demography, capital markets and pension risk management adair turner imf seminar washington, 7 th...
TRANSCRIPT
Demography, Capital Markets and
Pension Risk Management
Adair Turner
IMF Seminar
Washington, 7th February 2007
2
Demographic factors at work
• Increasing longevity
• Lower fertility
• Retirement of Baby Boom
3
Estimates of cohort life expectancy: Male at 65 UK Government Actuary’s principal projections
(2003)
10
15
20
25
30
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Coh
ort
life
expe
ctan
cy a
t 65
Historical Principal Projection
1983-based Projection 1992-based Projection
4
Increasing longevity – The non-problem
Increased % of life beyond post retirement ages
Increased ratio of pensioners to contributors
Increased saving to fund longer retirement
• Long-term effect K/L rises Return on capital falls
• Transitional effect: asset prices rise
Increase retirement ages proportionally to keep % stable
Unchanged affordability at unchanged contribution rate
No/minimal charges in K/L ratio for unchanged real income in retirement
PAYG
Funded
Possible problem Solution
5
From pyramids to columns
0 - 4
5 - 910 - 1415 - 1920 - 24
25 - 2930 - 3435 - 3940 - 4445 - 4950 - 5455 - 5960 - 6465 - 69
70 - 7475 - 7980 - 8485 - 8990 - 9495 - 99100 +
Age Group
B
A A
B
A
B
6
People over SPA to those aged 20 – SPA*
0
0.1
0.2
0.3
0.4
0.5
0.6
2006 2020 2030 2040 2050 2060 2070
* SPA: State Pension Age
With SPA fixed at 65
With SPA rising proportionally (to 68.5 in 2050 and 70.2 in 2070)1
(1) This proportionate adjustment maintains the proportion of life over 20 years old which is spent in retirement at 27.5%
7
Lower fertility – The inherent challenge to pension systems
Increased ratio of pensioners to contributors
Savers of generation 1 have to sell accumulated assets to “smaller”* generation 2
Transitional asset price fall effect
K/L rises: return on capital falls
Lower pensions relative to average earnings
Increase Pension Age more than proportionally with life expectancy
Higher contribution rates
PAYG
Funded
* Smaller can mean either absolutely smaller than G1 (if fertility 2.0) or “smaller than would be the case if fertility had not fallen”
8
Possible de facto demographic effects on funded systems and capital markets
Transitional asset price fall effect (at sale)
K/L rises: return on capital falls
Transitional asset price rise effect
Longer-term effect; K/L rises, return on capital falls
Not inherent but could occur if future pensioners do not adjust retirement ages but instead increase savings rate
Inherent effect of shift to lower fertility
Lower Fertility
Increased Longevity
9
Demographic impacts on returns to capital
• Garry Young: Baby-boom generation -0.1%Increased longevity -0.1%Falling fertility -0.3%
• David Miles: Given future actual trends in UK demographics, returns fall:
4.56% (1990) to 4.22% (2030) 4.56% (1990) to 3.97% (2060) if PAYG
phased out
Model Results
10
Real S&P500 price index and % of 40-64 year olds among total U.S population 1950-2003
Source:: Poterba (2004), with additional data to 2006
0
200
400
600
800
1000
1200
1400
1600
1800
2000
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Rea
l S
&P
500
Pri
ce I
nd
ex
24
25
26
27
28
29
30
31
32
33
34
Perc
enta
ge
of
40-
64
Po
pu
lati
on
Real S&P500 (LHS) 40-64 population/ total population (RHS)
Forecast
11
Theoretical & empirical approaches to measuring demographic effects
“Given the limited amount of time series on returns and demographic
variation, and the difficulty of controlling for all of the other factors that may
affect asset values and asset returns, the theoretical models should be
accorded substantial weight in evaluating the potential impact of
demographic shifts”
Poterba: “The Impact of Population Ageing on Financial Markets”
12
Global glut of savings hypothesis
• Fewer children enable higher savings rate
• Awareness of greater longevity, fewer children and lack of social welfare net, require a high savings rate
Global glut of savings relative to investment
Long-term, not just cyclical, fall in real interest rates
In China and other East Asian countries
Developed countries save more to cope with their demographic/pension challenges
Transitional positive asset price effects
13
Real yields to maturity on UK index-linked gilts
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
01
/01
/19
86
01
/01
/19
87
01
/01
/19
88
01
/01
/19
89
01
/01
/19
90
01
/01
/19
91
01
/01
/19
92
01
/01
/19
93
01
/01
/19
94
01
/01
/19
95
01
/01
/19
96
01
/01
/19
97
01
/01
/19
98
01
/01
/19
99
01
/01
/20
00
01
/01
/20
01
01
/01
/20
02
01
/01
/20
03
01
/01
/20
04
01
/01
/20
05
Pe
rce
nt 2.5 Year
5 Year
10 Year
20 Year
1986 – 2004
14
UK Long-term real interest rates
Source: Morgan Stanley Research
-7%
-5%
-3%
-1%
1%
3%
5%
7%
9%
11%
1700 1716 1732 1748 1764 1780 1796 1812 1828 1844 1860 1876 1892 1908 1924 1940 1956 1972 1988 2004
Real interest rate
Long-term average (1700-2004)
Estimate for 2005
Estimate for 2005, as of 02 March 2005
15
Whole world gross savings rate
1981 - 2005
Source: IMF World Economic Outlook database
15
20
25
1981 1986 1991 1996 2001 2006
16
Gross savings rates: developing Asia and the US% of GDP
1981 - 2005
Source: IMF World Economic Outlook database
USA
DevelopingAsia
5
10
15
20
25
30
35
40
1981 1985 1989 1993 1997 2001 2005
17
Alternative hypothesis on global labour / capital balance
Very long-term future increase in K/L driven by demography
… but short/medium term massive increase in the economically relevant labour force
… not matched by increase in global savings/capital stock
Low real wage growth in developed countries, driven by:
• China and India in traded goods/services
• Immigration in non-traded services
Buoyant profits and profit share of GDP: high equity returns
18
Profit share of GDP – U.S.
1970 - 2004
20
25
30
35
1970 1980 1990 2000
Note: Gross Operating Surplus and Gross Mixed Income as % of GDP (Income approach)
Source: OECD: www.oecd.org/statistics/national-accounts
% of GDP
19
So why are real interest rates historically low?
Rise in the global supply of capital relative to labour
Particular asset allocation preference of major national savers
• Not
• But
20
Demographic challenges to funded pension systems
• Increasing longevity
• Lower fertility
• Uncertainty of longevity forecasts
Not inherent problem but possible de facto
Overwhelmed in short-term by globalisation effect
21
Estimates of cohort life expectancy: Male at 65 UK Government Actuary’s principal projections
10
15
20
25
30
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Coh
ort
life
expe
ctan
cy a
t 65
Historical Principal Projection
1983-based Projection 1992-based Projection
(2003)
22
Mortality rate declines & UK G.A. principal 2003 projection
10
15
20
25
30
35
40
1980 1990 2000 2010 2020 2030 2040 2050
Coh
ort
life
expe
ctan
cy a
t 65
1% pa Mortality Decline 2% pa Mortality Decline
3% pa Mortality Decline Principal Projection
Historical
23
Male cohort life expectancy at 65
10
15
20
25
30
1980 1990 2000 2010 2020 2030 2040 2050
Coh
ort
life
expe
ctan
cy a
t 65
Historical Possible Maximum
Possible Minimum GAD Principal Projection
Uncertainty in 2003 forecasts if already apparent 1983 errors/changes are the maximum possible and if error potential is symmetrical
24
Interpreting the range of uncertainty
• Inherent uncertainty not quantifiable risk
• Total error potential unclear from past errors
• Are the uncertainties symmetric?
• Are future potential error rates likely to be as high as 2003 vs 1983 comparison?
25
Male cohort life expectancy at 65: range of possible uncertainty around 2004 - based principal projection
10
15
20
25
30
1980 1990 2000 2010 2020 2030 2040 2050
Yea
rs
Historical GAD Principal 2003-based
Upper 90% bound? Lower 90% bound?
GAD Principal 2004-based
Source: Government Actuaries Department (GAD) and Pensions Commission estimates, UK
26
Longevity risk in UK pension provision
Legal liabilities or close to legal liabilities
Political promises
Can theoretically be changed
£bn of total liabilities – broad estimates at April 2005
* Latest figures (2006) suggest unfunded public employee liabilities now about £550bn
State Pensions
• Basic 870
• Earnings-related 260
Insurance CompaniesAnnuities
Pension Funds
Unfunded Public Employee Pensions
80
800
450*
Total 2460
27
Longevity risk in UK pension provision
Pre-retirement Post-retirement
Insurance Companies 10? 70?
Pension Funds 400? 400?
Unfunded Public Employee Pensions 260 190
State Pensions
• Basic
• Earnings-related
490
170
380
90
Total 1330 1130
£bn of total liabilities – broad estimates at April 2005
28
Three factors driving increased overt annuitisation
• Defined Benefit Defined Contribution shift Increased awareness of risks
• Defined Benefit legacy risk management
Bulk buyouts
Latent demand for longevity bonds
• Declining generosity of state PAYG demand for post-retirement annuities if private savings rise.
29
Possible long-term annuity or longevity bonds stock?
Overt Annuities
(Life Companies)
Annuity Promises
(DB Pension Fund) Total
Post
Retirement 70 400? 470
Pre
Retirement 10 400? 410
Required stock to replicate annuity promises given by final salary schemes
Required to manage legacy DB promises
Present Stock £bn
30
Who should bear cohort longevity risk?
Post-retirement:
e.g. the risk that the cohort of 65 year olds living in 2005 will live for 20 years not current estimate of 19 years
Long-Term pre-retirement:
i.e. the risk that the cohort of 35 years old living in 2005 will live for 25 years after reaching 65 in 2035 rather than the current estimate of 21.2 years
• Social interest in a fairly priced annuity market
• Longevity uncertainties moderate
• Natural offset exists in human capital / later retirement
• Longevity uncertainties huge.
31
The search for yield uplift
• Hedge funds: alpha without beta
• Complex yield enhancing strategies: credit derivatives
• Infrastructure finance
32
Conclusions
Long-term potential demographic effects swamped by medium-term globalisation and asset allocation effects driving
Falling K/L ratio, high capital returns
Low real interest rates
Decreasing willingness of corporates / governments to absorb longevity risk
Increased demand for liability matching assets
Increased demand for yield enhancement at low (?) risk
Macro-Effects
Pension Fund Management Effects