pension reform and financial markets: encouraging households savings for retirement
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Pension Reform and Financial Markets: Encouraging Households Savings for Retirement. Anita Tuladhar International Monetary Fund June 2007 Conference on International Forum on Pension Reform: Exploring the Link to Labor and Financial Market Reforms - PowerPoint PPT PresentationTRANSCRIPT
Pension Reform and Financial Markets: Encouraging Households Savings
for Retirement
Anita Tuladhar
International Monetary Fund
June 2007
Conference on International Forum on Pension Reform: Exploring the Link to Labor and Financial Market Reforms
The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.
Background
Rapidly ageing populations Unsustainable pension system and public finances in
the long run Introduction of funded pensions system with
mandatory private individual account and voluntary supplemental accounts, including in the region.
– 1998 (Hungary, Kazakhstan); – 1999 (Poland); – 2001 (Latvia); – 2002 (Croatia, Estonia, Bulgaria); – 2003 (Russia); – 2005 (Macedonia, Slovakia);
Shifting of responsibility for old-age income to households (by working more or higher financial savings)
Question: How to encourage household financial savings for retirement?
Outline of this presentation: Examination of household financial savings
– in particular, pension savings in some emerging and mature markets
Factors affecting pension fund savings – Descriptive analysis using cross country data– Empirical analysis using more detailed pension fund data
from Latin America.
Policy implications for pension fund regulations
Household balance sheets: Share of financial assets in total wealth varies considerably.
Composition of Household Wealth in Household Balance Sheets, 2000
0
20
40
60
80
100
120
Poland
Czech R
epublic
Singapore
Taiw
an
South A
frica
Spain
New
Zealand
France
Germ
any
Australia
Italy
Portugal
Japan
UK
Netherlands
Denm
ark
Canada
US
A
Average - E
M
Average - M
M
Non-financial assets Financial assets
Source: Davies, Sandstrom, Shorrocks and Wolff (2006)
Household balance sheets: Share of liquid assets in financial assets significantly larger in emerging markets.
Composition of Financial Assets in Balance Sheets, 2000
0
20
40
60
80
100
120
Bu
lga
ria
Cro
atia
Ro
ma
nia
Slo
vakia
Tu
rkey
Ko
rea
Cze
ch R
ep
ub
lic
Po
lan
d
La
tvia
Slo
ven
ia
Sin
ga
po
re
Hu
ng
ary
Ta
iwa
n
Lith
ua
nia
Esto
nia
So
uth
Africa
Be
lgiu
m
Jap
an
Po
rtug
al
Gre
ece
Sp
ain
Ne
w Z
ea
lan
d
Ge
rma
ny
Fra
nce
Ca
na
da
Italy
Au
stralia
Au
stria
UK
De
nm
ark
Sw
itzerla
nd
Ne
the
rlan
ds
US
A
Ave
rag
e - E
M
Ave
rag
e - M
M
Liquid assets Shares and equities Other (including pensions)
Source: Davies, Sandstrom, Shorrocks and Wolff (2006)
Household balance sheets (contd.)The low share of pension fund savings also observed in the OECD.
Select OECD Countries: Composition of Household Financial Assets (In percent)
0
0.2
0.4
0.6
0.8
1
1.2
CZE POL HUN SVN JAP FIN NOR AUS
Others
Equities
Loans
Securities except shares
Insurance reserves (inclpensions)
Currency and deposits
Source: OECD.
Factors Affecting Pension Fund Assets: A Cross-Country Comparison
Pension Fund Assets to GDP, 2005
0 20 40 60 80 100 120 140
Netherlands Iceland
Switzerland United States
Total OECD United Kingdom
Finland Chile
SingaporeAustraliaMalaysia
Ireland Canada
Non-OECDSouth Africa
DenmarkKenya
HongKongJapan
ColombiaSweden Portugal
UruguaryPeru
New Zealand Bolivia
Spain (6)El Salvador
PolandHungary
MexicoNorwayFrance
IndiaThailand
AustriaArgentina
BelgiumCzech Republic
KazakhstanGermany
EstoniaCroatia
ItalyBulgariaSlovenia
KoreaCosta Rica
LatviaPakistan
Dominican RepublicRussia
Slovak Republic China
LuxembourgLithuania
Turkey
Source: OECD.
Pension fund assets in non-OECD countries remains relatively low.
Pension Fund Assets in Selected Non-OECD Countries, 2005 (In percent of GDP)
0 10 20 30 40 50 60 70
Chile
Singapore
Malaysia
South Africa
Kenya
Hongkong
Colombia
Uruguay
Peru
Bolivia
El Salvador
India
Thailand
Argentina
Kazakhstan
Estonia
Croatia
Bulgaria
Slovenia
Costa Rica
Latvia
Pakistan
Dominican Republic
Russia
China
Lithuania
Indonesia
Ukraine
Weighted Average: 37 percent
Source: OECD.
Financial Market DevelopmentInvestment Opportunities
Liquidity constraints
Financial Market DevelopmentInvestment Opportunities
Liquidity constraints
PreferencesPreferences DemographicsDependency ratio
DemographicsDependency ratio
Alternative Income SourcesPublic pensions
(features and financing)Public transfersHousehold size
Alternative Income SourcesPublic pensions
(features and financing)Public transfersHousehold size
Macroeconomic conditionsIncome Wealth
Real Interest RatesInflation
Unemployment
Macroeconomic conditionsIncome Wealth
Real Interest RatesInflation
Unemployment
Household savings1. Level
2. Composition
Household savings1. Level
2. Composition
Theoretical foundations on determinants of household savings
Per Capital Income: Pension fund savings are positively correlated with income levels.
Per Capita GDP vs. Pension Assets
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
0 20 40 60 80 100 120 140
In percent of GDP
in U
SD
Full Sample
Non-OECD
Non-OECD
Source: OECD ; and IMF WEO.
Demographics: An older population or a faster pace of ageing Is not related to significantly higher pension fund savings
Old Age Dependency Ratio vs. Pension Fund Assets, 2005
0
10
20
30
40
50
60
70
0 20 40 60 80 100 120 140In percent of GDP
In t
ime
s
Full Sample
Non-OECDNon-OECD
Source: OECD; and United Nations.
Alternative income sources: Public pension policy affects incentives to save in pension funds.
Public Pensions Expenditure vs. Pension Fund Assets
0
2
4
6
8
10
12
14
16
0 20 40 60 80 100 120 140In percent of GDP
In p
erce
nt o
f GD
P
Full Sample
Non-OECD
Source: OECD.
Alternative income sources: Generosity of public pensions likely reduces incentives to save in pension funds.
Net Replacement Rate vs. Pension Fund Assets
0
20
40
60
80
100
120
140
0 20 40 60 80 100 120 140In percent of GDP
In p
erc
ent Full Sample
Non-OECD
Non-OECD
Sources: IMF staff; and OECD.
Pension Reforms: The maturity of the mandatory funded system is a significant determinant of the size of pension fund savings.
Pension Assets, 2005 (In percent of GDP)
0 20 40 60 80 100 120 140
Netherlands (1)Iceland
Switzerland (1) (8)United States (10)
Total OECD United Kingdom (1)
Finland (2)Chile
SingaporeAustraliaMalaysia
Ireland (4)Canada (1)Non-OECD
South AfricaDenmark
KenyaHongKongJapan (5)Colombia
Sweden (7)Portugal
UruguaryPeru
New Zealand Bolivia
Spain (6)El Salvador
PolandHungary
MexicoNorway
France (1) (3)India
ThailandAustria
ArgentinaBelgium
Czech Republic Kazakhstan
GermanyEstoniaCroatia
ItalyBulgariaSlovenia
KoreaCosta Rica
LatviaPakistan
Dominican RepublicRussia
Slovak Republic (1)China
LuxembourgLithuania
Turkey
Financial market development: Pension fund savings shows a strong positive relation with financial market development. Direction of causality?
Market Capitalization vs. Pension Fund Assets
0
50
100
150
200
250
300
0 20 40 60 80 100 120 140In percent of GDP
In p
erc
ent of G
DP
Full Sample
Non-OECD
Non-OECD
Source: Bloomberg; and OECD.
Financial market development: Pension fund savings are inversely related to financial market volatility. Market stability or preference for safer assets?
Equity Market Volatility vs. Pension Fund Assets
0
20
40
60
80
100
120
140
160
180
0 20 40 60 80 100 120 140In percent of GDP
Std
. dev
(In
per
cent
)
Full Sample
Non-OECD
Non-OECD
Source: Bllomberg; and OECD.
Financial market development: Pension fund savings are inversely related to risk adjusted returns in the equity market. Investment limitations or lack of deep liquid markets?
Risk Adjusted Return vs. Pension Fund Assets
0.0
0.5
1.0
1.5
2.0
2.5
0 20 40 60 80 100 120 140
Full Sample
Non-OECD
Non-OECD
Empirical analysis
Question: What factors enhance participation and pensions savings?
Equations:1. Change in pension fund participation =
f (fund performance, years since reform, change in income, change in unemployment rate)
2. Change in pension fund assets per participant = f (fund performance, change contribution rate, change in income,
rates of return on alternative investments) Data:
– Pension fund data: FIAP on Latin American countries – Macroeconomic data: WEO– Financial Market data: IFS, World Development Indicators,
Bloomberg Unbalanced Panel Data with 8 countries
Results: Equation 1
Fixed Effects EstimationDependent Variable: D(Number of Participants)
Explanatory Variables:Constant 0.06 0.06 0.05 0.04 0.42 0.32 0.02Lagged Dependent Variable -0.36 -0.36 -0.44 -0.48 -0.48 -0.46 -0.45Annual Rate of Return 0.002 0.002 0.001 0.002 0.002 0.002 0.003Lag Annual Rate of Return 0.000Dummy (Reform Years) 0.10 0.09 0.08 0.08 0.09D(Unemployment Rate) -0.23 -0.19 -0.21 -0.23Income Per Capita -0.05 -0.04D(Income Per Capita) 0.04Annual Rate of Return*D(Income Per Capita) 0.002 0.004
R-Squared 0.16 0.15 0.26 0.31 0.33 0.33 0.33F-Stat 1.02 0.78 1.67 1.93 1.88 1.49 1.68
Sample (adjusted) 1984 2005 1984 2005 1984 2005 1984 2005 1990 2005 1990 2005 1990 2005Included observations after adjustments 22 22 22 22 22 22 22Cross-sections included 8 8 8 8 8 8 8Total pool (unbalanced) observations 59 56 59 59 59 59 59
Results: Equation II
Fixed Effects EstimationDependent Variable: D(Pension Funds Per Participant)
Explanatory Variables:Constant 0.07 0.05 0.10 0.06 0.07 0.08Lagged Dependent Variable 0.04 -0.06 -0.19 0.07 0.14 0.08Annual Rate of Return 0.014 0.02 0.01 0.01 0.01 0.01Lag Annual Rate of Return 0.004D(Income Per Capita) 0.38 0.36 0.36Fund Contribution Rate (Net of Fees) -0.40Stock Market Return 0.00Government Bond Rate 0.00
R-Squared 0.47 0.58 0.47 0.54 0.82 0.54F-Stat 4.97 6.18 2.25 5.67 13.5 3.97
Sample (adjusted) 1984 2005 1984 2005 2000 2005 1984 2005 1996 20051993 2005Included observations after adjustments 22 22 6 22 10 13Cross-sections included 7 7 7 7 5 7Total pool (unbalanced) observations 54 51 33 54 33 45
Key Factors and Challenges to Pension Fund Savings
Structural factors limit pension fund coverage – high unemployment rate– low income levels
Pension savings on a voluntary basis low reflecting – still generous public pension system– level of financial sector development that limits investment
opportunities or low financial awareness thereof, or – myopia
Improved performance on pension funds encourage savings Other variables: savings incentives, other income sources,
demographic factors
Policy Implications
Enhancing coverage of pension income:– creates a need for non-contributory social safety net for
retirees (minimum public pensions or the zero pillar)– make pension fund savings mandatory or require automatic
enroll enrollment as default option to improve participation In CEC’s generally, participation to funded pensions is
designed as a carve-out of existing public pension contribution which is mandatory for younger workers. (~20 yrs for SVK, EST, MKD, HUN, ~30 yrs POL and LVA, ~40 yrs CRA, BLG, all for KZK)
– awareness/financial literacy
Policy Implications
Regulations for improving fund performance/net risk-adjusted returns:
– Investment in an optimum portfolio: regulations on asset allocation. For eg - shift from quantitative
investment limits to prudent person rule or loosen tight regulations taking into consideration the development of local securities markets
regulations on guarantees: For eg – minimum guaranteed return relative to industry
– Tax incentives on voluntary pension savings– Minimizing fees and costs: regulations on fees, industry
structure
Pension portfolios mostly in government bonds, reflecting both regulatory restrictions and lack of investment opportunities
Portfolio Allocation in Select Latin American Pension Funds, 1999-2006
0
10
20
30
40
50
60
GovernmentDebt
FinancialInstitutions
Non-financialInstitutions
Equities Mutual Funds ForeignInvestments
Others
Jun-99 Dec-06
Pension portfolios are shifting from bank deposits towards capital markets and international investments
Shift in Portfolio Composition of Pension Funds, 1999-2006
Government Debt
Financial Institutions
Non-financial
Institutions EquitiesMutual Funds
Foreign Investments Others
(In percent of total funds) Argentina 9.3 -15.6 -0.7 -4.6 5.1 9.5 -2.9Bolivia 8.8 -22.9 9.3 0.1 0.2 2.7 1.9Chile -24.2 -4.9 4.3 4.3 0.9 19.6 0.0El Salvador 10.5 -16.3 5.8 0.0 0.0 0.0 0.0México -24.2 4.7 8.0 1.8 0.0 9.6 0.0Perú 12.5 -30.1 -6.2 4.9 1.7 8.5 7.3Uruguay -4.1 3.4 1.1 0.1 0.0 0.0 -0.7
(In percent of total funds)
Investment limits: Need to enable diversification, and also allow life-cycle investing
Equity Foreign InvestmentUnited Kingdom PPR 1/ PPRUnited States PPR PPRGermany 30 20Japan 30 30Canada No limit 30Italy PPR 20
Argentina 50 20Chile 39 30Mexico 15 20Peru 35 10.5Colombia 30 20El Salvador n.a. 7
Slovakia n.a. 50Hungary 50 30Latvia n.a. 30Macedonia 30 20Croatia 30 15Kazakhstan 30 10Poland 40 5Bulgaria 5 5Sources: Poirson (2007), Chlon Dominczak (2003), Rutkowski (2006)1/ Prudent Person Rule (PPR)
Investment Limits
Policy Implications
Gradual easing of investment limits, especially on foreign investments
– facilitates diversification gains especially in lack of domestic investments, limits foreign exchange market volatility
Public debt management: – Longer term instruments, inflation hedge, establishing liquid
benchmark instruments, – ensuring pension funds don’t become captive markets for
government financing that provides cheap financing. Measures to strengthen capital market development
– Privatization, increasing available investment instruments, corporate governance regulations to improve supply
– Liquidity of these instruments also important
Minimum Return Guarantees (MRG): Significantly affects asset allocation and leads to herding behavior
Relative to the Pension Industry– Kazakhstan, Poland, Croatia, Slovakia
Relative to a benchmark– Hungary
No guarantees– Bulgaria, Latvia, Estonia, Macedonia
If MRG invoked, requires paying up from reserves, guarantee funds, etc.
Regulations on Guarantees: Flexibility in parameters of Minimum Return Guarantees, including setting of benchmark and portfolio choice
Country Benchmark and ReturnsAssessmet Period
Frequency of Evaluation
Full Disclosure of Portfolios
Argentina Min( 70 percent of ARS, ARS-2 percent) 1/ 12 months Monthly
Colombia Minimum Return = (A+B)/2 36 months Quarterly After 30 daysA = 70 percent of ARSB = 70 percent of Return on Synthetic Portfolio 70 percent of Return on Bogota stock exchange index 70 percent of return of S&P 500
Chile Risky Funds = Min (50 Percent of ARS, ARS-4 percent) 36 months Monthly After 10 daysConservative Funds = Min (50 Percent of ARS, ARS-2 percent)
Uruguay Min( 2 percent real, ARS-2 percent) 12 months Monthly
Poland Min( 50 percent of ARS, ARS-4 percent) 36 months Bi-annually YearlySource: IMF/World Bank (2007).1/ ARS = Weighted Average Return of the System
Minimum Guaranteed Return in Select Countries
Other considerations: Tax incentives for voluntary savings not very effective for lower income and liquidity constrained individuals.
No evidence of an increase in overall savings while mixed evidence of impact on composition of savings
Effectiveness of tax incentives depend on the substitutability of different savings alternatives. Non-substitutability could arise from the motivation for
– (i) precautionary savings if liquidity constrained – (ii) bequest to heirs
Strong distributional effects with benefits accruing to older and richer individuals who face higher marginal tax rates.
Fiscal costs
Industry structure: trending towards consolidation requiring a balance between competition in returns and scale economies to keep costs low
Number of Pension Fund Administrators
0
5
10
15
20
25
30
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
ARGENTINA BOLIVIA COLOMBIA COSTA RICA CHILE
EL SALVADOR MÉXICO PANAMÁ PERÚ Dominican Rep.
URUGUAY BULGARIA Kazakhstan Poland
Minimizing fees and costs are important to ensure high net returns
High fixed costs has more distributional impact on low-income savers.
Centralization of basic services with scale economies such as account management, collections. This is already the case in most CECs.
Minimizing costs from regulatory burden (for reserves, reporting, etc) and initial marketing costs.
Regulatory ceilings for fees on contributions/assets which decline over time as asset size grows.
Balance the costs with high concentration in the industry.
Financial Awareness
Financial education and awareness particularly if given choice of portfolio
Greater need if low-income savers Dynamic default portfolio for passive investors Public information including availability of simulation
models to analyze potential net replacement rates at retirement
Easy access to account information Transparency and Accountability of pension funds
– Publication of investment results and financial statements
Conclusions
Share of pension savings in household balance sheets are relatively small but growing rapidly.
Factors affecting pension fund savings – Pension reform, mandatory savings, fund performance, – Macro/Structural factors – Financial sector development
Policy implications for pension fund regulations– Enhancing coverage through mandatory forms of savings, default rules
and other social safety nets– Enhancing net risk-adjusted returns through increasing flexibility for
diversification gains, – Reducing costs by harnessing economies of scale and minimizing other
burdens– Investor protection through information and education