> <sup>- 2 -</sup>

unemployment, were not included. Taking more years into account shows a higher coverage and provides a more realistic picture of overall coverage. A study concerning occupational pension schemes in the period 1995-2000 shows that 93 percent earned the right to an occupational pension in at least one year of the period. This figure compares to the 80 percent in 2003 only.<sup>2</sup> Another characteristic of the Danish pension system is the extensive use of guaranteed minimum benefits in the second and third pillars. Plans operated by insurance companies and multi-employer pension funds offer both guaranteed minimum investment returns and guaranteed annuity conversion factors in both the second and third pillars. Banks do not offer guaranteed minimum investment returns and are not allowed to offer annuities.

The use of guaranteed benefits in occupational pension plans has been promoted by the active involvement of labor unions in collective bargaining and a strong emphasis on risk sharing arrangements that aim to protect retiring workers from large fluctuations in investment returns. The use of guaranteed annuity conversion factors involves the use of group annuities that reduce the occurrence of adverse selection in the decision to annuitize and lower the cost of annuities.

Like the pension systems of most economically advanced and demographically mature countries, the Danish pension system faces a number of important policy challenges. The first is the impact of the rapid aging of Danish society on the sustainability of the level of promised benefits. The second challenge concerns the financial security of guaranteed benefits, an issue that is linked to the efficiency of risk management and the appropriateness of the risk sharing arrangements used in Denmark. A third challenge is the effectiveness of regulation and supervision and its contribution toward adopting adequate risk management practices.

The main objective of this paper is to assess the adequacy and efficiency of risk sharing arrangements and risk management practices in the Danish pension and annuity market. Chapter II considers the overall structure of the pension system and reviews the relative role of different pension institutions. It also discusses the asset allocation and investment performance of different institutions and reviews the types of retirement products that are offered in Denmark. Chapter III focuses on the regulation and supervision of providers of pension services. It places particular emphasis on the growing reliance on risk-based supervision and the application of the so-called contribution principle. Chapter IV assesses the efficiency of risk sharing arrangements in Denmark. Risk sharing plays a significant role in the Danish pension system, but it raises challenging policy issues concerning equity and sustainability. The last chapter offers some concluding remarks.

The analysis has been constrained by the difficulty of calculating Money’s Worth Ratios (MWRs) for the different types of annuities. Because the Danish system relies extensively on the allocation and distribution of bonuses, calculation of MWRs would

> 2 The study was carried out by The Ministry of Economic and Business Affairs in the report “Increased Freedom of Choice in Pension Saving”, May 2003.