27

**Table 10: Simulation Results of Change in Interest Rates**

|Year|Change|Liabilities<br>DKKbn|Assets<br>DKKbn|AL Gains<br>DKKbn|Derivatives<br>DKKbn|Net Gains<br>DKKbn|
|---|---|---|---|---|---|---|
|2001|-1%|-65.0|49.4|-15.6||-15.6|
|2002|-1%|-66.6|26.7|-39.9|25.1|-14.8|
|2003|-1%|-52.0|40.2|-11.8|26.9|15.1|
|2004|-1%|-76.1|40.7|-35.4|43.8|8.4|

_Source_ : Ladekarl et al, 2006 In addition to these changes in asset allocation, there were also other important changes in the rules for profit distribution (the Danish system is dominated by risksharing or profit-sharing policies, as mentioned before). Until recently, most institutions set the rate of profit distribution to clients one year ahead. This rate was an important competitive parameter among pension institutions. However, after 2002, many institutions introduced a variable rate of profit distribution that depends on investment performance during the year. This more flexible approach made it easier for institutions to meet their obligations, but coupled with the substantial reduction in guaranteed rates of return it created considerable uncertainty in the eyes of policyholders.

Overall, the introduction of risk-based supervision in Denmark has led institutions to reduce their asset-liability mismatches through changes in asset allocation and greater use of derivatives. One important consequence of these adjustments has been the decline in the expected rate of return on the portfolio and the decreased enthusiasm of providers to offer benefit guarantees. The greater use of derivatives has apparently helped companies reduce asset-liability mismatches at a reasonable cost but does not seem to have been able to arrest a decline in the expected rate of return. Interestingly, new clients have been more willing to take more risk in exchange for a higher expected return, as indicated by the growth of unit-linked and other products that are offered without any guarantees or with reduced levels of guarantee. Therefore, the Danish system seems to be moving towards a more traditional DC system with fewer guarantees.

These trends seem to contradict the conclusion of other researchers, that the use of derivatives (especially long-term interest swaps) has allowed Danish companies to address the mismatches and also preserve returns.<sup>13</sup> On the contrary, the available evidence suggests that the new risk-based rules have induced pension funds to hold more conservative portfolios and lower guarantees, and that young members are favoring contracts that entail higher expected returns and more volatility. This is an area that should merit more research, as it would throw more light on the impact of risk-based supervision on portfolio strategies.

# **3. Australia**

There are two main elements to changes in the risk-based supervisory framework in Australia which have had an impact on superannuation (pension) funds over the past few years. The first to be introduced was the PAIRS/SOARS framework. The second was the introduction of a comprehensive licensing framework for all superannuation funds.

The PAIRS/SOARS framework was intended to improve APRA's supervisory performance and not directly impact on the industry. APRA assesses the timeliness and