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Why Sweden can save our pension system

By David Prosser

Published 08/10/2010

Having seen Gordon Brown's government turn to Sweden for a prototype of how to solve the banking crisis, it is the turn of the Conservatives to look to Stockholm for public-policy solutions.

Lord Hutton's interim report on public-sector pensions yesterday singled out the Swedish model as one we might adopt.

There is much to admire about Sweden's public-sector pension system: in particular, the way in which the interests of low-paid workers have been preserved at the same time as the burden on taxpayers has been reduced.

The trick is what the pension professionals describe as a "notional defined-contribution" scheme. The problem in Britain is that public-sector pensions are guaranteed, locking taxpayers into expensive commitments which have to be met whatever the prevailing economic or financial conditions. In the private sector, meanwhile, these defined-benefit plans are rare. Instead, defined contribution is now the norm, with workers' pensions dependent on the vagaries of the markets.

Sweden's "notional DC" combines the two concepts. Like ours, it is a pay-as-you-go system, with no actual funds set aside for the future. For basic pensions, the scheme assumes a set investment return is achieved each year, whether or not this is what the markets achieve, so workers know they are guaranteed a minimum income in retirement. Beyond the basic pension, for those who contribute enough, additional returns are granted with reference to the performance of Sweden's economy.

The arrangement has a number of advantages. Everyone gets a certain level of pension in retirement. For less well-paid workers, this may represent their whole entitlement, but they can at least be confident of their future. Better-paid workers, meanwhile, stand to get more from the scheme, but on this portion of their pension, they risk a funding shortfall off the hands of the taxpayer. If the economy disappoints, their pension top-ups will be correspondingly smaller.

In the long term, this sort of hybrid arrangement is likely to provide the template for an affordable system of public-sector pensions in the UK.

That said, it is important to recognise that there is little we can do to address funding issues of the short term. Anxiety about the hole in the finances of public-sector pensions over the next few years should not infect the debate about how to put these on a sounder footing for the coming decades.

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