Nick Silver, one of the three commended entrants who answered this question in the IFoA’s thought-leadership essay competition last year, summarises his paper. In it, he makes the case for a Swedish-style system
Moody noir detective dramas. Beautiful minimalist designer furniture. Trendy knitwear. Hygge. Erling Haaland. To the list of Scandinavian things that the UK should emulate, should we add the Swedish pension system?
The British system does have some good features (a minimum basic state pension and auto-enrolment), but it is failing citizens in many ways. On the beneficiaries’ side, it does not provide an adequate pension that retirees can live off, risks are transferred to the individual saver, who cannot necessarily manage them, and there is no certainty that savings will translate into a sufficient pension. The system is generationally unfair, with some older people receiving a very good defined benefit pension while the young only have inferior savings options.
For an economy to generate sufficient returns to support a growing ageing population, the savings must be invested wisely at a systems level. The UK has a lower savings and investment rate than its peers, prejudicing future growth. Investment is misdirected, which has led to the country having the OECD’s worst regional inequalities. Its capital markets are increasingly recognised as dysfunctional, with publicly listed companies tending to chase short-term returns at the expense of long-term growth – for example returning money to shareholders rather than investing it. This is the result of many years of long-term stewardship by a pension sector whose preferred measure of success is quarterly earnings targets.
A further outcome is that growth companies are no longer willing to list in UK stock markets, at least in part because of the lack of long-term risk capital. The current system is also expensive, with approximately half of pension lifetime value extracted in fees.
The gilt-market meltdown of late 2022, induced by liability-driven investment (LDI), is a case in point – LDIs were supposed to reduce risk, but pension funds invested in the same strategy en masse, causing a systemic risk. In addition, LDIs are not long-term productive investments; in essence, accounting rules are incentivising pension funds to lend money to the government.
There have been attempts to reform the system, but they have resulted in the current situation – one of the worst systems of any country. The cacophony of voices demanding that savings are invested into the economy’s long-term needs – for example into the net-zero transition and poorer regions of the economy – is increasing. However, for whatever reason, the current system cannot meet those needs, despite the relatively large amounts of available capital.
The UK cannot afford to muddle along with this failed system. Past reforms have, if anything, exacerbated the situation. As a wise man once said, insanity is doing the same thing over and over and expecting different results.
Looking further afield
One obvious way forward is to look at other countries to see if anyone else does things better, and if we can copy their models. Two examples stand out – Australia and the Netherlands, whose systems are not so different to the UK’s but work much better. Moving to these systems would involve consolidating the UK’s fractured pension funds and changing the investment and fiduciary rules.
Personally, I would be happy if this could be achieved to a satisfactory degree. However, I am sceptical, because these systems are similar to our current one – consolidation has already been tried and may soon be added to the junkyard of failed reforms; the incumbents are too entrenched and will resist changes (indeed, they have already done so).
I propose a much more radical solution that, counterintuitively, may have a higher chance of success: emulating the Swedish system. In Sweden, the Pensionsmyndigheten (Pensions Agency) administers and pays out the national public pension. It is successful, popular with Swedes and fairly straightforward. How does it work, and how it could be adapted for the UK?
The Pensions Agency
The agency is an independent government-owned entity with a mandate to administer the pension and ensure the system is in balance. Technically, the pension is a notional defined benefit pension and contributors all have a hypothecated personal account into which they pay. Accounts are annually credited with interest, in line with national average earnings; on retirement, the accumulated account is swapped for an annuity.
The scheme is partially funded, with some contributions paid into reserves that are invested in assets, and the rest used to pay pensioners. The agency ensures that the system is always in balance, meaning that the scheme always has sufficient assets (funded reserves plus future contributions from members) to meet its future liabilities (the future payments to pensioners).
The agency also accepts and administers people’s savings, sets specific social/sustainable dual mandates for asset managers, and oversees this asset management. Once established, it can be used for other pension products as and when the need arises. The scheme is mandatory, with workers and their employers mandated by law to contribute to the system.
Adjustments to the system
In Sweden, a proportion of the contributions is paid into four reserve funds. These can be externally managed, but the agency sets specific mandates, appoints the managers and monitors performance.
The Swedish system was established before environmental, social and governance criteria was recognised as an important investment element. There is now widespread acceptance of the need for long-terms savings to be invested for societal goals such as alleviating regional disparity and transitioning to net zero. Unlike in an occupational pension fund, the major ‘assets’ of the scheme are future contributions; the logical consequence of this is that it is in beneficiaries’ interest for the funds to be invested for a long-term sustainable economy, rather than on a purely financial risk-return basis.
I propose that, in adjusting the Swedish system for the UK, the reserve funds have dual mandates: along with financial returns subject to risk, they also have an explicit social objective. It would also make sense for the social objective to be different for each fund so that it could specialise; I suggest the following:
- Fund 1 to be invested in the economic development of poorer regions
- Fund 2 to be an impact investment fund
- Fund 3 to be invested in sustainable infrastructure
- Fund 4 to be invested in climate change and other environmental solutions.
Other arrangements
Once established, a UK pensions agency could also set up a long-term care insurance platform. The UK faces a crisis in this area, and no private sector insurance policy is available. The burden falls on the state, which seems unable to address the funding situation.
Investment vehicles alone may not be able to achieve effective investment in certain areas. To help them achieve this, national and regional development banks may be required. The UK Infrastructure Bank already exists, but it should be scaled up and repurposed to crowd pension monies into these investments in the UK economy.
There are two politically sensitive areas, defined benefit occupational schemes and the basic state pension, which the new system could address – but any attempts to mess with these will bring about a great deal of opposition. A greater chance of success would be to establish a new system; if it works and becomes trusted, an environment might be created in which these further reforms could be implemented.
Defined benefit schemes could be transferred into the new system, providing it with an asset base and de-risking it. The details would be complex and may, in any case, be academic, because most of these schemes may have been bought out by the time a new system is up and running.
In the Swedish system, the pension received is subject to a minimum, effectively acting as a basic pension. In the UK the basic state pension is a popular benefit and is a political totem. Integrating it into a new system would be politically fraught, and tricky decisions would have to be made, for example on means-testing and cross-subsidies. This would require extensive consultation.
The end of short-termism
To introduce a new system as proposed would not be simple, and there would be several objections to its introduction. Many of these are ideological – the idea that people should be able to choose their own pension, delivered by the ‘market’. However, the market is not delivering a pension, so other alternatives need to be employed. The Swedish system works, and Sweden is not on what Friedrich Hayek called the ‘road to serfdom’.
The introduction of this new system should make capital markets operate better – the structure of the current system means that pension funds are invested in the wrong asset classes (mainly government bonds) and are encouraging investee companies to make short-term decisions. The investment mandates of the proposed system counterbalance these tendencies, and because they will quickly gain critical mass, they could make the UK an attractive place for long-term investments again.
You can read Nick Silver’s full paper here
Nick Silver is the founder of Radix Big Tent, a think tank that aims to develop innovative ideas that challenge established notions. He is a visiting fellow for various academic institutions and director of Callund Consulting
