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Pension Payouts. Risks and
Alternatives
Solange Berstein
Superintendent of Pension Fund
Administrators, Chile.
Agenda
Product design
The Chilean Experience
Why do people annuitize?
Money worth ratios
Intermediation of retirement products
Conclusions
Design of Pension payouts
Myopic behavior at the accumulation phase: Is it
over at time of retirement?
Risks faced during the accumulation phase: Are
they the same during retirement?
Tolerance towards risk during accumulation: Are
they the same during retirement?
Preferences during accumulation phase: Are they
the same during retirement?
Design of Pension payouts
If myopia is not a problem: Strong case for lump-sum.
Risks at retirement: Longevity risk
Financial risk
Interest rate risk (Affect timing of retirement)
Inflation risk
Tolerance to these risks may decrease at retirement
Consumption preferences may differ: Bequest motive becomes more relevant.
Different pension options provide different coverage for these risks
Selecting Among Pension Options
Annuities:
Provide longevity risk coverage.
Provide financial risk coverage.
Do not fulfill bequest motive.
Decision is definite.
Programmed Withdrawal
Funds remain in participant’s account
Remaining funds upon death constitute bequest.
Allow to postpone annuitization decision.
More complex pension options
Alternative options have been designed in order
to combine advantages of these pension types.
Longevity protection plus bequest:
Annuity with guaranteed period
Temporary Programmed withdrawal with differed
annuity.
Longevity protection plus financial premium:
Variable Annuity
The Chilean Experience
Pension Regulation
In Chile, all pension products must be inflation
indexed and joint. Survivor beneficiaries are
defined by law.
Lump sums are allowed only if remaining
balance is enough to finance 150% of Minimum
Pension and 70% Replacement Rate.
Early retirement is allowed if balance is enough
to finance 150% of Minimum Pension and 61%
Replacement Rate. (To become 70% in 2010)
High rate of Annuitization in Chile
PENSION CHOICE, AS OF SEPTEMBER 2007
Constant Real
Annuity
Guaranteed for
a Period; 40549;
50%
Programmed
Withdrawal;
30768; 38%
Constant Real
Annuity; 9838;
12%
High rate of Annuitization in Chile:
Possible Explanations. Strict limits to Lump-Sum
No DB plans or alternative provision of longevity insurance besides Minimum Pension Guarantee.
Marketing Advantages to Insurance Companies.
Brokers in insurance market, but not for AFPs.
Fee structure.
Early retirement. (Combined with marketing efforts from Insurance Companies)
Competitive annuity market, gives participants good value for their money.
Source: James, Martinez, Iglesias (2005)
High Money Worth Ratios.
Source: James, Martinez, Iglesias (2005)
High Money Worth Ratios.
Money’s Worth Ratios for Chile Estimated by this Report, 1999 and 2003 March 1999 March 2003
RV-04 Cohort
Risk-free rate
Average
RV-04 Cohort
Risk-free rate
Average
RV-04 Cohort
Corporate bond rate
Average
Male, 65 0.996 1.069 0.955
Male, 55 0.981 1.049 0.897
Female, 60 1.021 1.077 0.971
Female, 55 0.994 1.049 0.905
Joint 0.998 1.050 0.892
Source: The World Bank (2006)
Sustainability of high MWRs
Annuity Rate and Interest Rates on Central Bank Bonds
and Corporate Bonds (% p.a.), 1993-2005
2%
3%
4%
5%
6%
7%
8%
9%
10%
1993 1995 1997 1999 2001 2003 2005
Annuity Rate (RV-04) Central Bank Bonds Corporate Bonds
“Since the early 2000s the average annuity rate has exceeded the risk-free rate, a result
which is unusual by international comparison”. (The World Bank (2006))
The SCOMP: electronic market for annuities
The SCOMP
Electronic
market for
annuities:
Closed market for
companies
allowed to sell
annuities or
programmed
withdrawals
(6 AFP, 23 LIC,
751 brokers)
Blind system:
All companies
receive relevant
data of a potential
pensioner and
voluntarily make
offers
Several
possibilities:
Bargain (offer
must exceed
minimum offered
in SCOMP)
Auction
Allow each
individual to
obtain, at no
cost, all relevant
offers of
annuities or PW
for her.
1. Makes quotes
through an AFP,
Insurance Company
or broker
Affiliate
5. Informs
the Affiliate
Affiliate
• Make a new quote
• Select an offer and obtain a pension
• Request an external offer
• Desist from pensioning
• Request a bidding process
6. After receiving offers affiliate may choose
between the following options:
2. Participant
sends quote to
the system.
3. System
sends quotes to
suppliers
4. Suppliers
send pension
offers to the
system
What does SCOMP do?
AFP
Life
Insurance
Companies
Insurance brokers
Participants Suppliers
AFP
Life
Insurance
Companies
System
We want people to take well informed
decisions
Percentage
of requests
accepting the
best offers
PENSIONEERS THAT ACCEPTED THE HIGHEST OFFER
46,52
52,30
50,77
49,14
38,77
42,77
50,1351,58
36
40
44
48
52
56
Ene-05
Feb-0
5
Mar
-05
Abr-
05
May
-05
Jun-0
5
Jul-0
5
Ago-
05
Sep-0
5
Oct
-05
Nov-
05
Dic
-05
Ene-06
Feb-0
6
Mar
-06
Abr-
06
May
-06
Jun-0
6
Jul-0
6
Ago-
06
Sep-0
6
Oct
-06
Nov-
06
Dic
-06
Ene-07
Feb-0
7
Mar
-07
Abr-
07
May
-07
Jun-0
7
Jul-0
7
Ago-
07
Sep-0
7
%
Difference between the highest offer and the
one that was accepted
1,511,151,36
2,68
3,12
2,10
0,00
0,50
1,00
1,50
2,00
2,50
3,00
3,50
Ene
-05
Mar
-05
May
-05
Jul-0
5
Sep
-05
Nov-
05
Ene
-06
Mar
-06
May
-06
Jul-0
6
Sep
-06
Nov-
06
Ene
-07
Mar
-07
May
-07
Jul-0
7
Sep
-07
%
Constant Annuity Constant Annuity with a Guaranteed Period
What do people think about their
choice?¿Did you choose the highest offer?
79%
19%
2%
Yes No NR
Base Encuesta IPSOS
MAYO 2006
46% of pensioners under life
annuity that think they have
chosen the higher offer did not
really chose the highest offer.
50% of the ones that think they
did not choose the highest offer
are comfortable with their
decision.
Average difference between the highest offer and the lowest one entered to SCOMP for regular and
guaranteed annuities
10,37
7,16
9,307,77
0,00
2,00
4,00
6,00
8,00
10,00
12,00
Ene
-05
Mar
-05
May
-05
Jul-0
5
Sep
-05
Nov
-05
Ene
-06
Mar
-06
May
-06
Jul-0
6
Sep
-06
Nov
-06
Ene
-07
Mar
-07
May
-07
Jul-0
7
Constant Annuity Constant Annuity with a Guaranteed Period
Dispersion in MWR has decreased after SCOMP
Mean, Standard Deviation and Coefficient of Variation of MWRs in Different Years March 1999 March 2002 March 2003 March 2004 March 2005
Bottom
Third
All
MWRs
Bottom
Third
All
MWRs
Bottom
Third
All
MWRs
Bottom
Third
All
MWRs
Bottom
Third
All
MWRs
Mean 0.980 0.980 1.077 1.080 1.034 1.036 1.060 1.064 1.055 1.062
Std. Dev. 0.049 0.049 0.041 0.047 0.043 0.042 0.042 0.045 0.041 0.045
Coef. Var. 4.956 5.009 3.807 4.363 4.137 4.074 3.942 4.239 3.928 4.245
Source of raw data: SVS
“The drop in broker’s commissions after 2000 reveals that the draft Law was credible and
the effects of its future approval were being strongly anticipated by market participants.
However, the full adjustment of the market could only be expected after the realization of
the expected event, that is, the approval of the Law in August 2004 and its implementation
in the following months.” (The World Bank (2006))
Dispersion in MWR has decreased after SCOMPMWRs and Premiums in 1999 and 2005
MWRs and Premiums in 1999
0.7
0.8
0.9
1
1.1
1.2
0 2000 4000 6000 8000 10000 12000
Premium (UF)
MW
R
MWRs and Premiums in 2005
0.7
0.8
0.9
1
1.1
1.2
0 2000 4000 6000 8000 10000 12000
Premium (UF)
MW
R
Source: The World
Bank (2006)
The reduction in the dispersion of MWRs was stronger at the lower end of the market
Conclusions
Design of pension payouts and regulatory options may
shape decisions taken by individuals.
Even as important as the pension products that are
available is the design of the transition from
accumulation to decumulation phase.
Better information and a more competitive market may
improve options available to retiring individuals.
Although it is still early to assess the effect of SCOMP,
it may have contributed in this direction.