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The Danish DC Pensions - Beauties and Challenges
The Association of Chilean Pension Funds - AAFP
Conference March 27 2018
Henning Hansen
Diclaimer: All content and views in this presentation represent the speaker and not the Danish FSA
The Danish FSA
Working for financial stability and confidence in financial undertakings and markets 2
Danish
FSA
Banks
Life&
Pension
Non-lifeInsurance
Invest-ment funds
Capital Markets
Mortgage lenders
Danish FSA - Supervising Life Assurance & Pension Funds
3
We do (e.g.) :
• On-site general inspections
• Theme based inspections and surveillances
• Off-site surveillance (QRT, ORSA, RSR & SFCR)
• Preparation of legislation
• Guidelines
• Longevity benchmark
• Fit & Proper approvals
We are (among other things) assessing that:
• The management is running and controlling the pension provider in a sound manner (best practice)
• There is sufficient capital to cover assumed risks
• Decent and fair profit sharing among the pension savers
• Decent and fair profit sharing between the pension provider and the pension savers
The Danish Pension System – Well recognized….
…..but still with a few challenges 4
Source: Mercer
ADEQUACY
SUSTAINABILITY
INTEGRITY
Melbourne Mercer Global pension Index 2017: Mercer is testing for:
The Danish pension system – building blocks
Interaction problem solved ? . 5
Source: DanAge, ATP & Borger.dk
1 DKK = 100 CLP
Pension Taxation – Handling the interaction problem with a XL “E”
6
Tax agreement February 2018:
• 108,2 % exemption* for saving done < 15 years before retirement
• 103,1% exemption* for saving done > 15 years before retirement
*) up to DKK 70.000/year
Saving Return Pension
EET Exempt Exempt Taxed
ETT Exempt Taxed Taxed
Source: OECD
15,3%
0%
10%
20%
30%
40%
50%
60%
1980 1990 2000 2010 2020
Pension Assets Return Tax Rate
Bonds
Equities
Danish Pension – ETT - Taxation of investment return
7
• Return taxation of 15,3%• A relatively flat marginal tax curve
Is pension saving still attractive?
15,3% return tax is still attractive compared to taxation of non-pension savings:- Equities 17/27/42% - Bonds 28-42 ….
…..and 15,3% is low compared to history
0%
20%
40%
60%
0 100 200 300 400 500 600 700Income DKK 1.000
Effective Marginal Income Tax Rate (%)
Source: SKAT and own calculations (Marginal tax cur is calculated as per December 2018. New Smaller adjustments is coming during 2018. The calculation is done for a person with labour income only (No interest rate income an no social benefit income)
Source: SKAT
1 DKK = 100 CLP
Danes are getting older
8
Women
Men
68
70
72
74
76
78
80
82
84
1960 1970 1980 1990 2000 2010 2020
Denmark - life expectancy*
1
2
3
4
1980 1990 2000 2010 2020 2030 2040 2050 2060
Dependency ratio (inverse)Age 20-64 / Age 65 or older
1980-2018
Forecast
Heading towards 2 providers per 1 dependent => action required
Source: Statistics Denmark Source: Statistics Denmark*) Historical
Pension saving needed to be increased
More saving and later retirement . 9
Late 80’ties and early 90´ties mutual agreement between…
- Politicians - Employers’ organizations- Trade unions
…..to gradually implement more pension saving for more people
Typical contribution for blue collar and white collar workers
Privileged groups and civil servants
0
2
4
6
8
10
12
14
16
18
1990 2000 2010 2020
% o
f Sa
lary
Contributions to occupational DC(examples)
DB for few
DC for few
DC for many
Evolution:
Source: PD & own estimates
60
62
64
66
68
70
2010 2020 2030 2040
Retirement agesState pension & Early ret. support
Retiremet
Early retirement
Working longer…….
….and more to come 10
62
63
64
65
66
2000 2004 2008 2012 2016 2020
Labour market - actual exit age (average)
Source: DSA and borger.dkSource: F&P and Statistics Denmark
Denmark – much more sustainable now
11
0%
50%
100%
150%
200%
1984 1988 1992 1996 2000 2004 2008 2012 2016
Denmark - Pension Assets / GDP
ATP Banks Life & Pension
Pension Assets / GDP
12
0 50 100 150 200
GreeceLuxembourg
HungaryTurkeyAustria
GermanyBelgiumSloveniaCzech…Poland
ItalyFranceNorway
PortugalSlovak…LatviaSpain
EstoniaMexico
New…KoreaJapan
IrelandOECD
IsraelFinland
ChileSwedenUnited…
AustraliaUnited…
SwitzerlandIcelandCanada
NetherlandsDenmark
Pension assets /GDP (%)
Source: OECD
Consolidation – 15 largest pension providers are holding 96% of assets
13
0
20
40
60
80
100
120
140
160
1999 2005 2011 2017
Number of pension providers*
Source F&P and FSA*) Legal entities. Banks, ATP & LD not included
Largest pension providers:
1 BDKK = 100 BCLP
Consolidation = cost efficient pension products, and……
14
750
800
850
900
950
1.000
1.050
2003 2006 2009 2012 2015
DKK.Annual administration cost per.
pension saver
Non-commercial
0,11
Commercial
0,33
0,0
0,1
0,2
0,3
0,4
0,5
0,6
0,7
0,8
0,9
2003 2005 2007 2009 2011 2013 2015 2017
% Adm. costs* / pension liabilities
*) investment costs not included
Source: Pension providers’ reporting to Danish FSA Source: Pension providers’ reporting to Danish FSA
Consolidation gives better scale to run high level expert organizations
…much to do! 15
“Yes,- US dollar will go up and we are solvent => we can actually pay out pensions!”
Solvency II ?, UFR ? and volatility
adjustment ?
Risk Management, Risk Assesment, Due Diligence, Portfolio Optimization, Actuarial Assumptions, Benchmarking, Vega, Curve Risk, Enchanchedindexing, Ultimate Forward Rate (UFR) , Volatility Adjustment ……
“Well he certainly does a very thorough risk analysis”
Source: Cartoon Stock + own text modification
The history of Danish life assurance & pension fund regulation
16
1904:First life-assurance Act:•Appointed actuary•Adequate and reason-
able technical basis• Investment rules
19351904 1981
1935:First pension fund act:•Separation from sponsor•Full funding/coverage of
pension commitments
1981:Multi employer occupational pension funds regulated as life assurance:•Same product, same protection•Subject to life-assurance directives and
solvency requirement
2000-15:•Market valuation of assets and liabilities• Traffic light• Flexible limits for equity exposure•Risk-based capital requirements• Life expectancy benchmark
2016:Solvency II
2000-15 2016
First private life-assurance undertakings established in 1870’ties
Market Valuation of both Assets and Liabilities
The perfect hedge is harder to get… 17
Assets
Interest rates down
Liabilities
120
Interest rates Unchanged
Assets Liabilities
OF=15
100 Provi-sions = 85
Interest rates up
Assets Liabilities
80Provi-sions = 105
Provi-sions = 65
OF=15OF=15OF=15
Pension Provision = NPV of future guaranteed pensions => i up = Provisions downAssets = Market value of investment portfolio (bonds) => i up = Assets down
The perfect hedge:
Living longer + interest rates down & below guaranty level…..
……makes guaranteed pensions products hard to handle 18
Sources: Statistics Denmark & Danish FSA
71
73
75
77
79
87 90 93 96 99 02 05 08 11 14 17
Age
Life Expectancy - Men
0%
2%
4%
6%
8%
10%
12%
87 90 93 96 99 02 05 08 11 14 17
10Y bond yield
0
2
4
6
8
10
12
14
16
87 90 93 96 99 02 05 08 11 14 17
DK
K
NPV of paying DKK 1 from age 65 to death
Guarantees are disappearing
19
0%
10%
20%
30%
40%
50%
60%
70%
80%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Development in market-linked products*
Market Linked - % of premiums
Market Linked - % of pension liabilities
Source: Danish FSA*) ATP & LD not included
More risk taking in unguaranteed pension products
20
Source: Jeff Parker + own text
More risk taking in unguaranteed pension products (2) – Asset allocation
21
Source: Danish FSA
More risk taking in unguaranteed pension products (3) - Alternatives
22
6%
8%
10%
12%
14%
Q4 2012 Q4 2013 Q4 2014 Q4 2015 Q4 2016
Alternative investments (ex real estate)% of Pension Assets
All Guaranteed UnguaranteedSource: Danish FSA based on reporting from pension providers
Evolution goes on…..
Pension when guarantees disappear ? 23
DB
For few
DC
Guaranteed
For few
DC
Guaranteed
For many
DC
Unguaranteed
For many
SII “Prudent Person Principle” - Goodbye to quantitative investment limits
Important that the pension saver understand the risk in the pension product!24
The Prudent Person Principle contains among other
things:
• The interests of the policy holders is first priority
• Investment can be done only in products where
the undertaking can perform proper risk
measurement and risk management
• Assets must be invested in such a manner that
security, quality, liquidity and profitability can be
assured
• The pension provider has to consider the link
between investment assets and the expected
pensions
Pension - Life cycle products
Each pension provider has its own product style and own risk definition 25
Age
Ris
k
Retirement
High
Medium
Low
Life cycle products – not easy to compare for the pension savers
Risk information must be improvet! 26
Source: Danish FSA based on Pension providers’ risk calculations reported to Danish FSA
Difference in risk for a 40-years-old pension saver across pension providers
40
Ongoing work: Harmonized risk declaration
Understandable information keeps up motivation for saving!27
Should be:• Linked to investment portfolio• Based on same methodology for all
pension providers• Based on advanced forward looking risk
models
…..but at the same time be communicated to and understood by all
High Risk
Medium Risk
Low Risk
Ongoing work: Pension forecasts linked to investment risk
From “one point” to pay-out profiles with uncertainty 28
Saving Consuming
DK
K Expected pension payout profile
Bad scenario
Good scenario
Takeaways
• Creating a sustainable pension system takes time and is best supported by unity among and support from all stakeholders
• Pension saving can be mandatory or voluntary. For voluntary savings systems you need to keep up pension saving motivation for the individual pension saver by ensuring that:
Tax incentives are consistent and easy to understand
Pension saving systems and risk are understandable for the savers
• Competition is nice, but scale is necessary to run cost efficient and professional pension providers
• For DB and DC-Guaranteed regulation Solvency II limits the risk taking (in Denmark) but lower risk also implies lower expected return
• DC-Unguaranteed gives wider investment opportunities and higher expected return, but also requires much better information to the pension saver
Diclaimer: All content and views in this presentation represent the speaker and not the Danish FSA
29
