Longevity Risk: Public and Private Sector Solutions and
Longevity Risk: Public and Private Sector Solutions and the Governments Role Ross Jones Deputy Chairman, Australian Prudential Regulation Authority September 2010 1 The impact of the financial crisis Despite substantial recovery funding levels for pension funds at the end of 2009 was significantly lower than two years before. Funding levels for pension funds of OECD members had median funding deficit (gap between assets and
liabilities) at 26 per cent at end of 2009. Decreasing band yields (which are used to calculate liabilities) in many countries meant that liabilities went up, offsetting the equities recovery. 2 The impact of the financial crisis Pension funds nominal investment rate of return in selected OECD countries, 2008-2009 (%). Source: OECD Global Pension Statistics and OECD estimates. 3 Policy responses to the crisis
(OECD and IOPS) Some governments are being pressured to retreat from private pensions but public PAYG systems have sustainability issues due to aging population and now higher levels of unemployment. Emphasis on long term nature. There has been a tendency in a number of countries to allow greater flexibility in access during crisis but this risks creating longer term deficits. Safety net should address issues of insufficient income at retirement e.g. top ups; for DC accounts but incentives may be needed to deep people working and to increase non compulsory contributions. 4 Policy responses to the crisis
(OECD and IOPS) Improve the design of DC plans including default e.g. flexibility in timing of annuity purchase, guarantees for DC (but who pays). Improved pension fund governance and risk management. Improved disclosure, communication and financial education. Funding and solvency rules for DB plans should be counter-cyclical with greater flexibility in funding requirements. 5 Three problems of longevity risk Funding of DB plans
Adequacy of retirement savings Lack of financial instruments for hedging 6 Funding of DB Plans extent of the problem depends on the structure of retirement system Defined Benefit Public Private Austria, Belgium, Canada, Czech
Republic, Finland France, Greece, Hungary, Japan, Korea, Luxembourg, Portugal, Spain, Switzerland, Turkey, UK, US Iceland, Netherlands, Switzerland Defined Contribution, or Germany, Italy, Norway, Australia, Denmark, Notional DC Poland, Slovak Hungary, Mexico, Republic, Sweden Norway, Poland, Slovak
Republic, Sweden Source: OECD Pensions at a Glance 2009 7 Australian system has reduced reliance on DB in the last decade Source: APRA Data, Total Superannuation Assets includes APRA-regulated funds and self-managed superannuation funds 8 The GFC has highlighted investment risk in DB funds and created severe underfunding problems
9 Source: Yermo and Severinson, OECD, July 2010 OECD Policy Recommendations Need to strengthen regulation of solvency issues Focus on counter-cyclical funding allowing over-funding in good economic times Limiting contribution holidays and sponsor access to surplus Stability of contribution patterns is important Regulators should incorporate flexibility into funding rules to reflect the overall volatility of funding valuations Source: Yermo and Severinson, OECD, July 2010
10 APRAs focus Supervisory attention on recovery plans for underfunded DB plans 11 Longevity Risk and DB under-funding Under-funding problems are larger than currently measured Netspar research suggests fully-funded DB plans need a surplus of 4-5% to cover longevity risk over five year period (De Waegenaere, Melenberg, Stevens, 2010) More countries moving from DB to Notional DC frameworks (Netherlands)
[Role of Government Insurers (PBGC in the US, PPF in UK) topic to be covered by Martin Clarke] 12 Three problems of longevity risk Funding of DB plans Adequacy of retirement savings Lack of financial instruments for hedging 13 Australian context Three pillar retirement framework Social security safety-net Universal superannuation Tax-advantaged voluntary additional savings
Mandatory employer superannuation contributions introduced in 1992 3% in 1992, 9% in 2002 Current proposal 12% Average balance of 55-64 year old is only $72,000 (ABS,2009) 14 Relative size of retirement savings Australia has large assets compared to other countries 15 Source: OECD Global Pension Statistics Australian Treasury projections of adequacy
suggest the system will provide for retirement Source: Treasury Projections from the Henry Tax Review Australias Future Tax System The retirement income system: report on strategic issues, May 2009 16 However projections of adequacy vary widely based on assumptions Source: NATSEM microsimulation results from Keegan, Harding, Kelly (2010) 17 What Retirement Products are used? Lump sum only
Lump sum or PW Lump sum, PW or annuity Hong Kong Indonesi a
Australia Luxembou Germany Argentina China Canada India Brazil Luxembou rg (SEPCAV)
Malaysi a Phillippin es Lump sum or annuity Partial PW or lump sum annuity or annuity rg
Source: OECD * indicates mandatory funds USA Ireland Annuity only Austria Belgium* Colombia Italy Chile
Portugal Costa Rica Germany* South Africa Mexico UK Norway
Netherland s Peru Croatia Hungary* Poland Russia Sweden Switzerland* Uruguay 18
OECD policy recommendations on adequacy and longevity risk Need to save for a long time Contribution rates and length of contribution period are primary importance in determining adequacy Increase retirement age as population ages If retirement phase focuses on annuities Life cycle investing is optimal If retirement phase focuses on gradual/prescribed withdrawals Maintaining a high allocation to equities throughout retirement can provide higher retirement income 19 Australian context Most lump sums are small (less than $60,000) reflecting the
immature superannuation system Account-based pensions cover 88% of retirement products Retirees still exposed to investment and longevity risk Government pension is main protection against longevity risk Annuity products not active INGs Money for Life, AXA North Guarantee, Macquarie Lifetime Income Guarantee Barrier to pooled solutions: DC mentality in Australia, bequest motives, expensive products 20 Three problems of longevity risk Funding of DB plans Adequacy of retirement savings Lack of financial instruments for hedging
21 Private Solutions Many papers at this conference are exploring this problem Private market solutions appear to be the best approach Not an immediate concern in Australia due to DC focus 22 OECD Policy Recommendations Government can help by providing updated mortality tables that incorporates longevity risk
Governments can play a role by developing a longevity index that can be used for pricing Governments can issue inflation-indexed long dated bonds to facilitate asset liability management [highlight APRAs engagement with UNSW researchers?] 23 Summary Public solutions to longevity risk problems Reforming retirement industry structure Regulations that encourage product innovation but preserve safety of retirement assets Investment in research Private solutions to longevity risk problems Innovative products to hedge risks
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