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 Banks Mortgage lenders Life & Pension Danish FSA Capital Markets Non-life Insurance Investment funds Working for financial stability and confidence in financial undertakings and markets 2
Danish FSA - Supervising Life Assurance & Pension Funds 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 3
The Danish Pension System Well recognized. Melbourne Mercer Global pension Index 2017: Mercer is testing for: ADEQUACY SUSTAINABILITY INTEGRITY Source: Mercer..but still with a few challenges 4
The Danish pension system building blocks Source: DanAge, ATP & Borger.dk 1 DKK = 100 CLP Interaction problem solved?. 5
Pension Taxation Handling the interaction problem with a XL E Saving Return Pension EET Exempt Exempt Taxed ETT Exempt Taxed Taxed Tax agreement February 2018: 108,2 % exemption* for saving done < 15 years before retirement 103,1% exemption* for saving done > 15 years before retirement Source: OECD *) up to DKK 70.000/year 6
Danish Pension ETT - Taxation of investment return 60% Pension Assets Return Tax Rate 50% 40% 30% 20% 10% 0% 1980 1990 2000 2010 2020 Source: SKAT 60% 40% Bonds Equities 15,3% Effective Marginal Income Tax Rate (%) 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 20% 0% 0 100 200 300 400 500 600 700 Income DKK 1.000 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) 1 DKK = 100 CLP 7
Danes are getting older 84 Denmark - life expectancy* Women Dependency ratio (inverse) Age 20-64 / Age 65 or older 82 4 80 78 76 Men 3 1980-2018 Forecast 74 72 2 70 68 1960 1970 1980 1990 2000 2010 2020 Source: Statistics Denmark *) Historical 1 1980 1990 2000 2010 2020 2030 2040 2050 2060 Source: Statistics Denmark Heading towards 2 providers per 1 dependent => action required 8
% of Salary Pension saving needed to be increased 18 Contributions to occupational DC (examples) Late 80 ties and early 90 ties mutual agreement between 16 14 12 10 8 Privileged groups and civil servants Typical contribution for blue collar and white collar workers - Politicians - Employers organizations - Trade unions..to gradually implement more pension saving for more people 6 4 Evolution: 2 0 1990 2000 2010 2020 Source: PD & own estimates DB for few DC for few DC for many More saving and later retirement. 9
Working longer. 66 65 Labour market - actual exit age (average) 70 68 Retirement ages State pension & Early ret. support Retiremet 64 63 66 64 62 Early retirement 62 2000 2004 2008 2012 2016 2020 Source: F&P and Statistics Denmark 60 2010 2020 2030 2040 Source: DSA and borger.dk.and more to come 10
Denmark much more sustainable now 200% Denmark - Pension Assets / GDP 150% 100% 50% 0% 1984 1988 1992 1996 2000 2004 2008 2012 2016 ATP Banks Life & Pension 11
Pension Assets / GDP Denmark Netherlands Canada Iceland Switzerland United Australia United Sweden Chile Finland Israel OECD Ireland Japan Korea New Mexico Estonia Spain Latvia Slovak Portugal Norway France Italy Poland Czech Slovenia Belgium Germany Austria Turkey Hungary Luxembourg Greece Pension assets /GDP (%) 0 50 100 150 200 Source: OECD 12
Consolidation 15 largest pension providers are holding 96% of assets 160 140 120 100 80 60 40 20 Number of pension providers* Largest pension providers: 0 1999 2005 2011 2017 *) Legal entities. Banks, ATP & LD not included Source F&P and FSA 1 BDKK = 100 BCLP 13
Consolidation = cost efficient pension products, and % Adm. costs* / pension liabilities 0,9 0,8 0,7 Commercial 0,6 0,5 0,4 0,3 Non-commercial 0,33 0,2 0,1 0,11 0,0 2003 2005 2007 2009 2011 2013 2015 2017 DKK. 1.050 1.000 950 900 850 800 750 Annual administration cost per. pension saver 2003 2006 2009 2012 2015 Source: Pension providers reporting to Danish FSA Source: Pension providers reporting to Danish FSA *) investment costs not included 14
Consolidation gives better scale to run high level expert organizations Risk Management, Risk Assesment, Due Diligence, Portfolio Optimization, Actuarial Assumptions, Benchmarking, Vega, Curve Risk, Enchanched indexing, Ultimate Forward Rate (UFR), Volatility Adjustment Solvency II?, UFR? and volatility adjustment? Well he certainly does a very thorough risk analysis Yes,- US dollar will go up and we are solvent => we can actually pay out pensions! Source: Cartoon Stock + own text modification much to do! 15
The history of Danish life assurance & pension fund regulation 1904: First life-assurance Act: Appointed actuary Adequate and reasonable technical basis Investment rules 1935: First pension fund act: Separation from sponsor Full funding/coverage of pension commitments 2000-15: Market valuation of assets and liabilities Traffic light Flexible limits for equity exposure Risk-based capital requirements Life expectancy benchmark 1904 1935 1981 2000-15 2016 First private lifeassurance undertakings established in 1870 ties 1981: Multi employer occupational pension funds regulated as life assurance: Same product, same protection Subject to life-assurance directives and solvency requirement 2016: Solvency II 16
Market Valuation of both Assets and Liabilities Pension Provision = NPV of future guaranteed pensions => i up = Provisions down Assets = Market value of investment portfolio (bonds) => i up = Assets down The perfect hedge: Interest rates Unchanged Interest rates down Assets Liabilities Interest rates up Assets Liabilities Assets Liabilities 100 Provisions = 85 120 Provisions = 105 80 Provisions = 65 OF=15 OF=15 OF=15 The perfect hedge is harder to get 17
DKK Age Living longer + interest rates down & below guaranty level.. 79 Life Expectancy - Men 16 NPV of paying DKK 1 from age 65 to death 77 75 14 73 12 71 87 90 93 96 99 02 05 08 11 14 17 10 12% 10% 8% 6% 4% 2% 0% 10Y bond yield 87 90 93 96 99 02 05 08 11 14 17 Sources: Statistics Denmark & Danish FSA 8 6 4 2 0 87 90 93 96 99 02 05 08 11 14 17 makes guaranteed pensions products hard to handle 18
Guarantees are disappearing 80% 70% 60% 50% Development in market-linked products* Market Linked - % of premiums Market Linked - % of pension liabilities 40% 30% 20% 10% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Danish FSA *) ATP & LD not included 19
More risk taking in unguaranteed pension products Source: Jeff Parker + own text 20
More risk taking in unguaranteed pension products (2) Asset allocation Source: Danish FSA 21
More risk taking in unguaranteed pension products (3) - Alternatives 14% Alternative investments (ex real estate) % of Pension Assets 12% 10% 8% 6% Q4 2012 Q4 2013 Q4 2014 Q4 2015 Q4 2016 All Guaranteed Unguaranteed Source: Danish FSA based on reporting from pension providers 22
Evolution goes on.. DB DC DC DC Guaranteed Guaranteed Unguaranteed For few For few For many For many Pension when guarantees disappear? 23
SII Prudent Person Principle - Goodbye to quantitative investment limits 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 Important that the pension saver understand the risk in the pension product! 24
Risk Pension - Life cycle products Retirement High Medium Low Age Each pension provider has its own product style and own risk definition 25
Life cycle products not easy to compare for the pension savers Difference in risk for a 40-years-old pension saver across pension providers 40 Source: Danish FSA based on Pension providers risk calculations reported to Danish FSA Risk information must be improvet! 26
Ongoing work: Harmonized risk declaration High Risk Medium Risk 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 Low Risk Understandable information keeps up motivation for saving! 27
DKK Ongoing work: Pension forecasts linked to investment risk Good scenario Expected pension payout profile Bad scenario Saving Consuming From one point to pay-out profiles with uncertainty 28
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
Thank you! hsh@ftnet.dk Ph: +45 41 93 35 45 www.linkedin.com/in/henningskovmosehansen