Contents
The section covers
- Rule
- EU regulation of life insurance companies and pension funds
- Description of traditional Danish life insurance and pension fund plans
- Description of unit-linked plans
Rule
The taxable yield on plans with life insurance companies and pension funds covered by Section 1(1), Item 1 of PAL is determined at custody account level as the development in the value of the pension holder's custody account. See Section 4(1) of PAL.
The purpose of taxation at custody account level is that the entire return on the custody account of the person liable to taxation is subject to taxation.
Plans with life insurance companies and pension funds are characterised by containing an insurance element. The individual pension holder's yield is thus not necessarily directly related to the yield on specific underlying assets. An exception to this are unit-linked plans in which the pension holder's yield is directly related to specific underlying assets.
The taxable yield on plans with life insurance companies and pension funds covered by Section 1(1), Item 1 of PAL is determined as the difference between the value of the policy's custody account at the end of the year of taxation (end-of-year custody account) adjusted under Section 4(3) of PAL and the value of the policy's custody account at the beginning of the year of taxation (beginning-of-year custody account) adjusted under Section 4(4) of PAL.
Transfers to the custody account which are included in the basis of taxation under Section 4(5) of PAL are exempt from this, see section B.3.2.2, Special conditions in relation to claims for a share of non-allocated bonus reserves.
See section B.3.2, Determining the basis of taxation in respect of pension plans with life insurance companies and pension funds.
EU regulation of life insurance companies and pension funds
Within the EU, the activities of life insurance companies are regulated by Directive 2002/83/EC of 5 November 2002 concerning life assurance. The directive concerns the access to direct life assurance pursued through companies established in a member state. The directive has also been implemented by the EEA states. Within the EU, the activities of pension funds are regulated by Directive 2003/41/EC of 3 June 2003.
Description of traditional Danish life insurance and pension fund plans
Most pension plans with Danish life insurance companies and pension funds are based on an insurance-technical system of guaranteed pension benefits. The guarantee system is not a specifically Danish phenomenon. It is known in various forms worldwide as a characteristic feature of life insurance and pension plans.
The connection between the pension provider's commitment in relation to individual pension holders and the pension contribution is thus based on a number of assumptions in relation to interest, mortality, disability frequency and costs; the connection appears from the technical basis of the life insurance company and the pension fund. In popular terms, the company etc. can calculate the retirement pension which will be available for disbursement when assuming a future interest rate (basic interest rate), when factoring in regular deductions of costs for the administration of the policy and for pension disbursements to those who become disabled and, finally, when taking into account that some people die before reaching normal pension age.
In principle, all insurance aims to distribute risks among the participants in the insurance portfolio. This also applies to life insurance and pension plans. A redistribution therefore takes place among the joint risk-takers. The redistribution is obvious in connection with disablement and death. Via their premiums, those who remain healthy pay compensation to those who lose their working capacity. In the event of death, the joint risk-takers pay compensation to the dependants for the loss of dependency. A redistribution also takes place in connection with age cover. The retirement pension is covered by the portfolio savings, but those who die earlier than the average pay by forgoing additional disbursements for the benefit of those who live longer.
The policyholder pays for the company assuming of the risk of the risk event occurring through a deduction in the premium, a so-called risk premium. Conversely, there is also the likelihood that the risk is never realised, in which case the policyholder's savings are distributed to the other policyholders.
In order to ensure that the company etc., when the time comes, has sufficient funds to comply with the pension provider's commitments in relation to individual pension holders, the assumptions about interest, risks and costs have been fixed on a prudent basis.
The - prudent - assumptions about interest, risks and costs etc. which form the basis of the calculation of the premium or pension benefit mean that the company etc. obtains a gain on the pension plans taken out. This gain enables the company etc. to pay a bonus.
A bonus contribution can be attached to each bonus element:
- Interest bonus is due to the company achieving a higher return than assumed when calculating the premium.
- Risk bonus is due to the difference between the mortality and disability rates assumed in the technical basis and the actual conditions.
- Cost bonus stems from a lower cost level than assumed in the technical basis.
Bonus thus arises on the basis of a surplus from the interest, risk and cost elements.
The company etc. must regularly consider how large a part of the realised results is to be paid to the pension holders in the form of bonus. Unless otherwise agreed for bonus-entitled policies the equity share of the realised results follows from the Danish Executive Order on the Contribution Principle (Kontributionsbekendtgørelsen).
The realised results mean the insurance-technical results achieved in the accounting period adjusted for, among other things, transferred investment yield, tax on yields from pension assets (PAL tax), bonus, special bonus provisions and changes in the market value adjustment. See Section 2 of Executive Order no. 1066 of 27 October 2006 on the Contribution Principle.
The Danish companies which operate with custody account interest traditionally fix the custody account interest in December prior to the forthcoming calendar year, and the custody account interest must therefore be based on a forecast of the investment yield for the subsequent year as well as the remainder of the current year. The custody account interest is the interest rate at which a life insurance policy's account reserve accrues interest, i.e. interest in accordance with the plan plus interest bonus.
The accrual of interest is based on the traditional schemes under the average rate of interest principle. The average rate of interest principle means that the return on a life insurance policy's saved reserve is not linked to specific securities or investments, but rather to the yield which the insurance company achieves on average on all of its investment assets. The yield which the individual policyholder obtains is therefore basically independent of whether he or she took out the policy at a time when interest rates were high or low. The principle entails that interest will accrue to all members of the plan in the individual year at the same interest rate irrespective of the basic interest rate applied when the pension plan was taken out.
In Danish companies etc., bonus is usually utilised for a proportionate revaluation of the policies (taking out supplementary insurance). However, bonus can also be accumulated in a special account ‘belonging' to the individual policyholder. This bonus is payable with interest when the policy is withdrawn from the insurance portfolio, either in connection with the occurrence of the insured event or upon the expiry of the policy (bonus accumulation), and can be used to reduce the future pension contributions or disbursed in cash.
Description of unit-linked plans
If a pension saver wants to exert direct influence on the investment of his or her pension funds, there is an alternative available in the form of pension products covered by insurance class III - so-called unit-linked plans.
Under unit-linked plans, the pension saver's yield reflects the yield on the investments actually made (market yield). Various types of guarantees can, however, be taken out in conjunction with unit-linked plans - e.g. a 0 per cent guarantee - typically, however, only against explicit payment and limitation of the portfolio selection. Under pure unit-linked plans, i.e. plans without any guarantee attached, the actual yield, both positive and negative, will be credited to the pension saver each year. Over the last few years, plans have been introduced, however, under which the yield is evened out over time.
Unit-linked pension plans offer the client the chance to compose a portfolio of different securities.
Under the unit-linked plans, the client pays a contribution fee and a fee if the client wants to withdraw the contribution again. Add to that, a regular annual fee as well as a commission in connection with changes to the client's portfolio. If a guarantee is attached to the plan, a separate fee will often be payable for such a guarantee.