DENMARK - ATP, Denmark's largest pension fund, is hoping to gain approval from the Danish parliament next month to launch an "innovative" new defined contribution pension product which has a level of guaranteed return on contributions at no extra cost, but also generates higher potential investment returns.
Lars Rohde, chief executive of ATP, told IPE the Danish parliament is expected to clear the way this spring for a "life-long guaranteed pension product" which is priced mark-to-market but hedges interest rate risk and the associated potential lower returns on contributions by applying swaps overlay to a set amount of the investment.
"We are attempting to answer the call for pensions product innovation. Our product looks like a defined benefit pension, but through this the employer has put the contribution in and is then off the hook. It has been put forward in parliament and we have had good support so we hope it will come into law before March 1," said Rohde.
More specifically, the collective DC product has been designed to carry conditional indexation similar to that seen in the Netherlands but with built-in longevity adjustment.
The design provides a guarantee by using 80% of the contribution to buy a life-long annuity, using the swap interest curve to price the annuity. The interest rate risk attached to the pension liability is hedged away by a swap overlay and the annuity is priced according to a "best estimate" on longevity.
The use of a swap overlay means there is no use of liquidity on hedging so the pension fund is able to invest in a broad range of assets only restricted by the overall risk considerations. Then 20% of the total contribution is a "bonus contribution" which serves as a risk capital element. The total return of the fund, less cost of the variable leg of the swap contracts, is gradually used to raise the pensions, so indexation is therefore conditional, said Rohde.
"We always have the reserves in excess of 20% of the pension. We have to have a dynamic asset allocation and risk rules so there is a one-to-one connection to the reserves and the risks to the portfolio. The higher the reserves, the higher the risk capacity. If overall risk reduces, we match the reserves to it, and vice versa," he said.
Rohde said there will be additional cost to members for the guarantee - the average total cost of administration and internal investment management was less than €8 per individual in 2007 - as it will be equal to the costs of a traditional with-profits deferred annuity.
Instead, there is no additional cost to the guarantee element because Monte Carlo simulations indicate the improved risk management framework will generate a higher potential return along with the possibility of "riding the positive slope of the interest yield curve", according to Rohde.
ATP hopes this idea would go some way towards tackling the gap between generating returns through riskier assets for defined contribution pensions and ensuring members' assets are not at huge risk over the period of investment.
The German Pensionskassen market, for example, has struggled to provide higher than average returns on investments because providers are essentially required to "insure" assets and are therefore more likely to place them in fixed income investments.
Launch of the product follows recent calls from European Union officials for innovative pension products which can provide defined contribution members with some level of risk guarantee which protects a reasonable portion of their assets from investment risk and allows policyholders and employers to take higher risks with the assets and generate the returns needed to meet pensions income requirements. (See earlier IPE story: EC seeks pensions innovations, with guarantees)
ATP is a key player in the Danish pension arena because it is charged in part with distributing Pillar 1, or State, pensions income and has been a mandatory Danish labour market pension funds since 1964. ATP today has €65bn in assets under management and 4.3 million members.
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