The Danish DC-approach to 2nd Pillar Pensions

1
The Danish DC-approach to 2nd Pillar Pensions

• Contractual Pensions Seminar
• Washington DC., 29 April 3 May 2002
• Ole Beier Soerensen,
• Ph.D., Chief of Analysis, ATP, Denmark
• OBS_at_ATP.DK

2
Pension Reform Objectives

• Objective different from that of other countries
• To enhance 2nd pillar coverage
• To increase replacement rates for low and
  mid-income workers
• Expansion and completion rather than retrenchment

3
Process and Results

• Three partite agreement 1987
• Collective agreements 1987 to 1993
• 85 of all employed workers
• 9 to 18 of gross wages
• ATP turned into a universal, funded 1st pillar
  DC-scheme
• Reform in line with 20th century development

4
Three Elements of this Presentation

• The Danish preference for DC-principles
• Some technical properties
• Cause for further consideration

5
Basic - but Trivial - Principles

• Core principles
• coverage by external capital settlement
• standards applied to life-insurance
• assets must match liabilities
• subject to supervision by the supervisory agency
• current evaluation of an approved actuary
• Abolition of book-reserves and internal pension
  funds
• In force for the entire industry since 1936 (1903)

6
1936 and onwards

• Occupational pensions were rare and mostly DB
• Increased coverage during the post-war period
• Three main characteristics
• new schemes are DC
• DB is replaced by DC
• collective insurance principles

7
Undisputed DC-preference

• No debate over the DB/DC choice
• Trivial considerations
• capital settlement
• vesting periods
• portability
• distortionary labour market effects
• severance payments etc.

8
Lead Role of the Public Sector

• Drive towards DC in the 50'ies and 60'ies
• demography and anticipated public sector growth
• DB and groups with a high job-mobility
• Without an ultimate sponsor of last resort
• a DC-model was the only alternative
• The role model of the following 30 years

9
From DB to DC in the Private Sector

• DB replaced by DC during the 60'ies and 70'ies
• high inflation rates
• high wage growth rates
• increased job-mobility
• paternalism dissolved
• new hiring preferences
• Remaining DB-schemes belong to multinationals

10
Choice of Model Properties

• Two general objectives
• guarantees similar to DB
• sharing of social risks and investment risks
• Model choice
• collective insurance model
• insurance package old-age, disability and
  survivors benefits

11
The Pension Contract

• Minimum interest guarantee
• Excess return allocated over time as annual
  increases
• Prudency and real-value regulation
• The contract
• compulsory membership of designated scheme
• the right to insurance benefits covered
• the right to accrue on terms given at entry
• The annuity is drawn up at entry

12
The Overall Pension System

• Inclusive rather than exclusive
• Avoids individualisation of risk
• Security, credibility and predictability
• Not the intended outcome of pursued strategy

13
Pension Model in Question 1

• Increased life-expectancy strengthens demand for
  reserve funds
• Less scope for future value adjustments of
  promises and pensions

14
Pension Model in Question - 2

• Lower nominal interest rate questions
• the prudency of interest guarantees
• the scope for future value adjustment
• Enhancing security and complying with 3rd
  EU-directive on life-insurance
• Lower maximum allowed guaranteed interest rate
• "New" and "old" members?

15
Pension Model in Question 3

• New regime of accounting principles as of 2002
• Assets and liabilities valued at market value
• Absolute solvency on a day-to-day basis

16
Market Value Interest Rate - 2002
17
Pension Model in Question 4

• Co-ordination of public and private pensions
• Individuals influence on the investment behaviour
  of pension funds
• individual choice or investment democracy
• ethics and the focus on return
• Compulsory membership of designated schemes
• violation of the consumers free choice?
• pre-requisite for collective insurance

18
Concluding Remark

• Technical questions with heavy political
  implications
• Influencing the performance of the overall system
• Risk shifting should be carefully considered
• There may be no turning back