Decumulation in Mandatory DC Pension Environment
Decumulation in a mandatory DC
pension environment
John Piggott
University of New South Wales
Outline of talk
•
Demographics
•
Market developments
•
What do people want?
•
How can this be delivered?
–
Policy designs – some specific country
examples
•
Future trends and new products
Increasing longevity
S
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Population aged 65 and
over,
by region (millions)
Old-age dependency ratios 2005, 2050
Trends in the Market
•
P
o
l
i
c
y
:
–
Withdrawal of PAYG
–
More reliance on mandatory DC
•
P
r
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s
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s
:
–
DB
DC
•
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:
–
L
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p
s
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m
s
–
Phased withdrawals
–
Reverse mortgages
Implications of govt and market shift
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•
P
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e
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:
–
Investment
individual account, no inter-
cohort smoothing
–
Longevity/health
no post employment
attachment
•
G
o
v
e
r
n
m
e
n
t
:
–
Demographic shift
Concerns with
fiscal
pressure
are more important
–
Less inter-generational risk-sharing
1981 – Chile
1985 – Switzerland; Netherlands
1986-92 – Australia
1993 – Argentina*; Columbia*, Denmark, Peru
1996 – Uruguay
1998 – Hungary; Kazakhstan; Bolivia; Mexico
1999 – El Salvador; Poland
2000 – Hong Kong; Sweden
2001 – Latvia
2003 – Dominican Republic
*Not strictly compulsory
439 million people
potentially affected
since 1980
India now has
compulsory DC
schemes for state
employees
China is playing with the
idea
Recent International Growth
of mandatory DC schemes
U.S. Health and Retirement Study 1992-2000, with over 12
000 respondents
Benefit Design
Source: Panis (2003)
Dealing with it:
traditional response
•
P
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Dealing with it: Product response
Save (or be forced to save) for your own
retirement. Then take a lump sum or buy:
•
Life annuities
•
Phased withdrawals
•
Guaranteed minimum income annuities
•
Other products:
•
Reverse mortgages
•
LTC insurance
Components of
Retirement Provision
T
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d
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)
Components of
Retirement Provision
P
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P
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a
n
a
g
e
d
•
1986 Accord: compulsory saving arose as
part of union wage deal
•
Superannuation Guarantee Act 1992
•
9% of earnings
, phased in to 2002
:
employer mandate
•
Around 90% of Australia’s workforce is
covered
•
Administered in the private sector
•
No restrictions on form of payout
International Experience
Australia
First Pillar:
Targeted Age Pension
•
Eligibility age of 65, for men, moving
to 65 for women
•
Available regardless of work history
•
Flat rate, but means tested
•
High take-up: 75 -80% get some
pension, 50% get full pension
•
Set at 25% of average male full-time
earnings for singles, 40% for married
couples
Second Pillar: the Superannuation
Guarantee
•
F
u
n
d
i
n
g
–
Fully funded (9% of earnings)
–
Individual accounts
–
Few investment restrictions
•
C
o
v
e
r
a
g
e
–
High for employees
–
Self employed not covered
Features of the Superannuation
Guarantee
•
A
c
c
u
m
u
l
a
t
i
o
n
r
e
g
u
l
a
t
i
o
n
s
–
Defined contribution
–
Fully vested, preserved, portable
–
Preservation age 55, moving to 60.
–
No early withdrawals
•
B
e
n
e
f
i
t
s
–
No income stream requirement on payout
Policy Development Status
Policy Development Status
•
No inter-pillar co-ordination
–
Access ages
differ between pillars
–
Means test treatment
of superannuation
drawdown inconsistent
–
Tax treatment
inconsistent
•
No inter-agency co-ordination
–
Taxation office (ATO), Prudential authority
(APRA), Social Security (FaHCSIA) have no
common objective with retirement drawdowns
Lump sums and policy
•
Lump sums preferred until 2007
–
Tax-free threshold now >$100,000
•
But since 2005:
–
Transition to retirement legislation
benefits
taken as income accessed while still working
and contributing
•
2007: Tax-free benefits for 60+
better
to leave your money behind the super veil
Available products (Australia)
•
Phased withdrawals
–
Account-based pensions have minimum
drawdown only
•
Life annuities
•
Short term-certain annuities
•
Long term (life expectancy) annuities
On the radar:
GMIAs
What is still missing?
•
Most longevity insurance products under-
produced
•
Products which allow investment risk
exposure combined with longevity
insurance
•
Opportunities for accessing home equity
•
LTC insurance almost zero
•
Evidence based regulation
Current debates in Australia
•
Should there be a higher mandatory contribution
rate?
•
Should there be a “late-life” mandatory annuity?
•
Should the first pillar be “buy-able”?
•
Should earnings tests be relaxed on the age
pension?
•
Super funds in drawdown activity
International Experience
Chile
•
Transfer to full privatisation in 1981
•
Compulsory for all workers – but poor compliance
•
10% of wages invested in private accumulation
accounts
•
Regulated investment choice
•
Government guarantees annual returns (in range)
•
Administered in private sector by AFPs
•
Indexed annuity or phased withdrawal only
Some points about Chile
•
Contribution rate not debated
•
Elaborate drawdown policy e.g., early
retirement requires indexed life annuity at
a level to keep you off social pension
•
Annuity design includes reversion for
spouse
•
Major issue around participation
•
Big problem with fees and commissions,
now regulated
28
Time Pattern of Insurance Company
Commissions
(as front end % of balance)
Draft Law
Law Passed
•
Mandatory saving in accumulation accounts
•
Publicly administered Central Provident Fund set up in
1955
•
Regulated investment rules have constrained returns
severely
•
CPF also provides subsidised insurance and loans (esp.
housing)
•
Contributions compulsory up to maximum income
•
30% mandatory contribution, split equally between
employer and employee
International Experience
Singapore
Some points about Singapore
•
Accumulations not well preserved
–
Housing
–
Other drawdown possibilities
–
Health account not insurance
•
All publicly managed
•
Late life annuities being mandated
Principles and future trends
•
Two important ideas
: portfolio allocation;
late life bonus multiplier
•
Portfolio allocation
–
No reason to dramatically change asset
allocation at the point of retirement
–
It should be a continuous process to balance
human capital depletion
•
Late life coverage
–
Annuities give the best return if deferred to
late life
The Survivor Bonus Multiplier
•
Annuities are most effective when used to fund
consumption at older ages.
•
Assume 3% rate of return
–
Cost to 60 year old funding $100 consumption at age
100 = $100*1.03^(-40) =
$31.
–
If instead the 60 year old buys an annuity making a
single payment of $100 at age 100, then assuming a
2% probability of living to 100,
•
the cost is $100*1.03^(-40)*.02 =
$0.62
Ruin contingent life annuities (
RCLAs
)
•
A deferred annuity which pays when
–
You live to a specified (old) age
AND
–
The market performs poorly
•
Often linked with variable annuities
–
Could be offered as stand-alone
•
Captures both the above principles
–
Allocate most retirement wealth to a phased
withdrawal, with discretionary asset allocation
and drawdown
–
Exploit the mortality bonus multiplier
Other perspectives
•
Require annuitisation to remove access to
social pension
•
Insist on consumption smoothing by
requiring annuity purchase
•
Deductibles and risk sharing annuities
–
Investment
–
Inflation
–
Longevity risk and pooled annuity funds
Other concerns
•
Annuity markets thin everywhere:
–
Are solvency requirements too rigid?
–
Limited reinsurance market
•
Small number of swaps
•
Negligible securitisation
•
No longevity bonds
–
Distribution channels poor
•
Link retirement income purchase with DC funds?
Thank you
Questions?
John Piggott
j.piggott@unsw.edu.au
This content explores decumulation strategies in a mandatory defined contribution pension setting, discussing demographics, market trends, policy designs, future products, increasing longevity, survival probabilities, old-age dependency ratios, and market implications.
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Presentation Transcript
Decumulation in a mandatory DC pension environment John Piggott University of New South Wales
Outline of talk Demographics Market developments What do people want? How can this be delivered? Policy designs some specific country examples Future trends and new products
Increasing longevity 90 80 70 Years 60 50 40 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 Five-year period beginning Source: UN, World Population Prospects, 2004. World More developed regions Less developed regions
Survival probability to age 90 for at least one member of couple: Australia, Male 65/Female 60 80% 64.4% 56.9% 60% 37.6% 40% 20% 0% 1975 2005 2025 Source: Authors calculation based on mortality rates and 100-year improvement factors reported in Australian Life Table 2000-02.
Population aged 65 and over, by region (millions) 500 400 1990 2050 300 200 100 0 AFRICA LATIN NORTHERN AMERICA EAST & SOUTHEAST ASIA, OCEANIA SOUTH ASIA CENTRAL & WESTERN ASIA EUROPE AMERICA & CARIBBEAN
Old-age dependency ratios 2005, 2050 0.60 2005 2050 0.50 Old age dependency ratio 0.40 0.30 0.20 0.10 0.00 Africa Asia Europe Latin America and the Caribbean Northern America Oceania
Trends in the Market Policy: Withdrawal of PAYG More reliance on mandatory DC Private sector pensions : DB DC Private insurance: Lump sums Phased withdrawals Reverse mortgages
Implications of govt and market shift Risk sharing is now much more limited Private sector: Investment individual account, no inter- cohort smoothing Longevity/health no post employment attachment Government: Demographic shift Concerns with fiscal pressure are more important Less inter-generational risk-sharing
Recent International Growth of mandatory DC schemes 1981 Chile 439 million people potentially affected since 1980 1985 Switzerland; Netherlands 1986-92 Australia India now has compulsory DC schemes for state employees 1993 Argentina*; Columbia*, Denmark, Peru 1996 Uruguay 1998 Hungary; Kazakhstan; Bolivia; Mexico China is playing with the idea 1999 El Salvador; Poland 2000 Hong Kong; Sweden 2001 Latvia *Not strictly compulsory 2003 Dominican Republic
Benefit Design novelty-party-time U.S. Health and Retirement Study 1992-2000, with over 12 000 respondents 69% of those who rely on DB pensions are happy with their retirement; only 54% without annuity income After 10 years of retirement, those with annuity incomes are 45% more likely to be very satisfied Retirees with annuity income streams are 30% more likely to have no depression symptoms Source: Panis (2003)
Dealing with it: traditional response Personal resources: fail to save, early retirement, no insurance, wealth locked in the family home. Family resources: the child as your pension BUT less children. Working longer: a natural solution for longevity adjustment BUT doesn t cope with fertility decline Social security: usually defined benefit schemes. Many are under-funded, implying fiscal stress. Occupational pension plans: Many DB plans are insolvent or under stress
Dealing with it: Product response Save (or be forced to save) for your own retirement. Then take a lump sum or buy: Life annuities Phased withdrawals Guaranteed minimum income annuities Other products: Reverse mortgages LTC insurance
Components of Retirement Provision Universal SAFETY NET Targeted PAYG Publicly provided Funded COMPULSORY EMPLOYMENT RELATED Privately managed Privately provided Publicly managed Employment related VOLUNTARY SAVING Tax preferred Other Non tax preferred (private saving)
Components of Retirement Provision PAYG Publicly provided Funded COMPULSORY EMPLOYMENT RELATED Privately managed Privately provided Publicly managed
International Experience Australia au-flag1 1986 Accord: compulsory saving arose as part of union wage deal Superannuation Guarantee Act 1992 9% of earnings, phased in to 2002: employer mandate Around 90% of Australia s workforce is covered Administered in the private sector
First Pillar: Targeted Age Pension Eligibility age of 65, for men, moving to 65 for women Available regardless of work history Flat rate, but means tested High take-up: 75 -80% get some pension, 50% get full pension Set at 25% of average male full-time earnings for singles, 40% for married couples
Second Pillar: the Superannuation Guarantee Funding Fully funded (9% of earnings) Individual accounts Few investment restrictions Coverage High for employees Self employed not covered
Features of the Superannuation Guarantee Accumulation regulations Defined contribution Fully vested, preserved, portable Preservation age 55, moving to 60. No early withdrawals Benefits No income stream requirement on payout
Policy Development Status Financing Decumulation First pillar (unfunded) General tax revenue Age pension Super Guarantee contributions Second pillar (funded) ?
Policy Development Status No inter-pillar co-ordination Access ages differ between pillars Means test treatment of superannuation drawdown inconsistent Tax treatment inconsistent No inter-agency co-ordination Taxation office (ATO), Prudential authority (APRA), Social Security (FaHCSIA) have no common objective with retirement drawdowns
Lump sums and policy Lump sums preferred until 2007 Tax-free threshold now >$100,000 But since 2005: Transition to retirement legislation benefits taken as income accessed while still working and contributing 2007: Tax-free benefits for 60+ better to leave your money behind the super veil
Value of Benefits taken 2001 - 2007 35000 30000 25000 AUD million (current) 20000 Total annuities Allocated Pensions Total Retirement products Lump sums 15000 10000 5000 0 2001 2002 2003 2004 2005 2006 2007 Year
Available products (Australia) Phased withdrawals Account-based pensions have minimum drawdown only Life annuities Short term-certain annuities Long term (life expectancy) annuities On the radar: GMIAs
What is still missing? Most longevity insurance products under- produced Products which allow investment risk exposure combined with longevity insurance Opportunities for accessing home equity LTC insurance almost zero Evidence based regulation
Current debates in Australia Should there be a higher mandatory contribution rate? Should there be a late-life mandatory annuity? Should the first pillar be buy-able ? Should earnings tests be relaxed on the age pension? Super funds in drawdown activity
International Experience Chile Transfer to full privatisation in 1981 Compulsory for all workers but poor compliance 10% of wages invested in private accumulation accounts Regulated investment choice Government guarantees annual returns (in range) Administered in private sector by AFPs Indexed annuity or phased withdrawal only
Some points about Chile Contribution rate not debated Elaborate drawdown policy e.g., early retirement requires indexed life annuity at a level to keep you off social pension Annuity design includes reversion for spouse Major issue around participation Big problem with fees and commissions, now regulated
Time Pattern of Insurance Company Commissions (as front end % of balance) Draft Law Law Passed 28
International Experience Singapore singapore-flag Mandatory saving in accumulation accounts Publicly administered Central Provident Fund set up in 1955 Regulated investment rules have constrained returns severely CPF also provides subsidised insurance and loans (esp. housing) Contributions compulsory up to maximum income 30% mandatory contribution, split equally between employer and employee
Some points about Singapore Accumulations not well preserved Housing Other drawdown possibilities Health account not insurance All publicly managed Late life annuities being mandated
Principles and future trends Two important ideas: portfolio allocation; late life bonus multiplier Portfolio allocation No reason to dramatically change asset allocation at the point of retirement It should be a continuous process to balance human capital depletion Late life coverage Annuities give the best return if deferred to late life
The Survivor Bonus Multiplier Annuities are most effective when used to fund consumption at older ages. Assume 3% rate of return Cost to 60 year old funding $100 consumption at age 100 = $100*1.03^(-40) = $31. If instead the 60 year old buys an annuity making a single payment of $100 at age 100, then assuming a 2% probability of living to 100, the cost is $100*1.03^(-40)*.02 = $0.62
Ruin contingent life annuities (RCLAs) A deferred annuity which pays when You live to a specified (old) age AND The market performs poorly Often linked with variable annuities Could be offered as stand-alone Captures both the above principles Allocate most retirement wealth to a phased withdrawal, with discretionary asset allocation and drawdown Exploit the mortality bonus multiplier
Other perspectives Require annuitisation to remove access to social pension Insist on consumption smoothing by requiring annuity purchase Deductibles and risk sharing annuities Investment Inflation Longevity risk and pooled annuity funds
Other concerns Annuity markets thin everywhere: Are solvency requirements too rigid? Limited reinsurance market Small number of swaps Negligible securitisation No longevity bonds Distribution channels poor Link retirement income purchase with DC funds?
Thank you Questions? John Piggott j.piggott@unsw.edu.au
