The Danish pensions and insurance industry has spent the past year negotiating with the government to effect a number of minor changes in pensions legislation.
Last year there was a significant (and costly) change to the way insurance entities assess their risks. The Danish Financial Services Authority (Finanstilsynet) significantly revamped the calculation of solvency requirements for pension funds by implementing the solvency capital requirement (SCR) model from Solvency II, albeit with some simplifications.
The initiative, which aims to ensure harmonised protection of policyholders, also incorporates changes in governance rules and new reporting requirements based on Solvency II. The new rules took effect on 1 January 2014.
Meanwhile, the transitional period following the 2012 change in tax laws has been extended. Since 1 January 2013, pension fund contributions for lump-sum pensions have been taxed on a TTE basis (taxed contributions, taxed investment income and capital gains of the pension institution, and exempt benefits). Previously, an ETT system was used.
But existing pension accounts built up under the old regime can be treated under the new rules if the saver pays, up-front, the tax originally due on payout at pension age. Normally this would mean a 40% tax charge.
Last year, the government encouraged savers to do this by giving them a tax rebate. Capital transferred to the new regime during 2013 was taxed at 37.3%, the lowest rate of tax for earned income. The window for doing this has now been extended to include 2014. Meanwhile, annuities and lifelong pensions are still taxed on an ETT basis.
Two reform processes are currently ongoing in the Finnish pensions sector. They concern changes to national solvency regulation and pension benefit rules.
The first two phases of solvency regulation are now in force. The goal of the third and final phase of the regulation amendment includes dealing with all the risks recognised in Solvency II in a national framework. This should take effect in or after 2016.
Government and social partners have agreed on a more extensive pension reform to come into force in 2017. The aim of the social partners is to agree on the main features of the reform before the end of 2014. The ministry of social affairs and health would then prepare a legislative proposal to be considered by the new parliament, which will be elected in 2015.
The reform mainly concerns pension benefit rules, but also some issues relating to contributions. The social partners have already agreed some increases in contribution rates. The most important issue is to set out new rules for the pensionable age. This issue is still the subject of the biggest pensions debate in Finland.
The statutory retirement age is flexible, from 63 to 68 years. Employer associations favour raising at least the lower age limit, while trade unions are generally against. The Social Democratic Party is also against raising the lower age limit, but those other political parties in the cabinet that have expressed a view want to raise the age limit.
Both government and social partners are aiming for an average retirement age of 62.4 years by 2025.
Currently, for those retiring after age 63, the accrual rate is high (4.5% of their annual salary). However, a cohort-specific adjustment is also made to the monthly benefit. As life expectancy rises, the coefficient for more recent cohorts is reduced. But independent studies have concluded that the incentive of high accrual rates and life expectancy adjustment after 63, together with the continuing decrease in the incidence of disability, will not be enough for the age target to be reached.
A high-level expert group chaired by Jukka Pekkarinen, director general of the ministry of finance, published a comprehensive report on the options for the imminent pension reform. The group’s task was to recognise and analyse the alternatives, but not to make recommendations.
The expert group analysed many of the reforms suggested by Prof Nicholas Barr of the London School of Economics in his evaluation report on the Finnish pension system last year. One suggestion was that the lower limit of pensionable age should be linked to life expectancy.
Another evaluation report by Keith Ambachtsheer on the governance issues within the Finnish pension system was also published in 2013. One of his main recommendations was that Finnish pension funds should co-operate more, making use of economies of scale.
The ministry of social affairs and health is also preparing changes to governance and competition rules for pension funds. But the work has been delayed because of different views on how much more information about transactions should be reported publicly.
There is also debate as to what extent the competition rules should take into account differences in the size of insurance contracts, because smaller contracts will have higher administrative costs per capita than larger contracts. This means that authorised pension insurance companies with mainly smaller clients will be at a disadvantage if competition in administrative efficiency is boosted.
Several new laws affecting the pensions sector have been enacted in the past year. One of these governs the tax treatment of occupational pension systems, restricting certain tax-efficient procedures previously allowed by the Federal Tax Court (BFH).
These procedures enabled employers to increase their book reserves (the figure for tax purposes) without raising the level of their pension promises. The new law now restricts the tax-efficiency of these procedures, allowing companies to adapt their tax balance sheets for this purpose over a transitional period of 15 years.
Legislation to enact the EU’s Alternative Investment Fund Management (AIFM) legislation also allows vehicles to be set up for the purpose of pension asset pooling.
Another new law improves private old age and disability protection. Its main aims are to provide better transparency in products for investors, and higher tax relief for products covering disability risk.
Considerable progress has been made on plans for future legislation. The new grand coalition in Berlin agreed to take measures in the near future to raise the minimum level of state pensions; to avoid deductions for long-term insured employees (45 years of contributions to the state pension system) in the case of early retirement at age 63 (in future, this will be 65), to raise state pensions for mothers of children born before 1992 and to slightly raise the level of state pensions in cases of disability.
In a process that started in 2013, the retirement age is being gradually raised through monthly increases, to reach age 67 by 2025. There was also a second cut in pension benefits in 2013 and some funds will still have to make further cuts in 2014.
The law to reduce yearly tax-free accruals on second-pillar schemes has also been enacted, so that tax-free accruals will be reduced from 2.25% (at age 65) to 1.875% (at 67) in 2015. Tax-free accruals are also capped at €100,000.
However, the way forward from this point is anything but clear.
Solvency legislation is still in limbo, and the first draft version of the FTK has been postponed again until March 2014 or beyond.
There is a big question mark as to whether the new laws will be enacted this year or in 2015, according to Tim Burggraaf, a principal at Mercer in Amsterdam, who sees this as the most crucial issue in Dutch pensions.
Last year, the government decided to abandon the previous administration’s plans for two supervisory structures (FTK1 and FTK2), instead introducing a supervisory structure based on one FTK2, accommodating both nominal guaranteed and conditional real pension arrangements. However, that plan, in turn, has been jettisoned.
“A structure that lies between nominal and real values is very difficult to build, and it seems there may not be enough backing for it,” says Burggraaf.
The government now intends to introduce a different framework, with a Parliamentary Bill to be presented in March, to take effect from 1 January 2015.
The promotion of intergenerational solidarity continues and there are plans to move away from forcing employers to pay in average contributions at the same level for all workers irrespective of age, as is common for Dutch industry-wide schemes.
“This probably means that for young
workers, contributions will halve, while significantly more is paid out in pensions to older workers, as is already common in insured retirement plans,” notes Burggraaf.
In tandem with this development, the ministry of social affairs has announced that a nationwide debate on the pensions system is needed.
This would affect the vast majority of people in the Netherlands, as 80% are enrolled in industry schemes. Burggraaf says: “The question for them is, what will the effect on their pension be if the average contribution falls? That is likely to dominate the pensions sector for the rest of this year.”
Regulations published under the Insurance Business Act and setting up a new legal framework for friendly societies, including pension funds, are still subject to a transitional period to the end of 2014.
As of 31 December 2013, new regulations were implemented introducing a Solvency II-like method to derive the discount rates used to calculate technical provisions. The new regulations are applicable to insurance undertakings. Occupational pension funds, which are under different regulations, will also be able to apply the new method after permission is obtained from Finansinspektionen (FI), the Financial Supervisory Authority.
FI will comply with all EIOPA guidelines for the preparation of Solvency II by encouraging undertakings and insurance groups to take appropriate actions to prepare for Solvency II.
The Ministry of Finance is preparing an update of the Insurance Business Act to comply with Solvency II.
A new, separate, proposal regarding pension funds, compliant with the IORP Directive, is expected by the end of May this year.
Meanwhile, the Ministry of Finance is also processing comments made on the proposed rules for the demutualisation of life companies. There is no timetable for legislation.
Last year, a public referendum backed legal changes allowing shareholders of listed companies the right to reject company remuneration plans. The changes also meant a ban on severance and advance payments while, in turn, pension funds would have to exercise their voting rights in the best interests of their members, disclosing how they voted at shareholder meetings.
The new law took effect on 1 January 2014, although pension funds have until 1 January 2015 to implement the new provisions.
But Simon Heim, pension lawyer at Towers Watson, says the change will be a mixed blessing.
“Although the aim of the law is to increase investor engagement, adding value to a company, it could also push some pension funds away from direct investments and into mutual funds, because it may result in an extra layer of governance to monitor activity,” he says. “Mandatory voting screams ‘box-ticking’ and could lead to low-quality voting decisions, as pension funds try to do it as cheaply as possible.”
A number of pending pensions regulations are still on hold, partly because of the way in which delays are effectively built into the Swiss legislative system.
New laws typically start with a proposal to parliament from government. But unless specific areas are considered a priority, things can move slowly.
When the bill moves through parliament, it has to be approved by both chambers, and with four short sessions a year, time is limited. Once the bill is passed, there is a period of 100 days to allow the collection of 50,000 signatures opposing any aspect of the new law; this would then trigger a referendum.
The second draft bill to change the law on vesting in pension plans is still to be published. This bill waives certain guarantees for pension plans, where the individual member chooses their investment strategy.
At present, members are assured of a minimum level of benefits even if they opt for a risky strategy that delivers poor returns.
However, many responses to last year’s public consultation said the law did not go far enough, since some guarantees still remain.
There was a similar public consultation on a draft Bill, which allows retirement benefits to be withheld where the individual retiring has failed to provide child or spouse support.
Although there is general agreement that this law is sensible, the pension industry has complained about the extra administrative burden it would impose.
This draft bill is still to be published and debated in parliament.
Another pending item is the revision of the Civil Code provisions on splitting pensions in the case of divorce. The main change would be to allow some splitting of pension rights if a couple divorce after one of the individuals concerned has retired.
A draft bill has been published, to be debated in parliament this year, but it is unlikely that any law will take effect before 2016.
Potentially the most important activity in Swiss pensions involves plans for pension reform to take effect in 2020.
As with many other European countries, Switzerland must tackle an escalating structural deficit in its state pension system, expected to stand at CHF 8.6bn (€7bn) by 2030.
Politically, reducing benefits would be difficult, so the government plans to raise additional money by increasing VAT by up to 2%. It also plans to raise the state retirement age for women from 64 to 65 years, the same as for men.
As regards the second pillar, the retirement age for women would also be raised to 65, and the minimum age for early retirement for both sexes increased from 58 to 62.
The retirement age flexibility that exists in the second pillar (lower benefits for early retirement, or deferring until 70 for higher benefits) would be extended to state pensions as well.
However, the key change here would be to reduce the guaranteed conversion rate in occupational schemes (used for converting the member’s cash account balance to a pension).
In 2010, a proposal to reduce the rate from 6.8% to 6.4% was overwhelmingly rejected in a referendum. The new conversion rate being proposed is even lower – 6%.
However, one solution being considered is to raise both employers’ and employees’ contribution rates, so that final pension payments would remain roughly the same. The government is now commissioning a study to analyse the related costs.
“The current conversion rate is definitely too high from an actuarial point of view, and as a result, there is significant cross-subsidy by active members,” says Heim. “However, unions are challenging the need for an adjustment and employers are not in favour of higher contribution costs, so there are serious discussions going on with the government.”
In addition, pensionable salary will be set at a higher level. And transitional arrangements have also been agreed. Plan members over 40 will receive transition credits into their savings accounts.
The draft proposals were published last November, with the public consultation ending at the end of March 2014.
Heim expects that the proposed reform will be subject to highly controversial discussions in parliament but even if it gets through, the chances of a public referendum are high, he says. “It is a good proposal, but it’s one of the biggest decisions ever in relation to Swiss pensions, and the political reality is that both the main stakeholders have already expressed serious concerns.”
The government’s Pensions Bill was progressing through Parliament as IPE went to press, with enactment likely in July.
The bill aims to set up a simple foundation for the state pension by merging the basic pension with the state second pension (SERPS), resulting in a flat-rate pension of £144 (€174) per week, in 2012-13 terms. It will mean an end to contracting-out of state second pension by defined benefit (DB) schemes.
There has been a further round of consultation on the government’s plans to reinvigorate occupational pension schemes, chiefly to introduce greater risk-sharing between employers and employees. This should make DB schemes more sustainable, while lessening some of the risk for members of defined contribution (DC) schemes.
A consultation paper published by the Department for Work and Pensions (DWP) last November supported the idea of innovation
by the industry, setting out several different models for how risk-sharing within schemes might look. The DWP is now considering responses.
A further paper is expected, outlining the government’s favoured options as well as the legislative timetable. There should be enough time to get legislation passed before the 2015 UK general election if the government can get a slot in the last Parliamentary session.
Another consultation, concerning a new objective for the Pensions Regulator to minimise its impact on employers’ sustainable growth, was about to end as IPE went to press. Carried out by the Pensions Regulator (TPR), the consultation unveiled proposals for regulation covering the long-term affordability of deficit recovery plans, as this affects sponsoring employers.
On the DC side, the most important event over the past year has been last September’s Office of Fair Trading (OFT) report into the DC pensions market, which identified market failures in terms of governance and value for money. This has spawned a series of initiatives on issues of concern, such as a review of legacy schemes with high charges.
“There is a question mark over the level of governance in contract-based workplace schemes such as group personal pensions,” says Richard Wilson, senior policy adviser for DC at the National Association of Pension Funds (NAPF). “However, any government action on this issue is likely to be led by insurance providers.”
The government has also carried out a consultation on a cap for the annual charges paid by DC scheme members who are auto-enrolled, with a suggested limit of 0.75% or 1%.
The cap was announced last October and intended to take effect early this year, but will now be delayed until April 2015, the government accepting that there was not enough notice for providers to adapt.
The recent OFT report also criticised the lack of transparency in the annuity market. As a result, the Financial Conduct Authority (FCA) is now carrying out a thematic review of the market, putting pressure on providers to make it easier for consumers to shop around for the best deal.
“The end result is likely to be changes in the FCA’s code of conduct for insurers, for instance, the way they are allowed to promote annuities,” says Wilson. “However, the government will have to rush to get this done before the general election in 2015.”