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Ministry of Social Affairs, file nr. 040-267Ministry of FinanceMinistry of Economic and Business AffairsMinistry of Employment

13 September 2002

National strategy report on the Danish pension system, 2002

1. IntroductionIn December 2001, the Laeken European Council adopted a strategy for implementing the open

method of coordination in the area of pensions. Eleven objectives to secure the sustainability of pensionsystems were also adopted. Taking into account these overall objectives, member states must presenttheir national strategy reports for pensions before 15 September 2002. This report is the Danishcontribution.

The 11 objectives are stated in Appendix 1, which contains a point-by-point summary of the report.

The Danish pension system is assessed as well-balanced and able to secure present and future pension-ers adequate coverage. If the aim of reducing general government debt is also achieved, fiscal policy andthus the organisation of the pension system is assessed to be robust in relation to the ageing of thepopulation. Hence, no major adjustments in the systems are planned at present.

In recent years, the Danish pension system has undergone a number of changes. For example, labourmarket pensions and supplementary pension schemes administered by ATP have become moreprevalent, the anticipatory pension system has been reformed and older persons now have strongereconomic incentives to remain in the labour market. These changes have made the system more robust,for example in relation to the demographic challenge.

The pension system and overall fiscal policies cannot be assessed independently. The standard of livingand the replacement rate provided by the pension system must be seen in conjunction with the fact thata substantial part of total public consumption is aimed at the older part of the population. Similarly, thelong-term requirements to fiscal policy must be considered in view of the facts that public pensions are

financed on a pay-as-you-go basis, and that large government assets in the form of deferred income taxpayments have accumulated in the savings-based pension schemes.

Therefore, general government debt must continue decreasing at the present rate for thepension system to be financially sustainable in the long term. The Government aims to maintainan average surplus on general government finances of 1-2 per cent of GDP up to 2010.

This wil l secure a sustainable f iscal pol icy due to the reduction of publ ic debts.

To support debt repayment and make space for lower taxes and a certain rise in public consumption peruser, labour market reforms are being considered that may help increase the labour force and furtherreduce unemployment. Specifically, the aim is to raise employment by 87,000 persons from 2000 to

2010, for example by better integrating immigrants, getting students through the education system faster


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and giving young people better financial incentives to seek employment in the labour market. This is anambitious goal, since labour market participation in Denmark is already high by international standardsand higher than the common objectives set in Lisbon.

The Danish pension system is based on three pillars, each having its own main goal consistent withthose proposed by the World Bank. The first main goal is to secure a decent minimum standard of liv-ing for all citizens. Public old-age pension performs this function, with supplementary, typically income-related, benefits granted to all citizens irrespective of their previous labour market attachment. The sec-ond main goal is to secure citizens a reasonable replacement rate when they enter retirement. Labourmarket pension schemes perform this function and presently cover the majority of wage earners. Thethird main goal is to ensure flexibility, i.e. the ability to allow for individual requirements. This task isrealised through a wide range of different offers from insurance companies, etc., within the frameworkof relatively favourable tax rules. Additionally, there are a number of supplementary pension schemes(ATP, SP, SAP) that cannot definitely be placed within one of the three pillars. ATP, SP and SAP alsocover certain recipients of transfer payments, thus enabling them to save up for supplementary pension

in a period when they pay no contributions to labour market pension schemes.

In the Danish pension system, public old-age pension is financed on a pay-as-you-go basis, while thesupplementary pension schemes (labour market pension, etc.) are contribution-defined and savings-based schemes. Savings-based schemes help reinforce the system in the face of demographic outlooks.

The existing labour market pension schemes are characterized by being based on collective insuranceand compulsory membership of a specific scheme.

In 1997, public old-age pension accounted for some 51% and in 1998 for some 50%, of pensionersgross incomes, and constitutes their main source of income. If the present rules are maintained, futurepensioners can look forward to significant increases in income, because public pensions are adjusted on

the basis of trends in wages, and because the groups incomes will rise due to the greater prevalence andexpansion of supplementary pension schemes. In 2045, however, public old-age pension will stillrepresent the chief source of income for the 50 per cent of pensioners with the lowest incomes.

With the current rules, the anticipated rise in life expectancy will also mean that citizens will receivepublic old-age pension, etc., for a greater part of their lives. Consequently, in reality, the coverage periodof public old-age pension will be longer, thus increasing government net obligations, since the effectiveage of retirement cannot be expected to rise in step with rising life expectancy.

The greater prevalence and expansion of the labour market pensions means that, in the future, pillar 2pensions will carry more weight in the overall pension system. Thus, fewer pensioners will experience a

significant decline in income when they start receiving pension payments. The average replacement rate(a persons total income after tax as a pensioner compared with the persons income after tax in the lastyear as actively employed ) is estimated to rise from the present 74 per cent to 90 per cent in 2045. Thereplacement rate is anticipated to rise for low- and middle-income groups in particular, because thesegroups have most recently set up pension schemes. Consequently, there is reason to expect that incomedistribution among pensioners will be more even in 2045 than today.

The distribution of consumption opportunities between future pensioners as well as the decision toretire depend on the trends in labour market pensions, but also on future pensioners net asset position,including that the build-up of the savings-based schemes will in all likelihood crowd out other savings,not least in the high income groups.


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Finally, the aims are to make the pension system more transparent and flexible, and to ensure that theindividuals freedom of choice in relation to the pension system is not hampered unnecessarily. Today,there are limitations for the individual person as to possibilities of influencing his/her pension schemeand of making individual choices. The Government wants individuals to exercise greater influence on

the investment and management of their pension savings.

Security is high for pillar 2 and pillar 3 pensions, since they are savings-based and covered by investmentand diversification rules as well as by the financial supervision of pension institutions. A majority of thepolitical parties made an agreement in 2000 to the effect that public old-age pension should form thesound foundation for present and future pensioners.

The changes made in the overall pension system during the past couple of decades have necessitatedheightened focus on the interaction between individual schemes and the need to look at individualschemes and any changes therein in relation to the overall pension system.

2. The present pension systemThe Danish pension system encompasses a number of statutory pension schemes (public old-agepension, ATP, SP, SAP, civil service pension for central government employees), labour market pensionschemes and individual pension savings plans.

The public pension system is targeted at ensuring all citizens a pension (public old-age pension)irrespective of their former attachment to the labour market. Public old-age pension as well as thepossibility of receiving a number of supplementary, typically income-related, public benefits is intendedto prevent poverty in old age for all citizens. Public old-age pension is assumed to continue being the

sound financial foundation of old age, on the basis of which individuals can plan their life in retirement.

The mainly PAYG-financed public pension system should be seen in the context of the greaterprevalence of savings-based pension schemes during the past decades, especially the labour marketpension schemes, which presently cover most of the Danish labour market. The savings-based schemesinvolve higher replacement rates when citizens shift to pension income, but typically also involve certaininsurance benefits providing protection against special risks. Finally, a number of tax-privilegedpossibilities for building up individual pension savings contribute to flexibility as regards meetingindividual requirements for replacement rate, etc.

In figure 2.1 the Danish pension schemes are broken down by the three pension pillars, each having its

own goal and administration:


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Figure 2.1. Contents of the pillars when taking the multipillar approach Pillar 1

Publicly administered schemes.Mandatory

Pillar 2Privately administered schemes.Mandatory

Pillar 3Privately administered schemes

with voluntary contributions

Goal Redistribution, prevent poverty Savings and replacement rate Savings and flexibilityMethod Same benefit to all citizens

orIncome-related benefitorGuaranteed minimum pension

Personal pension schemeorPension scheme in relation toemployment

Personal pension schemeorPension scheme in relation toemployment

TheDanishsystem

Public old-age pension Labour market pensions Individual pension savings

ATP

Civil service pension SAP

SP

Public old-age pension. Public old-age pension is a pillar 1 pension scheme. It is a basic,statutory retirement pension granted to all citizens from the time they turn 67. The officialretirement age will be reduced to 65 in 2004 with effect for persons born on 1 July 1939 or later.Calculated before tax, the pension amounts to DKK 105,400 (EUR 14,190)1 for a singlepensioner in 2002. For a married or cohabiting pensioner, the pension amounts to DKK 77,200(EUR 10,390). A personal allowance, granted on the basis of a needs assessment, may be addedto the above amounts. The pension should be seen in conjunction with a number of other

government, expense-related allowances and free services that public old-age pensioners canreceive. In 1999, public old-age pension for a single person with no other income correspondedto 47 per cent2of an average workers wage (after tax). The size of the pension is independent ofthe recipients previous attachment to the labour market, but depends on the pensionerspresent income and marital or non-marital relations. The pension is adjusted annually on thebasis of wage trends in the private sector. Eligibility for public old-age pension is based on timeof residence in Denmark. Public old-age pension is financed on a PAYG basis.

The Labour Market Supplementary Pension Scheme (ATP). ATP is a statutory,supplementary pension scheme. ATP is a mandatory scheme covering all wage earners, etc.,including certain groups of transfer payment recipients. ATP is meant to ensure all wage earners,etc., a savings-based supplement to public old-age pension, depending on the scope of their

previous employment. The ATP contribution depends on the individuals scope of employmentand typically amounts to DKK 2,684 (EUR 361) annually for a full-time employee, equal to 1per cent of an average employee income. ATPs Board of Directors and Council, which arecomposed by representatives from the social partners, decides the size of the contribution. ATPcannot unambiguously be placed as a pillar 1 or a pillar 2 pension. As a statutory scheme with

very broad coverage ATP can bee seen as belonging primarily to pillar 1 pensions. Theinstitutional set-up of ATP and way of financing nevertheless also links it to pillar 2 pensions.

1Rate of exchange: EUR 100 = 743 DKK2

Cf. Elements of Social Security. Hans Hansen, the Danish National Institute of Social Research, February 2002. A personalallowance of DKK 2,300 (EUR 310) is included.


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The Special Pension Savings Scheme (SP). SP is statutory, supplementary pension scheme.The objective of SP is to increase savings, but it also helps ensure all wage earners, etc. a higherpension, depending on their previous earned income. SP is a mandatory scheme covering all

wage earners, etc., and groups of transfer payment recipients. The SP contribution amounts to 1

per cent of earned income. The SP legislation was changed in 2002 to the effect that SP becamea savings-based scheme without any redistribution. Thereby the SP scheme became a moreunambiguous pillar 2 pension but as a statutory scheme with a broad coverage it hascharacteristics in common with pillar 1 pensions as well.

The Labour Market Supplementary Pension Scheme for Recipients of AnticipatoryPension (SAP). SAP is a statutory, supplementary pension scheme for recipients of anticipatorypension. SAP is a voluntary scheme. The objective of SAP is to give recipients of anticipatorypension access to a labour market pension-like supplement to public old-age pension. The SAPcontribution amounts to DKK 4,320 (EUR 581), corresponding to 2.8 per cent of theanticipatory pension for a single person. The contribution is adjusted on the basis of wage-increases in the labour market. The scheme falls under pillar 2 pensions, but have also

characteristics common with pillar 1 and 3 pensions. Civil Service Pension Scheme. This is a labour market pension scheme for public sector

employees, i.e. a pillar 2 pension. For public servants in central government, the scheme is pre-scribed by statutory law, while, for local authority officers, it is laid down in pension regulations.

Thus, civil service pension also shares features in common with pillar 1 pensions. Unlike mostagreement-based labour market pension schemes, civil service pensions are defined benefit pen-sion schemes, since benefits are calculated on the basis of the previous pensionable salary andyears of service upon retirement. The pension is financed by central government, or the countyor local authority on the basis of current revenue, i.e. tax. The Civil Service Pension Scheme isthe only labour market pension scheme not based on prior savings. However, most local au-thorities and a few counties have hedged their commitments by taking out insurance in Munici-

pal Pension Insurance Company Limited, KP, to which the local authorities currently pay pre-miums. Payments from KP thus cover these local authorities expenditure on payments of civilservice pensions. The importance of the Civil Service Pension Scheme will diminish in centralgovernment administration, since central government employees increasingly come undercontribution-financed and contribution-defined schemes that are consistent with the moreflexible and individual forms of pay implemented in the public sector.

Labour market pension schemes. Labour market pension schemes are pillar 2 pensions. Theyare mandatory for individual persons and linked to employment. The mandatory affiliationmeans that individuals can take out labour market pensions entirely or partly without havingtheir health assessed, and at costs that, on average, are more advantageous than can be obtainedon their own. The agreement-based labour market pension schemes are set up on the basis ofagreements made between the social partners or in the enterprises. A distinction can be madebetween agreement-based schemes agreed between employers associations and trade unions, onthe one hand, and schemes agreed in individual enterprises, on the other hand. Life insurancecompanies or pension funds administer both types of schemes. The bulk of labour marketpensions are contribution-defined, i.e. the size of benefits depends on the contributions paidand the interest earned on them as well as on the insurance risks associated with death anddisability. Retirement pensions in these schemes are based on prior savings. Almost 82 per centof full-time employees between the age of 25 and 59 paid contributions to a labour marketpension scheme in 1998. In addition, some wage earners who did not pay in 1998 may have paidin previous years. From 2004, the contribution will typically amount to 8-16 per cent of the

wage.


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Individual pension savings plans. These are individual pension schemes set up with banks,insurance companies or pension institutions. About 1.1 million persons pay contributions tosuch schemes. They are pillar 3 pensions. Generally, the same supervision rules and tax condi-tions apply to individual schemes and labour market pension schemes. As in the labour market

pension area, individual pension schemes can generally be divided into schemes with currentbenefits to the persons entitled to pension, annuity pension schemes, and capital pensionschemes where the capital is paid as a lump sum.

The weight of individual schemes in pensioners total earnings appears from table 2.1. The figures arefor 1998, and thus a long time before the labour market pension system shows full impact.

Table 2.1. Weight of individual schemes in pensioners total income, 1998

Pension scheme Percentage made up of individual pensionschemes in a pensioners (over the age of 67)

income in 1998.Public old-age pension 49.6

ATP 2.4SPSAPCivil service pension scheme 8.8Labour market pension schemeIndividual pension savings plan

12.1

Other income 27.0Note: SAP enters into force on 1 January 2003. SP entered into force on 1 January 1999.Source: Contribution from Denmark to the questionaire on safe and sustainable pensions, February 2001.

Pension payments are taxable (payments under a capital pension scheme are subject to a tax of 40 percent of the one-time payout). This should be seen in conjunction with the fact that contributions topension schemes are deductible when taxable income is calculated. Pension asset returns have beensubject to taxation since 1982. As from 2001, pension capitals saved up are subject to a return-on-capitaltax of 15 per cent of the return on bonds, as well as on shares.

2.1. Most recent changes in the Danish pension systemA number of changes in the Danish pension system have been implemented in recent years, includingchanges with significant consequences for the importance of individual pillars in the overall pensionsystem. Furthermore, the retirement system has been reformed for the purpose of giving older persons

more incentive to continue working.

Overall, the above changes have made the pension system more resilient to the consequences of agrowing population of older persons. Since public pensions and other general government expenditureon older persons, for example in the form of care and health care benefits, are financed on a PAYGbasis, ageing will continue to place heavy demands on economic policy; see Chapter 4.

2.1.1. Old-age and anticipatory pension and VERPIn 1999, a change in legislation reduced the public old-age pension age from 67 to 65, with effect from 1

July 2004. Moreover, the means testing of public old-age pension was eased as regards income fromwork. The changes formed part of a reform of the voluntary early-retirement pay scheme.


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The voluntary early-retirement pay, or VERP, scheme is a labour market policy measure allowing per-sons with long-term labour market attachment (now 25 years membership of an unemployment insur-ance fund) to retire and receive a mainly publicly financed allowance between the age of 60 and 65. Thepurpose of the reform was to provide financial incentives for older persons to remain in the labour

market and facilitate the option of gradual retirement. The reform of the VERP scheme included: theintroduction of a special tax-exempt premium for people who postpone entering voluntary earlyretirement; the means testing for all forms of pension savings in the early-retirement benefit, wherepreviously only certain types of current pension payments were set off; easier means testing for pensionsavings when the shift to the early-retirement benefit is postponed; and greater flexibility as regards

work in the VERP period.

The reform led to a fall in the implicit tax on continued work (amount of pension, etc. lost in con-nection with a persons continuing to work compared with his/her wage) from age 60 up to andincluding age 66. The fall was in the order of 10-15 percentage points (see A Sustainable PensionSystem, The Government, 2000).

The reduction of the official retirement age (in connection with the VERP reform) is not estimated toaffect the effective supply of labour to any considerable extent. The average retirement age as calculatedby Statistics Denmark was 61,5 years in 2000. This is considerably below the official retirement age of67, one reason being the VERP scheme. Nor are there signs of any noticeable fall in the labour forceparticipation rates for the years around the official retirement age, which may be because means testingrules are much more favourable for public old-age pensioners than for recipients of early-retirementbenefits. As expected, the VERP reform has caused a fall in the share of 60-61-year-olds shifting to

VERP.

Following a change in legislation in 2002, the anticipatory pension system was reformed with effect

from 2003. The reform includes a number of initiatives making it more attractive to employ personswith reduced capacity for work. The reform significantly simplifies the anticipatory pension system. Themain purpose of the reform was to ensure that people who have (residual) capacity for work are actuallygiven a chance to prove their ability in the labour market, possibly through a government-supportedjob. Consequently, the reform will result in a lower influx of new anticipatory pensioners than wouldotherwise have been the case. In recent years, changed practices have helped reduce the influx to theanticipatory pension scheme.

2.1.2. ATP, SP, SAP

In 1993, the ATP scheme was extended to include transfer payment recipients. As from 1997, a doublecontribution is paid for recipients of unemployment, sickness and maternity benefits. With effect from1997, the scheme was further extended to include recipients of cash assistance and rehabilitationbenefits, and recipients of anticipatory pension and early-retirement benefits also became able to make

voluntary payment contributions. Transfer payment recipients pay only one third of the contributionthemselves.3

The ATP scheme was changed with effect from 1 January 2002 to the effect that in the future, pensionrights will be calculated on an age-dependent basis. The individual benefits will hereafter better reflectthe value of the contributions.

3

In the voluntary scheme, members pay 50 per cent of the contribution. As part of the anticipatory pension reform, thisshare is reduced as from 1 January 2003 to one third of the full contribution for anticipatory pensioners.


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Public old-age pension is adjusted on the basis of wage increases in the labour market.4The adjustmentof public old-age pension, the relatively simple calculation principles and the political agreement onpublic old-age pension give individual citizens security and transparency in relation to the level of publicold-age pension they will receive when retiring, and thus also in relation to the standard of living

rendered possible.

Expanding the ATP scheme to include persons who receive transfer payments from the governmenthas meant that individual citizens receive an ATP pension of a certain size as a supplement to publicold-age pension. In the case of labour market pensions no pension contributions can be paid inconnection with unemployment, etc.

The proportion of public old-age pensioners in 2000 with an income of less than 50 per cent of themedian income for persons under 67 is 2.7 per cent. This is a very small proportion by internationalstandards.

2.3. Persons without pension savings and with a low replacement rateToday, only relatively few people have no pension savings and may experience substantial changes intheir standard of living on shifting to pension income. This is partly a consequence of the greaterprevalence of the ATP scheme during the last few years, which has strengthened the basic pensioncoverage in Denmark, as mentioned above.

In 1996, some 15 per cent of all 50-year-olds made no supplementary pension savings (besides savingsin the ATP) within the past ten years.

A considerable proportion of these people are persons with no employment, for example unemployedpersons and anticipatory pensioners, who will typically have a high replacement rate when shifting to

public old-age pension. For unemployed people, increased contributions to ATP are being made (since1997), the purpose being to compensate partly for the shortfall in savings in a labour market pensionscheme during unemployment. For anticipatory pensioners the contribution to the ATP scheme is madecompulsory for the new anticipatory pensioners from January 2003. The Governments efforts toensure a higher rate of participation in the labour force may help reduce the size of the group with nopension savings.

The pension savings of an estimated 2.1 per cent of those aged 40-49 are so small that unless thesepeople change their behaviour, the replacement rate is estimated to be less than 50 per cent when theystart receiving public old-age pension. One quarter of the above persons will have been self-employedand do not necessarily have a pension problem since their businesses may represent accumulated

wealth. The remaining persons may also be saving up in other ways, for example by owning theirhomes. The figures given also overestimate the group, since the SP scheme had not been initiated in theanalysis year, and since the analysis only considered contributions in a single year. Thus, about half ofthe 50-year-olds with no savings other than ATP in a single year have paid contributions to a pensionsavings scheme during the previous nine years.

The number of persons without pension savings and with a low replacement rate is thus modest. Peri-ods without pension savings (because of unemployment, etc.) and the difficulties involved in preciselypredicting the income a person will have as a pensioner may mean that the total pension amount will be

4The adjustment of public old-age pension, etc., is described in box 3.1.


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smaller (or larger) than originally expected and desired. For this reason, paramount importance is beingattached to securing high and rising employment and greater transparency in the pension system.

2.4. Gender equalityThe rules concerning public old-age pension do not distinguish with respect to gender. Thus, the sameamount of public old-age pension is paid to men and women; the age limit is the same, etc. The sameapplies to the public pension schemes ATP and SAP. In these savings-based schemes, pension rights areearned on the basis of a unisex principle5, which is an advantage for women because of their longer lifeexpectancy. SP is a purely savings-based scheme with no redistribution.

The weight of public old-age pension in the Danish pension system helps equalise men and womensfinancial circumstances as pensioners. Thus, womens typically lower total time of employment duringtheir working years and lower wage have a smaller impact on their financial circumstances as pensioners.In addition, women receive pension for a considerably longer period as a result of their longer life

expectancy.

Nor do the labour market pension schemes distinguish with respect to gender. The schemes aresavings-based and the calculated pension rights are also calculated on a unisex basis. However, nopension rights are awarded during periods without contribution payments, for example in connection

with unemployment or maternity without wage, which affects women more than men.

Concerning the individual pension schemes there are no requirement for a unisex basis.

As the labour market pensions are expanded, pensioners financial circumstances will increasingly reflectlabour market differences (i.e. with regard to wage and to periods outside the labour market) and the

consequential differences concerning the pensioners own savings in the labour market pensionschemes. On average men have a higher annual income and a higher labour income which means thatother things being equal they will accumulate more savings in the labour market pension schemes.

3. Incomes of future pensionersThe current rules mean that in 2045, pensioners financial circumstances will automatically have im-proved because of the general growth in productivity. This is because transfer payments, includingpublic old-age pension, are adjusted on the basis of wage increases in the private sector; see box 3.1.Theindexation rules thus imply that productivity improvements generate a general rise in the standard ofliving for people in the labour force as well as pensioners. Furthermore, the expansion of the labourmarket pensions will lead to higher incomes for pensioners.

Box 3.1. Adjustment of pension transfers.The rates for different types of transfer payments (and the progressive limits, etc. in the tax system) are automatically ad-justed once a year on the basis of wage increases in the private sector (the area covered by the Danish EmployersConfederation). Transfer payments are adjusted using the rate adjustment percentage; cf. the Rate Adjustment Percentage

Act.

The rate adjustment percentage for a given fiscal year is determined on the basis of wage trends in the wage year, which isthe year two years before the fiscal year. The rate adjustment percentage for 2003 has thus been fixed on the basis of the

wage increase from 2000 to 2001. Wage increases are assessed on the basis of the Structural Statistics compiled by the

5Application of the same death probabilities for men and women.


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Danish Employers Confederation. In calculating the annual wage for blue- and white-collar workers, respectively,inconvenience payments, pay during sickness absence, etc., and pension contributions in the relevant year are excluded.Moreover, labour market contributions are deducted simultaneously in relation to the fiscal year, since transfer paymentrecipients do not pay labour market contributions. The annual wage for blue- and white-collar workers is co-weighted, andonly wage information from firms that have reported to the statistics in both years (identical businesses) is used.

If the rise in annual wage is above 2.0 per cent, an amount corresponding to the rise in annual wage is 2.0, but not morethan 0.3 per cent, is applied for a pool amount. The rate adjustment percentage is equal to the rise in annual wage minus thepercentage rate set aside for the pool amount. The pool amount is used for financing various initiatives to the benefit oftransfer payment recipients.

In the calculations referred to in the text it is assumed that the funds transferred from the rate adjustment pool areretransferred to the pensioners in the form of a pension increase. In the calculations, public old-age pension is thusadjusted in step with wage increases.

The report A sustainable pension system, The Government, 2000, includes calculations illustratingthe possible income levels and distribution for future pensioners. The calculations are based on

information from 1997-1999. Since the report was prepared, collective bargaining has taken place (in2000), resulting in quicker and, for some groups, greater expansion of the labour market pensions thanassumed in the calculations. Moreover the results shall be seen in light of the fact that no allowance ismade for the reorganisation of SP and ATP, a fact affecting the results; see below.

It appears from the report that if productivity and real wages in the private sector rise by 1.5 per centannually, and tax rates, etc. are maintained, then disposable real income for an average pensioner can beabout 2 times higher in 2045 than in 1997. The real value of public old-age pension alone is estimatedto rise by 75 per cent, while the calculated actual payments from the labour market pension schemesalmost quadruple. Overall, the average pensioners disposable income will thus rise by almost 20 percent more than wages in the same period, mainly due to the expansion of the labour market pension

system through the past decades.

Table 3.1. The average financial position of a pensioner in 1997 and 2045.

Amount in DKK 1,000/(EUR 1,000)

1997 .

2045(1997 wage level)

2045(1997 price level)

Public old-age pension 69 (9) 58 (8) 122 (16)Pension payments 36 (5) 65 (9) 136 (18)

ATP and SP 5 (1) 25 (3) 53 (7)Capital income 24 (3) 15 (2) 31 (4)

Total income 134 (18) 163 (22) 341 (46)Tax 40 (5) 49 (7) 103 (14)

Income after tax 94 (13) 114 (15) 238 (32)Housing subsidy, etc. 4 (1) 3 (0.4) 5 (1)Disposable income 97 (13) 116 (16) 243 (33)Potential wealth consumption 23 (3) 15 (2) 32 (4)Resulting disposable income 121 (16) 132 (18) 276 (37)

Source: A sustainable pension system, The Government, 2000.

Labour market pensions and the payments from ATP and SP will make up an increasing proportion ofpensioners total incomes. This is because these payments grow faster than wages, and thus than theindexation of public old-age pension, and the rules for means testing of the public old-age pensionsupplement. Overall, the various savings-based schemes will thus be at least as important to pensioners

income as public old-age pension in 2045.


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Besides current income, pensioners also have the possibility of gradually reducing and thus consuming their wealth, as their residual life expectancy falls. Consequently, potential wealth consumption can beincluded in the statement of pensioners financial circumstances. The report assesses pensioners

potential wealth consumption to grow by some 1/3 less than wages. This shal l be seen in the light ofthe fact that accumulation of labour market pensions is assumed partly to reduce the accumulation ofother assets. The assumptions concerning savings behaviour are uncertain and are inherently of greatimportance to future pensioners overall private consumption possibilities, which, besides incomes, alsodepend on the pensioners overall wealth position.

Public old-age pension is the main source of income for present pensioners. Still, the overall averageincome of pensioners is presently somewhat higher than the public old-age pension, because of returnson assets and supplementary pension payments. However, not all pensioners receive supplementarypension payments. Only some 30 per cent of present pensioners receive payments over DKK 20,000(EUR 2,692) from supplementary pension schemes6.

As mentioned above, public old-age pension will generally make up a falling proportion of pensionersincomes up to 2045, but for the 50 per cent of pensioners with the lowest incomes public old-agepension will remain more important to their income than all the various supplementary pensions puttogether; see figure 3.1.

Figure 3.1. Composition and size of pensioners gross income in 2045 by deciles of disposableincome

0

50

100

150

200

250

300

350

1 2 3 4 5 6 7 8 9 10

0

5

10

15

20

25

30

3540

45

Old-age pension Labour market pensions

Capital income Private pension

ATP and SP Housing subsidy

EUR 1,000DKK 1,000

Decil

Overall, the calculations thus indicate that the income distribution for pensioners will be more even in2045 than in 1997, since income rises most steeply for the groups with low and medium incomes, wherelabour market pensions have not been expanded until within the recent decades; see figure 3.2. The6

Moreover, only some 40 per cent of pensioners receive payments from supplementary pension schemes over DKK 10,000(EUR 1,346).


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average disposable income of retirees from the low and medium income groups is estimated to rise 25-50 per cent more than average wage in the period until 2045. For groups with higher incomes, the rise isestimated to be 10-20 per cent. This is because persons in the highest income brackets were alreadyreceiving payments from labour market pensions in 1997, so growth in their incomes in the period until

2045 will be lower.

The likely development towards a more equal income distribution will probably be uneven, sincepension payments to the highly paid must for a period (10-20 years) be expected to rise at a greater ratethan for the low-paid, because the schemes for the high wage segment were started at an earlier point intime. Furthermore, the results should be seen in light of the fact that such long-term projections areinherently subject to many uncertainties and sensitive to the choice of assumptions, not least includingtrends in real interest rates.

Figure 3.2. Income distribution of pensioners (disposable income in 1997 wage level), 1997 and2045

0

25

50

75

100

60 90 120 150 180 210 240 270

0

25

50

75

100

2045 Distribution 1997 Distribution

2045 Av. disp. income 1997 Av. disp. Income

Per cent Per centSingles

Disposable income(DKK1,000)

0

25

50

75

100

90 150 210 270 330 390

0

25

50

75

100

2045 Distribution 1997 Distribution

2045 Av. disp. income 1997 Av. disp. Income

Per cent Per cent

Disposable income (DKK 1,000)

Couples

The increasing supplementary pension payments are raising the average replacement rate defined as apersons total income aftertax as a pensioner compared with the persons income after tax in the lastyear as actively employed7. In 1997, the average replacement rate is thus estimated to be some 70 percent, of which public old-age pension make up 40 per cent, while the rest is supplementary pensionsand a calculated return on assets. With the assumptions applied, the calculated average replacement rate

will increase to some 90 per cent in 2045; see figure 3.3.Under the current rules for means testing, publicold-age pensions contribution to the replacement rate will diminish in step with the increase insupplementary pensions. Consumption possibilities are also affected by the development in a persons

other savings, including whether the assumed rise in labour market pensions will crowd out othersavings8.

7A persons income when he/she was in the labour force, which is the basis of comparison, corresponds to the personsincome (after tax) in the period before he/she retired i.e. the last period the person was in the labour force adjustedupwards by the trends in wages. This will affect the replacement rate if some income groups systematically tend to enterpartial retirement.8

In the calculations it is assumed that the rise in labour market pensions will crowd out other savings by 30 per cent onaverage, which generates a relatively substantial savings effect.


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Figure 3.3. The average (after tax) replacement rate 1996 and 2045 by sources of income

0

10

20

30

40

50

60

70

8090

100

1996 2045

0

10

20

30

40

50

60

70

8090

100

Old-age pension Other pensions Capital income

Per cent Per cent

Note: Other pensions are labour market pensions, ATP and individual pensions. The average of replacement rates for allwage earners and self-employed persons has been calculated in the figure.

The replacement rates decrease with income; see figure 3.4.In the low deciles of income, the calculatedreplacement rate is thus higher than 100. This reflects that public old-age pension, together with the

ATP schemes and the more favourable housing subsidy rules for pensioners, is of great importance tothe low-income groups.

The calculated replacement rates increase for the medium income groups in particular, both for singlepensioners and for couples. The average replacement rate for the medium income groups has been cal-culated at some 83 per cent for couples and some 94 per cent for single pensioners in 2045. The averagereplacement rate for the medium income groups was 60-65 per cent in 1996.

Figure 3.4. Replacement rate in 1996 and 2045.

0

50

100

150

200

1 2 3 4 5 6 7 8 9 10Decil

0

50

100

150

200

1996 Replacement rate 2045 Replacement rate

Per cent Per centSingles

0

50

100

150

200

1 2 3 4 5 6 7 8 9 10

Decil

0

50

100

150

200

1996 Replacement rate 2045 Replacement rate

Per cent Per centCouples


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In the calculations, the basic and supplement amounts of public old-age pension are adjusted in stepwith wage trends, since the contribution to the rate adjustment pool is assumed to be retransferred aspublic old-age pension; see box 3.1. However, the pension amounts paid out rise somewhat more slowlythan wage, which is due to the rules for means testing and hence the rise in the disposable incomes of

pensioners. Furthermore, the prospect of longer life expectancy implies that, on average, pensioners willreceive public old-age pension for more years and thus for a greater part of their lives. This involveslarger pension expenditure per pensioner during his/her life, and growing future pension obligations forthe public sector, which tightens requirements for debt reduction in the period until 2010.

In the population projection used it is assumed that the average life expectancy will increase by 4 yearsfor men and 1 years for women up to 20759. This will extend the period in which persons are entitledto public old-age pension to 18 years for women and 17 years for men, compared with some 18 and15 years respectively today; see figure 3.5a.

Applying the current 2002 rules and rates, the amount that a single, female public old-age pensioner

receives over lifetime will go up from some DKK 1.88m to DKK 1.93m before tax (i.e. DKK 52,000 orEUR 7,000 at 2002-level), while the corresponding figures for a single, male pensioner will go up fromDKK 1.56m to DKK 1.78m (i.e. DKK 220,000 or EUR 29,600); see figure 3.5b.

Figure 3.5a. Number of years a person receives publicold-age pension

Figure 3.5b. Amount of pension during the lifetime of a(single) public old-age pensioner

14,5

15

15,5

16

16,5

17

17,5

18

18,5

2005 15 25 35 45 55 65 75

14,5

15

15,5

16

16,5

17

17,5

18

18,5

Number o f years a woman receives old-age pension

Number o f years a man receives old-age pension

Years Years

1,5

1,6

1,7

1,8

1,9

2,0

2005 15 25 35 45 55 65 75

1,5

1,6

1,7

1,8

1,9

2,0

Old-age pension per person, wom en

Old-age pension per person, men

DKKm DKKm

As mentioned above, the labour market pensions have expanded more rapidly and, for some groups,more greatly than assumed in the report, and the ATP and SP reforms have not been taken into ac-count.

The new SP scheme is a purely savings-based scheme that is not redistributive precisely like DMP,which was introduced in 1998 and subsequently (in 1999) replaced by the former SP scheme. Thereform of SP impacts on future income distribution in the sense that future payments from the scheme

will now depend on an individuals earnings during his/her working years, while continuing the old ruleswould involve some redistribution from high-income to low-income groups. Estimates thus suggest thatthe disposable incomes of pensioners in the lowest income deciles would be some 2 per cent higher in

9 Compared with population projections for the other West European countries and the US, this is a modest projected

growth in average life for women in particular; see United Nations (2001). World Population Prospects, The 2000 Revision,Highlights Population Division, Department of Economic and Social Affairs, UN, New York.


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2045 with the old rules than with the new ones. Overall, this does not change the expectation of a trendtowards a more equal income distribution among pensioners in 2045 than today.

4. Ageing and general government financesBesides transfer payments to older persons, for example in the form of public old-age pension, thepublic sector is responsible for major parts of the health care and health care services provided to olderpersons. The expenditure incurred in this connection is financed on a PAYG basis. This means thatageing will put increasing upward pressure on expenditure in future. Moreover, demographicdevelopments are expected to shrink the labour force in the long term, which will tend to erode thegovernments revenue base.

To prepare the Danish economy for the demographic challenge, the Government aims at maintaining afiscal surplus averaging 1 2 per cent of GDP up to 2010. This target is assessed to ensure the

sustainability of fiscal policy, so that future generations will not be impelled to introduce fiscaltightenings because of an accumulation dept burden. The requirement on public finances in order toensure robustness in relation to ageing is thus stricter than the targets of close to balance set out inthe Stability and Growth Pact.

The requirement has been calculated on the assumption that the Danish PAYG-financed pensions, in-cluding adjustment rules, etc., can be maintained without subsequent tightenings of fiscal policy. Thus,fiscal policy will be the means by which to secure the sustainability of the pension system, since the aimof debt reduction creates room for financing the PAYG-financed public pensions for older persons.

The contribution and savings-based pension system is in itself robust in relation to ageing. However, the

expansion of this system has primarily helped reduce the debt reduction requirement to the extent thatPAYG-financed pensions would have been higher in the absence of these savings-based schemes. Also,a further expansion of the contribution and savings-based pension system would not be expected tolead to any significant changes in the sustainability requirement on public finances.

The calculated requirement for general government finances is based on an overall assessment of thepublic sectors future net obligations, given that current tax rates as well as standards and replacementrates in public services are maintained. The calculation shows that annual government surpluses mustamount to an average of 2.1 per cent of GDP up to 2010 to ensure a sustainable trend in generalgovernment finances; see table 4.1.This requirement can be divided into three components:

Thefirstcomponent is the future net additional expenditure on pensions, care for older persons, etc.

This corresponds to a permanent net rise in expenditure of 2.7 per cent of GDP. The secondcomponent covers the part of government surpluses stemming from public funds (0.8

per cent of GDP), including ATP. These funds are earmarked for higher pension payments in thelong term and can therefore not be used to finance the future expenditure pressure.

The thirdcomponent is a correction for the fact that the continued rise in production and the pricelevel in itself helps reduce general government debt to GDP ratio. This corresponds to a permanentnet reduction in expenditure of 1.4 per cent of GDP.


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Table 4.1. Long-term requirements for general government finances, % of GDP

Average, 2002-10Rise in future net obligations1) .................................................................... 2.7+ Balance in public funds............................................................................. 0.8

+ Erosion of debt because of growth......................................................... -1.4= Calculated requirement for government balance incl. funds .............. 2.1

Target for public balance .............................................................................. 1 2Note: The calculation is based on a sustainable development in general government finances starting in 2002.

The figures sta ted are calcu lated averages for the per iod from 2002 to 2010 seen as a whole.1) This is expressed as an average permanent r ise (in per cent of GDP)

The calculation thus supports the medium-term target of securing an average surplus of 1.5-2.5 per centof GDP up to 2010. The target for general government finances has been set as an interval because ofthe general uncertainty associated with calculating the sustainability requirement.

Pension savings are not income taxed until the time they are paid out. Consequently, the tax value of thereserves accumulated in the savings-based pension systems reflects a government asset in the form ofdeferred income tax payments, which serves to improve government finances as the system matures andthe net payments from the schemes increase. In the calculation, the rise in net payments alone generates

compared with today an improvement of government finances in the order of 2.5 per cent of GDPin 2045; see 4.1.3.However, this should be seen in conjunction with the fact that the tax-deduction forpension contributions has historically eroded the governments revenue base, thus increasinggovernment net debt.

The Government has set up the following key medium-term targets:

Securing a surplus on government finances averaging1.5 2.5 per cent of GDPup to 2010. This

implies a reduction of about 50 per cent of government debt in per cent of GDP.10

A tax freeze

Expanding employment by 87,000 persons up to 2010.

Within the bounds of debt reduction and tax freeze, the presumed increase in employment will providesome latitude for limited growth in public consumption per user in the years up to 2010. Moreover,

within a sustainable fiscal policy framework, labour income taxes are assumed to be reduced by some0.25 per cent of GDP net. This marks the Governments intention to reduce tax on earned incomefrom 2004, if the necessary fiscal leeway can be found.

4.1. Overall changes in general government revenue and expenditure in the long-term

With the revenue and expenditure rules applied, overall expenditure on general government transfersand public consumption is estimated to increase by 7.4 per cent of GDP up to 2035; see table 4.2. Of thisincrease, increased expenditure on public old-age pension and health-related general government

10The sustainability requirements and the target interval set for the government surplus in per cent of GDP have beenreduced by 0.5 percentage points compared with previously as a result of the transformation of the Special Pension SavingsScheme (SP) into a (mandatory) individual scheme. In popular terms, the reform means that the SP scheme is no longercounted as part of the public sector. The result is a downward adjustment of the surplus in the public funds, and thus ingeneral government surplus, of some 0.5 per cent of GDP in the years 2002 to 2010. Since subsequent (net) payments from

the SP scheme will not be included as general government expenditure (but as consumption of private savings), therequirement for government surpluses is, however, reduced by exactly the same figure, some 0.5 per cent of GDP.


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It is recognised that a certain decline in income-related allowances will cause the rise in expenditure onpublic old-age pension in the long term. The increased decline in these allowances reflects that, onaverage, pensioners incomes rise more steeply than the basic amount of public old-age pension, sincepayments from funded pension schemes will rise. Presently, about one third of public old-age pension is

granted in the form of income-related allowances.

4.1.2. Expenditure on public services

With the prospect of a growing the number of older persons up to 2040, expenditure due to demo-graphic changes in the area of care for older persons will grow by some 40 per cent, while theexpenditure on health care services will grow by just over 10 per cent; see figure 4.1.

Figure 4.1. Expenditure in key areas due to demographicchanges

80

90

100

110

120

130

140

150

05 15 25 35 45 55 65 75

80

90

100

110

120

130

140

150

Hospit al services Resident ial care homes

Child care Education

Index2002=100 Index2002=100

General government expenditure on health care and care for older persons is presently 7.4 per cent ofGDP and is, in step with demographic changes, anticipated to increase gradually by 2.0 percentagepoints up to 2035; see table 4.4.

Table 4.4. Expenditure on public consumption in the long term, % of GDP

2002 2005 2010 2020 2030 2035 2050Level ---------- Change compared with 2002 ---------

Public consumption ................................................ 25.5 -0.1 0.0 0.7 2.6 3.4 2.9Of which health care and care for the elderly..... 7.4 -0.1 0.0 0.6 1.6 2.0 1.8Source: The Sustainability Projection and the Convergence Programme, January 2002.

4.1.3. Pension assets and taxation of pension payments

The expansion of the contribution- and savings-based pension system, including in particular the labourmarket pension schemes, has led to a steep increase in pension assets during the last 10-20 years. Over-all, pension assets amounted to just over 100 per cent of GDP in 2000, of which private schemes ac-counted for three fourths, while the statutory schemes including in particular ATP accounted for theremainder. Thus, pension reserves have more than doubled since 1987 (measured in per cent of GDP);see table 4.5.


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Table 4.5. Assets in pension funds

1986 1990 1995 2000------------- per cent of GDP -------------

Life insurance companies ............................................................ 20.6 24.4 31.2 43.6

Occupational pension schemes etc. .......................................... 10.3 13.3 16.1 18.8Banks .............................................................................................. 8.3 11.6 14.2 17.1

Total non-statutory schemes.................................................................... 39.2 49.3 61.5 79.4Supplementary pension schemes (ATP, etc.) 1) ....................... 10.6 13.2 16.1 25.4

Total...................................................................................................................... 49.8 62.5 77.6 104.81) Including ATP, the Employees Capital Pension Fund (LD), the Special Pension Savings Scheme (SP) and the

Temporary Pension Savings Scheme (DMP), which was abo li shed and repl aced by SP.Source: The Danish Financial Supervisory Authority and own calculations

It is crucial to include contributions received and payments made from the pension sector when makinga long-term projection of general government finances because of the large scope of pension savings,

and because pension savings are mainly taxed when the pensions are paid out, while contributions topension schemes can be deducted from ordinary income tax.

Whether the amount is taxed at the time of contribution or at the time of payment makes littledifference for individual pension savers if the income tax rate is the same at the two dates. On the otherhand, the time of taxation is crucial to the development in recorded general government debt. When thepension system is being built up, the right to deduct pension contributions leads to a reduction of taxrecipients, which will exert an upward pressure on general government debt. However, this should beseen in conjunction with the fact that the government is building an implicit asset in the form ofdeferred taxes, administered by the private pension sector.

In the long term, the fiscal additional revenue from such net pension payments can compared withtoday be estimated to amount to some 2.5 per cent of GDP; see figure 4.1a.This reflects that, from2004 onwards, pension contributions will equal some 6.5 per cent of GDP, while pension payments willrise from just over 4 per cent of GDP to 10-11 per cent of GDP in the long term (both figurescalculated before tax). All else being equal, the future increase in tax revenue will benefit generalgovernment finances. However, because the future revenue springs from deferred tax payments, thegeneral government net debt is also higher today.

Figure 4.1a. Change in revenue from taxationof net pension payments

Figure 4.1b. Pension assets as well as contributionsreceived and payments made in the pension sector

-0,5

0,0

0,5

1,0

1,5

2,0

2,5

3,0

05 15 25 35 45 55 65 75

-0,5

0,0

0,5

1,0

1,5

2,0

2,5

3,0

%of GDP %of GDP

3

4

5

6

7

8

9

10

11

05 15 25 35 45 55 65 75

100

120

140

160

180

200

220

240

260

Cont ribut ions recei ved Payments made

Pension assets (ri ght axis)

%of GDP %of GDP

Source: Own calculations.


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The trends in contributions received and payments made in the pension sector mean that after 2040total pension assets will amount to more than twice of GDP, which represents a doubling compared

with today; see figure 4.1b.

4.2. Targets for labour force and employmentAn important part of the medium-term strategy is the objective of increasing employment by 87,000persons up to 2010. A rise in the labour force of 67,000 persons will generate the bulk of the increase,

while a further reduction of unemployment is to contribute the remaining 20,000 persons.12

All else being equal, changes in the size and make-up of the population are expected to reduce the la-bour force by 66,000 persons up to 2010. Consequently, a rise in the labour force of 67,000 personsimplies that employment rates in individual age groups are increased, corresponding to a growth in thelabour force of 133,000 persons; see table 4.6.

Table 4.6. Changes in the labour force, etc. from 2000 to 2010------------ 1,000 persons -----------

Employment ............................................................................................... 87Unemployment........................................................................................... 20Labour force ............................................................................................... 67Contribution to increase in labour force:- Changed demography1) .......................................................................... -66- Requirement for increase in activity rates ........................................... 133Contribution to increase in activity rates :- Unrealised requirements ......................................................................... 53- Implemented initiatives, etc.2) ............................................................... 80

1) The contribution from changed demography has been calculated by keeping the level participation ratesin the labour force, distributed on gender, age and origin, unchanged from the 2000 level.2) The contribution is based on an overall assessment of the effects of implemented reforms regarding, for

example, the transitional (early retirement) benefit, VERP and anticipatory pension schemes, includingrecent years fall in the influx to the early retir ement scheme.

Source: Economic Survey, May 2002.

The possibilities of achieving the rise in activity rates must be seen in light of the reforms implementedwith regard to, for example, the transitional (early retirement) benefit, voluntary early-retirement pay(VERP) and anticipatory pension schemes. Overall, the influx to these schemes has fallen considerablysince 1996, and the most recent figures show increased activity rates for the vast majority of age groupsbetween 55 and 66 years; see box 4.1.This has helped reverse the downward trend in activity rates seen

since the end of the 1980s; see figure 4.2a. If the trends in the influx to early retirement, etc. aremaintained at their present lower level, more than half of the required contribution from higher activityrates up to 2010 will be realised.

The presupposed increase in activity rates for individual age groups and for immigrants will mean thatthe overall average activity rate will remain largely unchanged up to 2010. The same is true for em-

12Thus, unemployment in 2010 will be reduced to 130,000 persons, or 4.5 per cent of the labour force. This means thatlong-term unemployment will largely be abolished, and that unemployment will thus predominantly be of shorter duration,occurring, for example, in connection with a change of jobs etc. This will place heavy demands on the way the labour market

works. A higher level of education and a more targeted labour market policy will help underpin a long-term unemployment

level of 4.5 per cent of the labour force. If unemployment is to average such a low level, prolonged downturns in theeconomy also need to be avoided.


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ployment rates. This is chiefly because older persons in the labour force and immigrants, who haverelatively low activity rates, will carry more weight in future. On the other hand, standardised activityand employment rates, cleansed of the future change in the make-up of the labour force, will increase 13;see figure 4.2b.

Figure 4.2a. Contribution to growth in thelabour force from change in activity rates

Figure 4.2b. Activity and employment rates

-45

-30

-15

0

15

30

81 83 85 87 89 91 93 95 97 99

-45

-30

-15

0

15

30

1,000 persons 1,000 persons

68

70

72

74

76

78

80

82

90 92 94 96 98 00 02 04 06 08 10

68

70

72

74

76

78

80

82

Employ. rat e Employ. rate, st d.

Activity rate Activity rate, std.

%of the labour force %of the labour force

Note: In figure 4.2a, the contribution to growth in the labour force from the change in activity rates has beencalculated as the change that would have occurred in the labour force if the size and make-up of thepopulation were maintained as regards age and gender, given the observed changes in the age- and gen-der-specific activity rates (from primo this year to the next year). Similarly, the standardised activity andemployment rates in figure 4.2b have been calculated with the same makeup of the population as regardsgender, age and origin as in 2000. The calculations concern persons over 14 years of age.

Source: Register-Based Labour Force Statistics (RAS) and own calculations

Most of the effects produced by the reforms of the VERP and anticipatory pension schemes as well asrecent years fall in the influx to early retirement will occur in the coming years, when the reforms havebeen fully phased in and the persons in individual age groups have been replaced by new generations

who will continue working longer. But further structural improvements in the labour market are neededto attain the medium term labour force target.

In autumn 2002, the Government will present an action plan for More people in work, which willfocus on more flexible measures aimed at finding the fastest way to employment, promoting greaterefficiency in the initiatives to find people jobs and to improving the financial incentives to work.Furthermore, the Governments integration plan focused on getting refugees and immigrants into work

quickly. Finally, initiatives are being considered to help young people get through the education systemfaster.

13The difference compared with the non-standardised rates thus reflects demographys contribution to the labour force.


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Box 4.1. Early retirementFor a number of years, the trend in Denmark has been for people to retire from the labour market before old-age pensionage, see figures a and b.Early retirement reduces the labour force (and employment) and places a burden on general govern-ment finances through lower tax revenue as well as higher expenditure on transfer payments. This gives the government lessfiscal latitude.

Figure a. Age-dependent activity rates, 55-to-70-year-olds

Figure b. Average retirement age, , 1981-2000

010

2030

4050

6070

8090

55565758596061626364656667686970

010

2030

4050

6070

8090

1998 2001

% %

57

58

59

60

61

62

63

64

82 83 84 85 86 8 7 88 89 90 91 92 93 94 95 96 97 98 99 00

57

58

59

60

61

62

63

64

Women Men

Age Age

Note 1: The rise in activity rates for persons between the ages of 66 and 67 should be seen in light of thecalculation method. Thus, by definition, recipients of early-retirement benefits are not included in thelabour force, even if they have other paid employment, whereas old-age pensioners that have a minimumof 80 hours employment are included in the labour force.

Note 2: Retirement age is calculated for a 50-year-old in the labour market. It is assumed that the labour forceparticipation rate for 67-years-old is 0. The scope of early retirement was extraordinarily large in 1995(over 80,000 persons), following which the right to start receiving transitional (early retirement) benefits

was abolishedSource: Statistics Denmark.

The mainly publicly financed possibilities of retirement are part of the reason why the retirement age is 62-63. Generally,benefits in the public retirement schemes in the form of, for example, early-retirement benefit and old-age pension, are notor only to a limited extent graded according to the retirement age. (An important exception is the tax-free premium intro-duced in connection with the VERP reform in 1998 for persons entitled to early-retirement benefit who turn 62 withouthaving retired from the labour market). This reduces the financial gain that private individuals get from remaining in thelabour market beyond the age that they are entitled to receive benefits from the schemes.

5. Transparency, flexibility and modernisation of the pensionsystemAs society develops, it must be ensured that the pension system remains capable of satisfying the re-quirements posed to the system. In this context, it is important to note that changes in one area of thepension system may impact on other parts of the system. In recent years, attention has focused on thetransparency and flexibility of the pension system. More attention has also focused on individual per-sons contributory influence on their pension schemes and their possibility of making individual choices.


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the figures on an ongoing basis, so that individual policyholders/members can compare and assess theschemes.

5.2.2. Security

The security for the subsequent right to pillar 2 and pillar 3 pensions widely stems from the fact that themoney is set aside to cover the earned pension rights. In pension schemes, which are pure savingsschemes, the cover is provided by accumulation of the contribution on the individual account.

For some of the savings-based pillar 2 and pillar 3 pensions, a commitment has been made to grant apension benefit of a certain size. In Denmark, such schemes must be fully hedged in either a lifeinsurance company or a pension fund. This means that irrespective of whether a person takes out an lifeinsurance policy individually or in connection to employment or is a member of a pension fund, theremust be full coverage for the pension rights earned at any time. The purpose of this requirement is toensure that the life insurance company or the pension fund has sufficient means at all times to ensurethat private individuals or employees with an occupational pension scheme connected with theiremployment do not risk losing their earned pension rights and thus all or part of their income base onretirement. The Financial Supervisory Authority currently supervises insurance companies and pensionfunds.

To carry on life insurance and pension fund business in Denmark it is required to set up an lifeinsurance company or pensions fund, respectively, and besides the requirement for full hedging ofpension obligations a special requirement concerning these institutions capital base is imposed. In theevent that a company or pension fund fails to meet the requirements for capital base, thus endangeringthe policyholders or members interests, the Financial Supervisory Authority will demand that thecompany or pension fund make a restoration plan, the purpose of which is to re-establish the necessarycapital within a short time frame. Failing this, the company or the pension fund will come underadministration, and attempts will be made to transfer the pension schemes to other companies orpension funds having the necessary capital adequacy.

The act contains several precautions to prevent life insurance companies and pension funds from get-ting into situations where their capital bases are insufficient. Firstly, life insurance companies and pen-sion funds must be licensed by the Financial Supervisory Authority to carry on business. Secondly, themanagements of these institutions are required to be qualified and honest, and a responsible actuary

with special insurance mathematical knowledge must be appointed. Special requirements are also set tothe investments made by life insurance companies and pension funds. The investment rules are toensure the return on and quality of the investment portfolios in the companies and pension funds, sothat the company or pension fund will almost certainly be able to meet its obligations.

5.3. The importance of the pension system to labour market flexibility

The pension system should be organised in a way that avoids obstructing labour market flexibility un-necessarily. This applies to the access to pension schemes in connection with non-standard employmentas well as with job changes.

5.3.1. Access to pension schemes

It should be noted that the requirement for access to a pillar 2 pension scheme is relatively flexible. Thetypical requirement is a minimum age of 20 and 9 months of service in the line of business.


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Also, it should be noted that the Danish pillar 2 and pillar 3 pensions are similar in many ways eventhough there of course also are some differences. They are savings-based, and the size of the pensiondepends on total contributions and the return on savings. This uniformity means that groups with non-standard employment are not so dependant on coverage from pillar 2 pensions, since they can choose

to enter a pillar 3 scheme instead. It could be noted, that many of the pillar 3 pension schemes are puresavings schemes whereas the pillar 2 pension schemes typically are insurancebased. The point is,however, that the person can choose an insurancebased pillar 3 pension scheme if he or she wishes todo so.

Conditions for access to pillar 2 and pillar 3 pensions schemes, respectively, may differ slightly. If theindividual wishes to choose an insurancebased pillar 3 pension scheme, it will not be calculated on thebasis of a unisex principle, contrary to the insurancebased pillar 2 schemes. Also there will not always bea test of the persons health when joining an insurancebased pillar 2 scheme, but there will be such a test

when joining an equivalent pillar 3 scheme. There are also some differences as regards tax calculation.For example, as regards contributions to pillar 3 pensions, the right to deduct contributions can be

divided over more years than the years in which the contributions were actually made. However, thedifferences are not estimated to be so great as to impact on the choice of non-standard employment.

5.3.2. Situation in case of a job change

Most Danish labour market pensions are savings-based and the size of the subsequent pension dependson the amount of contributions paid and the return obtained on the savings14.If employees change jobs,they will not lose their pension rights. Employees continue to have the pension rights earned while they

worked in their present jobs.

When changing jobs, employees may choose to gather their labour market pension savings in the insti-tute into which the contributions from the new job are paid. The so-called job-change agreement en-sures that individuals have this transfer possibility; see box 5.1.Alternatively, individuals may choose tolet the pension assets remain in the institute, thus entitling them to the pension already earned in thatinstitute.

Box 5.1. The job-change agreement and rules in connection with relocation to another countryIt is a statutory requirement that life insurance companies and pension funds have rules involving that policy-holders and members in mandatory pension schemes can transfer their pension schemes, without losing theirpension rights, to another company or pension fund in connection with a job change or in connection withtransfer of ownership of a company or reorganisation of a company. On the basis of these rules, the insurancecompanies have made an agreement on the transfer of pension schemes, called the job-change agreement Allinsurance companies and pension funds have joined the agreementand the agreement is used in relation to

largely all schemes, i.e. also in relation to non-mandatory schemes. The agreement means that, to a far greaterextent than provided by the act, policyholders and members have the possibility of transferring their pensionschemes when they commence new employment. The agreement also implies that a transfer of a pensionscheme in connection with a job change is free of charge.

Nor are pension rights forfeited if a person gets a job abroad. However, the act lays down no rules re-garding the specific situation where a policyholder or a member moves abroad. In these situations, the

14 Many civil servants have defined benefit pension schemes. However, this group has a certain degree of flexibility inconnection with a change of jobs. When taking up a civil servant position, individuals may on certain predeterminedconditions have their pension savings converted to a civil service pension scheme. When a person leaves his/her position as

a civil servant, the earned pension right is maintained as deferred pension. The deferred pension may on certainpredetermined conditions be converted to an amount to be transferred to the persons new labour market pension scheme.


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extent to which the pension scheme can be transferred to another country depends on the terms of thelife insurance agreement or the pension scheme. Basically, however, it follows from the requirement forthe hedging of pension schemes that policyholders and members are entitled to a paid-up policy,meaning that such persons are entitled to the pension already earned, or to a withdrawal benefit equal to

the value of the paid-up policy.

Hence, the Danish pension system seems to create no unnecessary obstacles to labour market mobility.

5.4. Transparency of the overall pension system

Getting a clear picture of their overall pension rights can be difficult for individual persons, since thepension system is made up of benefits from several different schemes and sources. For example, almostall people have prospects of receiving public old-age pension supplemented by pensions from the ATPschemes. In addition, many people have entitlements from one or more of the pension schemes agreedin connection with labour market agreements.

However, individuals receive information from the various pension institutes that can be combined togive an overall picture. To make it easier for citizens, a website PensionsInfo - has been set up to helpgive them an overview; see box 5.2.

As a part of the governments plan for simplification of rules and regulations a project on developmentof a webbased system for pension calculations is started, which citizens with a right to a state civilservants pension can access by internet. The system will enable state civil to calculate their futurepension and will be connected with Pensioninfo.

Box 5.2. PensionsInfo

PensionsInfo has been set up in cooperation between a number of pension funds, life insurance companies andpublic authorities. A huge number of pension-scheme suppliers have joined the system, but not all pensions arein the system.

PensionsInfo gives an overview of:

Public old-age pension

Whole-life insurance

Disability pension

Other coverage for example coverage in the event of critical disease

PensionsInfo also provides the possibility of calculating public old-age pension, anticipatory pension or ear ly

retirement payment.

To gain access to PensionsInfo, a person must submit both his/her personal registration number and a personalpassword. With these, a person can get personal information on his/her financial circumstances on transition topension income and calculations of differences in pension rights on retirement at different ages.


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APPENDIX 1

Summary of the strategy report vis--vis the eleven objectives forsecuring the sustainability of pension systems

(The parentheses indicate the sections in the strategy report in which the subject is dealt with)

Introduction and main features of the strategyThe Danish pension system is assessed as well-balanced and able to secure present and futurepensioners adequate coverage.

The pension system and overall fiscal policies cannot be assessed independently. The standard of living

and the replacement rate provided by the pension system must be seen in conjunction with the fact thata substantial part of total public consumption is aimed at the older portion of the population. The long-term fiscal policy requirements should also be seen in light of the fact that public pensions are financedon a pay-as-you-go basis, and that large government assets in the form of deferred income tax paymentsin the savings-based pension schemes have accumulated.

If the Governments aim of reducing general government debt is achieved, fiscal policy and thus theorganisation of the pension system is assessed to be robust in relation to the ageing of the population.

To support debt repayment, etc., labour market reforms are being considered with a view of increasingthe labour force and further reduce unemployment.

In the recent years, the Danish pension system has undergone a number of changes. For example,contribution-defined and savings-based labour market pensions have become more prevalent, theanticipatory pension system has been reformed and older persons now have stronger financialincentives to remain in the labour market.

Consequently, no major adjustments in the system are planned at present.

(The introduction, etc.)

Meeting the Common Objectives

1. Adequacy of pensions

1. Ensure that older people are not placed at risk of poverty and can enjoy a decent standard ofliving; that they share in the economic well-being of their country and can accordingly

participate actively in public, social and cultural life.

In the Danish pension system, all older persons are ensured a public pension (public old-age pension),which is financed on a pay-as-you-go basis. Eligibility for public old-age pension is based on time of

residence in Denmark and is independent of previous attachment to the labour market.


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Public old-age pension secures all older persons a basic payment that, politically, is considered fair. Thecurrent rules for adjusting public old-age pension and other transfer payments mean that increases inproductivity and welfare automatically benefit pensioners.

The amount of public old-age pension should be seen in conjunction with the fact that public old-agepensioners are entitled to a number of special benefits, etc. (favourable housing benefit rules, heatingbenefits, health allowances, reduced tax on owner-occupied housing). In addition, public old-agepensioners are entitled to a number of free services, such as home help and hospital treatment. A largeproportion of public consumption in these areas is spent on the elder part of the population.

Moreover, both public and private pension provision, taken out either in relation to labour marketschemes or on a purely individual basis, supplement public old-age pension. Today, most wage earnersare covered by a labour market pension scheme.

A great majority of the political parties made a political agreement in 2000 to the effect that public old-

age pension should be the sound foundation for present and future pensioners.

(Chapters 2.2-2.3, 3, 4.1.1-4.1.2)

2. Provide access for all individuals to appropriate pension arrangements, public and/orprivate, which allow them to earn pension entitlements enabling them to maintain, to areasonable degree, their living standard after retirement.

The establishment of a number of new labour market pension schemes around 1990 and the presentexpansion of these schemes mean that most wage earners can look forward to receiving supplementary

labour market pension in addition to public old-age pension and thus a higher replacement rate whenthey start receiving pension. The labour market pension schemes are mandatory for wage earnerscovered by a collective agreement or agreements made in the individual enterprises. Persons notcovered by labour market pension schemes may take out individual pension provision on largelyuniform terms.

Moreover, the mandatory ATP (Labour Market Supplementary Pension Fund) scheme for wage earners,etc. was extended in 1993 and 1997 to include transfer payment recipients, and recipients of anticipatorypension and early-retirement benefits have been given the opportunity of paying voluntarycontributions to the scheme. Almost all persons who start receiving public old-age pension will receivesupplementary pension benefits from the ATP and SP (Special Pension Savings) schemes.

(Chapters 2.0-2.1, 3, 5.3.1)

3. Promote solidarity within and between generations.

The organisation of the pension system and the fiscal policy in general aims at promoting solidaritybetween generations.

The current rules for adjusting public old-age pension and other transfer payments thus ensure that arise in wealth is distributed between the active and the retired.


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The anticipated significant rise in replacement rates (a persons total income after tax as a pensionercompared with the persons income after tax when he/she was actively employed) is due to the graterprevalence and expansion of savings-based schemes, which involve no significant redistributionbetween generations. The replacement rate is estimated to rise from the present 74 per cent to 90 per

cent in 2045.

The replacement rate is anticipated to rise for low- and middle-income groups in particular, becausethese groups have most recently set up pension schemes. Consequently, it is expected that pensionersincome will be distributed more evenly in 2045 than today. The results should be seen in light of thefact that such long-term projections are inherently subject to many uncertainties and sensitive to thechoice of assumptions, not least including trends in real interest rates.

The debt reduction strategy is to help ensure that the anticipated growth in the number of olderpersons, and thus in expenditure on pension, etc., will not lead to rising taxes for future workinggenerations. The strategy will thus help promote solidarity between generations in future, since a

combination of rising expenditure on older persons and rising taxes may otherwise put solidarity underpressure.

(Chapters 2.1.3, 2.3, 3, 4.0).

2. Financial sustainability of pension systems

4. Achieve a high level of employment through, where necessary, comprehensive labourmarket reforms, as provided by the European Employment Strategy and in a way consistentwith the BEPG.

The Government aims to increase employment by 87,000 persons up to 2010. The main part of theincrease is to be generated from a rise in the labour force of 67,000 persons, while a further reduction ofunemployment is to contribute the remaining 20,000 persons. The possibilities for realising the rise inthe labour force must be seen in the light of the implemented reforms of, for example, the transferpayment, voluntary early-retirement pay and anticipatory pension schemes.

In autumn 2002, the Government will present an action plan for More people in work, which willfocus on more flexible measures aimed at finding the fastest way to employment, promoting greaterefficiency in the initiatives to find people jobs and ensuring that work pays. Special attention will be

focused on increasing labour force participation rates for immigrants.

The Governments objectives should be seen in conjunction with the fact that, by internationalstandards, Danish employment and activity rates are already high, and higher than the objectives set inLisbon.

Trends in, for example, the labour force are being followed continuously. The need for further reformswill depend on whether the initiatives taken have the desired effect.

(Chapter 4.2.)


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5. Ensure that, alongside labour market and economic policies, all relevant branches of socialprotection, in particular pension systems, offer effective incentives for the participation ofolder worker

Documents

da_pensionreport_en.pdf