Saturday, November 6th, 2021
Model of Swedish pension funds
How should a pension be financed in the long term?
By Charlotte Raskopf
As fewer and fewer people pay into the pension scheme, more and more retirees have to be paid a pension. In Germany, share-based old-age provision is not yet an integral part of the pension system. But a pension fund based on the Swedish model is conceivable.
How will Germany finance pensions in the future? Today, this question is more acute than ever because the pay-as-you-go system is reaching its limits. While fewer and fewer young people are paying into pension insurance, more and more retirees have to be paid their pensions. The federal government is already paying around 100 billion euros as a subsidy to the statutory pension scheme to maintain the system. The Ifo Institute calculated: If the applicable stop lines for pension levels and contributions are retained, the federal government will have to spend 60 percent of the federal budget on pensions in future.
How the pension should be financed in the long term is also a concern of the traffic light parties in their talks about a future government. In their position paper, they already stated that they would “get into a partial fund of the statutory pension insurance in order to stabilize the pension level and pension contribution rate over the long term.” Other countries are showing what a funded old-age provision could look like: Norway, for example, with the largest sovereign wealth fund in the world, Australia and New Zealand with traditional pension and provision funds, or Sweden with its very own “Swedish model”.
In Sweden, share-based old-age provision has been an integral part of the pension system since 2000: Swedish employees pay 16 percent of their gross salary into the classic pay-as-you-go pension. In addition, there is 2.5 percent, which automatically and compulsorily flow into capital market-based products.
Hundreds of funds to choose from
The Swedes can decide for themselves which products exactly: There are several hundred funds from private providers to choose from, but most – currently more than five million people – opt for the AP7 equity fund. Although “decide” is perhaps not the right word, because whoever does not actively choose one of the privately managed funds, their contributions automatically end up in the state AP7 fund, which is therefore often smiled at as a “fund for lazy people”. It is the “default option” of the Swedish model.
The performance of the AP7 is quite impressive: Over the past 20 years, the fund has achieved an average return of 11 percent, and the ongoing fees are extremely low at just 0.1 percent. So what is the AP7’s recipe for success? The pension fund consists of two parts: the AP7 Equity Fund and the AP7 Fixed Income Fund. The AP7 Equity Fund invests broadly diversified in more than 3000 companies from different regions and branches of the economy, 96 percent in global equities, the remaining four percent flow into private equity. The 96 percent invested in stocks should reflect the MSCI All Country World Index. The private equity portfolio, meanwhile, consists of indirect investments in mutual funds, which in turn invest in private equity. The fund also invests in clean technologies. The AP7 Fixed Income Fund invests in fixed income securities.
What exactly the contributions of Swedish workers are invested in depends largely on their age. Up to the age of 55, all contributions are invested in shares, i.e. in the AP7 Equity Fund. The closer to retirement, the more the money is shifted into fixed-income securities, i.e. the AP7 Fixed Income Fund. If the contributors are between 56 and 75 years old, between three and four percent of the money goes to the Fixed Income Fund each year, after which two thirds of the money remains in the Fixed Income Fund for the remainder of the contributor’s life.
Global players in the AP7 portfolio
The top positions of the AP7 include global players such as Apple, Microsoft, Exxon Mobile and Johnson & Johnson. Anyone who violates the fund’s guidelines as a company, for example, has connections to nuclear weapons or disregards labor rights, ends up on the black list: In addition to numerous Chinese companies, there is also Deutsche Telekom for “violating labor rights in the USA”, is it[called
Because of its good returns, the “Swedish model” is seen as a role model in many places and could also be discussed again in the coalition negotiations. But even with the Swedish model, things didn’t always go smoothly. In the early years, the fund fell sharply: in 2000 it recorded a minus of seven percent, in 2001 one of eleven, and in 2002 even 27 percent. Fraud cases also caused dissatisfaction: managers of private funds embezzled funds.
Strictly speaking, the Swedish pension fund is not a sovereign wealth fund, as it is fed solely from the contributions of savers, unlike in Norway, where the largest sovereign wealth fund in the world is managed. It is not only financed through social security contributions, but is mainly fed by income from the country’s oil production.
A German state fund?
So could Germany simply set up a sovereign wealth fund and thus supplement the statutory old-age provision? In theory yes, says Jens Boysen-Hogrefe from the Kiel Institute for the World Economy. Contrary to what the name debt brake suggests, the state could certainly incur more debts without violating them.
“If financial assets, such as stocks or bonds, are acquired, additional borrowing is permitted,” he says. The central point is that federal bonds yield lower returns than the financial assets that are acquired.
“The pension fund cannot be expanded at will, because the federal government’s creditworthiness is likely to fall with increasing debt,” says Boysen-Hogrefe. Currently, Germany is doing very well, especially in comparison with other large economies, “so that limited borrowing should offer advantages for an equity fund,” says the IfW economist.
A German pension fund would be possible, so how successful it would be, but it depends on the investment strategy and what it would look like is open. The only clues that can be drawn from the funds that are already state-supervised today are: On the one hand, there is the fund for financing nuclear waste management, or Kenfo for short. Around 24 billion euros of endowment capital is administered here, the proceeds of which are intended to finance the search for and operation of a nuclear repository in Germany.
The Kenfo invests in accordance with the ESG criteria, broadly diversified in various asset classes: equity, corporate and government bonds, real estate, infrastructure projects and unlisted corporate investments. On the other hand, there are two pension funds for federal civil servants, which are supervised by the Federal Ministry of the Interior and whose money is invested by the Frankfurter Bundesbank. 80 percent of the money is in safe bonds, 20 percent in stocks, the portfolio includes Amazon, Microsoft, SAP and Sanofi-Aventis.
It remains to be seen whether the “Swedish model” will become a model for Germany. With the partial funding of the statutory pension insurance, which the traffic light parties agreed in their exploratory paper, the first step towards a trend reversal has already been taken.
This article is at first Capital appeared.