The Swedish pension system is unique and has attracted worldwide attention. This is because it is designed differently from those of other countries, taking into account the effects of economic and demographic trends. As a result, the Swedish system is considered financially robust.
The national retirement pension comprises the following: an income-based pension, a premium pension and/or a guarantee pension. The pension is financed in the form of a levy of 18.5 percent on total income earned. Of this amount, 16 percent is used to finance pension disbursements for the year (income-based pension), while 2.5 percent is invested, to generate interest in an individual premium pension account. There is also a guarantee pension, funded by the State.
One of the challenges faced by most national pension systems is their vulnerability to demographic change. The burden simply becomes too great when generations featuring a limited birth rate find themselves supporting baby-boom generations.
In response to this challenge, the pension system we now have was introduced in early 2000. The reformed pension system means that future pensions are more clearly determined by the level of each and everyone’s individual income, based on income received over an entire working life. One important component of this new pension system is the automatic balancing mechanism, or ‘brake’. This ensures that pensions are adjusted upwards more gradually at times when liabilities exceed assets.
In the Swedish pension system, as in most national pension systems, ‘contribution assets’ comprise the largest single asset. Accounting for some 90 percent of the system’s combined assets, these contribution assets reflect the value of future pension contributions, determined mainly by salary and wage levels, levels of employment and retirement age. To these are added the assets managed by the buffer funds (the First, Second, Third, Fourth and Sixth AP funds), corresponding to fifteen percent of the system’s total pension assets. These buffer funds have been established to minimize the system’s vulnerability to fluctuations caused by economic and demographic trends.
The size of pension is determined by length of time worked and level of income. Furthermore, an upward adjustment is made to account for the mean rise in income. However, for pensions to be optimally adjusted upwards, the system must be in balance, with pension assets equal to or in excess of pension liabilities. Contribution assets and the AP funds’ combined capital assets shall at least equal accumulated pension liability.
The relationship between assets and liabilities is defined in terms of a balance ratio (BR). Where liabilities are greater than assets, the balance ratio is less than 1.0, and automatic balancing is applied (commonly referred to as ‘the brake’). This slows the upward adjustment of pensions. This slower rate of adjustment is maintained until parity is re-established within the pension system.
The balance ratio (BR) represents the system’s assets divided by combined pension liability. If the balance ratio is less than one, balancing is applied. This means that pension liability and pensions are adjusted upwards only by wage growth multiplied by the balance ratio. This process continues until parity is re-established. Once the balance ratio has regained a value in excess of 1, this triggers a more rapid upward adjustment in wage growth.