As one of the few countries in Europe to have tackled the problem of an ageing population, Denmark faces the future secure in the knowledge that its pensioners will be well cared for in financial terms.
As well as a basic state pension, Danes also benefit from two other mandatory pension schemes, as well as having access voluntarily to insurance plans. All this comes at a price, however, as Denmark currently boasts the highest tax burden in the western world. Personal income tax for income exceeding U44,000 is roughly 67%, while tax on capital income is not far behind. As an EU member any disposable income suffers from VAT at 25%.
Of the workforce of around 3m 90% are covered by the schemes mentioned above. The basic state pension, or Folkepension is administered by the state on a PAYG basis. It is unusual in Europe in that it is funded out of general taxation, and there are no dedicated contributions. Legislation has recently been passed to lower the retirement age to 65.
In addition to this pension the workforce pays into a compulsory, statutory Danish Labour Market Supplementary Pension, known as the ATP. Since 1 January 1998 the scheme has been extended to include a number of people not presently employed, for whom the state makes a contribution to the fund. Currently approximately 90% of the population is a member of this scheme either as a contributor or beneficiary. It is further estimated that as of 2000 99% of future pensioners will benefit from the scheme.
In 1998, in an era of fiscal tightening, a temporary secondary ATP scheme was introduced. All employees, the self-employed, recipients of unemployment benefit and social cash benefits were charged 1% on their income, and this was earmarked in the new fund.
The third part of the system is made up of mandatory occupational retirement schemes. These include cross industry pension funds representing a number of sectors, labour market pension funds and schemes with pension insurance groups established by individual companies. Approximately 80% of the workforce are involved in these schemes.
Finally the provision system is rounded off by individual schemes through banks and insurance companies, of which a small number hold the vast majority of the market share. Recently tax advantages have been reduced, as the government seeks to streamline retirement benefits within the mandatory system. This policy aims to secure almost identical retirement benefits for all Danish wage earners on a fully funded basis. This is already a reality for a small group of funds catering for the professions.
Established as long ago as 1963 ATP contributions have been raised regularly as part of the collective bargaining process, with contributions from employers and employees in a ratio of 2:1. These ratios apply across all the schemes.
Consequently the size of benefits from the occupational pension schemes varies considerably. Most schemes when combined with the state pension aim at providing between 60–70% of final income, and most schemes also include a lump-sum payment. ATP and state pension combined provide an income of between E10,000 and E15,000.
Contributions to pension schemes are normally tax deductible, but for contributions to lump sum schemes a ceiling is in place. Annuity payments are taxed as personal income, and lump sum payments are taxed at 40%. The treatment of occupational pensions and private individual pensions is identical.
All the funded schemes carry a guaranteed rate of return on premium reserves of between 2% and 4%, and at present most pension funds are over-funded with free reserve levels ranging between 20% and 35% of liabilities. This partly reflects the liberalised placing rules, the international diversification of assets and buoyant capital markets over the past 10 years.
The institutions may place up to 50% of their minimum required assets in securities denominated in euro and another 20% in non-euro securities. Furthermore there are very few restrictions on the placement of free reserves, and there is little doubt that the impact of the euro on investment practise has been quite profound.
Among the public funds ATP obviously dominates with total assets of $30bn. It along with other public funds tends to invest in the domestic market, conventional wisdom suggesting that this is in the “national interest”. As mentioned above, however, the private sector can and does maximise its 70% accessibility to foreign markets.
A glance at the size of the insurance sector, suggests that many Danish companies still prefer to establish pension schemes through this sector, rather than set up their own corporate sponsored plans. Where such plans are in place there is a widespread use of external managers and far greater diversification.
Despite the relatively rosy scenario, there are still some challenges for the industry, as still only a few institutions have developed and maintained a structured and disciplined approach to risk and sensitivity analysis.
Nor do funds employ consultants as widely as other EU countries, especially when out-sourcing management. This often means that costs, especially those relating to the management of the assets are not properly analysed and controlled.
In conclusion, however, it is fair to say that the Danish government has tackled the problem of an ageing population better than most. In particular the decision as early as the sixties to introduce mandatory supplementary pensions has proved well founded, even though the tax burden remains high.