On December 12, 2002 the financial authorities in Denmark issued a new regulation relating to certain pension calculations. This came into effect at the end of 2002 and could have a significant impact on defined benefit schemes (DB).
The regulation lays down two separate sets of rules, referred to as the ‘underwriting basis’ and the ‘evaluation basis’ respectively.
Underwriting basis
This basis governs the ways in which such things as contributions and individual pension transfers are calculated. The key principle is to be ‘conservative’ in deciding upon suitable actuarial assumptions. ‘Conservative’ is not, of course, defined. Further, the new rules give rise to two specific problems:
o Mortality rates used for retirees in G82 (the standard Danish mortality tables) are not currently regarded as conservative;
o The rules restrict the maximum interest rate to 60% of after-tax yields on various government bonds – which translates into 2% currently. However, this rate must be adjusted down if pensions are linked to salaries or inflation – as low as 0.5% in some cases.
As a result, not only is it expected that changes in the underwriting basis will take place more frequently than before but the downward adjustments required are likely to add considerably to the costs of providing pensions.
Evaluation basis
This is the basis used for certain pension funding regulations. Unlike the ‘conservative’ requirement for the underwriting basis, assumptions under the evaluation basis must be adopted as a ‘best estimate’. For interest rates, the requirement is to use either the actual yield (after-tax) of the assets, or the discount factor published by the financial authorities.
‘Actual yield’ is not, however, a defined term and this immediately raises questions: is it the current yield, or the yield over the prior 12 months, or what? The ‘discount factor’ published by the financial authorities was 3.81% (after-tax) at the end of 2002.
Regardless of the above, the rate must be reduced to allow for benefits that are linked to salaries or inflation (similar to adjustments under the underwriting basis). When examining the ‘actual yield’, best estimates are to be used to make these allowances, subject to a minimum rate of 0.5%. For the discount factor, it is likely that the Authorities will sanction allowances of 2.5% for salary increases and 2% for inflation.
Finally, it should be noted that, for active pension plan participants, liabilities calculated under the evaluation basis must be no less than those calculated under the underwriting basis.
To add to the confusion, the laws of supervision of company pension funds are to be updated in spring 2003, and an attempt will soon be made to introduce the IAS 19 pension accounting standard.
Ole Block is secretary of the Association of
Company Pension Funds and senior partner of
S B Aktuar-Rådgivning in Copenhagen, part of the
Milliman Global network