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Denmark unveils measures to help pension funds cope with low yields

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DENMARK - The Danish government and pensions industry has agreed a package of measures to help pension funds cope with low bond yields, including changes to the long end of the discount yield curve and restrictions on bonuses and dividends.

Peter Damgaard Jensen, chairman of pensions industry body Forsikring & Pension (F&P), said: "The cost of the change is zero, both for the state and for others.

"It is not a rescue package but a change of the methodology that fails to function under the current exceptional market conditions."

The agreement was reached after several days of talks between F&P, the ministry of business and growth and the regulator Finanstilsynet.

Damgaard Jensen described the pact as "solid".

"It will give us the ability to deliver the highest possible pensions to our customers and at the same time to contribute to the country's growth agenda," he said.

Minister for business and growth Ole Sohn said the solution was sustainable and balanced.

"It is key that insurance companies and pension funds have the ability to provide the pensioners of the future the highest returns," he said.

"The regulatory environment should not force companies into short-term investment decisions due to exceptional market conditions."

Yields on 10-year Danish government bonds fell to historic lows of around 1% at the end of May, as demand for the country's sovereign debt swelled on global market jitters.

Since many pensions in Denmark carry a guaranteed nominal interest rate, current market conditions combined with regulation on provisions risked forcing pension funds to invest with a short-term perspective, the ministry said.

Under the agreement, the long end of the discount yield curve will be raised to a level equivalent to normal market conditions and in line with generally agreed long-term projections for growth and inflation, it said.

"This avoids insurance companies and pensions funds locking in customers' future returns at the current historical low level interest rates," the ministry said.

The discount yield curve is only being changed for maturities of more than 20 years.

These will be extrapolated using an 'Ultimate Forward Rate' (UFR) of 4.2%, based on long-term growth and inflation expectations.

The introduction of this UFR is in line with the EU Commission's current proposal for Solvency II, the parties said.

"This change in the discount rate curve in an important step towards the future EU regulation of insurance companies (Solvency II)," it said.

Other measures listed in the agreement are the avoidance of cross-generational redistribution, reduced use of nominal guarantees, increased consolidation and an evaluation of F&P's transparency initiatives.

The measures to increase consolidation include a ban on dividend distribution to pension company owners unless there is a significant excess of capital, and a 2% cap on account dividends.

The parties stressed that pension providers did have enough capital at the moment to withstand a further decline in interest rates.

There was no immediate risk of the sector not being able to live up to their pension promises, they said.

"However," they added, "a continuing low interest level can force companies into short-term investment decisions at the expense of pension savers' long-term objectives."

Damgaard Jensen said that, as things stood, pension funds would have had to react as if bond yields would stay at their current low levels for as many as 60 years.

"We would be forced to invest too cautiously, and customers would be the losers," he said. "As well as this, our options for contributing to the creation of growth for the benefit of society would have been limited."

He said the change in the yield curve released reserves for the pension companies, but not money that could be spent here and now, either in the form of bonuses or as payouts to company owners.

"The money can only be used to create greater freedom to invest," he said.

The text of the agreement acknowledged that current regulation assumed firms were able to hedge their interest rate risk effectively on the financial markets.

But liquidity in the interest-rate hedging market had shrunk considerably, and it was now very difficult and expensive for companies to cover their interest-rate risk, the parties said.

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