Risk Based Supervision Of Pension Institutions In Denmark

Abstract: This paper examines the move towards risk-based supervision of pension institutions in Denmark. Although Denmark has not adopted a comprehensive model to assess risk it has developed a number of building blocks which it uses for risk-based assessment. The motivations for improving risk assessment include a desire to identify emerging problems, and concerns about the solvency of pension institutions. In Denmark there is extensive use of guaranteed minimum returns in both the accumulation and payout phases which create substantial obligations on pension institutions, and focus attention on the integrity and solvency of the institutions which provide them. In conjunction with freeing up investment restrictions and moving towards market valuation of assets, the supervisor has introduced a 'traffic light' stress test model which calculates the effect of several market scenarios - the red test which is the more plausible and the yellow test which is possible but less likely. In addition to the use of the traffic light system, there has been a growing emphasis on the adequacy of internal risk control systems and greater reliance on market discipline. Pension institutions have sought to reduce their exposure to market volatility by better matching of assets and liabilities. There is a much better understanding of the risks inherent in the pension institutions' portfolios, and there has been a substantial increase in the use of hedging instruments.

This paper examines the move towards risk-based supervision of pension institutions in Denmark. Although Denmark has not adopted a comprehensive model to assess risk it has developed a number of building blocks which it uses for risk-based assessment. The motivations for improving risk assessment include a desire to identify emerging problems, and concerns about the solvency of pension institutions. In Denmark there is extensive use of guaranteed minimum returns in both the accumulation and payout phases which create substantial obligations on pension institutions, and focus attention on the integrity and solvency of the institutions which provide them. In conjunction with freeing up investment restrictions and moving towards market valuation of assets, the supervisor has introduced a 'traffic light' stress test model which calculates the effect of several market scenarios - the red test which is the more plausible and the yellow test which is possible but less likely. In addition to the use of the traffic light system, there has been a growing emphasis on the adequacy of internal risk control systems and greater reliance on market discipline. Pension institutions have sought to reduce their exposure to market volatility by better matching of assets and liabilities. There is a much better understanding of the risks inherent in the pension institutions' portfolios, and there has been a substantial increase in the use of hedging instruments.

This paper examines the move towards risk-based supervision of pension institutions in Denmark. Although Denmark has not adopted a comprehensive model to assess risk it has developed a number of building blocks which it uses for risk-based assessment. The motivations for improving risk assessment include a desire to identify emerging problems, and concerns about the solvency of pension institutions. In Denmark there is extensive use of guaranteed minimum returns in both the accumulation and payout phases which create substantial obligations on pension institutions, and focus attention on the integrity and solvency of the institutions which provide them. In conjunction with freeing up investment restrictions and moving towards market valuation of assets, the supervisor has introduced a 'traffic light' stress test model which calculates the effect of several market scenarios - the red test which is the more plausible and the yellow test which is possible but less likely. In addition to the use of the traffic light system, there has been a growing emphasis on the adequacy of internal risk control systems and greater reliance on market discipline. Pension institutions have sought to reduce their exposure to market volatility by better matching of assets and liabilities. There is a much better understanding of the risks inherent in the pension institutions' portfolios, and there has been a substantial increase in the use of hedging instruments.

'Risk-Based Supervision of Pension Funds' provides a review of the design and experience of risk-based pension fund supervision in countries that have been leaders in the development of these methods. The utilization of risk-based methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries, including pension funds and insurers. The trend toward risk-based supervision of pensions reflects an increasing focus on risk management in both banking and insurance based on three key elements: capital requirements, supervisory review, and market discipline. Although similar in concept to the techniques developed in banking, its application to pension funds has required modifications, particularly for defined contribution funds that transfer investment risk to fund members. The countries examined–Australia, Denmark, Mexico, and the Netherlands–provide a range of experience that illustrates both the diversity of pension systems and the approaches to risk-based supervision, and also presents a commonality of focus on sound risk management and effective supervisory outcomes.

Risk-Based Supervision of Pension Funds provides a review of the design and experience of risk-based pension fund supervision in countries that have been leaders in the development of these methods. The utilization of risk-based methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries, including pension funds and insurers. The trend toward risk-based supervision of pensions reflects an increasing focus on risk management in both banking and insurance based on three key elements: capital requirements, supervisory review, and market discipline. Although similar in concept to the techniques developed in banking, its application to pension funds has required modifications, particularly for defined contribution funds that transfer investment risk to fund members. The countries examined - Australia, Denmark, Mexico, and the Netherlands - provide a range of experience that illustrates both the diversity of pension systems and the approaches to risk-based supervision, and also presents a commonality of focus on sound risk management and effective supervisory outcomes.

This paper provides a review of the design and experience of risk-based pension fund supervision in several countries that have been leaders in the development of these methods. The utilization of risk-based methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries including pension funds and insurers. The trend toward risk-based supervision of pensions is closely associated with movement toward the integration of pension supervision with that of banking and other financial services into a single national authority. Although similar in concept to the techniques developed in banking, the application to pension funds has required modifications, particularly for defined contribution funds that transfer investment risk to fund members. The countries examined provide a range of experiences that illustrate both the diversity of pension systems and approaches to risk-based supervision, but also a commonality of the focus on sound risk management and effective supervisory outcomes. The paper provides a description of pension supervision in Australia, Denmark, Mexico and the Netherlands, and an initial evaluation of the results achieved in relation to the underlying objectives.

Subject: This paper considers the overall structure of the Danish pension system, reviews the relative role of different types of pension institutions, and discusses their asset allocation strategies and investment performance. The paper also examines the regulation and supervision of providers of pension services, the growing reliance on risk-based supervision, and the application of the so-called contribution principle. The Danish pension system includes a modest universal social pension with a supplement for low-income pensioners and near universal participation in occupational and personal pensions that are primarily based on defined contribution plans. The annuity market is well developed: 50 percent of annual contributions are allocated to the purchase of deferred annuities, while immediate annuities are also purchased at or even after retirement. However, detailed comprehensive data on the rate of annuitization are lacking. Distinct features of the Danish pension system include the widespread use of profit participating contracts with minimum guaranteed benefits and regular provision of bonuses, covering both the accumulation and payout phases, and extensive use of group deferred annuity contracts. A new traffic light system with periodic stress testing has resulted in greater emphasis on asset liability matching and hedging strategies by pension institutions and a shift in investment policies in favor of foreign bonds and long-term swap contracts

This paper provides a review of the design and experience of risk-based pension fund supervision in several countries that have been leaders in the development of these methods. The utilization of risk-based methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries including pension funds and insurers. The trend toward risk-based supervision of pensions is closely associated with movement toward the integration of pension supervision with that of banking and other financial services into a single national authority. Although similar in concept to the techniques developed in banking, the application to pension funds has required modifications, particularly for defined contribution funds that transfer investment risk to fund members. The countries examined provide a range of experiences that illustrate both the diversity of pension systems and approaches to risk-based supervision, but also a commonality of the focus on sound risk management and effective supervisory outcomes. The paper provides a description of pension supervision in Australia, Denmark, Mexico and the Netherlands, and an initial evaluation of the results achieved in relation to the underlying objectives.

This paper considers the overall structure of the Danish pension system, reviews the relative role of different types of pension institutions, and discusses their asset allocation strategies and investment performance. The paper also examines the regulation and supervision of providers of pension services, the growing reliance on risk-based supervision, and the application of the so-called contribution principle. The Danish pension system includes a modest universal social pension with a supplement for low-income pensioners and near universal participation in occupational and personal pensions that are primarily based on defined contribution plans. The annuity market is well developed: 50 percent of annual contributions are allocated to the purchase of deferred annuities, while immediate annuities are also purchased at or even after retirement. However, detailed comprehensive data on the rate of annuitization are lacking. Distinct features of the Danish pension system include the widespread use of profit participating contracts with minimum guaranteed benefits and regular provision of bonuses, covering both the accumulation and payout phases, and extensive use of group deferred annuity contracts. A new traffic light system with periodic stress testing has resulted in greater emphasis on asset liability matching and hedging strategies by pension institutions and a shift in investment policies in favor of foreign bonds and long-term swap contracts.