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The Danish DC-approach to 2 nd Pillar Pensions

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 OBS@ATP.DK. Pension Reform Objectives. Objective different from that of other countries

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The Danish DC-approach to 2 nd Pillar Pensions

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  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@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

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