Guillermo Larrain R.

SuperintendenteSuperintendencia de Valores y Seguros

Chile

Longevity risks in Pension Systems viewed from the pay-out phase in

Chile

Sao Paulo, Mayo 2008

I. Hard facts: longevity is a world wide phenomena.

II. Consequences: longevity affects all pension systems:

• DB/DC, • PAYG/Capitalization, • Closed/Open

III. Looking for solutions in the Chilean DB payout phase

Agenda

Ageing, an international comparison

Ageing is affecting all. Chile is ageing relatively more

Life expectancy at birth (both genders)

Mortality Tables for pensioners in Chile : 2004 vs 1985

Tablas de mortalidad rentistas hombres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

50 60 70 80 90 100

Años

Qx RV2004 H

RV 85 H

Tablas de mortalidad rentistas mujeres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

50 60 70 80 90 100

Años

QxRV2004 MRV 85 M

Tablas de mortalidad beneficiarios hombres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

Años

QxB 2006 HB 85 H

Tablas de mortalidad beneficiarios mujeres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

1 11 21 31 41 51 61 71 81 91 101

Años

QxB 2006 MB 85 M

Mortality Tables for beneficiaries in Chile: 2006 vs 1985

Tablas de mortalidad inválidos hombres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

1 10 19 28 37 46 55 64 73 82 91 100109

Años

QxMI 2006 HMI 85 H

Tablas de mortalidad inválidos mujeres

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

0,80

1 11 21 31 41 51 61 71 81 91 101

Años

QxMI 2006 MMI 85 M

Mortality Tables for disabled persons in Chile: 2006 vs 1985

Life expectancy at each age in Chile: a gender issue appears

Edad

RV-85 RV-2004 Diferencia RV-85 RV-2004 Diferencia

45 32,71 35,17 2,46 37,79 42,48 4,69

50 28,36 30,71 2,35 33,16 37,67 4,51

60 20,29 22,12 1,83 24,32 28,38 4,06

65 16,65 18,16 1,51 20,21 24,04 3,83

70 13,34 14,56 1,22 16,36 19,83 3,47

Edad

B-85 B-2006 Diferencia B-85 B-2006 Diferencia

45 30,28 35,31 5,03 35,55 40,82 5,27

50 26,07 30,83 4,76 31,01 36,13 5,12

60 18,41 22,21 3,80 22,44 27,12 4,68

65 15,04 18,24 3,20 18,52 22,88 4,36

70 12,05 14,61 2,56 14,9 18,87 3,97

Edad

MI-85 MI-2006 Diferencia MI-85 MI-2006 Diferencia

45 23,79 25,04 1,25 29,25 31,83 2,58

50 21,18 21,97 0,79 26 28,51 2,51

60 15,97 16,72 0,75 19,52 21,84 2,32

65 13,43 14,3 0,87 16,34 18,48 2,14

70 10,96 11,88 0,92 13,22 15,15 1,93

Esperanza de vida según tabla de mortalidad

Rentistas hombres Rentistas Mujeres

Esperanza de vida según tabla de mortalidad

Inválidos Hombres Inválidos Mujeres

Esperanza de vida según tabla de mortalidad

Beneficiarios Hombres Beneficiarios Mujeres

Pensioners Male Female

Male Female

Male Female

Beneficiaries

Disabled

Increase in life expectancy at age

0

1

2

3

4

5

6

0 1 2 3 4 5 6

Male

Fem

ale

Beneficiaries

Pensioners

DisabledAge group (increasing)

Conclusions: Women on top

45°

Preliminary conclusions

• Ageing is universal• It is more acute in countries like Chile• It may have more impact in rich countries

because they had developed more generous PAYG pension systems

• Two broad conclusions:– Retirement age is critical in view of ageing

populations– Women appear to outpace men's ageing. Huge

gender issue with vast implications (social, political, economic, etc…)

I. Hard facts: longevity is a world wide phenomena.

II. Consequences: longevity affects all pension systems:

• DB/DC, • PAYG/Capitalization, • Closed/Open

III. Looking for solutions in the Chilean DB payout phase

Agenda

Impact on Pay-as-you-go pension systems

Increasing dependency ratios

require:• Increasing state financing (to be

financed by taxes or reducing other expenditures)

• Increasing personal contributions

Source: SVS, based on INE

Ageing progresses without clear bound and birth rates stall, hence

The previous process is unbound: enormous fiscal pressure whose political economy is complex (tendency to delay decisions evident)

Dependency ratios

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1950

1960

1970

1980

1990

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

0

5

10

15

20

25

30

35

40

45

Old age

Overall

0-14 years (% pop, right axis)

Impact on Capitalization pension systems

Pensions are diminished (for any size of personal savings, it is necessary to finance more years of survival): the buffer becomes people

´s pensions instead of public finances… or so it seems at first glance

Phase I : accumulation

Retirement age

Phase II : Payout

Interphase

Lifetime

This is a system. As such, the outcome depends on all of its parts

Impact on Capitalization pension systems

Net savings

Life expectancy at retirement

Pension =

Personal contributions (size, frequency, starting age)

Financial returns in accumulation phase

Costs

Operational during accumulation phase

Transactional in the interphase of acc/payout

Operational during payout phase

Financial returns in payout phase

Employers contributions (matching)

State contributions (incentives)

Retirement age

The ongoing pension reform in Chile took care of all of this elements plus a critical redefinition of the zero-first pillar

Trayectoria de la pensión en Retiro Programado (fuente: SAFP)

Líneas verticales expectativas de vida: --- RV85 y RV 2004

Estimated effects of ageing on programmed withdrawals in Chile (DC)

Consequences for Life Insurance Companies (annuity providers, DB)

Spreads are reduced inducing LICs to look for ways of compensation

Potential increase in investment risks

Incentive to reduce operational costs:

potential market concentration

Increase in capital and reserve requirements to face increased pension obligations

Increased competition may induced “commercial war” with unintended consequences on undesired practices

I. Hard facts: longevity is a world wide phenomena.

II. Consequences: longevity affects all pension systems:

• DB/DC, • PAYG/Capitalization, • Closed/Open

III. Looking for more solutions in the Chilean DB payout phase

Agenda

Individual Voluntary Savings Scheme (APV)

• Tax incentive (suitable therefore only for income tax payers: upper middle class)

• More financial institutions allowed

• Attractive liquidity feature : unless mandatory savings, APV can be consumed before retirement.

• Taxes are paid when consumption takes place

1. Promote voluntary savings: Individual (APV)

-

100.000

200.000

300.000

400.000

500.000

600.000

-

500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

4.500

Número de cuentas Saldo acumulado (MMUS$)

Number of accounts

Balances

Colective Voluntary Savings Scheme (APVC, just introduced)

• Tax incentive with liquidity feature as in APV

• Financial institutions allowed as in APV

2. Promote voluntary savings: Collective (APVC)

New features

• Matching contribution from employer, tax deductible

• All APVC plans offered to employees are open to them: no discrimination permitted

• Worker has rights over her savings and earns the right over the matching contribution after some time. Possible use as an incentive device to promote permanence in the firm (hence, training, productivity…)

• Minimum number of workers within the firm must adhere to any savings plan to make the firm eligible for tax benefit: this grants access to lower middle classes

3. Tougher conditions for early retirement

Tougher conditions for early retirement and use of excedent of free disposal.

Early retirement.

• Before 2004: resulting pension should be 110% of minimum pension and greater than the 50% of the last 10 years income.

• After 2004: same criteria but new parameters 150% of minimum pension and 70% of last 10 years income..

Excedent of free disposal.

• Antes de 2004: Igual que retiro de ELD

• Ley Año 2004: Igual que retiro de ELD

Gradually increase in legal retirement age, still a possibility for the future

Diminish asymmetries of information, promote healthier competition reducing fees charged : the SCOMP system

4. The challenge of the interphase: The SCOMP system

Objective: promote a clear and comparable market for annuities and other retirement products

Electronic market for Life Insurance Companies, Pension Fund Administrators, Brokers

Blind quotation mechanism: each LIC compete for providing the best possible annuity to an unknown client

Client can iterate (even organizing an auction among providers) or postpone decision (except in case of auction)

Joint supervision: SVS - SAFP

Started 19 de agosto de 2004.

3. Diminish asymmetries of information, promote healthier competition reducing fees charged : the SCOMP system

4. The challenge of the interphase: The SCOMP system

0,00%

1,00%

2,00%

3,00%

4,00%

5,00%

6,00%

7,00%

Solicitudde Ofertas

AFP o CSV oCorredor RV o

Asesor Previsional

SCOMPCertificadoElectrónico

Saldo

Montos RP,Bono, Proyección

Ofertas

Formulario Solicitud de Ofertas

AFPorigen

InicioTrámite

Certificado Saldo

Certificado de Ofertas

ConsultanteSolicitud de Ofertas

+Certificado de Saldo

CSVn

AFPn

7

4

56

1 2

22

3

4. Working of the SCOMP

8Oferta Externa de RV

9Remate

AFP Compañía de Seguros

Corredor, Asesor Previsional

AFP

CIAS. SEGUROS

Solicita Oferta

Solicita O

ferta al S

istema

Envío Antecedentes del potencial pensionado

Recepción Ofertas de Montos de Pensiones

Certificado de Ofertas de Montos de Pensiones

TRABAJADORPOTENCIAL PENSIONADO

SISTEMA

4. Working of the SCOMP

Better risk-adjusted returns on assets

• More flexible approach focused on financial and operational risks. It should allow investments on more variable income instruments looking for a better risk-return profile

• Hedging instruments desirable

• Critical good governance of LICs

• Risk based capital requirements

5. New Investment Regime for Life Insurance Companies

Differed Annuity.

• It allows to fix the terms of an annuity during the working life period. This annuity, coupled with other pension products will consist in the final pension.

• It transfers longevity risk to the insurer

• It allows future pensioners to take advantage of good market conditions for buying annuities. It requires significant financial advise.

6. Potential new pension products : Differed Annuity

Inflation protection

• In Chile annuities are indexed to inflation measured by the Consumer Price Index

• Consumption bundle of retired persons eventually coincide with the average worker (relevant for CPI purposes) but it gradually moves significanly away from it as the person gets older

• The older the person, less relevant is CPI as relevant measure of inflation

• Challenge: • Create a Pensioner Price Index• Design a market for instruments linked to this:

government, private companies (health institutions,…) including derivatives or outright subsidies

7. Potential new pension products : Bonds indexed to relevant inflation

8. Potential new pension products Longevity Bonds

A longevity bond promises a yearly payment indexed to a mortality index which replicated the behavior of the pensioners

Pago del Bono(CLP bn)

Años

-

2

4

6

8

10

1 3 5 7 9 11 13 15 17 19 21 23 etc

Longevidad menor a la esperada

Longevidad mayor a la esperada

• LICs would obtain an instrument to hedge against longevity risk. Indexation could consider size of payments or maturity of the instrument

• Hedge is adequate, even though not perfect as it relies on average mortality, not LIC specific

• Issuer • Must have interest in exposing itself to this kind of risk• Derivative market desirable• Transfer longevity risk to a reinsurer.

• Calculation of official mortality tables critical: Which entity will do it? Public or private? How frequent?

8. Potential new pension products Longevity Bonds

Guillermo Larrain R.

SuperintendenteSuperintendencia de Valores y Seguros

Chile

Longevity risks in Pension Systems viewed from the pay-out phase in

Chile

Sao Paulo, Mayo 2008