PENSION FUNDS INTRODUCTION HOW CAN WE DEFINE THE PENSION FUNDS? WHICH KIND OF IMPACT DO THEY HAVE ON FINANCIAL MARKETS? THE STRUCTURE OF PENSION FUNDS PENSION FUNDS IN ITALY
PENSION FUNDS:DEFINITION • Pension funds are institutions carrying out the collection of contributions of employees and / or employers. Contributions have to provide beneficiaries with a relevant paid-in capital at the end of the working life. Benefits will be paid either in the form of annuity or in the form of full/mixed payment. Institutional investors are having a social security benefit. the shares are the contributions paid during the period of employment which, properly invested, will ensure the provision of future pension benefits. In fact this is a system based on capitalization. Pension funds collect funds which will be returned at the end of employee’s working life and then the manager is faced with liquidity constraints, which are less strict about the choices of the forms of investment.
THE IMPACT ON FINANCIAL MARKETS • In view of the social security purposes, the long-term perspective ofinvestment, and the considerable size of these actors in the global capital markets, the PFsnow constitute a category of investors vital to the growth of modern economies. In fact, they contribute : • a) to increase the size of financial markets (it helps to increase the capitalization of financial markets) • b) to increase efficiency (it improves the international diversification of private savings portfolio) • c) to improve the governance of companies they invest in,exerting political activism , because it implies the involvement of investors in the management of investing companies.
TYPES OF PENSION FUNDS • Depending on the person establishing the fund, we can identify two types of pension funds: OPEN AND CLOSED FUNDS. • Closed funds : closed-end funds are defined as such because they are reserved exclusively for certain categories of workers or firms. They are legal entities of association promoted by trade associations, trade unions, business organizations. (eg, lawyers and doctors) • Open funds : are called open because they do not refer to particular categories of workers, in fact you can join all those who are not eligible to enter a closed pension fund.
TYPES OF PENSION FUNDS “2” • We can also distinguish pension funds according to different lines of investment: single sector funds and funds with multiple compartments. Contractors are entitled to enter for a predetermined period of time to one of these lines of investment, depending on their risk appetite. in single-sector funds there is only one line of investment, either bonds or balanced; while in multi-sector funds there are several lines of investment and in this case contractor may choose between cash, equity, bond and mixed. the choice is determined by some factors, such as: age (which defines the investment horizon), the total wealth of the worker, marital status, education, gender.
PENSION SYSTEM DESIGN:ITALY • Italy’s pension system consistsof a PAYG public pension pillar aswellasvoluntaryoccupational and private pensionplans. With a total ofapproximately EUR 350 billionpensionassets under management in 2004, Italy isoneof the largestEuropeanpensionmarkets. Its life insurance market is at the fourthplace out ofall the Europeanmarkets and itis set to continue outpacing the Europeanaveragegrowth rate. Although Italy’s investedpension market isstillsmall, the outlookforthissectorhasbrightenedwith the passingof a newbillthatwassigned in October 2006. The billencouraged the transfer ofindemnitypayments (severancepay, whichiscompulsory in Italy) to the private pension market. Weexpectnewpensionfundstogrow at a compoundannualgrowth rate ofaround 30% until 2015, turning Italy intooneof the mostimportantEuropeanmarkets. Total pensionassets in the market are expectedtogrow at anannual rate of 5.9% reaching EUR 914 billion in 2020.
THE AMOUNT OF PENSION BENEFITS • Nowdays in the system the amountofpensionbenefitswillnotdepend on salarylevelsbut on the contributiondeposits. At the end, a notional capital stock isformedfrom the contributionspaid in. Calculationof the pension benefit takesinto account thisnotional sum and the recipient’s remaining life expectancy at the timeofretirement. The statisticforecastshowsthat the averagepensionlevelof a 60-year-old is set tosinkfrom 67% todayto 48% by 2050. However, means-tested social assistancepensions and supplementsto social security pensionswillguarantee a minimum incomelevelbeyond the ageof 65.
OPEN & CLOSED PENSION FUNDS AND IPP(INDIVIDUAL PENSION PLAN) In Italy there are twotypesofpensionfunds: • Closed or contractualpensionfundswhich are implementedeitheras company pensionfundsby a single company or asindustry-widepensionfundswhich are set up by the employers’ association and bytradeunionsfor a specificgroupofparticipants; • Open pensionfundsthat are offeredbybanks, insurancecompanies or investment management companiesfor a genericgroupofparticipants, i.e. the self-employed. • the employee can choosebetween open and closedpensionfunds and the individualpensionplan PIP. However, itisnotcertainthatitwillleadto a realcompetitionbetween the threecorepensionproducts, i.e. closedpensionfunds, open pensionfunds and the individualinsuranceplans.Allpensionfundshavetosignan agreement withanexternalinvestment manager that can onlybeaninsurance company, a bank or a registeredasset management company (‘Società Gestione Risparmio’ or SGR). • Today, allpensionfunds operate on a definedcontributionbasis, asthisis the onlypossibletypeofpensionplan.
Terminationindemnitypayments (TFR) • Uponterminationofemploymentforanyreason, employershavetopay a terminationindemnity (‘Trattamento di fine Rapporto’ or TFR) toallemployees. In Italy the TFR isusedas a backup in the eventofredundancy or asanadditionalpension benefit afterretirement. Severancepayiscalculatedas 6.9% ofeachyear’s annualsalary, revalued on the basisof 75% ofinflation plus a fixed rate of 1.5% during the periodofaccrual, and ispaidas a lump sum. Assumingthat the TFR benefit isaccumulatedthroughout a full career, itisexpectedtoprovide a pensionof 10% to 15% offinalpay.
Countriesanalysed • Greece Valentina Gaddoni • Germany Francesca Farinelli • United Kingdom Saverio Monti • ScandinavianCountries Teresa Lamonica • New EuropeanCountries Sergio Cibotari • UnitedStates Elena Paesetti
The case ofGreece Pension system: • based on a public pension pillar • Private pensionsplansexist 2008Government: reform • Increaseearlyretirementage • More incentivesto work longer • Lesscomplexity and more clearness in public pension system • Decreasenumberofpensionfundsavailable The generosity of the pension system will be a heavy burden on public finances in the yearsto come. 1
Retirement&Publicpensions The officialretirementage is 65(men)and 60(women), but retirement is also possible after 30 years of contributions, or based on a combination of age and contribution periods. 1° Pillar: complex and important It covers employees and certain self-employed. Oneof the main public pensionschemesis IKA( Social InsuranceInstitute). 2
Pensionfunds… Pensionfunds:Legislation concerning occupational pension funds was introduced in 2002. The pensionfundsare autonomous, non-profit privateentitieswith own legal personality. They are supervised by the Ministry of Employment and Social Protection. More than 130 funds provided primary and supplementary pension coverage (now only about 13). 3
…Pensionfunds… Pension funds are subject to quantitative limits: • A maximum of 70% of assets may be invested in equities or corporate bonds • No more than 5% may be invested in investmentfunds • Investments in non-EU and non-EEA countries are generally not permitted Taxationof occupational pension funds is unclear 4
Conclusions Life insurance and pensions funds play a subordinate role in Greek household portfolios, accounting for only 3% of assets. Pension fund assets account for less than 1%of GDP. This is a reflection of Greece’s underdeveloped funded pensions, but it has a great deal of development potential. (Greek retirement marketCAGR:13.9%) 5
GERMANY PENSION SYSTEM: • Predominanceof the public pillar 2002 “RIESTER” REFORM: • Reductionof public pillar • More attentionto the occupationalpensions • Planswith capital preservationguarantees • Challenge: the retirement market willgrowat a CAGR (Compounded Average Growth Rate) of 4.6% until 2020.
PUBLIC PENSIONS The public pension pillar contributes more than two-thirds of retirement income to people over 65 years of age Public service schemes are financed directlythrough public budgets German public system isknownas “pay-as-you-go system” and itismandatoryforallemployees Some exceptions are providedforcertainprofessions, suchas lawyers or architects …and for the self-employed
PUBLIC PENSIONS: RETIREMENT AGE REQUIRED:Actually people retire at 65 years. However, recentreformswill increase the retirement age to 67 in the period between 2012 and 2029 TAXATION: Since 2005, at least 50% of pension benefits havebeentaxed. This share will rise to 100% in 2040. The contribution rate issharedequallybetweenemployers and employees and amountsto 19.9% ofsalary.
OCCUPATIONAL PENSIONS Since 2001, employeeshavehad the legal right to access occupational pensions. Employers can offer occupational pension provision in fiveways: • Directpensionpromises (Direktzusage) • Directinsurance • Supportfunds (Unterstützungskasse) • Pensionskassen • Pensionfunds(Pensionsfonds)
PENSION FUNDS Theywereintroduced in 2001 and are separate legal entities. They are more return oriented and subject to much more liberal rules than Pensionskassen: there are no limits to equity investments, foreign investments or other asset classes. However, there are limits to investments in single issuers or issues and a 70% currency matching requirement. They guarantee the paid-in capital minus costs.
..PENSION FUNDS.. Since 2005, Pensionskassen and Pensionsfondsand direct insurance have been taxed in the same way. Contributions of up to 4% of the social security ceiling are tax-deductible, up to an amount of EUR 2,544. In addition, while investment income is tax-exempt, benefits are taxed.
FINAL CONSIDERATIONS Occupationalpensioncoverage in Germanyhas been on the rise in recent years. The recentgovernmentdecision to extend the social security exemption ofpensioncontributionswillalso help the funded occupational pillar, that is, pension funds as well.
The pensionfundschemes in the UK • the mostlarge and challengingpension market in Europe • oneof the mostdevelopedfundedpensionsystems
Quick look at the currentpension system: • Basic State Pension • OldAgePension • flat-ratescheme • State SecondPension • earnings-related • unlike the Basic State Pension, partecipationto the S2P isvoluntary
Itispossibletocontract out of the S2P byjoining: • occupationalpensions(arrangemetnsestablishedbyemployerstoprovidepension and relatedbenefitsfortheiremployees) • Stakeholderpensions(first exampleof a private pensiondesignedbygovernamentwithfixedadministrativecosts) • Personal pensionplans(itisalsopossibleforanindividualtomakecontributions under anarrangementtheythemselvesmakewith a provider). • Accordingtoestimates, 60% ofemployees are in contracted-outschemes.
Pensionfunds The occupationalpension system in the UK isvoluntary and planshavetraditionallybeenimplementedthroughpensionfunds and insuranceschemes. Most medium and large-sizedcompanies sponsor theirownpensionplans; smallemployersfavourinsuranceschemes.
Pensionfunds • Pensionplan can beof the: • defined benefit (guaranteedlevelofpension benefit established in advance) • definedcontribution(pensiondeterminedby the valueof the fundcontributions) • hybridtype • The UK isoneof the first examplesfor the shiftfromdefined benefit todefinedcontributionplans.
Future trends While reforms in Continental Europe often try to encourage funded pensions in general, reforms in the UK strive to provide adequate pensions for lower-income earners. Attention is paid to lower-income earners as these are most affected by the low replacement rate of the public pillar. As for the the future market trends, since the pension funds are still highly exposed to equity markets, they will lose some of their value due to the current market downturn.
The Icelandic pension system • The pension system on the three pillar principle: • public pension • membership in occupational pension funds • individual pension saving with tax incentives
The problem of ageing • Smaller than among most developed European countries: • The Icelandic nation is younger than many other European nations and the problem of ageing will thus be less during the first decades of this century. • High labour participation rates of the elderly • Mandatory membership of fully funded pension funds (at least 10% of wages)
The Icelandic nation is younger than among most developed European countries and will continue to be so well into this century
Norway The Government Pension Fund of Norway comprises two entirely separate sovereign wealth funds owned by the Government of Norway: • The Government Pension Fund - Global (formerly The Government Petroleum Fund) • The Government Pension Fund - Norway (formerly The National Insurance Scheme Fund)
Sweden Unique Public Pension Pillar in Western Europe: Social security contribution is paid into individual investment accounts and a funded pension is build up with independent fund management companies responsible for the asset management.
Finland Pension Reform purpose: improve the structural features in the pension systems. Voluntary occupational schemes and private pension savings are not well developed due to the dominance of the existing compulsory scheme. How to fund the sharp rise in pension?
Denmark: the first direct investment in energy from a pension fund. PensionDanmark is a not-for-profit labour market pension fund established in 1993. It offers defined contribution pension, insurance and health care products on the basis of collective agreements covering 578,000 individuals employed in 27,000 companies within the private and public sector. Contribution rates range from 12.0 to 18.0 per cent of wages with the employers paying 2/3 of the contributions and the employees paying 1/3.
Denmark 26 September 2010, PensionDanmark makes landmark energy deal. “This is a model for risk sharing and it protects PensionDanmark from the downside. The risk-return ratio is attractive for us and for Dong Energy: they can reduce their capital to offshore parks and free up funds for other investment areas, where they can see higher returns.” Mr Möger Pedersen, PensionDanmark’s chief executive officer.
PENSION FUNDS IN THE NEW EU MEMBER STATES • During the 1990s many of the Member States that entered the EU in 2004 (Czech Republic ,Estonia ,Hungary ,Latvia ,Lithuania ,Poland ,Malta ,Cyprus , Slovakia and Slovenia) or 2007 (Romania and Bulgaria) facedsevere problems with the functioning of their statutory pay-as-you-go (PAYG) public pensionsystems. Particularly the: • relatively low retirement ages, • high replacement rates and • rather highsocial security contribution rates – which provided limited incentives to participate in the system putting the PAYG schemes under pressure as their economies shrank and the informal sector rose.
Overview of pension systems in the NMS All NMS have a funded pension pillar in combination with the standard old-age PAYGpublic pension. While all of these countries apart from Romania have aprivate pension scheme with voluntary participation, not all of these countries have yetimplemented a private pension scheme with mandatory participation. In the Czech Republic andSlovenia a mandatory private pension scheme does not exist at all, while in Lithuania, Poland andSlovakia, participation in these schemes is voluntary for some groups.
As next table shows, statutory funded private pension schemes differ significantly acrosscountries. First, the stage of development of these systems differs depending on the year of their implementation. For example, Hungary already introduced its statutory private pensionscheme in 1998, while Slovakia implemented it only in 2005. In other words, the Slovak scheme isin this sense less mature than the Hungarian. Second, statutory funded private pension schemesdiffer both in terms of contribution levels and how these are shared between employers andemployees. For example, in Poland and Romania the statutory pension scheme is fully financed byemployees, while it is fully financed by employers in Slovakia.
As we see, with 13.6 %, Bulgaria saw the largest increase in the employment rate between 2000 and 2008, followed by Latvia 11.1% and Estonia 9.4 %. The increase in unemployment over 2008-10 is projected to be the strongest in Lithuania 10.1 %, followed by Estonia 8.6 % and Latvia 8.5 %.The rise in unemployment also tends to reduce individual pensions accounts.
Pension fund performance and risks These risks include in particular the: inflation risk -namely the fact that inflation grows faster than nominal returns on assets financial market risk -which is associated with exposure of the pension assets to stock market developments.
The size and structure of private pension fund assets • The savings cumulated in the pension funds increased sharply in the NMS, but still remainedat low levels when compared to many of the old EU Member States. • For example, the pension funds assets as a share of GDP represented only about 4.7 % in the Czech Republic in 2007, 10.8 % in Hungary, 12.2 % in Poland and 4.2 % in Slovakia, while they were about 79 % in the United Kingdom or 138 % in the Netherlands.
The impact of inflation and financial market developments on pension fund performance isdetermined by the structure of pension fund portfolios. Private pension fund assets consist of: • (1) bills and bonds issued by the public and the private sector, • (2) mutual funds, • (3) shares, • (4)cash and deposits • (5) other investment (e.g. mutual funds).