Comparison of variable annuities between The Netherlands and Denmark
Recently, the Dutch parliament passed a law that enables retirees to invest their pension wealth of Defined Contribution products in risky assets during the decumulation phase. Before that law it was compulsory to convert pension wealth at retirement in a life-long fixed annuity. Under the new law, life-long variable annuities are allowed as well. Products related to the new law are now entering the market in The Netherlands, as well as in Denmark and Sweden. The Dutch law is called Improved Defined Contribution Scheme Act (Wet Verbeterde Premieregeling). These variable annuities are offered by several insurance and pension companies.
A variable annuity gives a stream of cash flows that can vary through time, as opposed to a fixed annuity which consists of guaranteed payments. By the new law, it is now possible to invest in risky assets after retirement such that the expected payments include the risk premium. The trade-off is that the payments are no longer free of risk. While for pension payments, uncertainty is typically not preferred. We can combine variable annuities with guarantees in the form of fixed annuities such that there is a certain lower bound on pension payments.
In Denmark, the regulations are still based on life-long fixed annuities however the relaxation of the guarantees are being discussed as some pensions funds have already privatized the risk by offering life-long variable annuities. Moreover, the expected pension payments are in some funds also adjusted for increases in life expectancies. A new proposal by the Danish Authority of financial regulations on variable annuities is expected to be published in March 2017.
In this project we investigate the differences in the pension products and regulation between The Netherlands and Denmark. The particular choice of the assumed interest rate (AIR) and the effect of smoothing financial market shocks can be shown in terms of a division of the initial capital over the remaining life-time or in terms of a dynamic deduction for pension payment. The first interpretation gives rise to comparisons of pension payments through time. The current law seems to protect retirees against decreasing pension payments by a maximum allowance of risk on the assumed interest rate. How the patterns of available products look like and which options customers have are questions that we investigate, e.g. whether this is common among the products within the country and among the countries and what the mechanism is that drives these expected payments. Likewise we investigate the impact of additional drawdown options and the impact of cumulation of these options.
In The Netherlands this refers e.g. to the option to take out more money in initial years (“high-low”) to compensate for an early start of retirement due to the lack of flexibility in the eligibility of the age for the state pension (AOW compensation). In Denmark this refers to the option of either partial annuitization and/or partial lump-sums. At retirement, this option is exercised by half of the workers as 35 percent opt for phased withdrawals and 15 percent for lump-sums. The flexibility in the Danish system allows for withdrawals (full or partial) prior to retirement at the cost of significant taxation rates of up to 60% as well as reduced pension payments from (if eligible) early retirement programs.
Hence, we plan a thorough comparison between the pension regulation in The Netherlands and in Denmark and relate that to the academic literature on what would be a desirable pension product. Some issues that we address are; which risk are to be insured? Is micro longevity risk hedged, is this mandatory? How do unexpected increases in life expectancy affect the variable annuity payments? How much choice variables are present in the available products? What is the impact of the choice on the pension income during retirement and is it possible to investigate the adequacy? And is the investment of pension capital in the accumulation phase adapted to the risk exposure in the decumulation phase? We can summarize these questions by; what are and were the differences between the new laws in each country? And in general, how are both pension system organized?