Pension Payouts. Risks and Alternatives. Solange Berstein Superintendent of Pension Fund Administrators, Chile.

Transcription

1 Pension Payouts. Risks and Alternatives Solange Berstein Superintendent of Pension Fund Administrators, Chile.

2 Agenda Product design The Chilean Experience Why do people annuitize? Money worth ratios Intermediation of retirement products Conclusions

3 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?

4 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

5 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.

6 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

7 The Chilean Experience

8 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)

9 High rate of Annuitization in Chile PENSION CHOICE, AS OF SEPTEMBER 2007 Programmed Withdrawal; 30768; 38% Constant Real Annuity Guaranteed for a Period; 40549; 50% Constant Real Annuity; 9838; 12%

10 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)

11 High Money Worth Ratios. Source: James, Martinez, Iglesias (2005)

12 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, Male, Female, Female, Joint Source: The World Bank (2006)

13 Sustainability of high MWRs 10% Annuity Rate and Interest Rates on Central Bank Bonds and Corporate Bonds (% p.a.), % 8% 7% 6% 5% 4% 3% 2% 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))

14 The SCOMP: electronic market for annuities The SCOMP Electronic market for annuities: Closed market for companies allowed to sell annuities or programmed withdrawals Blind system: All companies receive relevant data of a potential pensioner and voluntarily make offers Allow each individual to obtain, at no cost, all relevant offers of annuities or PW for her. Several possibilities: Bargain (offer must exceed minimum offered in SCOMP) Auction (6 AFP, 23 LIC, 751 brokers)

15 What does SCOMP do? Affiliate 1. Makes quotes through an AFP, Insurance Company or broker Participants AFP Life Insurance Companies 2. Participant sends quote to the system. System 3. System sends quotes to suppliers 4. Suppliers send pension offers to the system Suppliers AFP Life Insurance Companies Insurance brokers 5. Informs the Affiliate Affiliate 6. After receiving offers affiliate may choose between the following options: Make a new quote Select an offer and obtain a pension Request an external offer Desist from pensioning Request a bidding process

16 % We want people to take well informed decisions PENSIONEERS THAT ACCEPTED THE HIGHEST OFFER ,13 51,58 50,77 52, ,77 Ene-05 Feb-05 Mar-05 Abr-05 May-05 Jun-05 Jul-05 Ago-05 Sep-05 Oct-05 Nov-05 Dic-05 Ene-06 38,77 49,14 Feb-06 Mar-06 Abr-06 May-06 Jun-06 Jul-06 Ago-06 Sep-06 Oct-06 Nov-06 Dic-06 Ene-07 Feb-07 Mar-07 Abr-07 May-07 Jun-07 Jul-07 Ago-07 46,52 Sep-07 Percentage of requests accepting the best offers

17 % Difference between the highest offer and the one that was accepted 3,50 3,00 3,12 2,50 2,68 2,00 2,10 1,50 1,36 1,51 1,15 1,00 0,50 0,00 Ene-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Ene-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Ene-07 Mar-07 May-07 Jul-07 Sep-07 Constant Annuity Constant Annuity with a Guaranteed Period

18 What do people think about their choice? Did you choose the highest offer? Yes No NR 46% of pensioners under life annuity that think they have chosen the higher offer did not really chose the highest offer. 19% 2% 50% of the ones that think they did not choose the highest offer are comfortable with their decision. 79% Base Encuesta IPSOS MAYO 2006

19 Average difference between the highest offer and the lowest one entered to SCOMP for regular and guaranteed annuities 12,00 10,37 10,00 8,00 7,77 9,30 6,00 7,16 4,00 2,00 0,00 Ene-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Ene-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Ene-07 Mar-07 May-07 Jul-07 Constant Annuity Constant Annuity with a Guaranteed Period

20 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 Std. Dev Coef. Var 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))

21 MWR MWR Dispersion in MWR has decreased after SCOMP 1.2 MWRs and Premiums in 1999 and 2005 MWRs and Premiums in Premium (UF) MWRs and Premiums in Premium (UF) Source: The World Bank (2006) The reduction in the dispersion of MWRs was stronger at the lower end of the market

22 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.