PENSION POLICIES WHAT WORKS? WHAT DOES NOT WORK? Pablo Antolin Principal economist and Head OECD Private Pensions Unit, Deputy Head OECD Financial Affairs Division
Structure of the talk 1. Main OECD messages 2. Framework of thought ➢ Objectives and risks 3. Challenges facing pension systems ➢ Ageing, low growth, low return environment 4. Changing pension landscape ➢ Growth of funded pension arrangements ➢ Strengths and weakness of DCs 5. Need for improvements: OECD Roadmap for the Good Design of DC Pension Plans Accumulation: investments, risk-adjusted returns, ➢ defaults Retirement phase: longevity protection/sharing ➢ 2
Main OECD messages on pensions ➢ Diversify the sources to finance retirement ➢ Financial economics: do not put all the eggs in the same basket ➢ Funded private pensions complementary to public pensions and not a substitute ➢ How pension objectives are met and risks shared ➢ Non-contributory pensions (safety net) financed from the budget, general taxation ➢ Improve design funded pension (coherence): OECD Roadmap for the Good Design of DC Pension Plans 3
Objectives of pension systems ➢ The primary objective of pensions is to make sure that people have resources at old age (economic security) ➢ This includes 1. Reduce or eliminate poverty at old age 2. Make sure people save during their working life to finance their retirement: saving for retirement – consumption smoothing 3. Insurance against risks during working life and in old age 4
Objectives of pension systems ➢ Other secondary goals of pension systems 1. Financial and fiscal sustainability 2. Adequacy ➢ What is adequacy? Minimum, living standard, income or RR ➢ Balance act btw sustainability and adequacy 3. Coverage 4. Preserve inter and intra-generational equity 5. Support (not distort) incentives to work and save 5
Poverty alleviation ➢ The first objective is to bring people at old age above certain level of income (poverty alleviation) ➢ It leads to redistribution . ➢ It is part of the State safety net. ➢ They include basic, national or minimum pensions ➢ They are non-contributory public pensions ➢ OECD main message: finance them from the budget, from general taxation. 6
Saving for retirement – Consumption smoothing ➢ It is financed through contributions ➢ It can be PAYG (current contributions cover current pensions) or funded (accumulated assets back up pensions). ➢ PAYG financed pensions are generally managed by the public sector: Public pensions ➢ Funded pensions are generally managed by the private sector. ➢ Funded pensions can be occupational (linked to an employment relationship) or personal (no employment link). ➢ It can be mandatory (compulsory) or voluntary , especially funded private pensions 7
Saving for retirement – Consumption smoothing ➢ Contributory based pensions, whether funded private or PAYG financed public, depending on the relationship between contributions and benefits (pension payments) can be: − Defined benefits plans: pension benefits are pre- defined (e.g. public pensions, funded DB pension plans) − Defined contribution plans: pensions benefits depend on the amount of assets accumulated at retirement (e.g. DCs, 401(k)s, Superannuation, Riester, PPM, ATP, UK auto-enrolment, individual accounts) − They may include some type of guarantees (e.g. minimum returns, minimum income floor) 8
Criteria to assess different pension programs within a country pension system 1. Whether they are mandatory or voluntary ➢ Soft-compulsion auto-enrolment with opt-out 2. How pension benefits are financed − PAYG: with current contributions − Funded: with assets accumulated 4. Relationship btw contributions and pensions: DB, DC, guarantees 5. Employment relationship: occupational, personal. Role of the employer: ➢ record keeping, contributes 9
Criteria to assess different pension programs within a country pension system 4. Who manages the plans: public or private 5. Who bears the risk: employer (DB), State (employer, tax payer public pensions), individuals (DCs), or risk sharing. ➢ No pillars, characteristics ➢ Important a combination: PAYG and funded, mandatory and voluntary, DB and DC 10
Risks ➢ Planning for retirement requires to make assumptions regarding several parameters going forward. ➢ Parameters such as: GDP growth, productivity, employment/ unemployment, wage growth, inflation, returns to investment, interest rates (discount rates), and life expectancy. ➢ Future is uncertain, assumptions rarely materialise as expected: risks 11
Risks ➢ Labour market risks: spells unemployment, career real wage paths (flat, hump-shaped, growth) ➢ Macroeconomic risks: inflation, GDP growth, productivity growth ➢ Financial risks: returns to investment, volatility ➢ Demographic risks: longevity risk ➢ Pension management risks: costs, asset and risk management ➢ Social risks: disability and family members survivors ➢ Political risks: pension policy changes ➢ All these risks will affect the adequacy, coverage and the sustainability of pension policies. 12
Pension systems across OECD countries ➢ All countries have a combination of the different type of arrangements or programs: public, private, PAYG, funded, occupation, personal. ➢ It just changes the weight of each components in the overall retirement income ➢ All countries have a non-contributory public pension (safety net): minimum, national or basic pension ➢ Most countries have PAYG financed public pensions ➢ All countries have funded private pensions: ➢ all have voluntary personal, ➢ some have occupational, either voluntary or mandatory, DB or DC 13
Pension systems across OECD countries ➢ Occupational defined benefit plans either mandatory (e.g. Korea, Netherlands) or voluntary (e.g. Canada, Germany, Finland, Japan, UK, USA) ➢ Occupational defined contribution plans either mandatory (e.g. Australia, Chile, Baltics, Hong- Kong, Korea, Mexico, Singapore, Sweden, Turkey), voluntary (e.g. Canada, Czech Republic, France, Germany, Japan, Slovak Republic, Poland, USA), or auto-enrolment (e.g. Italy, New Zealand, UK, USA) 14
CHALLENGES FACING PENSION SYSTEMS
Challenges facing pension systems ➢ Pension systems (PAYG DB, funded DB and DC, whether voluntary or mandatory) face many challenges ➢ Population ageing: ➢ financial sustainability, solvency and adequacy ➢ Financial and economic crisis ➢ Economic environment characterised by low interest rates, low returns, and low growth ➢ Less resources to finance retirement 16
Population Ageing ➢ Population ageing refers to an increase in the average age of the population ➢ Increase is the result of a decrease in fertility, (already over: return to previous levels) baby boom. ➢ And an increase in life expectancy (LE). ➢ The baby boom is temporal ➢ The increase in LE is relatively permanent effect (bar wars and epidemics) 17 17
Population ageing: Increase in the median age 55 Japan 50 45 France 40 Germany 35 30 USA China 25 Brazil 20 15 10 5 0 Brazil China France Germany Japan USA 18
0.0 0.5 2.0 3.0 4.0 2.5 3.5 1.0 1.5 • Fertility returns to previous lower levels, stable 1933 Population Ageing 1935 1937 1939 1941 1943 1945 1947 1949 1951 France 1953 1955 1957 1959 1961 1963 USA 1965 1967 1969 1971 1973 1975 OECD 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 19
Population Ageing • Fertility fall (developing countries) 7 6 South Africa Brazil 5 4 India 3 China 2 1 0 20
80 60 65 70 85 75 Population Ageing 1950 1952 1954 1956 • Large increases in life expectancy 1958 1960 1962 Life expectancy at birth (increase = 2.2 1964 1966 1968 1970 1972 1974 1976 yrs per decade) 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 21
20 22 24 10 12 14 16 18 Large increases in life expectancy (at age 65) 1950 Population Ageing 1952 Life expectancy at 65 (increase = 1 yrs 1954 1956 1958 1960 1962 1964 1966 per decade) 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 22
Population Ageing: Implications • More people in retirement and for longer. 19 Number of people in working age per 18 person 65+ 17 Brazil 16 15 14 China 13 12 11 Japan 10 9 8 7 Germany 6 USA 5 France 4 3 2 1 0 Source: UN Population Projections, 2010 Revision 23
0.0 2.0 3.0 0.5 2.5 3.5 1.0 1.5 1950 years in retirement Population Ageing: years contributing to 1953 1956 Working from 25 to 65 over life expectancy 1959 1962 1965 1968 1971 1974 1977 1980 1983 at 65 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 2025 24
What is the impact of PA on pensions? ▪ Basic principle: what it goes in (saving during working life) and what it gets out (pension benefits during retirement) need to be equal • Baby boom (temporary): smaller cohorts working than retiring. • This affects mainly PAYG-financed pensions because current workers pay for current pensions. • Affects also indirectly (through returns on investment) funded pensions 25
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