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REGULATION/LEGISLATION

World’s best-funded pension market shows dark side of new rules

Copenhagen, Denmark

No country on the planet has a better-funded pension system than Denmark. So when its life insurance industry encounters some hurdles, it's worth paying attention.

Because of a challenging cocktail of record-low interest rates and stricter capital requirements, pension funds have been transferring risk to customers instead of keeping it on their own books.

Given the developments, the head of Denmark's financial supervisor wants a regulatory rethink to reflect the new world order he says many pension clients don't yet understand. Failure to reach agreement now just means rules will probably be even harsher in the future, he says.

Jesper Berg, the director general of Denmark's Financial Supervisory Authority, says insurers need to offer a range of risk-weighted returns that target a specified payout at retirement, and supervisors should be empowered to police those commitments more actively. Pension funds already divide product offerings into different risk categories, but the FSA says there's plenty of room for improvement. What constitutes medium risk, for example, varies widely.

Privatizing risk

It's up to pension funds “to specify the risk-return framework they want to operate within,” Mr. Berg said in an interview on the sidelines of a March 9 conference in Copenhagen addressing what's being dubbed the privatization of risk. “We are likely to have a job in certifying that they actually follow those things they say and that the information they provide is valid.”

Denmark's pension system has been ranked the world's best five years in a row by the Melbourne Mercer Global Pension Index. Total savings exceed $650 billion, or $118,214 in assets per capita, placing the industry among the richest in the world, according to UBS's Pension Fund Indicators 2016.

But during that time, Denmark's pension industry has undergone some profound changes. Payments into market-based products, which are riskier for savers than guaranteed products, have climbed to account for more than 60% of annual contributions, according to a February report by the FSA. That's triple the percentage from a decade ago.

In part, the regulatory environment has encouraged the shift. The FSA has limited the returns that pension funds can offer on new contracts, making guaranteed products less attractive. But providers' efforts to pitch market-based contracts have played an equally important role, according to a December report by the Danish central bank.

The historically low interest-rate climate has also done a lot to shape developments. The yield on the Danish government's bond maturing 2039 traded at around 1.2% on Monday. Back in 2008, when the bond was introduced, that yield was well above 4%. Rates in Denmark are anchored by the monetary policy objective of the central bank, which is to keep the krone pegged to the euro. Those efforts have driven the benchmark deposit rate well below zero since 2012.

Market products

The shift to products whose returns depend on the markets, and not a corporate guarantee, means a “common understanding” is needed of what is “a sensible risk-return trade-off” and what “government information structures” are needed “to support the management of that risk-return trade-off,” Mr. Berg said.

The alternative may be a wave of even tighter regulation later, he warned. “Whether it's banks or pension plans or nuclear power plants, if they mess up it has political consequences and the regulatory backlash is often stronger” than it would have been “if one had managed a meeting of minds at an earlier stage,” Mr. Berg said.