring – why so complicated? [Att gå i pension – varför så krångligt?]