sou · H7B344 · 2019-11-04 00:00:00 — The Inquiry notes that saving in the fund marketplace can lead to outcomes that are both higher and lower than the State’s ambition for the premium pension system as expressed in the objective of the default option. This is an unavoidable consequence of the fact that the system contains freedom of choice. Whether this is acceptable is ultimately a matter of suitability that has to be decided in a political position. However, the Inquiry wishes to point to some factors that ease this conflict of interests, according to the Inquiry. First, the Inquiry considers that the State should make clear that only savers who want to, and consider they are able to, should choose funds in the fund marketplace. Second, the choice architecture should support this happening. Third, the funds in the fund marketplace should be procured and also be audited to a greater extent than they are at present. The selection entailed by procurement creates a possi- bility – that does not exist at present – to weed out funds that are judged to have a lower likelihood than others of generating good returns, just as is done by other insurers in, for example, occupa- tional pensions. A special payment product needs to be investigated The Inquiry proposes that in order to achieve the objective of a premium pension with low volatility during the payment period, a separate investigation should be made of whether to supplement the premium pension system with a special product aimed at the pay- ment phase. As part of such an investigation, proposals should be developed to handle the transition between the saving and the pay- ment phase. The objective of the default option is consistent with the objective of the premium pension system The Inquiry makes the assessment that the objective of the default option that is proposed in the ’s review of the default option in the premium pension is consistent with the object- tive of the premium pension system that is proposed by the Inquiry. The Inquiry considers that the objective of the default option should be regulated by law. The role of the fund market place in achieving the objective The Inquiry proposes that the procured fund marketplace should give pension savers the possibility to influence the risk level and investment approach of their premium pension assets by choosing among procured funds. The procured fund marketplace should offer a selection of funds suitable for the premium pension system with different risk levels and investment approaches that provide real freedom of choice. The funds should be cost-effective, sustainable, controllable and of high quality. Our terms of reference state that it is not part of the Inquiry’s remit to take a stand on the number of funds in the fund marketplace. It is not possible to give an exact definition of what is meant by or should be meant by real freedom of choice. This is because the meaning of the concept is subjective and therefore depends to a great extent on the ’s values. However, the Inquiry considers that a definition suitable as a starting point is that the range of funds should be broad enough to satisfy most of the pension savers inter- ested in making their own choices. Moreover, the more exact meaning of the term real freedom of choice is likely to change depending on the performance of the financial market. The funds ought not to be too similar, both to simplify the choice for savers and to create a cost-effective and con- trollable fund marketplace for the organisation charged with ex- amining the funds continuously. The various fund categories should be based on generally accepted categories in the light of the best industry standards at any particular time. The Inquiry considers that it ought to be the new agency, not the legislator, that sets these re- strictions on the basis of the financial knowledge available at any particular time. 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. But simply weeding out the funds that have the poorest of offering a good saving product increases the possibility that the fund marketplace will contribute to achieving the objective of the premium pension system. By establishing a procured fund marketplace, the competition aspect of the premium pension system can become relevant again and create sound price pressure and relevant innovative power in the fund market. 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 but should be determined by the new agency after professional as- sessments. Should the risk in the fund marketplace be limited? The Inquiry makes the assessment that there should not be any prior limitations on the fund marketplace regarding the risk level and investment 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 supporting conscious choices; and it should do so by making it possible to compose diversified portfolios on the basis of savers’ wishes. 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, 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 freedom of choice. At the same time, the risk of in- appropriate 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. should be tasked with measuring achievement of the objective The Inquiry proposes that 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 Inquiry proposes that the Government should give this role to the . Behavioural economics research casts light on deficiencies in the design of the premium pension system In recent decades, a new branch of academic studies has emerged in the borders between economics and psychology: behavioural eco- nomics. Alongside this, twenty years of Swedish premium pension saving have provided considerable insights into individuals’ behav- iour in financial matters. The general conclusion of behavioural economics – that, for various reasons, individuals are not as rational as economic models assume – is of particular relevance for pension saving. Pension saving is a recurring example of a complicated decision situation in which indi- viduals either save too or too much, seek or are offered advisory assistance that is not always economically rational or take invest- ment decisions that are not always economically rational either. There are special difficulties associated with individuals’ behav- iour 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. 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. It is a global problem that, as buyers of financial products, savers are seldom knowledgeable about the goods – so high fees can be charged and extensive marketing put in place that generates switches from good and cheap products to worse and more expensive ones. The fact that savers are not knowledgeable about the goods is not only due to savers themselves but is also because the characteristics of the goods are not, and cannot be, well-defined and are, instead, only described on the basis of historical experience using statistics that are of unclear or, at any rate, uncertain importance for the future characteristics of the goods. A change of approach is under way in several other countries as part of various pension solutions – a change from a conviction about the possibilities and interest that individuals have in making choices to an understanding of how individuals actually behave in practice. Even if pension systems of other countries have a different design from the Swedish system and function in a different environ- ment and culture there are, however, distinct similarities concerning experience of how individuals behave, or do not behave, and of how the advisory market grows when the system becomes too com- plicated. The Inquiry can conclude that neither information, trans- parency nor standardisation is of any help if the product sold is too complex for most individuals. Choice architecture is the key to a well-functioning premium pension system The Inquiry proposes that the choice architecture of the premium pension system should encourage pension savers to make informed and considered choices about how to invest their premium pension assets. The Inquiry makes the assessment that the premium pension system should be designed and administered in such a way that only savers who want to and can compile their own fund portfolios in the fund marketplace do so. A well-considered and well-maintained choice architecture, which provides support and guidance, is crucial in ensuring that this will come about. The Inquiry also makes the assess- ment that the selection of funds in the way done by insurance providers in, for instance, the occupational pension system counters some of the problems faced by individuals when choosing funds in the premium pension system. One prominent conclusion of behavioural economics research is that individuals seldom behave in a rational way in the type of decision situation that arises in pension saving. This is why designing a well-considered choice architecture is a central task for insurers providing pension insurance. One starting point is that even relatively small changes in the decision situation can make it simpler for individuals to make decisions that promote their own welfare, and sometimes also collective welfare, without limiting their own free- dom of choice. This corresponds to what is called ‘libertarian pater- nalism’ or, put simply, nudges or behavioural insights. As early as a couple of years after the introduction of the premium pension system it was noted that pension savers faced considerable difficulties in choosing from the large range in the fund marketplace. Since then one frequently advocated solution has been to design various types of decision support for savers. The Inquiry considers that the overall experience gained in recent years and the conclusions of behavioural economics research show that decision support as solution for those savers who can not choose funds is no longer fully relevant. Relatively deep knowledge and continuous engagement are required to be able to make long- term financial decisions about pensions. Many pension savers do not have this knowledge and these abilities. is it reasonable, as part of a compulsory social insurance system, to demand such knowledge and abilities, or to build the design of the system on the basis that savers have this knowledge or these abilities. The experience of the system up to now also shows that, in practice, it is not possible to supply such knowledge and abilities for a broader group of pension savers through decision support or financial education of the popula- tion. People who cannot compose and manage a well-diversified portfolio should therefore not do so either. They should even less be encouraged to do so, either directly or indirectly. Behavioural eco- nomics research indicates that these people should stay in the default option. Moreover, the conclusions of behavioural economics and the experience from the premium pensions system so far gained point to a considerable imbalance between those faced with choosing a financial product (pension savers) and those supplying the product (fund managers) in terms of knowledge and information. This is probably at least part of the reason why almost all insurers in the occupational pension system apply a selection procedure. The selec- tion procedure means that funds judged to be less well-placed than others to give a good return are weeded out or, as is most common, the funds judged to be best placed to give good returns are selected. Viewed in the light of the experience of the premium pension so far and of the conclusions of behavioural economics, the Inquiry sees no reasons why the State as an insurance provider should act differently. So, only savers who have sufficient knowledge ought to choose funds in the fund marketplace, but this does not mean that these savers should be left to do so without support and good tools for choosing funds. In the view of the Inquiry, a well-considered and well-maintained choice architecture should supply relevant informa- tion based on the needs of the target group and build on modern information technology. The stronger the choice architecture, the more funds are possible in the fund marketplace The Inquiry makes the assessment that a well-designed choice architecture with clear steps in the choice process and blocks of unwanted and poorly considered choices provides scope to permit a relatively large number of funds with different risk levels and invest- ment approaches in different categories. Vice versa, a weak choice architecture only provides scope for a small number of funds in the fund marketplace. The Inquiry notes that the large number of funds in the present system has made it difficult for savers to make conscious choices. Of course, the new agency’s procurement of funds must take account of this and of what is shown by behavioural economics research. However, the inquiry considers that a robust and clear choice envi- ronment with in-built blocks to prevent individuals who lack the knowledge or will to choose funds from nevertheless reaching the fund marketplace does enough to reduce the risk and disadvantages of a relatively large range of funds. It does not appear unlikely that a number of funds at the level of the maximum number of funds in the selectable part of the occupational pension system could func- tion in accordance with the objective proposed by the Inquiry below. features of a choice architecture for the premium pension system The Inquiry makes the assessment that at least the following require- ments need to be set for the choice architecture in the premium pension system. The default option should be the starting point for all savers, and this must be reflected in the design of the choice architecture. Since the default option is the starting point, the investment and choice environment is designed so that no activity or financial knowledge is required on the part of the saver. Pension savers who choose to leave the default option should be informed that, by doing so, they are taking over the responsibility for choices and the maintenance of choices. In conjunction with this, the saver needs to be given information, support and guidance for their assessment of whether it is appropriate to leave the default option. It should be possible to choose a risk level as part of state manage- ment without having to enter the fund marketplace. If the saver wants to leave the default option, they should first be given informa- tion about and take a decision on their choice of risk level. If the saver does not only want to choose risk level, there should be a possibility, in the first place, of choosing one or more fund categories that the saver can invest their assets in. If the saver does not only want to choose categories, there should be a possibility for the saver of investing their assets in procured funds in the fund marketplace. The number of categories and the number of funds in each category vary depending on factors including the demand from pension savers and the possibility of achieving the objective of the pension system and maintaining the principle of freedom of choice. The Inquiry considers that the saver should confirm in writing, normally by a digital signature, that they have read information about what compiling their own fund portfolio means. over and above the fact that the confirmation is needed to move forward in the choice process, it should not be assigned any further legal importance, but should serve as an important point for the saver to note. As at present, it should be possible to choose the default option again after choosing funds in the fund marketplace. In the electronic choice environment savers should be given appropriate tools, guidance, support and information to simplify their choices in and before every step. Regulation of the choice architecture The main features of the choice architecture should be regulated by law since it is a central part of the functioning of the premium pension system. How the environment is designed will also be of great importance for the number of funds and what kind of funds are procured. The Inquiry’s terms of reference state that one clear purpose of the reform of the premium pension system is to create a regulatory framework that means that the Government is unable to steer the selection of funds. For this reason, too, the main features of the choice architecture should be regulated by law. However, the more detailed regulation of the choice architecture ought to take place at a lower level in the legislative hierarchy. One important reason for this is that the choice architecture needs to be reviewed and adapted continuously on the basis of saver behaviour, the performance of the fund market and behavioural economics research. The legislative process is unnecessarily protracted and complicated for these specific needs. Since the design of the choice architecture is of great importance for the selection of funds and the design of the fund marketplace, such more detailed regulations about the choice architecture should not be issued by the Government; this should be done by the new agency. The main addressee of regulations concerning the choice archi- tecture is the , which supplies the choice architecture in their online interface in relation to savers. Figure 1 Choice architecture of the premium pension system as part of state one fund category. the premium pension. Survey of occupational pension selection central demonstrates the existence of and methodology for fund selection Our terms of reference state that the Inquiry is to survey ways of working and contractual solutions for the selection central in the occupational pension system. If they are assessed as appropriate for the procurement of funds for the fund marketplace in the premium pension, the Inquiry should propose such solutions. The Inquiry’s assessment is that the ways of working and con- tractual solutions of the selection central in the occupational pension system can only serve to a limited extent as models for the procure- ment of funds for the fund marketplace for the premium pension. This is for two reasons: only one agreement area applies procure- ment and the main role of the selection central is to administer the occupational pensions under collective agreements and not to procure funds. Therefore, the Inquiry is not presenting any proposals based directly on the ways of working and contractual solutions of the selection central. In contrast, there are ways of working in the selection of funds by insurance providers that are relevant to the pre- mium pension system. These mainly concern the fact that a selection is performed and the methodology for selection. There are, or ought to be, clear similarities between the mandator- ship that insurance providers have in the selection of funds in the occupational pension system and the role that the State will have for the selection of funds to the fund marketplace of the premium pension. The fund selection methodology of insurance providers in the occupational pension system is based on commercial decisions and on research. The companies’ commercial considerations are based on there being commercial benefit, i.e. potential profit, in trying to select the best funds and deselect the worst, in terms of expected returns. The additional return attained or assumed by the companies varies, but the companies generally assume that the selection gives a substantial additional return as a result of the fund selection process. The survey of insurance providers’ ways of working in selecting funds shows that assessments with some degree of subjectivity are a central part of fund selection. So such assessments will probably be required as part of the procurement of funds for the fund market place of the premium pension. However, the need to leave it up to a government agency to make discretionary assessments to some extent as part of decision-making in central government is not unique to the selection of funds for the fund market place of the premium pension specifically. It is actually an accepted and essential principle of administrative law so as to enable all relevant and known circumstances to be taken into account in decision-making about matters that cannot be described in clear and objectively verifiable terms. There is no opposition between an administrative authority observing objectivity and impartiality when making decisions in its activities while using discretionary assess- ments at the same time. On the contrary, the requirements for object- tivity and impartiality include an obligation to take account of all the relevant factors in the particular case and assign them their correct weight.