FDC’s legal mission is to manage the compensation reserve of the general pension insurance scheme and to achieve an effective return while diversifying risks. FDC’s creation was thus initiated in the context of allowing the compensation reserve benefit from financial market movements.
FDC was established by the amended law of 6 May 2004 on the administration of the assets of the general pension insurance scheme. Its mission is to prudentially manage the compensation reserve of the general pension insurance scheme and to achieve an effective return while diversifying risks. In this way, article 248 of the Social Security Code provides that:
The compensation reserve is invested in order to ensure the long-term viability of the general pension insurance scheme. To ensure the security of investments, all the assets and liabilities, the financial situation as well as the structure and foreseeable evolution of the pension scheme shall be taken into account. Investments shall comply with the principles of appropriate risk diversification. To this end, the assets must be spread across different investment classes as well as different economic and geographical sectors.
As such, FDC’s creation was initiated in the context of allowing the compensation reserve benefit from financial market movements by diversifying the assets in a portfolio that takes into account strict risk and return criteria.
As part of its mission and in accordance with the amended law of 13 February 2007 on specialised investment funds, FDC created a collective investment scheme in the form of an open-ended investment company with legal status of a public limited company in 2007. This company, entitled Fonds de Compensation de la Sécurité Sociale, SICAV-FIS and subject to the supervision of the Commission de Surveillance du Secteur Financier, has since then been FDC’s investment vehicle. A large part of the compensation reserve entrusted to FDC is invested through the SICAV, knowing that a Grand-Ducal regulation imposes limits to the values of the compensation reserve that might be invested through collective investment undertakings.
General pension insurance scheme and compensation reserve
The basis of the Luxembourg pension system is the general pension insurance scheme covering the private sector. This scheme is compulsory for everyone working in the Grand Duchy of Luxembourg. The National Pension Insurance Fund is responsible for the management of the pension insurance under the general scheme. The general scheme is based on a pure pay-as-you-go system (i.e. pension contributions paid by the working population are used to finance pension benefits paid to pensioners) on the basis of ten-year coverage periods and with a compulsory creation of a compensation reserve equivalent to 1.5 times the annual pension liabilities.
The fact that the global contribution rate, which is currently set at 24% and is split equally between employees, employers and the State, and which has regularly exceeded the overall distribution rate in the past (i.e. the ratio of current expenditures to total contribution income derived from pensionable wages, salaries and revenues) has enabled the general scheme to generate substantial financial surpluses and to build up a reserve well in excess of the amount required by law.
The compensation reserve is neither an actuarial reserve to cover benefits due nor an actuarial reserve to cover any expectations of the insured. The purpose of this reserve is exclusively to mitigate external disruptions in terms of contribution income or liabilities which, in a pure pay-as-you-go system, can lead to sudden changes in the contribution rate.
Moreover, this reserve can only contribute to a limited extend to the financing of future pension liabilities given the characteristics of the general scheme, such as the adaptation of pension benefits to the cost of living index and the real level of wages or a risk community open to future generations. In fact, the return on the reserve will have to be used primarily to adjust it to the rising level of pension benefits and the increase in the number of insured persons in order to maintain its relative level and will therefore hardly allow the global contribution rate to be reduced below the global distribution rate.