The OECD Roadmap for the Good Design of Retirement Saving ... · PDF filefor the Good Design...
Transcript of The OECD Roadmap for the Good Design of Retirement Saving ... · PDF filefor the Good Design...
The OECD Roadmap
for the Good Design of
Retirement Saving Plans
Pablo Antolin OECD DAF/FIN Pension Unit
Tallinn, December 2012
Background and motivation
Retirement saving plans in which benefits depend on assets accumulated are increasingly an integral part of most countries’ overall pension system.
All countries rely on these plans, different degree. Their importance keeps growing
In some countries is already the main source to finance retirement: Australia, Canada, Chile, Mexico, UK, US.
2
Background and motivation
The OECD has been working for a few years on improving the design of DC pension plans in order to strengthen retirement income from these plans.
We have compiled the lessons learnt into a set of policy messages.
Policy messages have been endorsed by the OECD WPPP: regulators and policy makers from OECD countries
3
Background and motivation
Saving for retirement is for the long haul.
Retirement income depends on several factors, some policy makers, regulators and individuals have certain control over (contributions, ret.age) and other uncertain (returns, life expectancy).
Financial and economic crisis highlighted the importance of risk factors.
4
Guiding principles
• The policy messages based on three
guiding principles:
–Coherence
–Adequacy
–Efficiency
5
Coherence
• Policy messages to strengthen retirement
income in DC plans need to assess these plans in the context of each country overall pension system, they are not in a vacuum.
6
Adequacy
• DC pension plans are complementary to
other sources to finance retirement (e.g. PAYG-financed pensions).
• DC plans need to be designed (e.g. contribution rates, contribution periods, payout phase, etc.) taking into account that they may provide a ret. income that complement other sources.
• What is an adequate ret. inc. is highly controversial. But assuming that for example, one can get by on 70% of pre-retirement income …
7
Efficiency
• Efficiency: reducing risks for retirement income or saving for retirement (de-risk).
• E.g. choosing investment strategies (many in the return-risk spectrum) that reduce the impact of extreme negative outcomes on retirement income
• Efficiency also required to properly structure the payout phase: allocate assets efficiently. Strike out a balance btw liquidity and flexibility, and protection from longevity risk
8
Main policy messages
9
Main policy messages
1. Ensure the design of DC pension plans is coherent (globally, internally, monitoring all risks)
2. Encourage people to enrol, contribute and contribute for long periods
3. Improve the design of incentives to save for retirement to increase contributions and coverage, in particular when voluntary.
10
Main policy messages
4. Promote low-cost retirement savings instruments
5. Establish appropriate default investment strategies, while also providing choice btw investment options with different risk profile and investment horizon
6. Consider establishing life-cycle investment strategies as defaults to protect against extreme negative outcomes
11
Main policy messages
7. Encourage annuitization as a protection against longevity risk
8. Promote supply of annuities & cost-efficient competition in the annuity mkt
9. Develop appropriate information and risk-hedging instruments to facilitate dealing with LR
10. Ensure effective communication and address financial literacy
12
Messages related to
cost, investment
strategies and defaults
13
M2. Encourage people to contribute
and contribute for long periods
• Best way reduce uncertainty about achieving a target retirement income is to contribute large enough amounts and for long periods.
• Long contribution periods allow for higher retirement income for given level of contributions (compound interest)
• Lengthening contribution period by postpo. retirement more efficient approach of increasing retirement income.
14
Encourage people to contribute
and contribute for long periods
• ∆ contributions or the contribution period ∆ the probability of reaching the target retirement income (RR).
15
Prob (RR≥30%) Prob (RR≥70%)
5% C – 40 years 61.6 13.9
10% C – 40 years 91.7 52.8
5% C – 20 years 2.8 0.1
10% C – 20 years 33.0 1.3
M3. Improve the design of
incentives to save for retirement to
increase contributions and coverage
• Contribution could be ∆ through mandates or with the help of “nudge” measures.
• “Nudge” measures include matching contributions (employer or state), and auto-escalation (e.g. SMTP).
• Also important to increase the number of people saving for retirement in DC plans
16
Improve the design of incentives to
save for retirement to increase
contributions and coverage • Compulsion
• Soft compulsion: auto-enrolment with an opt-out clause (Italy, New Zeeland, UK). Take advantage of behavioural financial literature stressing the role of inertia or passive decision.
• Strengthen the value of tax incentives for mid to low income people: tax credits or matching contributions instead of tax deductions.
• Better communication and improve fin-ed 17
M4. Promote low-cost retirement
savings instruments
• The amount of fees charged has a large impact on retirement income.
18
Fee as % assets Reduction of pension
0.05 % 2 %
0.15 % 5 %
0.25 % 8 %
0.50 % 15 %
0.75 % 22 %
1.00 % 28 %
1.50 % 39 %
Promote low-cost retirement
savings instruments
• Policy approaches to keep fees reasonable
1. Disclosure-based initiatives: ensure members receive timely info on fees they pay, including comparisons btw providers
2. Pricing regulations: single charge structure, and setting ceiling on fees
19
Promote low-cost retirement
savings instruments
3. Structural solutions include: in occupational pensions employers and trustees act as intermediaries, can negotiate fees. Another option could be the establishment of a centralised institution (Sweden, Nest)
20
M5. Establish default investment
strategies with appropriate risk exposure
• DC plans aimed at providing people choice
• Behavioural econ and financial literacy research show that some people are either unwilling or unable to choose among I strategies.
• Default I strategies concentrate on reducing the risk of extreme negative outcomes on retirement income.
21
Establish default investment strategies
with appropriate risk exposure
• Choosing the appropriate default options
Balancing trade-off higher potential ret. inc. and associate risk.
Risk measured as ret. inc. in extreme negative outcomes
Choose the probability threshold established to assess risk: I strategies reduce downside risk by e.g. 99%
22
M6. Establish life-cycle investment
strategies as defaults • Life cycle I strategies reduce the exposure to
risk assets (e.g. equities) as people ages. Easy to understand
• They provide protection for those close to retirement in case of a negative stock market shock just before retirement
• They provide protection when contribution periods are short
• The glide path important: ones with sharp decrease in equities in the last decade
23
Estimated probability that pension benefits
based on LC strategies will be higher than
those based on a fixed portfolio strategy for
two different contribution periods
24
Life-cycle investment strategies 20 years 40 years 20 years 40 years
Sharp decrease after age 55230.2 42.1 71.0 61.5
Entire random
sample (10,000 obs)
Negative stock
market shock1
Contribution period Contribution period
Establish life-cycle investment
strategies as defaults
• Life cycle I strategies not a panacea: provide protection from extreme negative shocks for those close to retirement, but do not eliminate volatility, do not address adequacy
• LC strategies can be organised around one single fund (e.g. target date, US) or around several funds (e.g. multi-funds, Chile, Mexico)
25
M10. Ensure effective communication
and address financial literacy
• Members should be provided with regular individualised benefit statement. Including accounting info and projections on future benefits with prudent assumptions.
• Members able to access freely and readily comparative info on costs and performance
• Disclosure materials written using accessible language
26
M10. Ensure effective communication
and address financial literacy
• Use web tool to communicate risk
• Goal: members be pro-active:
– target retirement income,
– likelihood,
– contribute more,
– contribute longer
27
Ensure effective communication
and address financial literacy
• NPCC can be useful to inform the population about reforms and “ nudge” them towards specific choices (e.g. retire later).
• Targeted campaigns: one issue, well defined policy goal (e.g. increase savings)
• Measurable objectives
• Evaluation standards. Constant evaluation against obejctives
• Dedicated and sustainable budget. 28
Ensure effective communication
and address financial literacy
• Training in financial education (inc. pensions) should start as early as possible (e.g. as part of school curricula) in order to encourage individuals to start saving as young as possible.
• Training of financial advisers is also important.
29
Boxes:
Supporting evidence
31
Box 2:
The impact of market
conditions on
retirement income
32
Hypothetical RR in DC pension plans
33
Japan
France
United States
01
02
03
04
05
06
07
0
Retir
em
en
t in
com
e o
ver
fina
l sala
ry (
%)
194019451950195519601965197019751980198519901995200020052010Year retiring
Impact of market conditions at the time of
retirement is large large fluctuations in RR
0
10
20
30
40
50
60
70
80
193
9
194
1
194
3
194
5
194
7
194
9
195
1
195
3
195
5
195
7
195
9
196
1
196
3
196
5
196
7
196
9
197
1
197
3
197
5
197
7
197
9
198
1
198
3
198
5
198
7
198
9
199
1
199
3
199
5
199
7
199
9
20
01
20
03
20
05
20
07
Ret
ire
me
nt
inco
me
ove
r fi
nal
sal
ary
(%)
Year retiring
US Japan
Hypothetical replacement rate 40-yr contribution
Impact of market conditions at the time of
retirement is large large fluctuations in RR
0
10
20
30
40
50
60
70
80
90
100
110
120
130
193
9
194
1
194
3
194
5
194
7
194
9
195
1
195
3
195
5
195
7
195
9
196
1
196
3
196
5
196
7
196
9
197
1
197
3
197
5
197
7
197
9
198
1
198
3
198
5
198
7
198
9
199
1
199
3
199
5
199
7
199
9
20
01
20
03
20
05
20
07
Ret
ire
me
nt
inco
me
ove
r fi
nal
sal
ary
(%)
Year retiring
UK
Hypothetical replacement rate 40-yr contribution
Box 3:
Performance of different
LC investment strategies
using historical data
36
Hypothetical RR diff. LC (40 yrs)
37
fixed portfolio 50-50
life cycle steep at 55
life cycle ld
life cycle steep at 45
United States
10
20
30
40
50
retir
em
en
t in
co
me o
ver
final s
ala
ry (
%)
1940 1950 1960 1970 1980 1990 2000 2010Year retiring
Hypothetical RR diff. LC (40 yrs)
38
Fixed portfolio 50-50
Life cycle ld
life cycle steep at 55
life cycle steep at 45
JAPAN0
10
20
30
40
50
retire
men
t in
co
me o
ve
r fin
al sa
lary
(%
)
1940 1950 1960 1970 1980 1990 2000 2010Year retiring
Hypothetical RR diff. LC (20 yrs)
39
Fixed portfolio 50-50
Life cycle linear decrease
Life cycle steep at age 55
United States
510
15
20
retir
em
en
t in
com
e o
ver
fina
l sala
ry (
%)
1940 1950 1960 1970 1980 1990 2000 2010Year retiring
Hypothetical RR diff. LC (20 yrs)
40
fixed portfolio 50-50
life cycle steep at age 55
life cycle linear decrease
05
1015
2025
retir
em
ent i
nco
me
ove
r fin
al s
alar
y (%
)
1940 1950 1960 1970 1980 1990 2000 2010Year retiring
JAPAN
Box 4:
Tax incentives
41
Tax form – tax incentives
• Earned income
• Deductions, exemptions, reliefs (e.g. charity)
• Taxable income
• Applied tax rates by income brackets
• Tax due
• Tax credits (e.g. credits per child)
• Tax payments
42
Tax incentives
• Most common: deductions on income Tax deductions (incentives increase with income)
• Alternatively, tax credits (inversely related to income)
• Matching contributions
43
Tax incentives - Tax deductions
0
0.5
1
1.5
2
2.5
0.2 0.4 0.6 0.8 1 1.2 2 4 8 16
Re
du
cti
on
in
ta
xe
s r
ela
tiv
e t
o p
re
-ta
x i
nc
om
e
(pe
rc
en
tag
e p
oin
ts)
Income level (times median income)
Tax incentive – Tax credits
0
0.5
1
1.5
2
2.5
3
0.2 0.4 0.6 0.8 1 1.2 2 4 8 16
Re
du
cti
on
in
ta
xe
s r
ela
tiv
e t
o p
re
-ta
x i
nc
om
e
(pe
rc
en
tag
e p
oin
ts)
Income level (times median income)
Tax credit based on a fixed amount for all
Tax credit based on a percentage of contributions plus a cap
Incentive – Matching contributions
0
0.2
0.4
0.6
0.8
1
1.2
0.2 0.4 0.6 0.8 1 1.2 2 4 8 16
Re
du
cti
on
in
ta
xe
s r
ela
tiv
e t
o p
re
-ta
x i
nc
om
e
(pe
rc
en
tag
e p
oin
ts)
Income level (times median income)
Fixed contribution match (1 pp)
Fixed contribution match with a cap (1 pp,
plus cap of median income)
Tax deduction + matching contributions
0
0.5
1
1.5
2
2.5
3
3.5
0.2 0.4 0.6 0.8 1 1.2 2 4 8 16
Re
du
cti
on
in
ta
xe
s r
ela
tiv
e t
o p
re
-ta
x i
nc
om
e
(pe
rc
en
tag
e p
oin
ts)
Income level (times median income)
Tax deduction with a matching contribution of 1pp
Tax deduction with a matching contribution of 1 pp and a cap
at the median income matching
Work in preparation
• OECD developing project to examine tax rules on pensions systems
• Tax rules on contribution, returns & benefits
• Tax rules on the accumulation, on the payout phase and on different products (annuities, PW, lump-sums)
• Assess the impact of tax incentives (country specific)
• Assess the impact of alternative ways of introducing incentives (country specific)
48
Box 5:
What type of default
investment strategies?
49
IV. Default investment strategies
Stochastic modelling with different structures of the payout phase
Different investment strategies:
– Fixed portfolios
– Life cycle strategies (diff gliding paths):
• Linear decrease
• Step-wise linear approach
• Piece-wise linear approach
• Dynamic multi-shaped
• Average multi-shaped
– Dynamic risk budgeting
Default investment strategies:
Payout Phase • Life annuity
• Inflation-indexed life annuity
• Fixed programmed withdrawal
• Variable programmed withdrawal
• Combined arrangement mixing:
– Variable programmed withdrawal
– Deferred inflation-indexed life annuity that starts paying at age 80
Default investment strategies:
Results Life annuity: Median replacement rate vs. 5th percentile
Default investment strategies: Results
Payout Options Default Investment Strategies
Life annuities at retirement
Step or piece-wise life cycle strategies with medium exposure to equities (50-60%)
Programmed withdrawals
Average multi-shaped and dynamic risk budgeting with medium exposure to equities
Combined arrangements
A mixed of investment strategies from the other two payout options
The relative performance of investment strategies depends on the type of benefit during the payout phase.
Default investment strategies: Results
The introduction of dynamic management strategies can provide somewhat higher replacement rates for a given level of risk than the more deterministic strategies, at least in the case of pay-outs in the form of variable withdrawals
Default investment strategies: Results
Life cycle strategies that maintain a constant exposure to equities during most of the accumulation period, switching swiftly to bonds in the last decade before retirement seem to perform best.