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 of
investment, and the considerable size of these actors in the global capital
markets, the PFs
now 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 consists of a PAYG public pension pillar as well as
voluntary occupational and private pension plans. With a total of
approximately EUR 350 billion pension assets under management in 2004,
Italy is one of the largest European pension markets. Its life insurance
market is at the fourth place out of all the European markets and it is set
to continue outpacing the European average growth rate. Although Italy’s
invested pension market is still small, the outlook for this sector has
brightened with the passing of a new bill that was signed in October 2006.
The bill encouraged the transfer of indemnity payments (severance pay,
which is compulsory in Italy) to the private pension market. We expect
new pension funds to grow at a compound annual growth rate of around
30% until 2015, turning Italy into one of the most important European
markets. Total pension assets in the market are expected to grow at an
annual rate of 5.9% reaching EUR 914 billion in 2020.
THE AMOUNT OF PENSION BENEFITS
• Nowdays in the system the amount of pension
benefits will not depend on salary levels but on the
contribution deposits. At the end, a notional capital
stock is formed from the contributions paid in.
Calculation of the pension benefit takes into account
this notional sum and the recipient’s remaining life
expectancy at the time of retirement. The statistic
forecast shows that the average pension level of a 60year-old is set to sink from 67% today to 48% by 2050.
However, means-tested social assistance pensions and
supplements to social security pensions will guarantee
a minimum income level beyond the age of 65.
OPEN & CLOSED PENSION FUNDS AND
IPP(INDIVIDUAL PENSION PLAN)
In Italy there are two types of pension funds:
•
•
•
•
Closed or contractual pension funds which are implemented either as company
pension funds by a single company or as industry-wide pension funds which are
set up by the employers’ association and by trade unions for a specific group of
participants;
Open pension funds that are offered by banks, insurance companies or investment
management companies for a generic group of participants, i.e. the self-employed.
the employee can choose between open and closed pension funds and the
individual pension plan PIP. However, it is not certain that it will lead to a real
competition between the three core pension products, i.e. closed pension funds,
open pension funds and the individual insurance plans.
All pension funds have to sign an agreement with an external investment manager
that can only be an insurance company, a bank or a registered asset management
company (‘Società Gestione Risparmio’ or SGR).
Today, all pension funds operate on a defined contribution basis, as this is the only
possible type of pension plan.
Termination indemnity payments
(TFR)
• Upon termination of employment for any reason,
employers have to pay a termination indemnity
(‘Trattamento di fine Rapporto’ or TFR) to all
employees. In Italy the TFR is used as a backup in the
event of redundancy or as an additional pension
benefit after retirement. Severance pay is calculated as
6.9% of each year’s annual salary, revalued on the basis
of 75% of inflation plus a fixed rate of 1.5% during the
period of accrual, and is paid as a lump sum. Assuming
that the TFR benefit is accumulated throughout a full
career, it is expected to provide a pension of 10% to
15% of final pay.
Why should be convenient underwrite
a pension fund contract???
Countries analysed
 Greece
 Germany
 United Kingdom
 Scandinavian Countries
 New European Countries
 United States
Valentina Gaddoni
Francesca Farinelli
Saverio Monti
Teresa Lamonica
Sergio Cibotari
Elena Paesetti
The case of Greece
Pension system:
• based on a public pension pillar
• Private pensions plans exist
2008 Government: reform
1. Increase early retirement age
2. More incentives to work longer
3. Less complexity and more clearness in public
pension system
4. Decrease number of pension funds available
The generosity of the pension system will be a heavy
burden on public finances in the years to come.
1
Retirement &Public pensions
The official retirement age 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.
One of the main public pension schemes is IKA(
Social Insurance Institute).
2
Pension funds…
Pension funds: Legislation concerning
occupational pension funds was introduced in
2002. The pension funds are autonomous,
non-profit private entities with 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
…Pension funds…
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
investment funds
• Investments in non-EU and non-EEA countries are
generally not permitted
Taxation of 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 marketCAGR:13.9%)
5
GERMANY
PENSION SYSTEM:
• Predominance of the public pillar
2002 “RIESTER” REFORM:
• Reduction of public pillar
• More attention to the occupational pensions
• Plans with capital preservation guarantees
• Challenge: the retirement market will grow at a CAGR
(Compounded Average Growth Rate) of 4.6% until
2020.
PUBLIC PENSIONS
The public pension pillar contributes more than twothirds of retirement income to people over 65 years of
age
Public service schemes are financed directly through
public budgets
German public system is known as “pay-as-you-go
system” and it is mandatory for all employees
Some exceptions are provided for certain professions,
such as lawyers or architects
…and for the self-employed
PUBLIC PENSIONS: RETIREMENT
AGE REQUIRED: Actually people retire at 65 years.
However, recent reforms will increase the
retirement age to 67 in the period between 2012
and 2029
TAXATION: Since 2005, at least 50% of pension
benefits have been taxed. This share will rise to
100% in 2040.
The contribution rate is shared equally between
employers and employees and amounts to 19.9%
of salary.
OCCUPATIONAL PENSIONS
Since 2001, employees have had the legal right to
access occupational pensions.
Employers can offer occupational pension provision
in five ways:
1. Direct pension promises (Direktzusage)
2. Direct insurance
3. Support funds (Unterstützungskasse)
4. Pensionskassen
5. Pension funds (Pensionsfonds)
PENSION FUNDS
They were introduced 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 Pensionsfonds
and 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 taxexempt, benefits are taxed.
HOUSEHOLD PORTFOLIO
FINAL CONSIDERATIONS
Occupational pension coverage in Germany has
been on the rise in recent years.
The recent government decision to extend the
social security exemption of pension
contributions will also help the funded
occupational pillar, that is, pension funds as
well.
The pension fund
schemes in the UK
the most large and challenging
pension market in Europe
one of the most developed funded
pension systems
Quick look at the current pension system:
Basic State Pension
- Old Age Pension
- flat-rate scheme
State Second Pension
-earnings-related
- unlike the Basic State Pension, partecipation to
the S2P is voluntary
It is possible to contract out of the S2P by joining:
 occupational pensions (arrangemetns established by
employers to provide pension and related benefits for their
employees)
Stakeholder pensions (first example of a private pension
designed by governament with fixed administrative costs)
Personal pension plans (it is also possible for an individual
to make contributions under an arrangement they
themselves make with a provider).
According to estimates, 60% of employees are in
contracted-out schemes.
Pension funds
The occupational pension system in the UK is voluntary and
plans have traditionally been implemented through pension
funds and insurance schemes.
Most medium and large-sized companies sponsor their own
pension plans; small employers favour insurance schemes.
Pension funds
Pension plan can be of the:
 defined benefit (guaranteed level of pension benefit
established in advance)
 defined contribution (pension determined by the value
of the fund contributions)
 hybrid type
The UK is one of the first examples for the shift from
defined benefit to defined contribution plans.
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)
50
Old age dependency ratio:
Over 64 years old as a percentage
of 15-64 years old
%
1990
2030
40
30
20
10
0
U SA
UK
D e nma rk N e the rl. Ic e la nd
J a pa n
N orw a y Sw e de n G e rma ny
Sour c e: B ros e t.a l. (1994).
The Icelandic nation is younger than among most developed European
countries and will continue to be so well into this century
Labour force participation
Labour force participation rates among 55-64 years old
males in the Nordic countries, 1980-2010
1,0
0,9
0,8
0,7
0,6
0,5
Denmark
Iceland
Sw eden
0,4
0,3
1980
1985
Finland
Norw ay
OECD
1990
1995
2000
2005
2010
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?
Could renewable energy change pension funds?
Denmark
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)
faced severe problems with the functioning of their
statutory pay-as-you-go (PAYG) public pension
systems. Particularly the:
 relatively low retirement ages,
 high replacement rates and
 rather high social 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.
43
Overview of pension systems in the NMS
All NMS have a funded pension pillar in combination
with the standard old-age PAYG public pension. While
all of these countries apart from Romania have a
private pension scheme with voluntary participation,
not all of these countries have yet implemented a
private pension scheme with mandatory
participation. In the Czech Republic and Slovenia a
mandatory private pension scheme does not exist at
all, while in Lithuania, Poland and Slovakia,
participation in these schemes is voluntary for some
groups.
44
As next table shows, statutory funded private pension
schemes differ significantly across countries. First, the
stage of development of these systems differs
depending on the year of their implementation. For
example, Hungary already introduced its statutory
private pension scheme in 1998, while Slovakia
implemented it only in 2005. In other words, the
Slovak scheme is in this sense less mature than the
Hungarian. Second, statutory funded private pension
schemes differ both in terms of contribution levels and
how these are shared between employers and
employees. For example, in Poland and Romania the
statutory pension scheme is fully financed by
employees, while it is fully financed by employers in
Slovakia.
45
46
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.
47
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.
48
The size and structure of private pension
fund assets
 The savings cumulated in the pension funds increased
sharply in the NMS, but still remained at 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.
49
The impact of inflation and financial market developments
on pension fund performance is determined 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).
50
Structure of Pension Funds Assets in 2007
As they should secure income for their members in their post-retirement period,
pension funds in the NMS have often (but not always) opted for investing rather
conservatively.
51
Structure of Pension Funds Assets in 2007
As we ca see, in 2007, the share of pension fund assets invested in cash and
deposits, associated with low returns and low risks, varies from 70 % in Romania
to 1 % in Hungary.
52
Structure of Pension Funds Assets in 2007
Also we can see , apart from Estonia and Romania, bills and bonds issued by the
public and the private sector formed the largest share of private pension assets in
2007. The majority of these debt securities were issued by the public sector .
53
Structure of Pension Funds Assets in 2007
Source : OECD
54
The OECD estimates that the total investment loss worldwide of private pension
plans due to the 2008 turmoil in financial markets was around USD 5 trillion
(out of which USD 3.3 trillion in the United States).
Next figure shows a declining trend in the nominal yields of pension funds
between 2003 and 2006 in the NMS. The nominal yields of pension funds were
higher in the NMS than in the old EU Member States; they declined from
about 20 % in 2003 to about 16 % in 2006 in the NMS, while they fluctuated
in the old Member States. The explanation of higher returns in the NMS may be
higher inflation and more profitable investment opportunities in the NMS.
Employees’ and employers’ contributions to pension funds have been rising
sharply in the NMS since 2003; however, their level remained below that in the
old Member States in 2007, reaching only 1.2 % of GDP while it was about 1.7
% of GDP in the old Member States. This could potentially be an indicator
that the population in the NMS is not accumulating sufficient savings for the
post-retirement period.
55
Source: OECD
56
US PENSION SYSTEM
Pension funds
Pension funds
I PILLAR
The pay-as-you-go (PAYG)
basic state pension scheme
II PILLAR
Occupational pension
provision
PENSION
III PILLAR
Personal pension provision
Pension funds
THE FIRST PILLAR:
public pensions
The official name of American state pension system is OASDI
(Old.Age, Survivors and Disability Insurance Program). Assets
(not negociated in the market) are totally invested in bonds issue
by the Government.
is financed through social security taxes equally shared between
employers and employees.
The statutory
retirement
age lies
between 65
and 67
Pension funds
1983: increasing of the social
security tax
Accumulation of the surpluses in the Social
Security Fund to meet future expenditures
USD2.2
trillion:
amount of
the surpluses
in 2004
• 2042
year of the
expected
exhaustion of
the Security
Trust Fund
Pension funds
THE SECOND PILLAR:
occupational pensions
There are two categories of occupational pension plan:
Defined-benefit plans
Defined-contribution
plans
which are relatively heavily
regulated and are financed by the
employer.
Assets and liabilities are put into
the property of the firm.
the costs of which are more
predictable (≤15.000$ per year)
Es:401(k) plan
Defined contribution is based on
private funds managed by a
consultant (external from
firm)provided by the employer.
Pension funds
THE THIRD PILLAR:
personal provision
In 401(k) plans, occupational meets personal
pension provision
Pension funds
Financial crisis and US pension system
Economic recession
and public debt
growth are risky for
the long term
payments
Defined
contributions
schemes are risky
for savers
No stability of the
private investment
account system
• Less active workers, less
capital
• Their pensions depend from the fluctuactions
of financialmarket or banckruptcy of the firm.
• es. Enron: When Enron failed, its employees
lost not only their jobs but also most of their
pension.
• Pensions payed are highly
variable from one year to the
next
Pension funds
Government’s Program
President Obama is strongly opposed to privatizing Social Security.
“But the fact is a secure retirement is being threatened today. Part of the reason is rising costs. I don’t have
to tell you
about this. You feel the pinch every time you fill up a tank of gas because the price at the pump has tripled
over the
past several years. You feel it every time you go to the pharmacy and find that you’re paying more for the
same drugs
than you were this time last year…”
[Barack Obama, 10/27/07]
•Strengthen Social Security
•Create Automatic Workplace Pensions
•Expand Retirement Savings Incentives for Working
Families
•Require Full Disclosure of Company Pension
Investments
•Reform Corporate Bankruptcy Laws to Protect
Workers and Retirees
Pension funds