The most comprehensive example of the Danish contributory pension system at work is PKA, Denmark’s largest administration company for occupational pension funds.
PKA manages eight pension occupational pension funds with 173,600 members mainly employees in the public, social and health sectors. Of these 16,500 are pensioners
The pension scheme is mandatory, and is part of a benefits package negotiated in collective agreements between employers and unions. These agreements fix the contributions as a percentage of income. PKA fund contributions range from 12 to 17%. A typical contribution for a full time worker within the scheme would be a DKr2,500 a month (E337).
As with most occupational systems in Denmark, PKA pension and other benefits are guaranteed on the basis of the contributions paid. PKA is therefore similar to an insurance company and is subject to EU life directives and national insurance legislation. However, it differs from an insurance company because it is owned by members rather than shareholders.
Since pension benefits are not income-related but determined by contribution, they can be transferred when an employee changes jobs. The new employer simply pays the agreed contribution to the pension fund based on the new salary.
About 5% of the contribution is set aside to cover the administration fee. A further 20% goes to cover risks for all the benefits. The remaining 75% is paid into an account, which is then invested. However, there is usually a payback or rebate from the risk coverage and administration fee. This year, for example, the actual administration fee is between 2% and 3.25%.
The funds’ investment returns are taxed at a flat rate of 15% pa, including unrealised capital gains. They also have to pay a guaranteed interest of between 2.75% and 4.25%, depending on when employees joined the pension plan. This rate is a maximum rate defined by the Danish supervisory authority, and it is applied to both what employees have contributed and are expected to contribute. Some 80% of PKA members have the bulk their pensions guaranteed at the rate of 4.25%.
The progressive lowering of the guaranteed interest reflects the fall in bond prices. Under the EU Third Life Directive insurers in member countries cannot guarantee more than 60% of the interest of the country’s leading bond.
The PKA funds’ membership is heavily skewed towards women and part-time workers. Most 92% of its members are women with a life expectancy of 18 to 20 years after retirement.
The system of wage related contributions means that if employees become part time worker later in their working lives, their pensions are buoyed up by the fulltime contributions they have already made. Conversely if their salary increases substantially towards the end of their employment, their pension benefits will not increase proportionately, because of lower contributions made earlier on.
Although responsibility for the investment ultimately rests with the boards of the eight funds, they have an administration agreement with PKA, which manages the investments as well as all parts of the adminstration services.
Foreign equities are managed externally, with mandates for equities in the US, UK and continental Europe, as well Japan and East Asia. Danish and Nordic equities are managed internally. Real estate management is outsourced to a Danish company, which is 80% owned by PKA.
The strategy behind the investment in foreign equities has been that if one market falls another will not. However, all international markets have suffered from the current fall in equity prices. The Danish market is also small and pension funds need to diversify their risk.
Although generally, PKA is well funded, there are considerable differences in the level of the reserves of the eight funds. The oldest fund, the Pensionskassen for Ergoterapeuter og Fysiterapeuter, a fund for physiotherapists and occupational therapists, has built up large reserves, with contributions of 15% since 1954. The pension fund for social workers, the Pensionskassen for Socialrådgivere og Socialpædagoger, which started in 1976, is still building its reserves.
The risk profiles and investment strategies of the funds differ according to the size. A small scheme like the Pensionskassen for Jordemødre, for midwives, will be more risk averse than the largest fund, the Pensionskassen for Sygeplejersker, the pension fund for nurses.
Asset allocations reflect this. The smaller funds invest less in equities and more in bonds. However, the combination of falling equity values and falling interest rates has put risk reduction at the top of the agenda for all.
Last year PKA became the first fund in Denmark to use CMS (Constant Maturity Swaps) floors for risk reduction, paying DKr 900m to cover DKr40bn.