The Danish DC-approach to 2 nd Pillar Pensions Contractual Pensions Seminar Washington DC., 29 April – 3 May 2002 Ole Beier Soerensen, Ph.D., Chief of Analysis, ATP, Denmark

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

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

Three Elements of this Presentation The Danish preference for DC-principles Some technical properties Cause for further consideration

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)

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

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

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

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

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

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

The Overall Pension System Inclusive rather than exclusive Avoids individualisation of risk Security, credibility and predictability Not the intended outcome of pursued strategy

Pension Model in Question – 1 Increased life-expectancy strengthens demand for reserve funds Less scope for future value adjustments of promises and pensions

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 3 rd EU- directive on life-insurance Lower maximum allowed guaranteed interest rate "New" and "old" members?

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

Market Value Interest Rate

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

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