Danish pension funds hit out at cross-subsidy regulation

PKA and Sampension say cross-subsidy regulation threatens Danish pension system

Proposals by the Danish Financial Services Authority (FSA) to dramatically reduce the potential for schemes to cross-subsidise between policyholders are a serious threat to the sector’s future viability, according to senior figures in the industry.

The proposed rules are currently in consultation ahead of a January 2011 implementation date. They will require bonuses to be paid from dedicated earmarked funds to policyholders with guarantees within one percentage point bands, or with certain common demographic characteristics. This is in contrast to the current set-up where a group-wide asset pot is allocated among customers at the discretion of the management.

According to Mads Smith Hansen, chief financial officer at Copenhagen-based Sampension, this is likely to be catastrophic to any diversification benefits companies realise under the current regime. He criticises the timing of the measure and warned it may prove the end for with-profits in Denmark. “I don’t see a great future for the with-profits industry with this regulation. The whole idea is a collection of people sharing the risks, for example, in the investment portfolio, and that is reduced under these rules.

“We have been managing this issue in a different way to how we are now being instructed, so it is a big change for us. This is both a financial challenge as well as operational. The operational task of splitting the funds up by January is significant as it’s a relatively short time for us to be able to cope, as we have some cross-subsidies in existence."

This criticism is echoed by Peter Melchior, executive director of Hellerup-based PKA, who terms it “millimetre justice” and says it is contrary to the aims of the cross-generational solidarity principle that underpin the Danish pension sector. “This is a problem for the life subsidiary because they are trying to dictate allocation of surpluses. The whole idea of insurance is cross-subsidisation, with today’s premiums helping to pay for retirees. There is a lot of solidarity between our members, for instance. If something goes wrong, this is shared – all bonus potential comes out of the loss-absorbing part of our technical provisions. The company as a whole can afford a higher loss this way than if we take it one policy at a time.”

However, Jan Parner, deputy director-general of the Danish FSA, rejects these criticisms and says it is simply a matter of ensuring transparency in how schemes fund the guarantees they offer. And given that Danish pension funds will be subject to Solvency II unlike the majority of their European peers, he says the timeline is necessary to enable discussion of how the matter fits with the directive. “This regulation has been under consideration for years now, so they can’t be all that surprised. The core principle here is that profits should be allocated fairly, according to how they are generated, and that guarantees should have adequate and risk-appropriate funding,” he says.

“We know it will be a challenging timeframe for implementation, but we were forced to choose the best option from a bad bunch. There will be increased dialogue with the European Commission from next year and we wanted the results of this regulation included with QIS 5 submissions, to make it easier to raise with it.”

Parner says the FSA is unable to effectively supervise the business at present, because of its opacity. “The problem at the moment is that we are having difficulties supervising this type of business as it is presented in quite a complicated way. This should set up rules for the policyholders as a group, with the result that it is clear what each guarantee costs, how they are hedged and how assets should be allocated accordingly.”

In contrast to Melchior, Parner sees the regulation as bringing the industry back more in line with its aims. “The point of a life product is the quality of life that is returned at the end of the policy – this has nothing to do with a fixed interest rate guarantee being returned metronomically every year.”

But certain practicalities still need to be ironed out. The dynamic management of with-profits policies will be increasingly difficult under the rules, according to Smith Hansen.

“The question is what happens when you have a floating guarantee and it moves from one category to another? That policyholder might transfer from a rich group to a poor one – or vice versa – and by that also get a changed asset allocation. That is extremely complicated, both to manage and to communicate to the customer. We think we have found a way to cope, but others may not be so lucky.”