The Danish Pension SystemProperties, outcomes and challenges

Torben M. AndersenAarhus University, Denmark

Eight International FIAP- ASOFONDOS Congress,

Carteagena April 2015

Pension system: Multiple objectives

• Distribution: Ensuring that all elderly have a decent living standard (minimum standards)

• Consumption smoothing: Ensuring that living standards after retirement stand in a resonable relation to living standards while working

• Insurance: Coverage of various events (spouse, long life……)

Danish pension system

I: Public pensions (PAYG – defined benefits)– Base pension for all (flat rate)– Supplements – means tested– All benefits are wage indexed

II: Labour market pensions (defined contribution)– Bargained, but mandatory for the individual– Covers the majority of the work-force– Provide annuitities + insurance (spouse/children; health)

III: Private pension saving– Tax subsidized and tied until retirement– Free savings (property, financial assets…..)

World Bank

1994

International comparisons

Background -Danish welfare model

• Extended welfare state– Pensions– Health– Old-age care

• Universalism– Equal entitlements for all– Tax financed

• Strong distributional objectives

Current pension system - developments

• 1980s– Savings deficit – systematic current account

deficits

– Political discussion on employee-owned firms (wage-earner funds)

– Social partners: Agreement on development of labour market pensions (centralized labour market; high unionization)

• Collective - voluntary /bargaining• Individual - mandatory

Labour market pensions – stepping up

7

19841987

19901993

19961999

20002001

20022003

20042005

20062007

20082009

20102011

20120

50

100

150

200

250Pension wealth, % of GDP

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

0

2

4

6

8

10

12

14

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18

20

Contribution rates

LO-DA blue collarLO-DA white collarTeachersNursery teachersPublic sector, white collar

%

Changing importance of public and private pensions

19851988

19911994

19972000

20032006

20092012

20152018

20212024

20272030

20332036

20392042

20452048

20512054

20572060

20632066

20692072

20752078

0

1

2

3

4

5

6

7

8

9

Public pensions Private pensions

% of GDP Pensions, % GDP

Current system

-

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15

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45

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55

60

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0

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SeriesForSecondAxis Supplement I

1.000 kr. 1.000 kr.

Private pensions

Phasing out of public pension supplements

Replacement rates (2012)

1 2. 3. 4. 5. 6. 7. 8. 9. 100

20

40

60

80

100

120

0

20

40

60

80

100

120

140

Capital income Private pensions Public Pensions

Income decile

%%

Projections:- Replacement rates will increase- Private pensions will increase in importance- Public pensions will remain important

Low income among pensioners

65 66 67 68 69 70 71 72 73 74 75 >750.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

%. %.

Age

Share with income below 50% of median income for entire population

0.3 % of persons above 64 fallsbelow the official poverty line

Financially robust?

• Labour market pensions: – Funded– Non-firm specific

• Public pensions:– Criteria for fiscal sustainability are met!– Reforms to increase the statutory pension age

• Reducing possibilities for early retirement• Discrete increases in pension age from 65 to 67• Indexation of pension ages based on life expectancy

at the age of 60; expected pension period 14.5 years

Challenges

• Interplay between public and private pensions (means testing)

• Taxation of various types of savings

• Not all are covered by a labour market pension

• Balance expansion – macroeconomic (in)stability

Distribution dilemma

• Binding distributional constraint – ensure some minimum income (working age and pensioners)

• Impossible to reach this target through mandatory pension savings for groups with income close to the limit

• Division of labour between public and private pension via means-testing – targeting public pensions towards low-income groups

Means-testing and incentives

• How to transit from public to private pensions? (means-testing)’

• If higher private pension = lower public pension ;

implicit form of taxation in addition to regular taxes

• Effective tax rates can be high- Slow phasing out: low tax rates, but costly- Quick phasing out: high tax, less costly

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0

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120

140

160

180

200Public pensions

Supplement ISupplement IIBase amount

1.000 kr. 1.000 kr.

Private pension

Incentives – savings and retirement

• High effectiv tax rates on pension savings and later retirement

• Applies for low income groups!

0 100 200 300 400 500 60035

45

55

65

75

Private pension(1.000 kr.)

% %

Effective tax rates on pension savings

Means-testing and insurance

• Low contribution due to involuntary unemployment, illness etc.

• Low return on investments etc.

= lower private labour market pension= higher public pension

Stabilizes/insures total net pension

Taxation of savings

• ETT-regime for pension savings

• Large variations in taxation of various types of savings

– Asset allocation– Balance expansion

Return taxatio

n - pension

s

Property

Shares Capital income

0

5

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25

30

35

40

45

0

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% %.

Pension savings

Other types of savings

Balance expansion

• High level of pension savings (illiquid)

• High level of borrowing (large share with variable interest rate)

• High risk exposure?

• Effects on macroeconomic stability

Financial assetsFinancial liabilitiesFinancial net assets

Pension wealth, after taxDeferred taxes

% of GDP

Pensions for all!

• Bargained solution= support from social partners

• But not all covered! (recipients of social transfers, some employed, self-employed)

• ”Myopia” – insufficient savings (The argument for mandatory pensions saving)

• Free-rider aspects + effect on public budgets

• Solution: Mandatory pension savings for all??

Conclusions

• Long transition phase – still on-going• Robust system

– Meets distributional objectives– Ensures high replacement rates– Financially viable

• Unsolvable dilemma – how to reconcile (re)distribution with incentives?– Current system has clear incentive problems

(savings, retirement)– Uneven taxation of various types of pensions saving

• Ensuring coverage for all – mandatory scheme or?