Danish Insurance Association
File no. 126.96.36.199-001
Our ref. ASE/hl
A. Danish Pension System
The Danish pension system is very much in line with the general agreed recommendations from the OECD, The World Bank and other institutions. The Danish pension system consists of three pillars. The first pillar provides a universal minimum cover aimed at eliminating pov-erty. The second pillar consists of a variety of obligatory labour market related pension schemes aimed at providing reasonable replacement ratios compared to the wage income be-fore retirement. The third pillar consists of numerous voluntary and individual pension schemes for those who wish to have a higher income as retired than the first two pillars pro-vide.
The first pillar
The 1st pillar consists of the "Folkepension" which is governed by law and administered by the state. The scheme is financed on a pay-as-you-go basis out of general tax revenues. No earmarked contributions are paid to the financing of the scheme.
A person is eligible to the flat-rate social pension when he or she reaches the age of 67 (will be lowered to 65 from the 1st of July 2004) and the person is a Danish citizen and has perma-nent residence in Denmark.
Part of the social pension is dependent on contemporary income from for instance occupa-tional and private pensions.
ATP - The Danish Labour Market Supplementary Pension
In addition to the "Folkepension" the compulsory statutory Danish Labour Market Supple-mentary Pension (ATP) exists. It is managed by a separate fund set up for that purpose. Rep-resentatives from the unions and the employer's federation manage the fund. The scheme is a funded insurance scheme.
The ATP consists of two different schemes. In the oldest scheme established in 1964 all em-ployees between the age of 16 and 67 (age 65 from 2004) who work at least 10 hours pay con-tributions to the scheme. With effect from 1 January 1998 coverage under the ATP scheme has been extended to include a number of persons not presently employed. In these cases the state pays part of the contribution. The size of the contribution is dependent on the weekly hours worked by the employee, but not on the size of the salary. The contribution is partly paid by the employer and partly by the employee.
The pension is at the earliest paid out when the pensioner reaches the age of 67 (age 65 from 2004). It is estimated that close to 99 per cent of the future pensioners will receive some kind
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of benefit from the ATP. The ATP is a modest source of old-age provision as the contributions are relatively small.
In the new scheme established in 1998 all employees, self-employed, recipients of unem-ployment benefit and social cash benefits are charged 1 per cent of their income to the ATP.
Contributions to the ATP are tax deductible. Pension benefits from the ATP are subject to ordinary income tax.
An early retirement scheme exists in the first pillar, which pays out a pension to persons who leave the labour market between the age of 60 - 65 - without being disabled. Disabled persons are entitled to a special disablement pension independent of age. As the early retirement scheme has been increasingly popular and costly the rules for eligibility has recently been tightened and the benefit increased for persons postponing retirement to the age of 62.
The 2nd pillar
The private occupational pension schemes in Denmark are based on either collective labour market agreements or agreements in the individual companies. The pension scheme can be administered by either insurance companies, industry-wide pension funds or company pension funds. Industry-wide pension fund schemes cover well-defined categories of professionals. Schemes in insurance companies are either for special sectors or company schemes. All pension promises have to be funded no matter what body of administration is chosen.
The major part of the Danish schemes is defined contribution schemes. The size of the contribution is typically fixed as a percentage of the salary. The employee typi-cally pays one third of the total contribution and the employer two thirds.
Since the end of the 1980'ies obligatory occupational pension schemes have been introduced to other groups on the labour market than the high-income earners. That is a large group of professionals employed in the state and the municipal administra-tions and in the private sector. Now app. 80 per cent of the work force is comprised by an obligatory occupational pension.
Contributions and benefits
The contributions in the schemes agreed upon in the eighties and nineties were quite small. The contributions have been raised regularly as part of the collective bargain-ing on the labour market and with the latest renewal of the collective agreements most schemes will raise the contributions to 9 per cent during the next 4 years.
In the older schemes primarily designed for employees in the higher income brackets the contribution is usually 12-15 per cent of the employee's salary.
The size of the benefits from occupational pension schemes varies considerably, de-pending on the contributions paid. Most schemes, when combined with state pension,
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aim at providing 60 to 70 pct. of final income. In addition, most schemes also provide a lump-sum payment at retirement.
Contributions to pension schemes are normally tax deductible. For contributions to lump-sum schemes a maximum deductible contribution exists. Annuity payments are taxed as personal income (up to 60 per cent) and lump sum payments are taxed at 40 pct. The tax treatment of occupational pension and private individual pensions are the same.
From 1983 to 1999 the return on certain assets in pension schemes were subject to a real interest rate tax. The tax rate was fixed every year on the basis of the level of return and the rate of inflation in order to limit the real return on pension savings to 3.5 per cent.
From the year 2000 the real interest tax has been replaced by an investment return tax with a fixed tax rate of 26 per cent to be levied on the return on most assets owned by pension institutions, except shares. Shares are taxed by a special share tax of 5 per cent.
The 3rd pillar
Pension schemes in the 3rd pillar can be taken out with insurance companies or banks. In the 3rd pillar especially lump-sum schemes are popular where second pillar schemes mainly are based on annuities.
B. Pension Funds: legal framwork and regulatory develop-ments
The industry-wide pension funds in Denmark are subject to the insurance directives issued by the European Union. The insurance directives are implemented into Danish law, the most im-portant one being The Insurance business Act. The legal framework and supervisory regula-tion, therefore, are identical for pension funds and insurance companies. Company pension funds, which only play a marginal role on the Danish market, are not subject to the insurance directives, but the Danish law regulating these pension funds is very similar to the regulation of industry-wide pension funds and life insurance companies.
The Danish Financial Supervisory Authority is responsible for public supervision of insurance and pension fund business in Denmark. The Supervisory Authority is funded by a levy on insurance companies domiciled in Denmark and on branch offices of companies from non-EU countries. Violation of the legislation on supervision is punishable with a fine.
Authorisation and capital adequacy
Under current EU directives, insurance undertakings and pension funds are required to obtain an authorisation from the Financial Supervisory Authority. An application for an authorisation
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must be accompanied by various documents, including a memorandum of association and a business plan.
If an authorisation to write life and pension insurance is applied for, the technical basis for insurance needs to be reported to the Supervisory Authority. The Authority may refuse to ap-prove the technical basis.
A capital adequacy ratio is computed on the basis of the application and the business plan, setting the minimum requirement for the size of the company’s or funds capital. The com-
pany’s capital adequacy ratio will be computed every year. If the capital base is inadequate, various remedies are available to the Supervisory Authority, including the possibility of with-drawing an authorisation.
Life and pension insurance companies and industry-wide pension funds are required to em-ploy an actuary approved by the Financial Supervisory Authority. From 1 July 1995 large companies/funds have been under an obligation to introduce internal auditors who are directly accountable to the board.
The board of directors of an insurance company/pension fund is obliged to prepare written guidelines for the core activities of the company/fund, specifying the division of work be-tween the board and the executive committee.
Activities and investment regulations
Danish insurance companies and pension funds are required to invest their assets with a view to achieving the highest possible return, but with due regard to the safety of these investments. Under existing law insurance companies/pension funds are not permitted, either alone or jointly, to have a controlling interest in enterprises other than insurance companies. They may, however, engage in the following activities:
; Related activities, such as loss prevention, the production and sale of statistics, prop-
erty valuation, risk assessment and financing in which insurance is a significant ele-
; Finance companies, which may transact other business provided that two insurance
companies are owners of the finance company
; Long-term investment in real property
; Banking, mortgage credit, stockbroking and investment fund activities, provided that
such activities are conducted in a subsidiary company which is subject to supervision
by the Financial Supervisory Authority
; Agency activities on behalf of insurance companies or other businesses supervised by
the Financial Supervisory Authority
; Estate agency services provided by a subsidiary.
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In addition, the following investment regulations have been in force since 1 July 1994, based on the relevant provisions of the third life insurance directive:
Assets held by insurance companies and pension funds to meet commitments to customers are rated as gilt-edged (typically mortgage bonds and properties) and non-gilt assets (typically shares). A maximum of 50 per cent of the technical provisions may be invested in non-gilt assets. Life insurance subsidiaries and investment subsidiaries are subject to a consolidation rule, meaning that the assets of the subsidiaries are treated as the assets of the parent company. The same applies to pension funds. Investments in unlisted shares are restricted to a combined 10 per cent of technical provisions. A general rule limits individual exposure for life insurance and pension funds to 3 per cent of total technical provisions. An exception exists for single investments in properties. The investment must not exceed 5 per cent of technical provisions. An exception allows investment of up to 40 per cent of technical provisions in mortgage bonds issued by a single mortgage credit institution.
These investment regulations must be observed at the time of investment. If the limits are ex-ceeded on account of rising prices, mergers or acquisitions, the investment will not need to be reduced.
Annual report and accounts
Annual accounts and an annual report must be prepared each year. The accounts must include a balance sheet, a profit and loss account, notes to the accounts and a five-year summary. The annual accounts must give a true and fair view of the company’s or fund’s assets and liabili-
ties, its financial position and the results of operations.
In the accounts of life and pension insurance companies and pension funds, fixed-rate loans and securities are entered at cost with the addition of the increase in value arising from the shorter remaining time to maturity at constant yield (mathematical revaluation). Other listed securities are entered at market value.
Participating interests in subsidiaries are recorded at equity value according to the latest an-nual accounts of the subsidiary. Land and buildings are entered at market value. The com-pany/fund may choose, however, to enter land and buildings at cost.
The accounts of life insurers and pension funds do not distinguish between the underwriting profit on insurance operations and the return on investing activities. The underwriting profit thus includes investment income but not the share of this income that can be ascribed to the return on equity. The net profit for the year – after deductions as required by law and company
articles, including a transfer to the contingency reserve fund – may be paid as dividend to
shareholders/guarantors/members.The annual accounts of life insurance companies and pen-sion funds must disclose key figures and ratios related to the company’s return on investment,
costs, risks and consolidation. The purpose of this duty of disclosure is to offer transparency and information about the company’s situation overall.
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C. Pension Funds: Statistical situation
Investment of pension fund assets at end-1998 (DKKbn)
Life insur-Indurstry-Company pen-Banks ATP LD* Total
ance com-wide pen-sionfunds
panies sion funds
6.0 9.9 1.8 4.0 1.0 22.7 Land and
55.2 11.7 0.5 2.7 0.1 70.2 Subsidiaries
123.8 62.5 8.0 71.8 19.0 285.1 Participating
290.4 113.9 25.8 114.7 27.2 572.0 Bonds
2.3 0.8 0.0 - 0.1 3.2 Loans, se-
33.5 13.8 2.1 6.5 1.4 58.3 Other assets
511.2 213.6 38.2 190.7 199.7 48.8 1,202.2 Total assets
* A closed public fund with no contributions since 1978.
The total amount of pension assets (second and third pillar) approximately equals the Danish GNP.
In 1997 a total 1,652,000 persons had 3,572,500 pension accounts in the second pillar and 1,160,000 person had 1,701,000 pension accounts the third pillar. The Danish population is a little above 5 million people.
D. Main concerns and activities of the Association Forsikring & Pension - The Danish Insurance Association - is the trade association of pension funds and insurance companies (both life and non-life) in Denmark. The Association in its present form was established in 1997 by a merger of the Danish Insurance Association and the Danish Federation of labour Market Pension Schemes. This merger took place in recognition of the fact that the identical regulation and supervision of the pension funds and insurance companies made it efficient to join forces.
As a trade association Forsikring & Pension is safeguarding the common interest of the insur-ance companies and pension funds in relation to the government and other authorities. Fur-thermore, the association has an important objective of informing its members of all relevant legislation and political interests in the business performed by the industry.
As in other developed countries all over the world a major concern the last decade has been the demographic development and the suitability of the pension system to handle the chal-lenges. It is the opinion of the Association that the main structures in the Danish system are in place and, hence, the association has concentrated on securing that amended tax regulation and other governmental initiatives do not threaten the positive development of pension saving.
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The political focus in relation to the pension industry has the last few years been concentrated on equal treatment of men and women and the question of individual member influence on investment strategies pursued by the companies and funds. Furthermore, the political pressure for further disclosure of member relevant information should be mentioned. As the total re-tirement benefit is the result of payments from quite a few different schemes it can be difficult for the individual to survey how the economic situation will be as retired. This makes it diffi-cult for the individual to decide whether to increase or decrease savings to optimise consump-tion over lifetime.
E Pension Funds: Future reforms and outlooks.
As mentioned earlier the main structures in the Danish pension system are in place and no fundamental reforms are therefore expected or announced. It is the clear perception of the As-sociation that the growth in pension savings will continue for the years to come, though, the growth rate may decrease as a consequence of a approaching the saturation of the market. There are, though, indications that the members of the schemes want to broaden the services supplied by pension funds and insurance companies especially in the second pillar.
It is very likely that any major changes to the Danish system will be the result of new direc-tives from the European Commission. The announced directive on Pension Funds is antici-pated to have marginal effect on Danish relations, as the pension funds are already subject to European directives and therefore - as the situation is now - seems to be excluded from the new directive.