Financial and Inter-generational Balance? - An introduction to how the new Swedish pension system manages conflicting ambitions

The new Swedish pay-as-you-go pension system has been designed to be financially stable, i.e. regardless of demographic or economic development it will be able to finance its obligations with a fixed contribution rate and fixed rules for calculating benefits. This type of financial stability inevitably entails a risk that the value of pensions will vary over time. To minimise this variability, while at the same time securing the financial stability of the system, it has indexing rules that work asymmetrically. The aim of a stable pension level is attempted by basing the indexing of the systems liability on the growth in average income. As the growth in average income normally will deviate from the systems internal rate of return this index implies that assets may grow faster than liabilities, or vice versa. If and when liabilities should exceed assets, the basis for indexation is automatically switched to an approximation of the system’s internal rate of return, thus automatically adjusting pension levels as well. The pension level is automatically re-established, as is growth in average income as the basis of indexation, as soon as this is possible without undermining the financial balance of the system. Only historic transactions are used to calculate the liability and the assets.

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