Silviase/jgov_v1.4_full_ann huggingface dataset:
model with this facility (c f section 3.5). If the incentives of the new pension system and the current policy to give large tax rebates to those who work after the age of 65 make the younger generations stay longer in the labor market, the redistribution between generations would have come out differently.

### 3.4 The pension system

The Swedish pension system went through a major reform in the early 1990s. The old pay-as-you-go pensions based on the incomes during the fifteen best years were replaced by pensions determined by all work incomes from entry into the labor market to retirement. These pensions are thus of the type defined contributions, but a large share is still pay-as-you-go pensions, while only a small share is funded. The new system also introduced incentives to postpone retirement and a mechanism to reduce pensions if the liabilities exceeded the funds and the expected future inflow to the system – the so called “brake”.

#### 3.4.1 Policy issues

After the introduction of the new pension system research and policy interest has focused on the behavior of the system, in particular when the large baby boom cohorts retire and age. Interesting issues were: What share of GDP will the pension expenditures take? Will the system stay in financial balance, or will the brake reduce pensions? Which compensation rates will the retired get, and will the inequality of pension incomes increase?

#### 3.4.2 Simulation results

SESIM has been used to simulate the future path of the pension system. This has been done for the European Union Ageing Working Group (see for instance Sundberg, 2006), the medium term planning of the Ministry of Finance (SOU 2004:11), in preparing for a new administration of the pension system (SOU 2006:111) and by independent scholars (see for instance Flood, 2007 and Section 3.5 below).

The results show that the expenditures for public pensions will take an increasing part of GDP as the baby boom cohorts retire and will reach a maximum of almost 15 per cent around year 2040 (Diagram 6.2 in Sundberg, 2006). With the assumptions made the pension system will generate a surplus every year until 2050, although a declining one, and the financial assets of the system will thus increase. According to these simulations it would not become necessary to hit the brake. However, these simulations are now history, because the current financial and economic crisis has changed the scenario completely and the brake will become enforced already in 2010.

The simulations also show that the compensation rate will decrease for the younger generations unless they chose to retire later. With increasing longevity the notional pension capital will have to cover a longer period and the annual pensions will then have to decrease.
Flood (2007) demonstrates that variations in retirement age and return on financial assets are more important for the young cohorts than for the old. He computed replacement rates for disposable income $ ^{11} $ and showed that for people born in 1940 and with incomes in the middle of the income distribution, the replacement rate at the age of 68-72 was 73 per cent if they retired at the age of 63, but 81 per cent if retired at 67 – a difference of 8 percentage units. For people in the same income class but born in 1960, the replacement rates were 56 and 66 respectively – a difference of 10 percentage units.

If the retirement age was 65 but the annual return to financial assets was either 3 per cent or 7 per cent, the replacement rates for those born in 1940 were 73 per cent and 76 per cent respectively – a difference of 3 percentage units. For the cohort of 1960 the replacement rates became 55 and 73 percent respectively – a difference of 18 percentage units!

The explanation to the differences between the two cohorts is that the 1940 cohort mainly gets its pensions according to the old system and time has not permitted them to accumulate large funds in the funded part of the new system.

#### 3.4.3 Conclusions

The focus in SESIM on demography, income generation, taxes and pensions makes it a good tool to analyze the properties of the pension system and the outcome for the retired compared to those working.

The practice in the Ministry of Finance to restrict the retirement age to be the same for everyone highlights the properties of the pension system but lacks in realism. Similarly, the return on financial assets is assumed to be the same for everyone, while data suggest that there is a large individual variation in return. This becomes especially important in the simulation of the funded part of the pension for the young cohorts, because its contribution to the total pension will become much larger for them compared to older cohorts. There is thus reason to believe that we now underestimate the individual inequality in pension income.

SESIM could relatively easy be changed to accommodate these features. In fact varying retirement age is already allowed in the version of SESIM discussed in Section 3.5 below, while individual differences in return remain to become implemented.

### 3.5 Population ageing

#### 3.5.1 Policy issues

Like most Western countries Sweden faces population ageing. For instance, the old-age dependency ratio (population 60 and over relative to population 20-59) will increase from about 0.4 in year 2000 to about 0.65 in 2050 according to Eurostat. Statistics Sweden predicts that
the number of women who are 65+ will increase by 48 per cent from 2000 to 2040 and the number of men who are 65+ by 79 per cent. Those who are 80+ will increase even more, the number of women by 58 per cent and the number of men by 118 per cent. $ ^{12} $ Even if the number of men is predicted to increase faster than the number of women, the share of elderly women will still exceed that of men. The share of 80+ women was 65 per cent in year 2000 and is predicted to become 57 per cent in 2040. Even if these numbers suggest a major shift in the age distribution from working age to old-old age, the situation of Sweden is not that extreme compared to, for instance, the South European countries and Japan. $ ^{13} $ Their age pyramids will by 2050 have transformed into urns! $ ^{14} $

Population ageing will put burden on the pension system, the health care system and on social care. The expenditures for both public pensions and occupational pensions will increase quite a lot, while the population in working age will remain almost constant. This raises the question whether the pension system will be able to deliver the pensions people are expecting or if the compensation rate will decrease. Will the retired share of the population maintain its income standard relative to the working population?

Even if retired are able to maintain their income standard on average, the new pension system shifts more of the burden of risk from the entire collective to the individual pensioner compared to the old system. We may thus in the future face an increased problem with old-age poverty, which of course will become even worse if the relative income standard of the retired decreases.

Pensions are definitely the most important source of income for the elderly, but many of them also have capital incomes, and compared to previous cohorts the baby-boom cohorts are relatively wealthy. To get a more complete picture of the standard of living for the elderly one would not only have to simulate their future pensions, but also their wealth.

The age distribution of health care expenditures is heavily concentrated to the elderly. An increase in the number of elderly, in particular old-olds, will thus lead to a rather dramatic increase in these expenditures unless there will be a matching increase in the productivity of the health care industry.

Similarly, the expenditures for social care are much higher for the old-olds than for those in the age bracket 65-75. Those who need to be cared for in special homes for elderly, in particular those who need care 24 hours a day, generate very high expenditures for the local municipalities. For this reason one has tried to shift from institutionalized care to help at home, i.e., one or more times a day attendants visit the old person at home to help with dressing, food
Figure 3.5.1. Simulated average days of inpatient care by age 50-100 for the birth cohorts of 1930, 1940, and 1950. Men and women, respective-

Source: Figure 10.2 in Bolin et al (2008c)

The model was estimated separately for those above 50 years and for those 50 years or younger. We also estimated models without the lagged dependent variable, because there were no data about inpatient care in the 1999 LINDA data set. We thus needed to impute this variable in the start year 1999. The static model was also used when new individuals entered the population.

Figure 3.5.1 displays the utilization of inpatient care by age and gender for selected birth cohorts. The diagram shows the sharp increase in utilization among the old-olds, in particular for men, but also the simulation uncertainty at the end of the life-cycle when relatively few have survived.

Figure 3.5.2 displays the evolution of the total number of inpatient days by gender until 2040.
Figure 3.5.2. Simulated development of total number of days of inpatient care for the total Swedish population, by gender.

ce: Figure 10.7 in Bolin et al (2008c)

#### 3.5.4 Models for retirement

The retirement models distinguish between retirement with disability pension and with old-age pension. The former is considered primarily driven by ill health, while old-age pension is at least partly driven by economic incentives. Individuals who have been ill for a long time and are unable to work can get disability pension. At the age of 65 it is automatically turned into old-age pension. The typical pension age in Sweden is 65 and the pension systems have been designed such that people normally will retire at this age. It is though usually possible to take an early pension already at 61, but at a reduced compensation rate. The Swedish pension system has three “pillars”: the social security pensions which usually give a compensation rate at about 60 percent; the occupational pensions which give another 10 per cent for most retirees, and private pensions which are equivalent to private savings.

Before September 2001 most employees had to retire no later than at the age of 65. Contracts between employers and unions gave the employers right to discontinue the employment contract for those who reached this age. Parliament has now taken a law which shifts this threshold up to 67. The peak age of retirement is still 65, however. The old contracts and social conventions thus determine this peak, while early retirement is a decision subject to economic incentives.
population ageing and the fact that disability insurance is converted into old-age pension at the age of 65.

Figure 3.5.3 Simulated population shares in work, retirement and disability; all age groups

Source: Figure 5 in Bohlin et al (2008b)

Figure 3.5.4 displays the evolution of the average retirement age under two alternative scenarios. One is the base scenario when everyone is assumed to go into old-age retirement no later than at the age of 65. The alternative scenario extends this age limit to 70. In the first case the average retirement age remains at a level just below 64 years. In the alternative scenario the retirement age grows to a steady state between 66 and 67 years.

Figure 3.5.4 Average transition age to old-age retirement by gender using two alternative scenarios
Source: Figure 10 in Bolin et al (2008b)

#### 3.5.5 Models to simulate the evolution of the distribution of wealth

When simulating the evolution of the distribution of wealth it is not possible to use a conventional portfolio allocation model that can be estimated from a single cross-section of data. Such a model would give too much volatility in the simulated data. We needed a model which uses information about the stock of assets last year and then simulates any changes. We also needed a model which at least distinguishes between owner occupied housing, tax-deferred pension savings, study debts, other debts and other assets, because taxes and benefits would depend on this categorization. From an analytical point of view it might have been desirable also to distinguish between risky and less risky assets, and one might also have preferred to distinguish between mortgages and consumption credit. Data limitations and the fact that the main focus of our study did not require a detailed brake down of financial assets made us settle for the following groups of assets: owner occupied housing, other real estate (mostly vacation houses, farm- and forest properties, and apartment complexes), tax deferred pension savings, other financial asset, study loans and other debt.
Figure 3.5.5 Financial and real wealth and cost of housing in SESIM

Source: Figure 1 in Flood and Klevmarken (2008)
Figure 3.5.6 gives an example of the results of these simulations. The average cross-sectional age-wealth profile for the years 2000-2004 shows the well-known reversed U-shape with a peak at about 65. The simulations then show that the peak moves to the right and disappears at the end of the simulation period.

Figure 3.5.6 Mean net wealth by period and age of the oldest in the household (SEK in 1999 prices)

Source: Figure 3 in Flood and Klevmarken (2008)

#### 3.5.6 Simulation results

Our basic simulation scenario includes certain assumptions about the macro indicators which are fed into the model exogenously. For the period 1999-2004 we have used observed values. After 2010 the following assumptions apply:

Annual rate of change in inflation (CPI)	2.00 %
Annual average increase in real wage rates	2.00 %
Short-term interest rate	4.00 %
Long-term interest rate	5.00 %
Dividends	2.50 %
Rate of change in prices of stocks and shares	3.75 %
The market value of single family houses	3.50%

For the period 2005-2010 these rates were allowed to adjust from the last observed rate to the constant rates above. Demographic changes were aligned to the basic predictions from Statis-
tics Sweden and the average unemployment rate was aligned to the medium term forecasts from the Ministry of Finance.

In addition to this basic scenario we have run a number of alternatives to investigate the sensitivity of the results and explore policy alternatives. They will be explained below at the same time as key simulation results are explained and commented.

Let us start with the health status of the population, which is measured with an index based on self-reported health and self-reported ability to carry out work and other tasks. It takes on four values ranging from full health, good health and bad health to severe health. The simulations show a marginal decline in health status among the elderly as we approach year 2040. In the age bracket 50-74 the share with severe illness increases from 7 per cent to 10. Among women who are 74+ the share increases from about 28 per cent to 35. The health of the oldest men also decreases a little but not as much as for women. (See Figure 3.5.6!) These changes reflect the observation that the current health status among young adults is somewhat less than it was for the same age group of previous cohorts, due to for instance, increased obesity, allergies and mental problems.

Figure 3.5.6 Simulated health status 2000-2040 for people aged 75+. (Population shares by health status and year.)

Source: Figure 13 in Bolin et al (2008a)
The increased number of elderly and the (marginal) decrease in health status will increase the demand for health care. The first panel of Table 3.5.1 shows that the average number of days in hospital per year and person 65+ will increase marginally. This is a result both of the increase in the average age of this group and of the decrease in health status. The table also shows the result of two alternative scenarios. First we increased the health progression of the elderly by adjusting the health index for those aged 40-90 proportionally to their age minus 40 and the calendar year minus 2000 in such a way that a 90 year old person in 2040 will have the same health as an 80 years old in the base scenario. This implies that the improvement in health comes gradually and is largest for the elderly. The result was that the average number of hospital days was simulated to decrease rather than to increase. In this scenario the death rates were, however, kept at their old age-specific values. If health status increases one might expect that the death rates would decrease. For this reason the third scenario combines the increase in health status with a decline in age-specific death rates. After year 2010 and after the age of 35-40 each individual was assumed to have the death risk of a 5 year younger person in the base scenario. To avoid excessively old persons the death risks after the age of 100 was eased upwards towards the levels of the base scenario. The result is a rather dramatic increase in the average number of hospital days. The explanation is that we get an agglomeration of very old persons at the end of the simulation period.

The second panel of Table 3.5.1 shows the combined effects of the change in the average number of days and the population increase in the age segment 65+. The total number of days in hospitals for people 65+ will in the base scenario increase by about 70 per cent, in the improved health alternative only by 43 per cent, and when the death rates decrease the number of hospital days increase by as much as 142 per cent. The assumed decrease in death rates might be exaggerated, but these simulations show that the results are rather sensitive to the death rates. If the health status of the population improves such that people survive to very old age, but they then will be in need of much health care, we will in the future experience an explosive increase in demand for health care from the old-old.

Table 3.5.1 Average and total number of inpatient hospital days for people 65+ by year

Year	Average no of days	Total no of days (1000)
Base scenario	Improved health	Improved health & lower death risks	Base scenario	Improved health	Improved health & lower death risks
2000	3.2	3.3	3.2	4954	5068	4990
2020	3.2	3.1	3.5	6495	6270	8117
2040	3.4	2.9	4.0	8396	7241	12087

Source: Table 3 in Klevmarken (2008b)
We will also expect an increase in social care of the elderly. Figure 3.5.7 shows the simulated number of elderly with around-the-clock care for the period 2000-2039 by age group in the base scenario. We find that the number of old people who get this kind of institutionalized care will increase from about 70 000 to 160 000. It will increase in all three age groups but most among the very old. There are similar but not quite as dramatic changes for home help, see Figure 3.5.8.

Using data on average cost per person and hospital day and annual averages per person for institutionalized care and home-help, and the assumption that these numbers will increase by the average increase in the real wage rate, we have computed total expenditures for these three forms of care, see Table 3.5.2. The table gives estimates for three years. We find that the total will increase in real terms by a factor of 3.6. To understand how much this is we should have been able to simulate the future budget for the public sector, but SESIM is not able to do it. The model, however, simulates how much everyone pays in direct taxes, and we have thus put the total of these expenditures relative to the sum of all direct taxes from the household sector. The result is displayed in the second column of Table 3.5.2. We find that the expenditure share will increase from about 20 per cent in 2000 to 36 per cent in 2040. This suggests that the increased expenditures for health care and social care due to population ageing will become an increased burden to the public budget. $ ^{15} $

Figure 3.5.7 Total number of elderly with around-the-clock care 2000-2039 (1000s)

Source: Figure 6 in Fransson et al (2008)
Figure 3.5.8 Total number of elderly with home help 2000-2039 (1000s)

Source: Figure 6 in Fransson et al (2008)

Table 3.5.2 total expenditures for inpatient care, home help and institutionalized care for people 65+

Year	Total expenditures (millions of SEK in fixed prices)	Total expenditure as share of the sum of direct taxes from households (\%)
2000	92231	20.5
2020	166719	24.9
2040	339297	36.2

Source: Table 6 in Klevmarken (2008b)

Let us now turn to the income and wealth of the elderly. Figure 3.5.9 shows the simulated average taxable income for retired relative to the average taxable income of the working cohorts of age 20-64 for a few selected birth cohorts as they age. Everyone is assumed to retire no later than at the age of 65. At this age relative income lies in the interval 75-80 per cent. As the elderly age, their relative income decreases. The drop in income around the age 70 is a result of our assumption that the funded components of the pensions are paid out during the first five years. An individual can choose to have them paid out for a longer period or lifelong. Had we chosen such an alternative the kink at age 70 had been smoothed. We find that the relative income of these cohorts decreases down to about 50 per cent at the age of 80. The explanation is that the pension system is “front loaded”. Pensions are indexed by a wage rate index to make them follow the income changes of an average worker, but each year 1.6 per-
percentage units are subtracted, which implies that the income standard of the elderly will deviate more and more from that of workers as the elderly age. We might also note that the curves of the older cohorts lie higher than those of the younger. The main explanation is that the younger cohorts will on average live longer and their pensions will thus have to be paid out for a longer period. Their annual pension will then have to decrease, unless they retire later.

Because the group 65+ age and because younger cohorts get relatively lower pensions the relative income of the whole group 65+ will decrease. This is seen in Table 3.5.3, but for a different income concept – equivalized disposable income. Relative income decreases from about 70 per cent in 2000 to about 55 per cent in 2040 in our base scenario. If we allow people to work in the market until the age of 70 the situation improves. Relative income then only drops to about 62 per cent. The explanation is that the group 65+ will have market incomes, which are higher than pensions, for a few more years, and that the pension will be paid out during a somewhat shorter period.

Figure 3.5.8 Average taxable income for retired relative to the average taxable income of working cohorts aged 20-64, by birth cohort and calendar year.

Source: Figure 11 in Flood et al (2008)

Table 3.5.3 Median equivalized disposable income of 65+ relative to the median income of 20-64, by year in two scenarios.
Year	Base scenario age	High pension
2000	0.709	0.711
2020	0.634	0.693
2040	0.552	0.623

Source: Table 13 in Klevmarken(2008b)

Figure 3.5.9 Poverty share by birth cohort and age (equivalized disposable income less than 50% of the median income of the adult population)

Source: Figure 14 in Flood et al (2008)

The low relative income at the end of life raises the issue of poverty. We have defined poverty as having an equivalized disposable income less than 50 per cent of the median of the adult population. Figure 3.5.9 shows the poverty rate for a few cohorts as they age. It is very low among working age people, just a few per cent, but increases a few years before the typical retirement age of 65. In the age group 55-65 there are relatively many on disability pension