Challenges and Learning Points in the Danish Pension System - Tela
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Challenges and Learning Points in the Danish Pension System Presentation at Tela-ETLA seminar on “Intergenerational risk-sharing – “from early age to old age” Musiikkitalo, Helsinki, February 8, 2018 Svend E. Hougaard Jensen, Ph.D. Professor, ECON, CBS Director, PeRCent, CBS Chairman, Scientific Council, Bruegel
Outline
- Suggested by the organizers…
• Brief description of the pension scheme:
– the most important pension schemes, retirement ages and typical
replacement rates, and the role of voluntary pensions.
• Description of the earnings-related system:
– The key decision makers (e.g. the role of social partners), pension
funds, benefit accrual, DB or DC.
• Financial sustainability:
– what would happen if future fund returns turn out to be much
lower than the historical returns? How would the system adjust?
• Questions to be answered:
– What is especially good about the Dutch/Danish pension
system?
– What are the main concerns with the system?
– What are the main topics in current pension policy debates?
Mercer Global Pension Index (2017)
Denmark vs. ROW
Index
Grade Value Countries Description
A first class and robust retirement income system that delivers good benefits, is
A > 80
sustainable and has a high level of integrity.
Denmark
B+ 75 - 80 Netherlands
Australia
Norway New Zealand A system that has a sound structure, with many good features, but has some areas
Finland Chile for improvement that differentiates it form a A-grade system.
B 65 - 75 Sweden Canada
Singapore Ireland
Switzerland
Germany
C+ 60 - 65 Colombia
UK A system that has some good features, but also major risks and/or shortcomings
France Brazil that should be addressed. Without these improvements, its efficacy and/or long-
US Austria term sustainability can be questioned.
C 50 - 60
Malaysia Italy
Poland
Indonesia Mexico
A system that has some desirable features, but also major weaknesses and/or
South Africa India
D 35 - 50 omissions that need to be addressed. Without these improvements, its efficacy and
Korea Japan
China Argentina sustainability are in doubt.
E < 35 A poor system that may be in early stages of development or non-existent.
Source: Mercer (2017)Mercer Global Pension Index (2017)
Denmark vs. ROW
Denmark
Year Rank Overall Index Value Adequacy Sustainability Integrity
2017 1 78.9 76.5 79.8 81.3
2016 1 80.5 75.8 85.3 81.4
2015 1 81.7 77.2 84.7 84.5
Finland
Year Rank Overall Index Value Adequacy Sustainability Integrity
2017 5 72.3 70.2 61.3 91.1
2016 4 72.9 70.6 62.2 91.5
2015 6 73.0 70.7 61.8 92.4
Netherlands
Year Rank Overall Index Value Adequacy Sustainability Integrity
2017 2 78.8 78.0 73.5 87.5
2016 2 80.1 78.2 77.0 87.7
2015 2 80.5 80.5 74.3 89.3•Basic design characteristics…
The Danish pension system
Three pillars
Private, individual saving
schemes:
• Flexible and voluntary
• Banks and insurance
companies
3rd Accumulated pension savings, 2016
Pillar • 612 billion USD
Funded, DC: • 216% of GDP
• ATP: compulsory, all
contribute; relatively low
contribution rates
• OP: employment
relationship or collective 2nd Benefits, per person, annual, EUR, 2018
agreement between social Pillar • Basic flat-rate pension 10.059
partners • Means-tested supplements 10.851
• Total 20.911
PAYG, DB:
• Basic flat-rate pension
Public expenditures, 2016
• Means-tested
supplements 1st Old-age pension
• Indexed to wages * Pillar • 128 billions of DKK / 6,6% of GDP
Early retirement benefits
Source: Statistics Denmark & Danish FSA & OECD • 14 billions of DKK / 0,7% of GDPPublic pension (PAYGO)
Finland vs. Denmark, 2018
in EUR Denmark Finland Difference
monthly yearly monthly yearly monthly yearly
Denmark
Basic amount (same for everyone) 838 10056
Supplements Illustration of
means-testing
if married/cohabiting 448 5374
if single 904 10847
Finland
Basic maximum amount (means tested)
if married/cohabiting 629 7546
if single 558 6693
Supplementary guarantee pension
if married/cohabiting 146 1757
if single 217 2610
Total maximum amount
if married/cohabiting 1286 15429 775 9303 -510 -6126
if single 1742 20903 775 9303 -967 -11600
Source: Ældre Sagen & KelaPublic, old-age transfer payments, DK
Old-age pensions & early retirement benefits
DKK mio.
140 000
120 000
100 000
80 000
60 000
40 000
20 000
-
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Old-age pensions including supplements Early retirement
Source: Statistics DenmarkThe Bismarckian Factor Estimates for selected countries Source: Krieger, T. and S. Traub (2013). Note: data not available on empty cells.
Risk of poverty
Share of persons in the low-income group*
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Total, DK Old-age pensioners, DK
*the low-income group is defined as having a disposable income below 50% of the median income of the entire population
Source: Statistics DenmarkRisk of poverty Share of elderly in the low-income group
Pension investments
% of GDP, 2016
250%
Exceptionally high in
218%
Denmark
200%
155%
150%
135%
100%
80%
57%
50%
6% 7%
0%
Denmark Netherlands Finland Germany Italy Sweden United States
Source: OECDOP schemes
Contribution rates
Public employees
YearAccumulated pension savings in Denmark
1998-2015, billions of DKK
Investor 1998 2000 2005 2010 2015
1. Life insurance companies 511 650 953 1.351 2.074
2. Multi-employer pension funds 214 270 381 478 672
3. Pension funds, firms 38 43 42 51 60
4. Banks 191 215 298 405 446
5. Public pension funds 255 330 479 817 831
a. ATP 200 247 365 758 781
b. SP 6 21 51 2 0
c. LD 49 62 64 57 50
Total 1,208 1.507 2.154 3.103 4.083
Share of GDP 1,02 1,14 1,36 1,71 2,01
Source: Finanstilsynet (Danish FSA)Composition of pension schemes
2010-2016, billions of DKK
2010 2011 2012 2013 2014 2015 2016*
1. Annuities 43,7 42,5 50,6 54,6 56,6 59,4 61,6
2. Periodic installments 45,1 48,9 41,0 48,8 50,1 48,2 49,1
3. Indexed 0,10 0,08 0,07 0,05 0,04 0,02 0,02
4. Capital or supplementary lump-
sums 16,0 15,5 15,9 0,08 0,03 0,02 0,02
5. Age savings - - - 1,7 3,1 4,0 4,4
Total pension schemes 104,9 107,0 107,6 105,2 109,8 111,6 115,1
a. Of which banks 17,7 17,6 15,6 10,1 9,8 7,1 6,6
b. Of which insurance companies 87,2 89,4 91,9 93,4 96,9 100,5 104,1
c. Of which unclassifiable - - - 1,7 3,1 4,0 4,4
Source: SKATDecreasing number of pension funds Number of Danish pension funds Source: Insurance and Pension (2017)
Public vs. private pensions Private pensions will dominate from app. year 2040
Replacement rates
International comparison, 2016
120
100
80
60
40
20
0
Men Women
Source: OECDAverage replacement rates At age 66, across income deciles, 2012
Official retirement age
International comparison
68
67 67
67 66,6
66 66
66 65,5 65,5 65,6
65,0 65,0 65 65 65 65 65 65
65
64 63,8
62,9
63
62
61
60
Men Women
Source: OECD•Reforms…
Recent reforms
Postponing the retirement age
• Welfare reform (2006) and retirement reform
(2011)
• Discrete changes:
– Increasing the early retirement age from 60 to 62
years over the period 2014–17.
– Shortening the early retirement period from five
to three years over the years 2018–19 and 2022–
23.
– This implies an early retirement age of 64 in 2023,
and the pension age will increase from 65 to 67
years over the period 2019–22.Recent reforms
Postponing the retirement age
• Welfare reform (2006) and retirement reform
(2011)
• Longevity indexation scheme (“autopilot”):
– The early retirement age and the official pension
age are indexed to the development in life
expectancy at the age of 60.
– The aim is to target the expected pension period
to 14.5 years (17.5 including early retirement) in
the long run.
– Currently, these are about 18.5/23.5 years,
respectively.Recent reforms
Postponing the retirement age
• Welfare reform (2006) and retirement reform (2011)
• Key design characteristics:
– The system is semi-automatic: a change has to be
approved in parliament every fifth year.
– The changes are smoothened: the change in one year can
never be below 6 months and above 12 months.
– The changes are pre-announced with a lead of 15 years:
the first change will be implemented in year 2030 for
pension age (year 2027 for early retirement age).
– Specifically, in year 2015 it was agreed that the official
retirement age will be increased to 68 years in year
2030.Longevity adjustment of the retirement age
Different scenarios
Longevity atforage
Dansk periodelevetid 60
60-årige Retirement age
Folkepensionsalder for forskellige LC-modeller
85
LC 1975-2014 (median)
LC 1985-2014 (median)
LC 1995-2014 (median)
30
80
lifetime (in yeras)
Kvinder
Women
Folkepensionsalder
Retirement age
Restlevetid (år)
25
75
Remaining
Observed 70
Men Observeret
20
LC 1975-2014
LC 1985-2014
Mænd LC 1995-2014
65
2000 2020 2040 2060 2000 2020 2040 2060 2080 2100
YearÅr Year
År•Challenges…
The hammock problem…
•Mind the gap… •ETT or TTE
Old-Age Expenditures and Taxation of Pension
Savings (DKK, billion)
2015 2050 Difference
(a) Changes in age-related expenditures
Old-age pension expenditures 102,1 107,8
Old-age service provision 81,9 129,4
Total 184,0 237,2 53,2
(b) Revenues from taxation of pension savings
OP schemes: Pension benefits 63,9 134,7
Income tax revenue of pension benefits 25,5 53,9
Effect on VAT and other indirect taxes 9,4 19,8
Phasing-out of pension supplement 2,9 6,1
Total 37,8 79,8 42,0
Source: DREAM and own calculationsFrom ETT to TTE Taxation
Effects on Structural General Budget Balance
Pct. of GDP
4
3
2
1
0 BL
FC
-1
-2
-3
-4
-5
2010 2020 2030 2040 2050 2060 2070 2080
Baseline TTE fullFrom ETT to TTE Taxation
Effects on Structural General Budget Balance
Pct. of GDP
4 2016
3
2
1
0 BL
FC
-1
-2
-3
2020 2026
-4
-5
2010 2020 2030 2040 2050 2060 2070 2080
Baseline TTE full•OXIT?
Return to pension savings
Incentive problems due to means testing
DKK
160
140
120
100
80
60
40
20
0
Contribution 3 years before Contribution 5 years before Contribution 10 years before
retirement retirement retirement
Without means testing
With means testing
With means testing incl. housing benefitAlternative reform proposals
Tax rates and pension savings
Effect on real, effective tax rate on return to pension savings for persons with
incomes below EUR 47,300 (low-income group)
Real effective tax
rates
Years before retirement
Existing rules
Reform proposal (1)
Reform proposal (2)
Reform proposal (3)OXIT…
Projected time path of private pension funds
5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0
2010 2020 2030 2040 2050 2060 2070 2080
Baseline Abolish OP schemesCrowding out of private saving? •A major study shows that only 15 percent of Danes respond actively to retirement savings policies •This documents why mandatory labour market pension schemes are effective at raising total saving. •Yet, things are changing…
Effects on public finances
Structural primary budget balance
Pct. of GDP
3
2
1
0
-1
-2
-3
-4
2010 2020 2030 2040 2050 2060 2070 2080
Baseline Abolish OP schemesEffects on the current account
Fiscal policy unsustainable
Pct. of GDP
6
4
2
0
-2
-4
-6
-8
2010 2020 2030 2040 2050 2060 2070 2080
Baseline Abolish OP schemesSustainability index • The permanent improvement of the primary budget (measured as a share of GDP) that is needed to guarantee that the government’s intertemporal budget constraint is satisfied. • Baseline: -0.07 • OXIT: -0.93 (app. 15 billion of DKK)
•DB to DC
Is there a future for DB schemes? •Major shift from DB to DC schemes –Low return environment –Increased longevity –More stringent solvency rules
Guaranteed average interest rate products Danish pension fund JØP Date of Admission Level of Guarantee Before 1st January 1990 3,70% or 4,25% 1st January - 31st December 1996 3,70% 1st January 1997 - 30st June 1999 3,00% 1st July 1999 - 1st July 2005 2,00% From 1st July 2005 0,00%
The life expectancy will increase
Life expectancy at 65 (men)
Years
Source: OECD“Society-assumptions”
Summing up • Denmark’s retirement income system comprises a public PAYG basic pension scheme, a means-tested supplementary pension benefit, a fully funded defined contribution scheme, and mandatory occupational schemes. • Denmark maintains #1 position for six consecutive years • Political consensus and a collaborative approach to working with key stakeholders are key to parts of the success. • This is unlike the UK, a more of an individualistic society compared to the inclusive cultures of Denmark, Finland and the Netherlands. • Indeed, the recent downgrade of the UK’s pensions system from a B+ to a B was explained by the government’s decision to introduce freedom and choice at and in retirement.
Summing up
• While the Danish pension system is “world-class”, it
isn’t perfect…
• Still a number of challenges, mainly related to the
OP schemes:
– Poverty trap and means-testing: effective returns
on retirement saving may be low and this may
(strongly) reduce the incentives to save for
retirement…
– Trade union density is falling - and “zeitgeist”
against collective, mandatory arrangements…
– Uncertainty about rule(s) of taxation…You can also read
