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2014.01.10 - NAEC Seminar_Fostering long-term investment (Presentation 2)

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  • 1. New Approaches to Economic Thinking Seminar on Project A4, 10 January 2014 RESPONDING TO THE CHALLENGES OF AGEING AND LONGEVITY RISK Pablo Antolin OECD Financial Affairs Division, Pension Unit
  • 2. Issues addressed in this work  The challenges posed by population ageing  What is population ageing?  The impact of population ageing  Addressing its impact on pension systems  Improvements in mortality and life expectancy and the uncertainty surrounding future improvements  Assessing the amount of longevity risk (pension funds and annuity providers)  Managing longevity risk: capital markets solutions and the role of governments  The analysis and policy messages herein stem from the work discussed and examined within the context of the CMF, IPPC and WPPP. 2
  • 3. MEETING THE CHALLENGES POSED BY POPULATION AGEING ON PENSION SYSTEMS
  • 4. Population Ageing Population ageing refers to an increase in the average age of the population Increase is the result of a decrease in fertility, (already over: return to previous levels)  baby boom. And an increase in life expectancy (LE). The baby boom is temporal The increase in LE is relatively permanent effect (bar wars and epidemics) 4 4
  • 5. Population ageing: Increase in the median age 55 Japan 50 45 France 40 Germany 35 30 USA China 25 Brazil 20 15 10 5 0 Brazil China France Germany Japan USA 5
  • 6. 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Population Ageing •Fertility returns to previous lower levels 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 6
  • 7. 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 Population Ageing •Fertility fall (developing countries) 7 6 5 4 3 2 1 0 7
  • 8. Population Ageing • Large increases in life expectancy 85 80 75 70 Life expectancy at birth (increase = 2.2 yrs per decade) 65 2010 2007 2004 2001 1998 1995 1992 1989 1986 1983 1980 1977 1974 1971 1968 1965 1962 1959 1956 1953 1950 60 8
  • 9. Population Ageing Large increases in life expectancy (at age 65) 24 22 Life expectancy at 65 (increase = 1 yrs per decade) 20 18 16 14 12 2010 2007 2004 2001 1998 1995 1992 1989 1986 1983 1980 1977 1974 1971 1968 1965 1962 1959 1956 1953 1950 10 9
  • 10. Population Ageing: Implications •More people in retirement and for longer. 19 Number of people in working age per person 65+ 18 17 Brazil 16 15 14 China 13 12 11 10 Japan 9 8 7 6 5 4 Germany USA France 3 2 1 0 Source: UN Population Projections, 2010 Revision 10
  • 11. Population Ageing: Implications • Major future impact: increases in Lex. 6 5 4 3 Baby boom only Life expectancy 2 1 Number of working age people per person 65+ 0 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 11
  • 12. Impact of Population Ageing (PA) • GDP growth = productivity and labour force growth • Productivity decreases with age?: hard to assess (cognitive, learning by doing) (self selection bias) • PA reduces workforce if fertility rates continue falling (not the case). • Increases life expectancy with constant retirement age means people retired with longer claims on GDP • Savings will fall as long as retirees’ saving rates lower that those of the working age population. • Lower saving, lower investment (I=S) unless borrowing from abroad • Financial markets: PA may lead to potential lower returns, contributing to the current environment of low interest rates 12
  • 13. Fiscal impact of PA • Main fiscal impact of ageing population is through pensions and health care • Expenditures on both will increase as a share of GDP, in particular health care (percentage points of GDP) Country EU US Pensions 1.5 1.8 Health care 3.4 4.4 • Postponing retirement will go a long way to contain the increase in pension expending 13
  • 14. What is the impact of PA on pensions? • Basic principle: what it goes in (saving during working life) and what it gets out (pension benefits during retirement) need to be equal • Baby boom (temporary): smaller cohorts working than retiring. • This affects mainly PAYG-financed pensions because current workers pay for current pensions. • Affects also indirectly (through returns on investment) funded pensions 14
  • 15. What is the impact on pensions? • Higher life expectancy (permanent) increases the years in retirement relative to the years saving to finance retirement. • ΔLE creates problems of • Sustainability to PAYG-funded public pensions • Funding and solvency to funded DB pensions • Adequacy to funded DC pensions • PA also affects pensions indirectly through GDP growth, wage growth and returns on investment 15
  • 16. OECD messages to address the impact of PA on pensions Do not put all eggs in the same basket Diversify the sources to finance retirement Necessary to have public pensions as well as funded private pensions Funded private pensions are complementary to public pension provision. 16
  • 17. How to address the impact of PA on pension gap of ageing populations? • Link retirement age to life expectancy (Sweden): PAYG-financed pensions. • Better still, link years contributing to years saving for retirement (NDC, DCs) • Contribute and contribute for long periods • Promote annuities to protect people from longevity risk (increase role of defined contribution, DC) OECD Roadmap Good Design DC Plans 17
  • 18. MORTALITY ASSUMPTIONS LONGEVITY RISK
  • 19. More permanent problem of PA • How to deal with future improvement in mortality and life expectancy • Future improvements are uncertain  Longevity Risk (LR) • Difference between how future improvements are accounted for and their future realisation (unknown) is the amount of longevity risk that individuals and financial systems potentially are exposed to • Pension funds and annuity providers can go bankrupt, and individuals may fail to have adequate pensions • Government budgets and pension promises may become unsustainable 19
  • 20. OECD (CMF, IPPC, WPPP) Project • Assess the amount of longevity risk that pension funds and annuity providers (insurance companies) may potentially be exposed to. • So far 16 countries including China, Brazil and Mexico. 20
  • 21. Assessing LR 1. Look at the regulatory requirements and market practice regarding mortality assumptions – Many countries do not have requirements to account for improvements – In practice most countries account for improvements – It is more common in annuity providers than in pension funds • Are they still expose to LR? 21
  • 22. Assessing LR 2. Compare the annuity values that the regulatory requirements and the market practice mortality assumptions suggest (what is accounted or provisioned for) with what future improvements would suggest • As a proxy for the future, the project uses the mortality projections from 4 common mortality models • This comparison provides a measure of the value of additional reserves or provisions needed to meet future payments 22
  • 23. Assessing LR • The study finds that countries vary from those needed to be monitored (less than 2% shortfall in provisions) to significant (5% 10%) and serious shortfall (10% - 20%) • Countries least exposed to LR seem to be those where industry experts actively participate in defining standards and driving the analysis of mortality experience and assumption setting. 23
  • 24. How to manage LR? • In house (traditionally) through reserving and constant updating of actuarial parameters, accounting for future improvements and using stochastic modeling (probabilities) • Additionally, there is a need for financial instruments to help pension funds and annuity providers to hedge LR • Existing arrangements to manage LR (e.g. buy-ins) focus almost exclusively on transferring the LR from one party to another • Instruments that allow for hedging LR (longevity hedges) may be better 24
  • 25. Government role? • Legislation and regulation • Provide standardisation, liquidity and transparency 25
  • 26. Government role? • Regulate mortality tables to include stochastic forecasts of future improvements and regular updates • Develop a reliable longevity index to encourage standardisation and transparency • Issue longevity bonds? What is the market failure that justifies government intervention? – Provide liquidity – Idiosyncratic LR and aggregate (cohort) LR 26
  • 27. Policy conclusions • The main long term problem of PA stems from future improvements in mortality and life expectancy • Need to deal with the uncertainty surrounding these improvements, longevity risk • Require pension funds and annuity providers to use mortality tables that include improvements, require them to update their actuarial calculations and tables regularly, and use stochastic modelling (probabilities) • Governments should issue longevity indices • Encourage hedging financial instruments 27
  • 28. THANK YOU VERY MUCH www.oecd.org/insurance/private-pensions 28