Developing Annuities Markets: The Experience of Chile Roberto Rocha

Why the book was written The role of the private sector in the provision of retirement income has been enhanced – New second pillars and expanded third pillars Most countries unprepared for the payout phase – Deficient regulatory framework, lack of instruments Insufficient research on the payout phase – Most of the pension research had focused on the accumulation phase – Payout research limited to a few countries, topics –Little knowledge of good institutional arrangements and regulatory practices in the payout phase

Recent World Bank Project Addresses Basic Questions Can a market for retirement products be created from a low initial base? What are the weak/strong aspects of different institutional and regulatory arrangements? Countries selected for the project: –Australia, Chile, Denmark, Sweden, Switzerland –Large pension systems, different payout arrangements Chile one of the most relevant cases: –Large annuities market created from a low initial base –Good performance overall –Positive evolution of the regulatory framework

The Chilean Experience (1) Workers accumulate savings in individual accounts At retirement workers can choose:  Restricted access to lump-sums  Phased withdrawals (PWs) with regulated formula  Annuities (indexed, some choices allowed) Fast growth of the market since 1981 Number of retirement products in 2005  Phased withdrawals: 215,00  Annuities: 360,000 Assets of life insurance companies: 20% of GDP

Payment Paths for a 55 Year Old Chilean Pensioner

The Chilean Experience (2) Annuities represent 63% of the market –High degree of annuitization Most workers choose annuities, value protection against investment, inflation, and longevity risks –PWs are chosen primarily by low-income or very high-income workers Guaranteed annuities became very popular –80% of annuity contracts guaranteed for +10 years –Workers also value risk-sharing, bequests

The Chilean Experience (3) Chilean annuitants get today a better deal for their premiums than annuitants in most countries, especially comparing indexed annuities –Average money’s worth ratios (MWR) higher than one –Annuity rate higher than risk-free rate –Moderate profits of insurance companies What explains good market performance: –Competitive market –Supply of indexed instruments with long durations, higher yields –Positive evolution of regulatory framework

Lessons For Other Countries Feasibility of Developing the Market for Retirement Products from Low Initial Base –Market can be developed from low initial base in most reforming countries –Product menu should comprise PWs and annuities –Market development requires supportive regulatory framework –Market development requires supportive capital market agenda

Lessons For Other Countries: Product Regulation –Restrictive menu justified in Chilean case –Optimal menu will depend on the country’s characteristics: Countries where second pillar plays central role may need to maintain more restrictions, like Chile –Restrictions on lump-sums, PWs more regulated, restrictions on variable annuities, mandatory indexation Countries with multi-pillar systems and generous first pillar benefit may allow more options –Partial lump-sums, PWs with more liberal design, variable annuities from the start, no mandatory indexation

Lessons For Other Countries: Marketing Regulation Need to ensure a transparent market, ensure well-informed decisions on products and providers Chile’s experience shows the value of a transparent annuities quotation system to: –Ensure access to best annuity quotes –Allow easy comparison with PWs, both initial values and time path –Prevent excessive broker commissions

Lessons For Other Countries: Intermediary Regulation/Capital Market Need for a sound capital rule for annuity providers –Adoption of cohort mortality table –Capital rule that penalizes mismatches between assets and liabilities Need to develop financial instruments for annuity providers –Government debt management strategy must include role for indexed paper with long durations –Development of indexed private debt markets possible, although more challenging