Post on 13-Jan-2016
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THE CHALLENGE OF AGEING –PENSION REFORM, INTERNATIONAL TRENDS AND FUTURE IMPERATIVES
Chris Daykin, former UK Government Actuary
Chairman, PBSS Section of IAA
Malaysian Actuarial Society
Kuala Lumpur, 6 November 2007
JOINT COLLOQUIUM OF IACA, PBSS AND IAAHS
Boston, USA – 4-7 May 2008
Pensions and social security> challenges of longevity> de-risking DB liabilities> pension investment strategies> accounting for pension costs> actuarial roles in DC world> are DB plans dead?
Health> catastrophic risks> post-retirement health care> evaluating value for money> financing health for the poor> health risk management
Consulting practice> public interest & client relationships> handling conflicts of interest> actuarial communication> new areas of consulting practice> Enterprise Risk Management> Developments in actuarial educn.
Insurance> future of solvency regulation> IFRS> mergers and acquisitions> reserve variability> predictive modelling
JOINT COLLOQUIUM OF IACA, PBSS AND IAAHS
Boston, USA – 4-7 May 2008
Global Challenges and Opportunities
facing the Actuarial Profession
Hope to see you in Boston!
INCREASING LONGEVITY
Expectation of life at age 65 on cohort basis, E&W
10
14
18
22
26
1850 1900 1950 2000 2050
Year age 65 attained
Ex
pe
cta
tio
n o
f li
fe (
ye
ars
)
10
14
18
22
26
Females
Males
Total Period Fertility Rates, 1960-2010
1
1.5
2
2.5
3
3.5
4
4.5
5
5.5
6
1960 1970 1980 1990 2000 2010
UK
USA
Germany
France
Indonesia
Malaysia
Singapore
Thailand
Japan
China
Expectation of Life for Males, 1950-2020
40
45
50
55
60
65
70
75
80
85
90
1950 1960 1970 1980 1990 2000 2010 2020
UK
USA
Germany
France
Indonesia
Malaysia
Singapore
Thailand
Japan
China
Expectation of Life for Females, 1950-2020
40
45
50
55
60
65
70
75
80
85
90
1950 1960 1970 1980 1990 2000 2010 2020
UK
USAGermany
FranceIndonesia
MalaysiaSingapore
ThailandJapan
China
Dependency Ratios, 1970-2030(numbers 65 & over for every 1000 aged 15-64)
0
50
100
150
200
250
300
350
400
450
500
1960 1970 1980 1990 2000 2010 2020 2030
UK
USA
Germany
France
Indonesia
Malaysia
Singapore
Thailand
Japan
China
Percentage increase in numbers aged 65 & over1990-2030
0
100
200
300
400
500
600
700
800
% increase in nos. aged 65 & over
PENSION REFORM
What are the imperatives?> to recognise the impact of increasing longevity> to ensure sustainability of structure and financing> to ensure good coverage and adequate retirement income> to improve retirement incentive structures> to reduce intergenerational dependency> to improve incentives for saving
PENSION REFORM
Problems facing social security schemes> demographic ageing> maturing of defined benefit schemes> effective retirement age too low> poor overall levels of coverage> insufficient advance funding in system> inadequate or volatile outcomes from DC schemes> inadequate protection against longevity in DC schemes> excessive transaction costs and poor returns> perverse incentives affecting behaviour, eg retirement
PENSION REFORM
Needed reforms of social security> ensure long term sustainability> raise effective retirement age> reduce incentives to retire early and encourage deferral> increase incentives to work and to contribute> improve efficiency and reduce transaction costs> strengthen protection against individual longevity> find ways to extend coverage
PENSION REFORM
Individual account reforms> started in Chile in 1981
> by now includes most countries in Latin America
> Mexican reform in 1997
> also several countries in central and eastern Europe
> supplements or replaces DB social security pension
> competitive private sector investment vehicles
> usually mandatory for formal sector workers
> purchase of annuities at retirement…
> …or strictly controlled programmed withdrawal
PENSION REFORM
Individual account reforms - experience> coverage is still a problem…
> …individual account structure is not enough of an incentive
> transaction costs are generally still quite high…
> …competition does not bring down the charges
> churning and mis-selling have been an issue
> pension levels may not be adequate…
> …too many people will qualify for the minimum pension
> minimum pension creates incentive problems of its own
> individual accounts perpetuate inequalities
> most risks fall on individuals
PENSION REFORM
Problems with pay-out phase> uncertainty about life expectancy> programmed withdrawal has potential problems> need for more annuitisation to protect pensioners> compulsory annuitisation may be unpopular> insurance market not always receptive> high concentration of longevity risk for insurers> need for very long-dated bonds to match liabilities> preferably index-linked if backing indexed annuities> investment mis-match risk for insurers
PENSION REFORM
Alternatives for pay-out phase> life annuity – level or increasing> unit-linked annuity> with-profits annuity> unitised fund> partially annuitise with temporary annuity> controlled drawdown> …perhaps with eventual mandatory annuitisation
PENSION REFORM
Notional Defined Contribution> structured as defined contribution… > … but on a PAYG basis rather than funded> clear link between contributions and benefits…> …but not subject to investment risk> targets lump sum at pension age…> with ‘notional’ purchase of an annuity> permits flexibility of retirement age> passes on part of longevity risk> demographic adjustment factor needed to keep in balance
LESSONS FROM SWEDEN
Swedish NDC> DB state scheme replaced by NDC> …with fairly fast transition> revalorisation of individual accounts by average wage> credits for sickness and other absences> automatic economic regulator of pensions increase> annuity responds to improving mortality> automatic balancing mechanism
LESSONS FROM SWEDEN
Automatic balancing mechanism (‘actuarial accounting’)Annual balance sheet for scheme:
Liabilities = present value of all future outlay for pensions in payment+ accumulated individual accounts for all persons not yet in receipt of a pension
Assets =real assets in buffer fund + value of future contributions
Value of future contributions = contribution rate x wage mass x expected turnover duration
LESSONS FROM SWEDEN
Expected turnover duration
0
20
40
0 5 10 15 20 25 30 35 43 50 55 60 65 70 76 85 90 95
Ste
ady
stat
e pe
nsio
n lia
bilit
y
(in y
ears
of c
ontr
ibut
ions
)
= turnover duration 33 years
Age group
Expectedincome-weighted
age of income earners
Pay-in duration + Pay-out d.
Expected pension weighted age of pensioners
Expected pension-capital-weighted average retirement age
1
00 5 10 15 20 25 30 35 43 50 55 60 65 70 76 85 90 95
= turnover duration 33 years
Age group
Expectedincome-weighted
age of income earners
Pay-in duration + Pay-out d.
Expected pension weighted age of pensioners
Expected pension-capital-weighted average retirement age
LESSONS FROM SWEDEN
Individual accounts> mandatory funded individual accounts (PPM)> 2½% of earnings> contributions collected with NDC contributions of 16%> low administrative costs> choice of 700 investment funds> default arrangements if no funds selected> 90% of wage-earners covered by occupational schemes> operated largely on industry-wide basis
LESSONS FROM SWEDEN
Overall evaluation> hailed by many as a success story> sustainable PAYG system> increased level of savings achieved through PPM> but little real interest in investment choice> rising concern about expected fall in replacement ratios…> …and arbitrary effect of automatic balancing mechanism> inequality of earnings mirrored in retirement income
LESSONS FROM FINLAND
Dealing with demographic ageing> objectives of reform of earnings-related scheme> to postpone average age of retirement by 2 to 3 years> to adapt the pension system to increased expectations of life> to reduce pressures for future increases in contributions> to unify and simplify the various separate schemes> to harmonise public and private pension schemes
> average of last 10 years → career average revalued
> variable accrual rate> 1.5% a year from 18 to 52> 1.9% a year from 53 to 62> 4.5% a year from 63 to 68
LESSONS FROM FINLAND
Dealing with demographic ageing> introducing “life expectancy coefficient”
Life expectancy coefficient for year N (>2009) =
cohort life expectancy for those reaching 62 in 2009
cohort life expectancy for those reaching 62 in N
Multiply pensions of those reaching 62 in N
by life expectancy coefficient for year N
Thus adjusting a DB pension benefit for improving life expectancy
LESSONS FROM THE UK
Continuous pension reform since 1975> State earnings-related pension (SERPS) (1975)> contracting out (1975)> basic pension linked to retail price index (1980)> personal pensions for contracting out (1987)> cut back of SERPS (1988)> equalisation of pension age at 65 (by 2020) (1995)> State Second Pension replaced SERPS (2002)> pension credit with an earnings link (2003)> trend to more dependence on means-testing> longevity risk offset by revaluation and rising pension age
LESSONS FROM THE UK
Expenditure from National Insurance Fund as % of GDP
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060
Past data and future price uprating Future earnings uprating
1950
LESSONS FROM THE UK
Pensions by year of award as % of earnings (at average earnings levels)
0%
5%
10%
15%
20%
25%
30%
35%
40%
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060
Basic Serps Increase due to S2P
1950
LESSONS FROM THE UK
Issues to be addressed> declining value of Basic Pension (and State Second Pension)
> shift to dependence on means-tested benefits
> residual problem of coverage for older women
> declining significance of defined benefit plans
> defined contributions generally low
> individuals shouldering more of the risk
LESSONS FROM THE UK
Government proposals – Pensions Act 2007> restore earnings link for basic pension (from 2012 or later)> raise pension age to 68 by 2046> reform contribution conditions (now only 30 years needed)> simplify home responsibilities protection> State Second Pension to become flat-rate> abolish contracting-out on a defined contribution basis> individual accounts with auto-enrolment
LESSONS FROM THE UK
Occupational pension schemes> new stronger pensions regulator> the Pensions Protection Fund> the Financial Assistance Scheme> emphasis on improving funding levels> …but already too late for many company schemes> new attempts at simplifying regulatory requirements> defined benefit schemes unlikely to be resuscitated> problems of perceived privilege of public sector workers
PENSION REFORM FRAMEWORK
Goals of a pension system
Primary goals
> To provide adequate, affordable, sustainable and robust old-age income
Secondary goals
> To create developmental effects by> minimizing negative impacts> leveraging on positive impacts
PENSION REFORM FRAMEWORK
World Bank framework (1994)
1st Pillar
Mandatory unfunded public defined benefit social security
2nd Pillar
Mandatory funded and privately managed defined contribution
3rd Pillar
Voluntary savings retirement plan (or occupational pension plans)
PENSION REFORM FRAMEWORK
World Bank framework (2005)Pillar zero
Non-contributory scheme providing minimal level of protection
1st Pillar
Mandatory unfunded publicly managed DB or NDC providing some longevity insurance
2nd Pillar
Mandatory funded and privately managed DC (or DB)
3rd Pillar
Voluntary savings plans – regulated and privately managed
4th Pillar
Informal intergenerational financial and non-financial support
SOME GENERAL LESSONS
Sharing longevity risk
1. target lump sum at retirement…> …and convert to pension using current annuity value> …funded individual accounts or NDC
2. index retirement age based on cohort expectation of life...> …or maintain ratio between working and retired life periods
3. raise retirement age at intervals to offset rising cost
4. overall adjustment mechanism such as> life expectancy coefficient> sustainability factor> automatic balancing mechanism
5. risk-sharing between contributors and pensioners
SOME ISSUES FOR MALAYSIA
Provident Fund based system> already DC individual accounts – single institution> normal shortcomings of DC> coverage> underpin> investment constraints> investment dominance> retirement age> annuitisation
SOME CONCLUSIONS
Wide range of solutions – defined contribution favoured> each country has a different solution> …but all are starting from different points> DC widely favoured for its incentive structure…> …but lacks basic characteristics of protection> …unless in with-profits form or with strong underpin> …exposes members to investment risk> …and also collectively to longevity risk> minimum pension or DB underpin is desirable…> …but care is needed to avoid this having a dominant effect
SOME CONCLUSIONS
Wide range of solutions – new defined benefit thinking> DB mostly moving to career-average revalued…> …which is equivalent to a type of DC> …or to NDC - really a DB structure dressed up as DC> focus on fund at retirement facilitates longevity solutions> indexing retirement age also a possibility> cash balance is another alternative DB/DC hybrid
SOME CONCLUSIONS
Wide range of solutions – encourage later retirement> need stronger incentives to later retirement> a reason for DC but possible also with DB> higher pension age for unreduced pension forces trade-off> target lump sum at retirement instead of pension> annuitisation is needed – with innovative solutions> need better risk-sharing in decumulation phase
THE END
Questions and discussion