Rapport fra
Pensionsmarkedsrådet 1999

Summary in English

Summary of the Pension Market Council’s 1999 report

In the past year, the debate on pensions was characterised by a number of main issues, e.g. the future support burden, consequences of interest rate guarantees, the movements in pension returns, the complexity of tax and pension systems and thus also the uncertainty prevailing in the population as to how the individual person will be affected by the various rules and schemes.

In this year’s report, the Pension Market Council will discuss a number of these issues.

1.1 Pension contributions and rates of coverage for future pensioners

As mentioned above, one of the main issues discussed in the past year is the future support burden. Due to the anticipated future demographic change, there will be fewer to support more. Last year, the Pension Market Council decided to analyse the residual group in order to establish the extent to which groups which currently have no pension coverage will have a support problem in old age. Due to the above issue, the Pension Market Council has extended this analysis to include the prevalence and coverage of labour market pension schemes.

Chapter 2 shows that the latest pension initiatives (an economic package - the socalled "Pinsepakke" - and the 1999 Budget Compromise) will gradually reduce the group with no pension coverage, the socalled residual group, but that the time horizon is very long. It also appears from the chapter that there is now a great prevalence of pension schemes, including the Danish Labour Market Supplementary Pension (ATP) schemes.

With the current social pensions, the rates of coverage will be highest for the lowest paid, but the analysis also shows that there will be other groups with a relatively low rate of coverage. The calculations in the examples are based partly on the contribution rates paid today and partly increased contribution rates. The results can be used to a preliminary assessment of the need for additional pension savings. The calculations do not take any changes in social pensions, the tax system, etc. into account.

Another major topic in the past year’s pension debate was interest rate guarantees and thus the entire basis for insurance-based pension savings.

The current low interest rate level and the transition from a real interest tax to pension return taxation at a fixed rate have caused a good deal of concern about whether the pension companies can meet the interest rate guarantees issued. One of the questions raised in this connection is to what extent the potential problems will affect the companies’ investment strategies.

It appears from chapter 3 that, under the given interest rate and taxation conditions, the companies may possibly have difficulty in covering interest rate guarantees already issued through their investment policies. In that case, the risk exists that the managements of the companies will be forced to invest either in bonds only or in shares with an undesirably high risk. In either case, pension savers miss the advantages of a well-diversified portfolio. This risk is the result partly of the features that are characteristic of existing pension products where the companies have guaranteed customers benefits of a certain size and partly of the new taxation rules.

The interest rate guarantees are part of the traditional insurance technique designed for the purpose of ensuring maximum security and stability for policyholders. Life and pension insurances - particularly labour market pensions - are designed as support schemes, which enter into force when there is no longer, any earned income because of old age, death or disability. The insurance technique cannot be amended without product properties being affected to a greater or lesser extent.

To counteract potential restrictions in the companies’ investment policies, a reduction of the interest rate guarantees - or a complete abolition of the guarantees during the period of saving^[1] - might be considered. In the labour market pension schemes, such considerations must take place on a basis involving all significant matters and in close dialogue between members and management. For premiums and benefits already agreed, the guarantees cannot be changed without the consent of the individual person, just as the pension companies cannot unilaterally change the guarantees concerning agreed future payments. However, the interest rate guarantee may be changed for new policies and for non-agreed increases, including bonuses, on existing insurances. For these new contributions, the maximum technical rate of interest has been lowered to 2 % with effect from 1 July 1999, and many companies have carried out or are considering carrying out adjustments of their technical basis in order to prevent future risks in connection with a decline in interest rates. The Pension Market Council will present the initiatives taken in a later report.

1.3 Investment returns

Chapter 4 shows that there is a substantial difference in the average returns earned by the various pension companies over the past six years. Thus there is a difference of more than 5% p.a. between the highest and the lowest return, or 34% over a six-year period. The companies with a low return also have much lower bonus and equity reserves than companies with high returns. Viewed separately, this may make it difficult for companies with low returns to catch up with the difference in the return in the coming years.

Several of the calculations in this chapter are based on key figures for a six-year period. However, the calculations relating to the relationship between return, size of assets and share interest are based on shorter periods of time. The conclusions of the chapter should be seen in the light of the uncertainty attaching to the short period in which data are available.

The Pension Market Council will watch movements in the companies’ returns with a view to ascertaining whether the differences are increasing.

1.4 Costs

Last year, the Pension Market Council stated that the cost structure of pension companies would be examined more closely in a coming report. The Council has therefore examined the cost structure of the various categories of pension companies.

The examination shows that costs vary considerably, both within and between the various types of pension companies. Some of the reasons for this are the different options that members have, the composition of the pension portfolios, the general service level, and the age of the pension companies but probably also differences in scheme efficiency. As costs are a significant element in pension savings, the Pension Market Council will watch cost developments closely in future, both within and between the various types of pension companies.

1.5 Key figures

Since 1996, pension companies have published 11 key figures in their accounts. The key figures are aimed at the reader of the accounts, and it may be difficult to understand them fully without some technical insight. The key figures can be used to improve communications between the pension companies’ managements, boards of directors and committees of representatives.

In 1998, to improve the application of the key figures and make them more user-friendly, the Pension Market Council recommended, among other things, that a list of the key figures be prepared, grouping the companies by comparability, and that information be given about the relevance of the individual key figures to the individual groups of members and companies.

This recommendation was discussed in the industry and led to the list of key figures prepared by the industry being supplemented with additional information for the interpretation of the pension companies’ key figures. The Pension Market Council still holds the view that the key figures should be grouped by comparability.

Standardised policy information might also be a help to pension savers. The Pension Market Council is of the opinion that standard information should be prepared, incorporating the most relevant information that pension savers need. In addition to giving pension savers a quick overview of the development of the pension scheme, the standardisation should also be aimed at giving savers the opportunity of calculating the total pension coverage for other schemes, too. The Pension Market Council will continue its work on this matter.

1.6 Democracy and openness

Openness is crucial to the individual freedom of choice as well as to democracy. It appears from chapter 7 that, in recent years, much greater openness has been achieved in the pensions field, and many initiatives have been taken, both with respect to greater individual freedom and with respect to the promotion of democracy. This is a trend that the Pension Market Council considers favourable.

IT technology provides pension companies with a number of completely new opportunities for dialogue and contact with their members, thus strengthening members’ possibility of exercising active democratic control over pension schemes. The Pension Market Council recommends that these possibilities be further developed and used actively by the pension companies.

Theoretically, the further development of the pension system in the coming years could take two courses. One is based on the promotion of the individual freedom of choice. All other things being equal, this implies an easing of the requirements for democracy. Choice of pension company or pool, benefits, etc. are examples of this course.

The other development course is based on the promotion of democracy. This can be achieved by developing the democratic decision-making processes, e.g. by making indirect democracy more direct or by changing the composition of decision-making bodies.

The debate among members on investment strategies has included ethics. Last year the Pension Market Council recommended that to the extent pension companies use ethical guidelines in their investments, they should publish these. 13 pension companies have prepared an "ethical policy" in writing. At the same time, there is a growing trend towards pension companies publishing the names of the companies they invest in. This is a trend supported by the Pension Market Council.

In these years, the Swedish pension system is undergoing great changes, both the public pension system and the labour market pension schemes.

The Swedish pension system differs in important respects from the Danish system, both as regards the fundamental objectives and as regards the specific design of the individual elements.

The Swedish system may provide some experience - particularly in the long term - both with respect to the administration of options in mandatory schemes and with respect to members’ interest in utilising options, which will also be of interest in the Danish pension debate.

Chapter 8 describes the Swedish pension system, including the elements to which individual options are attached. The main features of the Swedish pension system are discussed first. Then there is a more detailed discussion of the "Premiepensionen" scheme and the labour market pensions. Lastly, the rules governing taxation of pension savings are described.

Part II

The Pension Market Council’s choice this year to take a closer look at taxation rules in the pensions field is due to the debate and the uncertainty that have arisen in the wake of "Pinsepakken" and the 1998 Budget Compromise as to the appropriateness of saving for one’s pension. By way of introduction, there are some reflections on how the taxation system should be seen in combination with the desire to encourage pension savings.

It appears from chapter 9 that, for virtually all pensioners, the composite marginal tax rates have fallen after the introduction of "Pinsepakken". However, the composite marginal tax rates are still high, at an average of around 60 and, for a few groups, close to 80, which may affect the economic incentive to make savings.

The composite marginal tax rates provide a static picture of taxation conditions for a pensioner but say nothing about whether, from an overall point of view, there is a tax incentive to save in a pension scheme.

Therefore, model calculations have been made for four types of families who save for their pensions in a pension scheme; make no savings; or make personal savings. The calculations show that, from an overall point of view, the taxation rules and the social services provide an incentive to save in a pension scheme whether you are single or a couple or whether you live in an owner-occupied home or a rented home, compared with a situation where you do not make savings or make personal savings and receive voluntary early-retirement benefit at the age of 62. If, however, you are single and receive voluntary early-retirement benefit at the age of 60, the incentive is reduced. The incentive for a single person is clearly lowest in the DKK 270,000-280,000 income range as a result of the effect produced in combination with public services.

From an overall point of view, the taxation rules and the social services also provide an incentive to save in a pension scheme for couples who are pensioners, irrespective of type of housing; whether the alternative is no savings or personal savings; and whether the couple receive voluntary early-retirement benefit at the age of 60 or 62. The incentive is lowest in the DKK 350,000-380,000 income range as a result of the effect produced in combination with public services.

^[1]Danish legislation does not prevent the abolition of interest rate guarantees if this is desired by those demanding or providing pension schemes.

Udgivet af Finanstilsynet november 1999
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