variable payout annuities. The infamous mis-selling scandal of personal pensions in the United Kingdom in the late 1980s and early 1990s (see Box 2) adds credence to this concern.

The right to switch annuity providers is a useful consumer protection feature when providers make drastic changes in their marketing policies or are involved in mergers with other companies with very different risk profiles (see further discussion in section 6). In these circumstances, any exit fees should be suspended in order to allow undeterred switching. In addition, rules should be

# **Box 3: The Regulation of Profit Sharing in Denmark**

In Denmark, the insurance companies and pension funds that offer profit participating annuities are required to submit to the supervisor an annual notification indicating their policy of profit distribution between policyholders and shareholders, essentially by setting out the rules and assumptions for the calculation of the part of the annual result that accrues to their equity. This is often a focus of attention in the media and an important parameter affecting the competitive environment among the companies. In order to improve market transparency and comparability, the supervisor has issued a guidance on this topic. Providers do not have to comply with the guidelines but if they do the supervisor will be less likely to ask for additional explanations.

In the notification, each institution must divide the equity's part of the result into one part related to the return on equity, which is normally equal to the return offered to policyholders, and one part reflecting the extent of the risk incumbent on equity. It must also explain the rationale for the particular allocation. The notification must be in place before the beginning of the accounting year. Among other things it must specify how much extra return could be awarded to the insured if the equity was not rewarded with a risk premium. The company must classify the assumptions behind the calculation of the risk premium into: risks which are not specific to the company in question, such as financial risks, biometric risks and risks relating to cost assumptions; and risks related to the business plan of the specific company, such as its investment strategy and reinsurance program.

A company is not allowed to change the principles and assumptions governing the calculation of the risk premium during the year but has the right to change its policy when the notification to the supervisor must be renewed. No later than eight days after board approval of the annual distribution of profits between policyholders and shareholders, the providers must notify the supervisor as to the _actual_ risk premium awarded to equity. Hence, the expected and actual risk premium to equity can be compared and any difference explained. The notification must also specify the amount of the equity risk premium that will not be transferred to the equity capital because the annual result is not expected to be sufficient. A larger part to owners than to policyholders may only be distributed to own funds, when this larger part plus the amounts distributed to the insurance portfolio can be covered by the result for the year. If the result for the year is not sufficient to allow distribution to own funds, the shortfall is recorded in a shadow account and is recovered from future profits.

The aim of this regulation is not to establish maximum ceilings on the risk premium to be allocated to shareholders, but to force the management to consider the risks facing equity holders and thus ensure that the remuneration of both policyholders and shareholders is fair and based on clearly specified criteria. The supervisor compiles and publishes an annual comparative table on the extra return that could be awarded to policyholders if the equity was not rewarded with a risk premium. This provides some indication of the comparative performance of different providers. However, to be fully satisfactory, the table should also include data on the level of operating costs of different providers and the returns obtained by policyholders. The complexity of products and the great variation in the terms and conditions of the multitude of collective labor agreements has impeded the compilation of such a comprehensive database, although it can also be argued that the presence of labor market associations, representing both workers and employers, may have reduced the need for it. Whatever the reason, the market suffers from the lack of completely meaningful transparency.

Source: Danish FSA, Andersen and Skjodt (2007).

adopted to ensure that exit fees are not excessive and that portable balances are not subject to improper valuations.

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