The pension reform and the
Demand for Indexed
Instruments in Emerging
Countries
Clemente del Valle
OPD, The World Bank
The Demand for Indexed Instruments:
Some historical perspective
„
In the 1970s-1980s, the demand was
strong in several high inflation countries:
• Several Latin American countries (e.g., Argentina,
Brazil, Chile, Colombia, Uruguay)
• Israel
• Some Central European countries
„
In the 1990s, the demand for indexed
instruments reduced considerably due to
stabilization
• Inflation was reduced to single digits in practically all
emerging markets
The Demand for Indexed Instruments:
Some historical perspective
„
Chile’s 1981 pension reform replaced public
PAYG by private pension system
• Practically all Chilean workers are now enrolled in
the new system, payout phase already advanced
• Strong demand for indexed instruments,
particularly in the payout phase
„
Several countries in Latin America and
Central Europe adopted variants of the
Chilean pension system in 1990s and 2000s
Regional Patterns
„
The demand for indexed financial
instruments will probably be stronger
in LAC and CEE
• Most countries that have introduced a
mandatory second pillar are in these two
regions.
„
The demand for indexed assets may
also be strong in countries with
relatively large voluntary pension
systems(defined-benefit basis).
Regional Patterns
„
Countries that have introduced a
second (mandatory) pillar:
• LAC: Argentina, Bolivia, Chile, Colombia,
El Salvador, Mexico, Uruguay
• CEE: Croatia, Estonia, Latvia, Lithuania,
Hungary, Kazakhstan, Poland, Slovakia.
„
Countries with growing third
(voluntary) pillars:
• Brazil, Czech Republic, South Africa
How strong will be the demand for
indexed assets in these countries?
„
„
„
It will depend primarily on the
regulations and the maturity of the
system
Most countries with new second pillars
have separated the accumulation phase
and the payout phase
The larger impact will come from payout
phase but some could come in the
accumulation phase with more flexibility
in the investment’s regulation
The demand for indexed assets in payout
phase with second pillars will depend
critically on three areas of regulation:
„
„
„
Regulations on the retirement products:
Lump-sums, PWs ,annuities
Regulations on the design of the annuity
product:
• Fixed v. Variable; Fixed Nominal v. Fixed
Indexed
Capital regulations on annuity providers
(particularly the latter):
• Fixed capital rules v. Risk-based capital
rules
Regulations on the
retirement products
„
„
The regulatory framework is not fully
elaborated in some countries.
Many reforming countries impose
restrictions on lump-sums, and some
on phased withdrawals
→Chile restricts lump-sums but allows PWs
and annuities. Even allowing PWs, the
degree of annuitization is 60%
→The degree of annuitization is expected to
be similar or higher in other countries
Regulations on the
design of the annuity product
„
„
„
Many reforming countries mandate
fixed, indexed annuities (Chile,
Colombia, Mexico).
Some countries have introduced wage
indexation Hungary), or mixed
arrangements (Colombia).
Few countries have not mandated
indexed annuities (Argentina)
Investment and capital regulations
on annuity providers
„
„
Investment regulations impose
restrictions on the amount of variable
income instruments that annuity
providers can hold
Strongest pressure to hold indexed
instruments with long durations will
come from the adoption of risk-based
capital rules (penalizing duration
mismatches)
The impact of the pay-out phase on
the demand for inflation index inst.
„
It is expected to be large due to:
• Mandatory nature of second pillars (large
numbers)
• The expected high degree of annuitization
• Mandatory price indexation of annuities
• Move towards risk-based capital rules, penalizing
mismatches
„
„
The average duration of indexed assets will
need to be around 12-14 years
The payout phase has already started in
many countries, but the large numbers are
expected to occur in the next decade
How strong will be the demand for indexed
assets in the accumulation phase?
„
In this phase there are some key
regulations affecting the preference for
instruments:
• The limitations by type of assets
• The limitation of portfolios offered
• The minimum rate of return
• The frequency on the disclosure of the
returns
„
They have induced a preference for
liquidity, low risk and short term returns
How strong will be the demand for indexed
assets in the accumulation phase?
„
Some reforms could induce a significant
move to higher duration and more risk
taken:
• Introduce Multi-funds
• Move to risk management control and
phase-out limits by type of assets
• Link minimum return to a long term
indicator
• Make detail disclosure by instrument less
frequent
Other considerations to improve
demand for inflation index products
„
„
„
Institutional investors are particularly
looking for :liquidity and market
transparency.
Chile is a good example that you can
achieve those qualities and maintain
good returns
However they benefited from a large
indexation of the economy
70
40
60
35
30
50
25
40
20
30
15
20
10
10
5
0
0
1990
1992
1994
Pension Funds
1996
1998
Insurance Companies
2000
2002
2004
Insurance/Pension Assets
R atio In s u ran ce/P en s io n s
P en s io n an d In s u ran ce A s s ets
Chile: Pension and Insurance Assets (% of GDP), 1990-2004
Chile: Breakdown of Stock of Pensions, by Type of Instrument, 1990-2004
Year
Total
PWs
TWs
Annuities
Number
% of Total
Number
% of Total
Number
% of Total
1985
7,609
7,373
96.8%
-
0.0%
236
3.2%
1990
57,119
36,696
64.2%
148
0.3%
20,275
35.5%
1995
190,400
98,699
51.8%
6,803
3.6%
84,898
44.6%
2000
343,965
147,532
42.9%
6,632
1.9%
189,801
55.2%
2004
520,793
196,242
37.7%
6,193
1.2%
318,358
61.1%
Chile: Insurance Premia: Total, Life, Non-Life, and Annuities
(in % of GDP), 1990-2003
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
1990
1992
Total Premia
1994
1996
Life Premia
1998
2000
2002
Annuities Premia
2004
Indexation of private instruments in
Chile contributed to high Market
Performance
„
Money’s worth ratios of indexed
annuities higher than one:
• Ratio of the present value of annuity
payments (discounted by the zero coupon
yield curve) to the annuity premium
„
Annuity rate higher than yield on longterm, indexed Government bonds
• Annuity rate: Internal rate of return on
the annuity contract
Annuity Rate, Adjusted Annuity Rate, Central Bank Bonds
and Corporate Bonds (% p.a.), 1993-2005
10%
9%
8%
7%
6%
5%
4%
3%
2%
1993
1995
Annuity Rate (RV-04)
1997
1999
Adjusted Annuity Rate
2001
PRC-20
2003
2005
Corporate Bonds
Chile: Portfolio of Life Insurance Companies (in % of Total), 1991-2005
1991
1995
2000
2003
2005
Government Sector
38.3
40.3
28.7
17.6
16.5
Financial Sector
23.0
28.4
45.1
37.6
34.6
Mortgage Bonds
13.9
18.6
24.2
18.8
12.8
Mortgage-Backed Securities
3.0
6.0
10.1
10.1
9.1
29.0
22.1
15.3
33.4
38.5
Shares
8.9
10.2
3.4
2.9
3.9
Bonds
20.1
10.7
10.7
29.3
33.5
Real Estate
7.8
7.7
7.4
7.3
7.5
Other Assets
2.0
1.5
3.6
4.1
6.8
100.0
100.0
100.0
100.0
100.0
Company Sector
Total
Portfolio Composition of Chilean Pension Funds (%), 1983-2004
1983
1990
1994
2000
2002
2003
2004
42.1
44.1
39.7
35.7
30.0
24.7
18.7
Government Bonds
16.5
1.5
0.2
0.0
0.0
0.3
1.2
Central Bank Bonds
25.6
42.5
38.5
31.9
24.4
19.1
12.6
-
0.1
1.0
3.8
5.6
5.3
4.9
55.8
33.4
20.1
35.6
35.0
27.3
29.5
Mortgage Bonds
42.9
16.1
13.7
14.4
11.1
8.8
6.8
Time Deposits/CDs
16.2
16.3
4.8
18.7
21.2
15.0
19.4
0.7
1.0
1.6
2.5
2.7
3.5
3.4
2.0
22.4
39.3
17.6
18.4
24.0
24.4
Shares
-
11.3
32.1
11.1
9.0
13.5
14.7
Bonds
2.0
11.1
6.3
4.0
7.1
7.7
6.8
Other
-
-
0.9
2.5
2.3
2.8
2.9
Claims on the Public Sector
Other
Claims on the Financial Sector
Other
Claims on the Corporate Sector
Claims on the Foreign Sector
Quotas of Mututal Funds
Other
Total
-
-
0.9
10.9
16.4
23.8
27.2
-
-
-
8.9
11.9
20.4
24.4
-
100.
0
-
-
2.0
4.5
3.4
2.8
100.0
100.0
100.0
100.0
100.0
100.0
-
11.3
33.1
23.1
24.2
37.8
42.8
5.6
22.0
38.0
50.4
55.8
59.9
59.1
Memo items:
Total Variable Income
Total Assets/GDP
Portfolio Composition of Chilean Pension Funds, by Type of Fund (%), Dec. 2004
Claims on the Public Sector
Claims on the Financial Sector
O/w: Mortgage Bonds
Time Deposits
Claims on the Corporate Sector
O/w: Shares
Bonds
Claims on the Foreign Sector
O/w: Mutual Funds and Shares
Debt Instruments
Other Assets
Total Assets
Total Assets (US$ million)
Memo Item: Variable Income
A
6.1
14.5
1.8
8.7
23.7
19.8
1.9
55.5
54.6
0.9
0.2
100.0
5,455
77.7
B
12.4
26.4
4.7
18.1
26.2
18.8
4.4
34.8
33.9
0.9
0.1
100.0
12,646
56.9
C
18.7
31.1
7.3
20.2
25.7
14.4
8.0
24.3
21.1
3.2
0.1
100.0
32,205
39.7
D
29.9
37.1
9.2
25.7
19.5
9.5
7.8
13.2
9.2
4.0
0.3
100.0
8,698
21.0
E
46.0
32.3
14.2
15.8
13.6
0.0
13.3
7.7
0.0
7.7
0.3
100.0
1,802
0.00
Total
18.7
29.5
6.8
19.4
24.4
14.7
6.8
27.2
24.4
2.4
0.1
100.0
60,806
42.8
Can the Chile experienced be
replicated in low inflation economies??
For the government segment some
traditional recipes may work:
• Large fungible issues
• Market makers
• Centralized trading platforms
„
For the private instruments???
• Large liquid instruments (GS) could offset
more illiquid /higher yield inst. in portfolio
• The yield curve ( in real terms) will help
Conclusions
„
„
„
„
„
The pension reform is bringing big
numbers to our local markets
The pay-out phase is around the corner
The quality of the regulation could
generate very different results
The Debt Management strategy as well.
The governments ( MOF, DMO and
regulators) need to start addressing this
issues in a more comprehensive way.
THANKS