In Denmark, pensions are highly sensitive to tax, as the Danish government has learned to its cost. Unlike its Nordic neighbours, the country has chosen the defined contribution (DC) option for occupational pensions. Labour market pension funds guarantee benefits from contributions.
When the government introduced an austerity tax on savings - the so-called Whitsun Package - in 1998, one of the effects was to make it more difficult for life insurance companies and pension funds to meet interest guarantees. These guarantees ensure that the companies achieve a prescribed average return after tax to meet their future obligations.
However, because of market conditions there was a danger that they would be unable to fulfil these guarantees. The attorney to the Danish Government advised the government that it could be held liable if pension institutions were unable to fulfil their guarantees because of the Whitsun Package.
Last December the government enacted a pension package intended to solve these problems. The new legislation stipulates that all future returns on both equities and bonds will be taxed equally at 15 %. This lowered the tax rate on returns on bonds and property from 26% and raised the tax rate on equities from 5%.
The insurance companies and pension funds are doubtful whether the equalisation measure represents a real reduction in tax burden. Certainly the lower tax rate on bonds has helped reduce the provision requirement. However, as PFA Pension, Denmark’s largest pension fund, points out, this is entirely due to computation techniques. The Danish Financial Supervisory Authority, the body that fixes the interest guarantee rate, allows only for the bond rate - where the tax has been lowered - and not for the return on shares - where the tax has been increased.
The Ministry of Finance insists that the equalisation of the tax on bond and equity returns is “revenue neutral”. However, PFA Pension is sceptical. It points out that in the long term the tendency of pension funds will be to put a higher proportion of their investments into equities. Assuming that equities will yield a higher return than bonds over the long term, the tax equalisation measures will represent a further tightening of the tax on pension schemes.
The move to raise the ceiling for equity investment from 50 to 70% can be seen as pushing at an open door, since the long-term investment strategy of the leading Danish pension funds is to increase their equity exposure.
However, Arbejdsmarkedets Tillaegspension (ATP), the country’s largest supplementary scheme, and insurers Danica and Tryg-Baltica say they were already close to the ceiling, and welcome the additional space it gives them. ATP says it plans to increase the equity allocation of its portfolio at the expense of bonds during 2001 and expects the equity allocation to be above 50% by the end of the year. Foreign equities will account for 60% of this portfolio. The scheme says the adjustment to its investment strategy was driven entirely by the raising of the maximum equity allocation in companies’ portfolios.