David Prosser: The Swedish model that might save our pensions system

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The Independent Online

Outlook Having seen Gordon Brown's government turn to Sweden for a prototype of how to solve the bankingcrisis – its bail-out of the banks in 1992 served as a blueprint for the former prime minister – 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.

He is right to do so because 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, who like their jargon more than most, 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 theprevailing 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 have the risk of a funding shortfall off the hands of the taxpayer. If the economy disappoints, theirpension 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 that everyone recognises – and Lord Hutton himself made this clear yesterday – that there is very little we can do to address the funding issues of the short term. And the anxiety about the sizeable hole in the finances of public-sectorpensions over the next few years should not infect the debate about how to put these on a sounder footing for the coming decades.

Nick Clegg, for one, has made much of how the gap between what public-sector workers pay into schemes and the pensions to be paid out of them is set to widen from £4bn to £9bn by 2015. He may be right, but unless the Deputy Prime Minister is prepared to rip up the pension promises made in the past to workers who are now coming up to retirement, it's too late to do much about that. Higher employee contributions, even if introduced right now, will make only a tiny dent in the deficit.

This is the great difficulty with pension reform – and one that has confounded successive governments. Even very meaningful changes to the system take many years to bear fruit, certainly longer than the five-year electoral cycles to which politicians are so finely tuned, but can be exceptionally unpopular in the short term. Pensions, then, provide an early test of whether David Cameron's government is genuine about "working together in the national interest".

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