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Pensions Core Course 2013: The Payout

  1. The Payout Phase For Pensions Will Price World Bank Pension Core Course April 2013
  2. The payout phase is a critical part of a pension system but receives far too little attention. It is central to the ultimate outcome of income security 2 Economic and political Environment Overall Framework – other pillars and key rules Supervision Market Structure, Entities and Conduct Efficiency Sustainability Security Coverage Adequacy Pension System Features Ultimate Outcomes
  3. Payout phase has many different potential products, rules and institutions. • Products • Lump Sums • Phased Withdrawals • Annuities (of differing types) • Most countries restrict lump sums to ensure minimum annuitization • Need to have the right capital market and regulatory structure for some types of payments • Risks of deliver can be born by insurance companies, pension funds, the government and arms length government bodies – all have to deal with core risks of longevity 3
  4. 1997+25 years: IMSS DC Annuity Market starts (AFORE + Gov MPG pays Ins Co. 2030 before many workers eligible Invalidity & Occ Risk (IV+RT) AFORE balance, plus IMSS, plus Gov for MPG pays Ins Co annuity ISSSTE Recognition Bond plus AFORE balance plus Gov MPG pay Ins Co annuity Private Sector Insurance Companies supply annuities for IMSS + ISSSTE (DB Invalidity Pension (IV+RT) (DC Retirement Pension -RCV), AFOREs offered Phased Withdrawals. Lump sums also taken. Public sector (IMSS, ISSSTE and Government administers and pays for DB Bens (IV+RT + RCV) part funded by part of the balances accumulated in AFOREs post 1997 1997 2007 2022 2030 2046 2052 2060 IV+RT IMSS under LSS73 - IMSS admin & Gov pays after AFORE balance potentially new retirees until 2047 (1997 plus 48 year career to 65) RCV IMSS 1973 Law - IMSS admin & Gov pays after AFORE balance used RCV – ISSSTE – pre 2007ISSSTE admin and Gov pays after ISSSTE balance – potentially until 2052 – 2007 and 45 year career to 60 (age of retirement in ISSSTE rising from 51 in 2010 to 60 by 2028 Government pays basic poverty alleviation (e.g. 70 y Mas) 1997+25 years: AFOREs offer IMSS Phased Withdrawals ISSSTE Recognition Bond plus AFORE balance – AFORE phased withdrawals There are multiple – and often complex – mechanisms to payout retirement income – as shown by this example of Mexico
  5. There are a wide range of products and variations 5 Risk Characteristics of Retirement Products for Pensioners Protection offered Benefits provided Longevity risk Investment risk Inflation riskRetirement product Bequest Liquidity Fixed real life annuities Yes Yes Yes Limited No Fixed nominal life annuities Yes Yes No Limited No Escalating real life annuities Yes Yes Yes Plus Escalating nominal life …... ….. ..annuities Yes Yes Partial Limited No Variable life annuities, .guaranteed benefits Yes Yes Possible Limited No Variable life annuities, bonus payments Shared Shared Shared Limited No Variable life annuities, unit linked Shared No No Limited No Lifetime phased …. …. … .. ..withdrawals No No Possible Yes No Term annuities No Possible Possible Yes No Lump sum No Possible Possible Yes Yes Self-annuitization No Possible Possible Yes Yes
  6. Regulation needs to determine who will provide any given product Centralized provision as adopted in Denmark and Sweden Advantages: Large risk pooling; Scale Economies; Risk sharing Disadvantages: Political interference in annuity pricing possible; Political interference in asset management Decentralization as in Chile and UK also has risks and advantages Using individual choice has the same issues during the accumulation phase You can combine decentralized provision with auctions to tackle issues with sales agents Bulk auctions also a possibility 6
  7. There are a range of risks that are being transferred when moving from accumulation to payout Shortfall Equities Bonds Insured Liabilities Before Risk removed Shortfall Equities     Subset of liabilities typically targeted Risk removed Shortfall Equities Bonds     Subset of liabilities typically targeted Risk removed Shortfall 1     Subset of liabilities typically targeted 1Shortfall paid either immediately or crystallised into a series of regular known payment 2 Diagram shows position just before issue of individual member policies Source: LCP Pansion Buy-ins, Buy-outs and Longevity Swaps 2012 Full buy-out Insurance Policy Insured Liabilities Pensioners Non-pensioners     Buy-in Insurance Policy Interest rate risk Inflation risk Asset risk Longevity risk Longevity swap Interest rate risk Inflation risk Asset risk Longevity riskResidual Liabilities Insured Liabilities Pensioners Non-pensioners   Residual Liabilities Hedged LiabilitiesBonds Interest rate risk Inflation risk Asset risk Longevity risk Pensioners Non-pensioners
  8. The Chilean’s pioneered an auction approach
  9. Mexico has also established an auction platform
  10. The ‘value’ of an annuity can be compared using a Money’s Worth Ratio – with care to ensure they are properly constructed Money's Worth Ratios in Selected Countries Computed with Cohort Annuitant Table and Risk-Rate Australia Canada Switzerland UK 1 UK UK 2 UK 3 (James) (James) (James) (James) (Cannon) (James) (Brown) Nominal Annuities Male, Age 55 - - - - - 0.921 0.934 Male, Age 65 1.013 0.981 1.046 - 0.977 0.908 0.927 Female, Age 55 - - - - - 0.928 0.937 Female, Age 65 1.002 0.976 1.036 - 0.979 0.907 0.927 Joint 0.988 0.98 0.985 0.981 0.987 - 0.929 Indexed Annuities Male, Age 55 - - - - - 0.867 - Male, Age 65 - - - - 0.887 0.854 0.822 Female, Age 55 - - - - - 0.876 - Female, Age 65 - - - - 0.877 0.857 0.782 Joint - - - - 0.88 - - Rocha and Thorburn (200&) citing various sources Notes: 1 Cannon and Tonk's estimate is the overall average, 2 for males 60 and 65 and females 60 and 65; 3 MWR for indexed annuities in the U.S. relate to annuities offered by Irish Life of North America (ILONA), which have never been sold
  11. Regulation of Providers has wide range of considerations • Prudential rules – insurance based options like Solvency II but modern risk based solvency capital can be difficult • Who and how do you choose allocation of risk • Investment allocation rules • Risk based supervision • Availability of capital market instruments
  12. Conclusion • Payout is fundamental – needs to be tackled urgently • Can’t say what you pension system is trying to achieve without setting out pay out phase • Need to chose type of product –annuities only product that guarantees income till death • Type of institution • Type of regulation 12
  13. Will Price 13