sou · H7B344 · 2019-11-04 00:00:00 — The Inquiry has given consideration to whether there should be a quantitative target for the return but takes the view that this is inappropriate. The historical performance of the capital market has certainly been good, but it is an unreliable indicator of future returns. The assessment of a responsible level of an objective for returns is 35The income index measures average growth in each year and is used to recalculate the income pension and the income pension accounts. 36The ’s agreement on long-term raised and secure pensions, reg. no S2017/07369/SF, p. 37The average capital-weighted rate of return in the premium pension system was 6,3 per cent at the end of . The corresponding number for the income pension system was 3,0 per cent. See report 2018, p. also likely to vary over time – depending on long-term economic performance, in and globally. An objective should be of a long-term nature. The Inquiry there- fore takes the view that it is not reasonable to set an objective based on historical returns or present-day assessments of future returns and that the general, long-term level of the objective set by law should only provide that the return should clearly exceed the income index. The Inquiry has also taken account of the fact that an objective will also be set for the default option. As stated in section 5.2.4, the Inquiry is of the view that that objective must be considered to express the State’s ambitions for the premium pension system in terms of the return on savings and the risk of variations in pension payments. The Inquiry also makes the assessment that it would be inappropriate to have different quantified objective for the premium pension system as a whole than for the default option. Payment period: Secure and stable pension On the basis that the premium pension is a part of the social in- surance system that is intended to provide for financial security after working life, the fundamental ultimate objective of the premium pension should be to deliver a secure and stable pension during the payment period. ‘Secure and stable’ means a pension payment with low volatility. Even if the pension capital during the saving period can encounter both strong downturns and upturns, insurees ought to be able to feel secure that the premium pension system after the working life will provide pension payments that are sufficiently pre- dictable and stable. The investment of assets in the capital market is, by definition, associated with risk. A higher risk provides the possibility of a higher return but can also result in the opposite. Obviously, the return should be as high as possible, but be balanced at the same time towards the objective of secure pension. The risk level will therefore always be a trade-off between the highest possible return and reasonable security. Since the fundamental purpose with the social insurance system is financial security, the Inquiry considers, in common with what is said in the original inquiry on a reformed pension system (SOU 1994:20), that security should normally be given priority. This does not entail the absence of risk. The inquiry’s proposal for objective for the payment period is a premium pension with low volatility, taking account of the remaining saving period. For savers it is natural and relatively unproblematic that their premium pension capital varies over their saving period on account of fluctuations in the capital market. Even though savers may feel concern when their premium pension capital decreases, many years may be left before the capital is to be realised in the form of pension payments. During the saving period what is important is that savers feel secure that their contributions paid in are being managed in a safe way and that they are enjoying the expected risk premium from the investment in the capital market with sufficient certainty. As savers approach retirement, volatility becomes of more direct importance. For the pensioners of the future, the premium pension will make up a considerable part of their aggregate pension. Then it is important that the premium pension feels secure in the sense of being managed in a safe way, and also that any decreases in the pay- ments are not so large as to be difficult to cope with financially. There is a value for the individual pensioner in being able to predict a stable pension payment that does not vary too much, either upwards or downwards. At the same time, it is not reasonable to introduce regulations excluding a decrease in the premium pension during the pay- ment period since this leads to low expected returns. Moreover, with present-day life expectancies the average payment period will be over 20 years. So, there are reasons for also taking sufficient risk during the payment period in order to further increase the yield on the capital. It is also worth taking account of the advance interest rate (forecast interest rate) in the annuity divisor which the return during the payment period needs to be higher than in order to avoid falling pension amounts.38 The income pension can also decrease, both because income growth is less than the advance interest rate of the income pension (the norm)39, and because of the impact of the balance ratio when the system is in a balancing period. It is not reasonable for the premium pension to be ring-fenced with stronger restrictions concerning the growth of pension amounts than the volatility in the income pension, 38At present the advance interest rate in the premium pension is 1.75 per cent. 39The advance interest rate in the income pension is 1.6 per cent and is laid down by law. especially as the premium pension account for a smaller share of the total national public pension. It should, however, be possible to base one conceivable benchmark for how large the variation of the pre- mium pension amounts should be on the variation of the income pension and also on the aggregate expected variation of both the income pension and premium pension payments. It will also be possible in the future for premium pension amounts to decrease in the event of negative performance in capital markets. Here, the proportion of equities in the portfolio plays a crucial role. To be able to deliver a secure and stable pension, a reasonable trade- off must therefore be made during the payment period between more risky investments like equities and less risky ones like fixed income. For the savers who make their own choices of funds, their choices will be able to lead to outcomes that are in conflict with the objective of a pension with low volatility. The Inquiry notes that this conflict between objectives exists and that it is genuine, and therefore cannot be solved without removing either the objective of low volatility or the right to freedom of choice. Completely preventing volatile out- comes would require such extensive constraints on freedom of choice that there would no longer be any real freedom of choice. Such an approach would therefore be inconsistent with both our terms of reference and the pension agreement. But the Inquiry considers that this does not actually need to be a problem at system level, given that the default option will be the start- ing point for saving in the premium pension system. However, the Inquiry makes the assessment that a special product adapted to the payment period should be investigated separately, see section 5.2.5. With the right design and right placing in a well-considered choice architecture, such a product ought to be able to considerably reduce the risk of this becoming a problem. The savers who want to influence their risk level and investment profile should have the freedom to do so Our terms of reference state that one purpose of the premium pen- sion system is to enable individuals to influence their pension by making their own choices of one or more funds that their assets are invested in. In addition to the default option, there should, accord- ing to our terms of reference, continue to be a fund marketplace for the premium pension containing funds with different investment approaches and risk profiles that pension savers who want to take on responsibility for the management of their premium pension assets should be able to choose between. For pension savers who so wish, there should be a possibility of investing premium pension assets in funds in a secure, controlled and professionally procured fund market- place. The procurement of funds should be conducted according to general principles of freedom of choice, sustainability and controll- ability. The funds offered on the fund marketplace should be of good quality and be cost-effective, sustainable and controlled, see chapter 10 and 11. Based on what has been stated in our terms of reference, the Inquiry can conclude that it is natural to view freedom of choice as an integrated right for savers in the premium pension system. Free- dom of choice provides a possibility for those who so wish to in- fluence their risk level and investment approach on the basis of their individual preferences by choosing the management of their premium pension assets. As shown in section 5.2.4 below, there is a tension between setting objectives for returns and volatility for pension payments and offering freedom for individuals to make their own choices of risk level and investment approach for the management of their pension assets. However, the Inquiry makes the assessment that this tension can and should be handled through a well-considered and well-main- tained choice architecture, see section 5.5. The objective of the premium pension system and the principle of freedom of choice should be regulated by law The objective of the premium pension system and the principle of freedom of choice is of central importance for the new agency’s operations in procuring funds for the fund marketplace. According to the Inquiry’s terms of reference, these operations are to be con- ducted on the basis of principles laid down in law. The Inquiry ther- efore considers that the objective should be regulated by law. This ensures that these fundamental conditions for the reformed premium pension system will not be altered unless there is a majority in favour in the Riksdag (the Swedish Parliament). This is intended to establish trust in the long-term approach and predictability that should charac- terise the pension system. Freedom of choice and quantitative objectives The Inquiry’s assessment: There is a tension between the State setting objectives for returns and volatility in a funded pension system and, at the same time, giving savers freedom to choose their own level of risk in their savings through funds in a fund marketplace. To handle such a tension without one of the interests having to completely give way to the other, there must be a clear and well-considered choice architecture that creates conditions for well-founded choices and increases the possibility of achiev- ing the objectives. Reasons for the Inquiry’s assessment Achievement of the objective in a system with freedom of choice The Inquiry notes that the objective to be proposed relates to the objective of the premium pension system, and not to the accounts of individual premium pension savers. So the State is setting an objective for its own operations. It is therefore natural to consider that the State is responsible for the achievement of the objective in the same way as applies, for instance, to the ’ management of the buffer capital in the income pension system. However, one crucial difference between the premium pension system and the income pension system is that the premium pension system offers savers the possibility of taking over responsibility for the investment decisions and influencing management and therefore their future return. This means that, individually and as a collective, savers take over the possibility for achieving the objective from the State. A conflict thus arises between the State setting objectives for the premium pension system in terms of return and volatility and offer- ing savers freedom of choice and the possibility of influencing the management of their assets. Freedom of choice in the premium pension system leads to savers in the fund marketplace being able to have both higher and lower risk in their portfolios than in the default option.40 In terms of expectations, the return and volatility can also be both higher and lower than in the default option. The fund marketplace will therefore, in terms of expectations, have a different objective achievement from the default option where the objective is aimed at return and volatility. The Inquiry does not consider that this needs to be a problem, if the outcomes are due to savers’ own choices based on sufficient knowledge. This is, however, an important circumstance to take into account in the design both of the premium pension system and of the objective for the system. The default option expresses the State’s ambition for the premium pension Our terms of reference state that the default option should be the starting point for saving in the premium pension and that there should not be any requirement to choose funds in the fund market- place so as to get a cost-effective, secure and stable pension insurance. According to the statement of the remit of the review of the default option in the premium pension, one starting point for the reform of the premium pension system is that the State needs to set an objec- tive and an appropriate risk level for the default option.41 In the view of the Inquiry the objective of and level of risk for the default option must therefore be considered to express the ambition of the State in terms of a desirable expected return and volatility in the premium pension system. According to the Inquiry, it appears to be directly inappropriate to set different quantitative objectives than for the default option since this would mean the State signaling that the degree of achievement of the objective would be dependent on whether or not individuals choose funds in the fund marketplace. The Inquiry considers that the conflict described above between freedom of choice and achievement of the objective is real and that it must affect both the design of the system and the level of detail of the objectives set. As regards the latter, it is, as stated in section 5.2.3, the view of the Inquiry that the objective of the premium pension system should be kept at a general level and mainly be aimed at qual- itative features and be described as the directions that they actually 40In practice this applies to all savers who deselect the default option, i.e. except the savers in the fund marketplace also the savers who choose their risk level or fund category, see section 5.5 on choice architecture. 41Fi2019/00913/FPM. Notwithstanding this, the premium pension system as a whole should be followed up through in-depth analyses and comparisons between, for instance, the return on capital and the volatility of pen- sion payments for those who have the default option and for those who have made choices in the fund marketplace, see section 5.3 about measuring objective achievement. 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 possibility –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, occupational pensions. A special payment product needs to be investigated The Inquiry’s proposal: To achieve the objective of a premium pension that has 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 payment phase. As part of such an investigation, proposals should be developed to handle the transition between the saving and the payment phase. Reasons for the Inquiry’s proposals As described above, the level of risk during the payment period is of crucial importance for the possibility of delivering a premium pen- sion with low volatility. In the default option this can be handled by, for example, an automatic de-escalation from equities to fixed income, a generation fund or a traditional insurance policy. Savers who have chosen funds in the fund marketplace can be informed about the need for risk adjustment at a suitable point in time before retire- ment. One alternative to make it even easier for savers in the fund marketplace to find an appropriate level of risk and a possibility for de-escalation could be to offer these savers a special payment product. The remit of the Inquiry does not include making a deeper investigation of and proposing such a product. However, such an investigation should be carried out in order to consider whether a payment product could replace the balance in the fund account on retirement. The payment product would involve an investment of the pensioner’s capital in an appropriate way taking account of the pensioner’s age. Savers in the default option could also be offered the payment product in cases where they want to have a de-escalation that differs from what is offered by the default option. To satisfy the interest of freedom of choice, such a product could be procured and possibly offered by several suppliers. The investigation should also consider how to design the choice environment for the payment product, for example whether it should be an opt out solution in which the saver needs to actively choose not to have the product. It should be mentioned in this context that the traditional insurance currently administered by the Swedish Pensions Agency could be a starting point for the development of a suitable payment product, for both the default option and the fund marketplace. However, the development of such a product needs to ensure that the product meets the diversification and other requirements that should apply to investments in such a product. In addition, the possibilities already available under current regulations to reduce the volatility of pay- ments by reviewing and developing present methods of calculating and recalculating the premium pension should be investigated. The role of the default option in achieving the objective The Inquiry’s assessment: The objective of the default option is consistent with the objective of the premium pension system. The objective of the default option should be regulated by law. Reasons for the Inquiry’s assessment The Inquiry’s terms of reference state that the starting point for the management of the premium pension should be the default option. However, deliberations about the risk level of the default option during the saving period and the payment period are not included in the remit of the Inquiry and have been investigated separately in the ’s review of the default option in the premium pension.42 The Inquiry notes above that the State’s ambition for the pre- mium pension system is expressed in specific terms through the default option. The remit of the Inquiry includes ensuring that the objective of the default option is consistent with the objective of the premium pension system. In the light of the above discussion, this is so by definition. The Inquiry considers that this requires that the objective of the default option is regulated by law. The objective of the default option is going to be of crucial impor- tance for the management of the capital in the default option. The risk level chosen is influenced directly by how the objective is for- mulated. The premium pension is part of the protection of standards that covers all insurees in old age, and its importance for the incomes of future pensioners will increase as the system is phased in. In these circumstances it is not appropriate to delegate the decision on the objective to the responsible agency. It follows from these reasons that the objective of the default option ought to be regulated by law. 42Fi2019/00913/FPM. The role of the fund market place in achieving the objective The Inquiry’s proposal: The procured fund marketplace should give pension savers the possibility to influence the risk level and investment approach of their premium pension assets by choos- ing 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, controll- able and of high quality. Reasons for the Inquiry’s proposals The fund marketplace should offer funds with different risk level and investment approaches in order to provide real freedom of choice. The inquiry considers that the procured fund marketplace should offer a range of for the premium pension system appropriate funds with different risk levels and investment approaches that provide real freedom of choice. 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 interested in making their own choices. But since there is also a clear requirement for controllability and cost control, there is not room for many similar funds in the fund marketplace. Moreover, the more exact meaning of the term real freedom of choice is likely to change depending on the performance of the financial market and will therefore be a matter for the new agency. The interest shown by savers in choosing funds in the fund marketplace will also be of importance. The funds ought not to be too similar, both to simplify the choice for savers and to create a cost-effective and controllable fund market- place for the organisation charged with examining the funds con- tinuously. The various fund categories should be based on generally accepted categories in the light of the best industry standards at any The Inquiry considers that it ought to be the new agency, not the legislator, that sets these restrictions on the basis of the financial knowledge available at any particular time so as to pro- vide sufficient flexibility. The various fund categories should therefore not be regulated by law. At present there are around 500 funds in the fund marketplace. In the view of the Inquiry this is very many more than necessary to attain real freedom of choice of funds with different risk levels and investment approaches. This is also demonstrated by the fact that there are many funds with very similar approaches. It can be asserted that real freedom of choice means that it should be possible to choose between several funds that, while very similar, have different managers.