Pension Reform and Financial Markets:
Encouraging Households Savings
for Retirement
Anita Tuladhar
International Monetary Fund
June 2007
Conference on International Forum on
Pension Reform: Exploring the Link to
Labor and Financial Market Reforms
The views expressed herein are those of the author and
should not be attributed to the IMF, its Executive Board,
or its management.
Background



Rapidly ageing populations
Unsustainable pension system and public finances in
the long run
Introduction of funded pensions system with
mandatory private individual account and voluntary
supplemental accounts, including in the region.
–
–
–
–
–
–

1998 (Hungary, Kazakhstan);
1999 (Poland);
2001 (Latvia);
2002 (Croatia, Estonia, Bulgaria);
2003 (Russia);
2005 (Macedonia, Slovakia);
Shifting of responsibility for old-age income to
households (by working more or higher financial
savings)
Question: How to encourage household
financial savings for retirement?
Outline of this presentation:
 Examination of household financial savings
–

Factors affecting pension fund savings
–
–

in particular, pension savings in some emerging and mature
markets
Descriptive analysis using cross country data
Empirical analysis using more detailed pension fund data
from Latin America.
Policy implications for pension fund regulations
Household balance sheets:
Share of financial assets in total wealth varies considerably.
120
Composition of Household Wealth in Household Balance Sheets, 2000
100
80
60
40
20
0
Average - MM
Average - EM
USA
Canada
Financial assets
Denmark
Netherlands
UK
Japan
Portugal
Source: Davies, Sandstrom, Shorrocks and Wolff (2006)
Italy
Australia
Germany
France
New Zealand
Spain
South Africa
Taiwan
Singapore
Czech Republic
Poland
Non-financial assets
Household balance sheets:
Share of liquid assets in financial assets significantly
larger in emerging markets.
120
Composition of Financial Assets in Balance Sheets, 2000
100
80
60
40
20
0
Shares and equities
Source: Davies, Sandstrom, Shorrocks and Wolff (2006)
Other (including pensions)
Average - MM
Average - EM
USA
Netherlands
Switzerland
Denmark
UK
Austria
Australia
Italy
Canada
France
Germany
New Zealand
Spain
Greece
Portugal
Japan
Belgium
South Africa
Estonia
Lithuania
Taiwan
Hungary
Singapore
Slovenia
Latvia
Poland
Czech Republic
Korea
Turkey
Slovakia
Romania
Croatia
Bulgaria
Liquid assets
Household balance sheets (contd.)
The low share of pension fund savings also observed in
the OECD.
1.2
Select OECD Countries: Composition of Household Financial Assets
(In percent)
1
Others
Equities
0.8
Loans
0.6
Securities except shares
Insurance reserves (incl
pensions)
Currency and deposits
0.4
0.2
0
CZE
Source: OECD.
POL
HUN
SVN
JAP
FIN
NOR
AUS
Factors Affecting Pension Fund Assets:
A Cross-Country Comparison
Turkey
Lithuania
Luxembourg
China
Slovak Republic
Russia
Dominican Republic
Pakistan
Latvia
Costa Rica
Korea
Slovenia
Bulgaria
Italy
Croatia
Estonia
Germany
Kazakhstan
Czech Republic
Belgium
Argentina
Austria
Thailand
India
France
Norway
Mexico
Hungary
Poland
El Salvador
Spain (6)
Bolivia
New Zealand
Peru
Uruguary
Portugal
Sweden
Colombia
Japan
HongKong
Kenya
Denmark
South Africa
Non-OECD
Canada
Ireland
Malaysia
Australia
Singapore
Chile
Finland
United Kingdom
Total OECD
United States
Switzerland
Iceland
Netherlands
Pension Fund Assets to GDP, 2005
0
Source: OECD.
20
40
60
80
100
120
140
Pension fund assets in non-OECD countries
remains relatively low.
Ukraine
Indonesia
Lithuania
China
Russia
Dominican Republic
Pakistan
Latvia
Costa Rica
Slovenia
Bulgaria
Croatia
Estonia
Kazakhstan
Argentina
Thailand
India
El Salvador
Bolivia
Peru
Uruguay
Colombia
Hongkong
Kenya
South Africa
Malaysia
Singapore
Chile
Pension Fund Assets in Selected Non-OECD Countries, 2005 (In percent of GDP)
Weighted Average: 37
percent
0
Source: OECD.
10
20
30
40
50
60
70
Theoretical foundations on determinants of
household savings
Macroeconomic conditions
Income
Wealth
Real Interest Rates
Inflation
Unemployment
Financial Market Development
Investment Opportunities
Liquidity constraints
Preferences
Household savings
1. Level
2. Composition
Alternative Income Sources
Public pensions
(features and financing)
Public transfers
Household size
Demographics
Dependency ratio
Per Capital Income: Pension fund savings are
positively correlated with income levels.
90,000
Per Capita GDP vs. Pension Assets
80,000
70,000
in USD
60,000
50,000
Full Sample
40,000
30,000
20,000
Non-OECD
10,000
Non-OECD
0
0
20
Source: OECD ; and IMF WEO.
40
60
80
In percent of GDP
100
120
140
Demographics: An older population or a faster pace
of ageing Is not related to significantly higher
pension fund savings
70
Old Age Dependency Ratio vs. Pension Fund Assets, 2005
60
50
Full Sample
In times
40
30
20
Non-OECD
10
Non-OECD
0
0
20
40
60
80
In percent of GDP
Source: OECD; and United Nations.
100
120
140
Alternative income sources: Public pension policy
affects incentives to save in pension funds.
16
Public Pensions Expenditure vs. Pension Fund Assets
14
12
In percent of GDP
10
8
Full Sample
6
4
2
Non-OECD
0
0
20
Source: OECD.
40
60
80
In percent of GDP
100
120
140
Alternative income sources: Generosity of public
pensions likely reduces incentives to save in
pension funds.
140
Net Replacement Rate vs. Pension Fund Assets
120
In percent
100
Full Sample
80
Non-OECD
60
40
20
Non-OECD
0
0
20
Sources: IMF staff; and OECD.
40
60
80
In percent of GDP
100
120
140
Pension Reforms: The maturity of the mandatory
funded system is a significant determinant of the
size of pension fund savings.
Turkey
Lithuania
Luxembourg
China
Slovak Republic (1)
Russia
Dominican Republic
Pakistan
Latvia
Costa Rica
Korea
Slovenia
Bulgaria
Italy
Croatia
Estonia
Germany
Kazakhstan
Czech Republic
Belgium
Argentina
Austria
Thailand
India
France (1) (3)
Norway
Mexico
Hungary
Poland
El Salvador
Spain (6)
Bolivia
New Zealand
Peru
Uruguary
Portugal
Sweden (7)
Colombia
Japan (5)
HongKong
Kenya
Denmark
South Africa
Non-OECD
Canada (1)
Ireland (4)
Malaysia
Australia
Singapore
Chile
Finland (2)
United Kingdom (1)
Total OECD
United States (10)
Switzerland (1) (8)
Iceland
Netherlands (1)
Pension Assets, 2005 (In percent of GDP)
0
20
40
60
80
100
120
140
Financial market development: Pension fund savings
shows a strong positive relation with financial market
development. Direction of causality?
300
Market Capitalization vs. Pension Fund Assets
250
Full Sample
In percent of GDP
200
150
Non-OECD
100
50
Non-OECD
0
0
20
40
60
80
In percent of GDP
Source: Bloomberg; and OECD.
100
120
140
Financial market development: Pension fund savings
are inversely related to financial market volatility.
Market stability or preference for safer assets?
180
Equity Market Volatility vs. Pension Fund Assets
160
Non-OECD
140
Std. dev (In percent)
120
100
80
60
Non-OECD
40
Full Sample
20
0
0
20
40
60
80
In percent of GDP
Source: Bllomberg; and OECD.
100
120
140
Financial market development: Pension fund savings
are inversely related to risk adjusted returns in the
equity market. Investment limitations or lack of deep
liquid markets?
2.5
Risk Adjusted Return vs. Pension Fund Assets
2.0
1.5
1.0
Full Sample
0.5
Non-OECD
Non-OECD
0.0
0
20
40
60
80
100
120
140
Empirical analysis


Question: What factors enhance participation and pensions
savings?
Equations:
1.
Change in pension fund participation =
f (fund performance, years since reform,
change in income, change in unemployment rate)
2.
Change in pension fund assets per participant =
f (fund performance, change contribution rate, change in income,
rates of return on alternative investments)

Data:
–
–
–

Pension fund data: FIAP on Latin American countries
Macroeconomic data: WEO
Financial Market data: IFS, World Development Indicators,
Bloomberg
Unbalanced Panel Data with 8 countries
Results: Equation 1
Fixed Effects Estimation
Dependent Variable: D(Number of Participants)
Explanatory Variables:
Constant
0.06
Lagged Dependent Variable
-0.36
Annual Rate of Return
0.002
Lag Annual Rate of Return
Dummy (Reform Years)
D(Unemployment Rate)
Income Per Capita
D(Income Per Capita)
Annual Rate of Return*D(Income Per Capita)
R-Squared
F-Stat
Sample (adjusted)
Included observations after adjustments
Cross-sections included
Total pool (unbalanced) observations
0.16
1.02
0.06
-0.36
0.002
0.000
0.15
0.78
0.05
-0.44
0.001
0.04
-0.48
0.002
0.42
-0.48
0.002
0.32
-0.46
0.002
0.02
-0.45
0.003
0.10
0.09
-0.23
0.08
-0.19
-0.05
0.08
-0.21
-0.04
0.09
-0.23
0.26
1.67
0.31
1.93
0.33
1.88
0.002
0.04
0.004
0.33
1.49
0.33
1.68
1984 2005 1984 2005 1984 2005 1984 2005 1990 2005 1990 2005 1990 2005
22
22
22
22
22
22
22
8
8
8
8
8
8
8
59
56
59
59
59
59
59
Results: Equation II
Fixed Effects Estimation
Dependent Variable: D(Pension Funds Per Participant)
Explanatory Variables:
Constant
Lagged Dependent Variable
Annual Rate of Return
Lag Annual Rate of Return
D(Income Per Capita)
Fund Contribution Rate (Net of Fees)
Stock Market Return
Government Bond Rate
R-Squared
F-Stat
Sample (adjusted)
Included observations after adjustments
Cross-sections included
Total pool (unbalanced) observations
0.07
0.04
0.014
0.05
-0.06
0.02
0.004
0.10
-0.19
0.01
0.06
0.07
0.01
0.07
0.14
0.01
0.08
0.08
0.01
0.38
0.36
0.36
-0.40
0.00
0.00
0.47
4.97
0.58
6.18
0.47
2.25
0.54
5.67
0.82
13.5
0.54
3.97
1984 2005 1984 2005 2000 2005 1984 2005 1996 20051993 2005
22
22
6
22
10
13
7
7
7
7
5
7
54
51
33
54
33
45
Key Factors and Challenges to
Pension Fund Savings

Structural factors limit pension fund coverage
–
–

Pension savings on a voluntary basis low reflecting
–
–
–


high unemployment rate
low income levels
still generous public pension system
level of financial sector development that limits investment
opportunities or low financial awareness thereof, or
myopia
Improved performance on pension funds encourage savings
Other variables: savings incentives, other income sources,
demographic factors
Policy Implications

Enhancing coverage of pension income:
–
–
creates a need for non-contributory social safety net for
retirees (minimum public pensions or the zero pillar)
make pension fund savings mandatory or require automatic
enroll enrollment as default option to improve participation

–
In CEC’s generally, participation to funded pensions is
designed as a carve-out of existing public pension contribution
which is mandatory for younger workers. (~20 yrs for SVK,
EST, MKD, HUN, ~30 yrs POL and LVA, ~40 yrs CRA, BLG, all
for KZK)
awareness/financial literacy
Policy Implications

Regulations for improving fund performance/net riskadjusted returns:
–
Investment in an optimum portfolio:


–
–
regulations on asset allocation. For eg - shift from quantitative
investment limits to prudent person rule or loosen tight
regulations taking into consideration the development of local
securities markets
regulations on guarantees: For eg – minimum guaranteed
return relative to industry
Tax incentives on voluntary pension savings
Minimizing fees and costs: regulations on fees, industry
structure
Pension portfolios mostly in government bonds, reflecting
both regulatory restrictions and lack of investment
opportunities
60
Portfolio Allocation in Select Latin American Pension Funds,
1999-2006
50
40
30
20
10
0
Government
Debt
Financial
Institutions
Non-financial
Institutions
Equities
Jun-99
Mutual Funds
Dec-06
Foreign
Investments
Others
Pension portfolios are shifting from bank deposits
towards capital markets and international
investments
Shift in Portfolio Composition of Pension Funds, 1999-2006
NonGovernment
Financial
financial
Mutual
Debt
Institutions Institutions Equities
Funds
(In percent of total funds)
Argentina
9.3
-15.6
-0.7
-4.6
5.1
Bolivia
8.8
-22.9
9.3
0.1
0.2
Chile
-24.2
-4.9
4.3
4.3
0.9
El Salvador
10.5
-16.3
5.8
0.0
0.0
México
-24.2
4.7
8.0
1.8
0.0
Perú
12.5
-30.1
-6.2
4.9
1.7
Uruguay
-4.1
3.4
1.1
0.1
0.0
Foreign
Investments
Others
9.5
2.7
19.6
0.0
9.6
8.5
0.0
-2.9
1.9
0.0
0.0
0.0
7.3
-0.7
Investment limits: Need to enable diversification,
and also allow life-cycle investing
Investment Limits
Equity
Foreign Investment
United Kingdom
PPR 1/
PPR
United States
PPR
PPR
Germany
30
20
Japan
30
30
Canada
No limit
30
Italy
PPR
20
Argentina
Chile
Mexico
Peru
Colombia
El Salvador
50
39
15
35
30
n.a.
20
30
20
10.5
20
7
Slovakia
n.a.
50
Hungary
50
30
Latvia
n.a.
30
Macedonia
30
20
Croatia
30
15
Kazakhstan
30
10
Poland
40
5
Bulgaria
5
5
Sources: Poirson (2007), Chlon Dominczak (2003), Rutkowski (2006)
1/ Prudent Person Rule (PPR)
Policy Implications

Gradual easing of investment limits, especially on foreign
investments
–

Public debt management:
–
–

facilitates diversification gains especially in lack of domestic
investments, limits foreign exchange market volatility
Longer term instruments, inflation hedge, establishing liquid
benchmark instruments,
ensuring pension funds don’t become captive markets for
government financing that provides cheap financing.
Measures to strengthen capital market development
–
–
Privatization, increasing available investment instruments,
corporate governance regulations to improve supply
Liquidity of these instruments also important
Minimum Return Guarantees (MRG):
Significantly affects asset allocation and leads to
herding behavior

Relative to the Pension Industry
–

Relative to a benchmark
–

Hungary
No guarantees
–

Kazakhstan, Poland, Croatia, Slovakia
Bulgaria, Latvia, Estonia, Macedonia
If MRG invoked, requires paying up from
reserves, guarantee funds, etc.
Regulations on Guarantees: Flexibility in
parameters of Minimum Return Guarantees, including
setting of benchmark and portfolio choice
Minimum Guaranteed Return in Select Countries
Assessmet
Period
12 months
Frequency of Full Disclosure
Evaluation
of Portfolios
Monthly
Colombia Minimum Return = (A+B)/2
A = 70 percent of ARS
B = 70 percent of Return on Synthetic Portfolio
70 percent of Return on Bogota stock exchange index
70 percent of return of S&P 500
36 months
Quarterly
After 30 days
Chile
Risky Funds = Min (50 Percent of ARS, ARS-4 percent)
Conservative Funds = Min (50 Percent of ARS, ARS-2 percent)
36 months
Monthly
After 10 days
Uruguay
Min( 2 percent real, ARS-2 percent)
12 months
Monthly
36 months
Bi-annually
Country
Benchmark and Returns
Argentina Min( 70 percent of ARS, ARS-2 percent) 1/
Poland
Min( 50 percent of ARS, ARS-4 percent)
Source: IMF/World Bank (2007).
1/ ARS = Weighted Average Return of the System
Yearly
Other considerations: Tax incentives for voluntary
savings not very effective for lower income and
liquidity constrained individuals.


No evidence of an increase in overall savings while
mixed evidence of impact on composition of savings
Effectiveness of tax incentives depend on the
substitutability of different savings alternatives. Nonsubstitutability could arise from the motivation for
–
–


(i) precautionary savings if liquidity constrained
(ii) bequest to heirs
Strong distributional effects with benefits accruing to
older and richer individuals who face higher marginal
tax rates.
Fiscal costs
Industry structure: trending towards consolidation
requiring a balance between competition in returns
and scale economies to keep costs low
30
Number of Pension Fund Administrators
25
20
15
10
5
0
1993
1994
1995
1996
ARGENTINA
EL SALVADOR
URUGUAY
1997
BOLIVIA
MÉXICO
BULGARIA
1998
1999
2000
COLOMBIA
PANAMÁ
Kazakhstan
2001
2002
COSTA RICA
PERÚ
Poland
2003
2004
CHILE
Dominican Rep.
2005
Minimizing fees and costs are important to
ensure high net returns





High fixed costs has more distributional impact on lowincome savers.
Centralization of basic services with scale economies
such as account management, collections. This is
already the case in most CECs.
Minimizing costs from regulatory burden (for reserves,
reporting, etc) and initial marketing costs.
Regulatory ceilings for fees on contributions/assets
which decline over time as asset size grows.
Balance the costs with high concentration in the
industry.
Financial Awareness






Financial education and awareness particularly if
given choice of portfolio
Greater need if low-income savers
Dynamic default portfolio for passive investors
Public information including availability of simulation
models to analyze potential net replacement rates at
retirement
Easy access to account information
Transparency and Accountability of pension funds
–
Publication of investment results and financial statements
Conclusions


Share of pension savings in household balance sheets are
relatively small but growing rapidly.
Factors affecting pension fund savings
–
–
–

Pension reform, mandatory savings, fund performance,
Macro/Structural factors
Financial sector development
Policy implications for pension fund regulations
–
–
–
–
Enhancing coverage through mandatory forms of savings, default rules
and other social safety nets
Enhancing net risk-adjusted returns through increasing flexibility for
diversification gains,
Reducing costs by harnessing economies of scale and minimizing other
burdens
Investor protection through information and education