Gearing up for Solvency II and winding down crisis measures are exercising Danish government and pensions groups, writes Nina Roerhbein

The mismatch between the market development of euro swap rates and mortgage bond rates in October 2008 threatened a wave of forced selling of mortgage bonds that would have devastated pension savers and home owners. This prospect prompted a stability agreement between the Danish government and the Danish Insurance Association, Forsikring og Pension, with regard to discount rates, solvency levels and interest rates that involved a temporary adjustment to the yield curve.

Under the stability agreement the discount rate is calculated on the basis of a euro swap yield curve adjusted in accordance with the Danish-German yield spread, plus a maturity-independent margin of 50% of the mortgage spread. The introduction of the mortgage bonds into the yield curve provided an incentive not to sell them off. It was also deemed positive for some pension companies because, despite having guaranteed rates of 4.5%, it allowed them to give savers a lower rate. Expectations were that the two curves would meet, which is what has happened since.

Other measures taken in the agreement included stronger consolidation terms by putting an upper limit on bonuses, and greater weight put on solvency requirements rather than ‘traffic light' scenarios.

Initially the stability agreement was set to end in 2009, but it was extended by a year in October 2009 because, although markets were stabilising, there was still a risk of volatile market conditions. It is now on course to be lifted at year-end 2010.

But it is the imminent introduction of Solvency II that appears to be the biggest issue occupying both the Danish regulator and the pensions industry at the moment. Danish legislation concerning insurance companies and lateral pension funds is gradually being adjusted to Solvency II. However, the basic principle of risk-based supervision was already present in Danish regulation. Its governance rules to a large extent already meet the requirements because the Danish supervisor is in charge of the working group, which made the drafts for the governance rules in Solvency II.

The rules concerning the Individual Solvency Assessment were revised in 2009 partly to better reflect the path towards the Own Risk and Solvency Assessment in Solvency II. They specify among other things that the responsibilities of the board and set up clear requirements to capital planning and contingency plans. Profit-sharing rules were revised in spring 2010. The new rules created a clear framework for fair profit sharing between equity capital and customers and between different customer groups.

Danish pension funds need to act on Solvency II because they are required to have a capital guarantee of up to 60-70% of the invested assets, which restricts the investment freedom of making an optimal portfolio in the pension companies. The administrative burden for pension companies in relation to corporate governance and management will also increase. As a result, Danish pension funds will have to lower their guaranteed interest rates, change them to declarations of intent or even consolidate with other pension companies.

As part of the preparations for Solvency II, a new Declaration of Contributions will come into force on 1 January 2011. It obliges pension companies to group their savers according to their risks, costs and guaranteed interest rates.

"The intention is to avoid savers in each of the groups substituting the other because some savers have a low guaranteed interest rate, while others have a high one," says Rikke Frandsen, head of the life and pension department at Kirstein Finans Consultancy. "The same applies to the risk of some savers."

Some pension companies have changed their guaranteed interest rate to a declaration of intent, such as Sampension, to which the financial supervisor, the Finanstilsynet, agreed.

In 2008, finance reform proposals - which were designed to stimulate the economy - included the introduction of an 8% special tax on individual pension plans worth above DKK284,000 (€38,118). But the initial proposals were modified before being introduced in 2010. The compensatory tax on big pension payouts applies now only to Danish tax-payers with a pension exceeding DKK362,800 (€47,700) a year. Those falling into that bracket will have to pay an excess tax of 6% starting from 2011. It will gradually be scaled down so that by 2015 the excess tax no longer applies.

The margins of taxes in Denmark were also lowered as part of the finance reform, meaning that now only the first DKK100,000 (€13,420) of pensions benefits paid out are tax deductible.

From 1 June 2009 until the end of that year Danish employees were allowed to withdraw money from their special pension (SP) savings accounts to stimulate consumer spending. Approximately 99.5% of the previous SP assets have been paid out, estimates the Finanstilsynet. In April 2010, the SP scheme was closed altogether, meaning that any remaining account holders must make a claim on their entitlement before 30 April 2015. After that date, disbursement of SP savings will no longer be possible.

On 1 January 2009, a law on corporate social responsibility (CSR) came into force, requiring Danish pension funds and the largest 1,100 companies to report their corporate, environmental and socially responsible investment policies. However, with many Danish pension funds being members of the UN Principles for Responspible Investment or applying responsible investment strategies already, this new law was not much of an issue.