Population aging is expected to affect the performance of financial markets in developed and emerging economies at a time when ever more countries are relying on funded provisions for oldage income support. For the former transition economies in the countries of Central, Eastern, and Southern Europe (CESE)—Albania, BosniaHerzegovina, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Kosovo, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Montenegro, Poland, Romania, Serbia, the Slovak Republic, Slovenia, and Ukraine—this creates special challenges because the aging of their populations is well advanced while the development of their financial markets is still in progress. At the request of the ERSTE Foundation in Vienna, and with their financial support, World Bank staff and consultants have investigated the challenges faced by these countries in the context of international experience from the OECD countries and Latin America under five broad topics:
DIREC TIONS IN DE VELOPMENT Finance Aging Population, Pension Funds, and Financial Markets Regional Perspectives and Global Challenges for Central, Eastern, and Southern Europe Robert Holzmann Editor Aging Population, Pension Funds, and Financial Markets Aging Population, Pension Funds, and Financial Markets Regional Perspectives and Global Challenges for Central, Eastern, and Southern Europe Robert Holzmann, Editor © 2009 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone 202-473-1000 Internet www.worldbank.org E-mail feedback@worldbank.org All rights reserved :: 12 11 10 09 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank The findings, interpretations, and conclusions expressed in this volume not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent The World Bank does not guarantee the accuracy of the data included in this work The boundaries, colors, denominations, and other information shown on any map in this work not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries Rights and Permissions The material in this publication is copyrighted Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org ISBN: 978-0-8213-7732-1 eISBN: 978-0-8213-7733-8 DOI: 10.1596/978-0-8213-7732-1 Library of Congress Cataloging-in-Publication Data Aging populations, pension funds, and financial markets : regional perspectives and global challenges for central, eastern, and southern Europe / Robert Holzmann, editor p cm Includes bibliographical references and index ISBN 978-0-8213-7732-1 (alk paper) — ISBN 978-0-8213-7733-8 Old age pensions—Europe, Central—Finance Old age pensions—Europe, Eastern— Finance Old age pensions—Europe, Southern—Finance Population aging—Europe, Central Population aging—Europe, Eastern Population aging—Europe, Southern Finance—Europe, Central Finance—Europe, Eastern Finance—Europe, Southern I Holzmann, Robert HD7105.35.E852A354 2008 331.25’2094—dc22 2008035533 Contents Preface Acknowledgments Abbreviations and Acronyms Chapter Chapter xi xiii xv Introduction, Main Messages, and Policy Conclusions Robert Holzmann Structure of the Book Overview and Key Messages Policy Conclusions and Future Priorities Note 11 Were Financial Systems in CESE Countries Prepared for the Challenges of Multipillar Pension Reform? Robert Holzmann, Csaba Feher, and Hermann von Gersdorff 13 Multipillar Reforms in Transition Economies Financial Sector Readiness in the Region 14 23 v vi Contents Current Status of the Financial Sector Conclusions Notes References Chapter Chapter Chapter How Can Financial Markets Be Developed to Better Support Funded Systems? 41 Ricardo N Bebczuk and Alberto R Musalem Is Too Much Money Chasing Too Few Assets? Bank-Based and Market-Based Systems Alternative Investment Options in Emerging Countries Conclusions Notes References 41 51 Population Aging and the Payout of Benefits Heinz Rudolph and Roberto Rocha 63 Lessons for Developing Annuity Markets Preparing for the Payout of Benefits: Challenges and Options Conclusions Notes References 64 Can the Financial Markets Generate Sustained Returns on a Large Scale? Ricardo N Bebczuk and Alberto R Musalem Gross Financial Returns and Pension Fund Asset Allocation Net Pension Fund Returns Conclusions Notes References Chapter 29 37 38 38 Does Investing in Emerging Markets Help? Ricardo N Bebczuk and Alberto R Musalem International Financial Diversification and Domestic Bias 55 57 58 60 73 79 80 80 83 84 89 91 92 94 97 97 Contents Chapter Appendix vii Return, Risk, and International Diversification Investing in Emerging Markets Conclusions Notes References 102 105 112 113 115 Will Population Aging Affect Rates of Return? Robert Holzmann 119 Demographic Developments and Motivation Will Aging Cause a Financial Market Meltdown? The Impact of Aging on the Implicit Returns of Unfunded Pension Schemes Conclusions Notes References 120 123 Readiness Indicators 139 Conceptual Considerations Ten Critical Areas of Readiness Assessment Applied Methodology for Rating References 139 149 155 156 Index 130 134 135 135 157 Figures 2.1 2.2 2.3 2.4 3.1 4.1 4.2 4.3 4.4 Readiness Indicator Scores at Reform and Five Years Later, Five CESE Countries Stock Market Capitalization as Percent of GDP, Five CESE Countries, 2000 and 2006 Stock Trading Volume as Percent of Market Capitalization, Five CESE Countries, 2000 and 2006 Readiness Indicator Scores, Four CESE Countries with Voluntary Pension Schemes Financial Structure, Chile, 1981–2007 Bank Assets and Per Capita Income, 50 Countries, 2005 Nonbank Financial Institution (NBFI) Assets and Per Capita Income, 50 Countries, 2005 Total Assets and Per Capita Income, 50 Countries, 2005 Ratio of Life Insurance Assets to Pension Assets, Chile, 1991–2005 26 27 28 29 54 66 67 67 71 viii 7.1 7.2 7.3 Contents Ratio of Savers to Dissavers by Region, 1950–2050 Asset Prices and Share of U.S Population Age 40–64, 1950–2050 Real Stock Prices, United States, 1950–2006 and Projected to 2050 Tables 2.1 Characteristics of Multipillar Pension Reforms in Transition Economies 2.2 Gross Public Pension Expenditure in Relation to GDP, European Union Members, 2004 and Projected to 2050 2.3 Transition Indicator Scores: Banking Reform and Interest Rate Liberalization, 1989–2007 2.4 Transition Indicator Scores: Security Markets and Nonbank Institutions, 1989–2007 2.5 Volume and Structure of Assets in Second-Pillar Pension Funds as of December 2005 2.6 Allocation of Assets across Bond Categories as of December 2005 3.1 Pension Funds and Financial Market Size, Selected Countries 3.2 Pension Fund Regulatory Limits and Actual Shares, Selected Countries, 2007 3.3 Bank Deposits and Stock Held by Pension Funds, Selected Countries, Recent Years 3.4 Number of Listed Firms and Concentration of Market Capitalization, Selected Countries, 1966 and 2006–7 3.5 Absolute and Relative Size of Banking Sectors and Capital Markets, Selected Countries, Circa 2006 4.1 Population Share of the Elderly and Per Capita Income, 2005 4.2 Assets of Banks and Nonbank Financial Institutions (NBFIs) as Share of GDP 4.3 Average Age, Average Wage, Average Balance, and Membership Size of Lifestyle Portfolios, Chile, December 2005 4.4 Composition of Lifestyle Portfolios, Chile, June 2007 4.5 Portfolios of Chilean Life Insurance Companies, Selected Years, 1986–2006 122 123 127 17 21 31 33 36 37 43 44 44 49 52 66 66 70 70 71 152 Appendix exists, that ownership is clearly recorded, and that purchase orders and issues can be accurately reconciled Custodial services are necessary to guarantee property rights over securities, to conduct or verify asset and portfolio valuations, and to verify that transactions are conducted in a lawful manner in accordance with the investment guidelines issued by pension scheme governing bodies In addition to the use of standardized contracts on regulated markets, settlement rules ensuring the timely delivery of funds and the transfer of ownership are crucial Availability and Quality of Critical Financial Services Pension schemes are complex contractual relationships that rely on existing financial services to collect contributions, invest pension portfolios, and provide benefits Prohibiting pension funds and their administrators from providing these services reduces the risk of conflict of interest and enhances investment returns because lower fees generally result when financial services are sourced through competitive processes Availability of Financial Instruments Whereas the above criteria deal primarily with the security of the investment process, the availability of financial instruments is the single most important factor determining whether a well-regulated pension industry can actually fulfill its promise of providing acceptably high rates of return at acceptably low levels of risk This issue, which reflects the liquidity, depth, and breadth of domestic securities markets, as well as access to established foreign markets, is often a subject of debate in the context of funded pension reforms There is general consensus, however, that, at a minimum, there must be a transparent, liquid market for government debt in which new issues appear regularly and the maturity structure of the debt contributes to the establishment of a yield curve Although investing excessively or exclusively in public debt is not desirable (with the possible exception of the payout phase and the periods immediately preceding it), a liquid public debt market typically offers the most reliable supply of instruments appropriate for pension funds to buy This is particularly true in the CESE countries, where overbearing banking sectors and the small number of potential private debt issuers have hindered the development of corporate bond markets The supply of investment instruments should be measured by how the supply relates to demand and how the relationship between the two influences the liquidity of the market, asset price dynamics, and the quality of securities being sold Measuring the supply of instruments along all three dimensions demonstrates the ambiguous impact mandatory defined Readiness Indicators 153 contribution schemes can have on domestic market development Domestic financial markets may (or may not) respond to increasing demand on the part of pension funds with reduced liquidity or with degradation in the quality of instruments If marginal demand leads to asset price bubbles or to the lowering of listing standards, the impact of pension reform on domestic financial markets may be adverse Such impacts can be avoided through foreign investment, but this is typically subject to regulatory and scale economy constraints In light of these concerns, a country can receive a lower rating five years after its reform if it appears that pension portfolios grew faster than did domestic financial markets in the absence of opportunities for investing externally Governance Establishing a private pension fund, providing investment management services, and serving as an administrator are costly but potentially rewarding long-term investments The rules of pension scheme governance are crucial to ensuring that the interests of pension plan participants are protected in situations where their interests and those of scheme managers conflict Conflicts of interest can arise over (a) the choice of investment policies, (b) the selection of financial service providers and the terms governing their service contracts, (c) the level and structure of administrative fees and charges, and (d) the trade-off between spending money on marketing to grow a fund and the benefits that accrue from a larger market share and potentially reduced operating expenses It would be a mistake to assume that pension scheme managers and financial service providers will always act in the interests of participants and will obey not just the letter but also the spirit of the law Therefore, it is important to establish detailed regulations regarding procedures, reporting requirements, and conflicts of interest and to ensure that external independent board members (that is, persons with no business or other ties to pension scheme managers or service providers) are included on pension fund boards to uphold governance standards Whether this requirement can be practically enforced in CESE countries remains to be seen because the size of their financial markets makes it difficult to identify independent board members with the appropriate professional experience Financial Literacy and Education Introducing a second-pillar scheme that requires participants to make choices regarding the investment of their assets and the purchase of annuities requires a degree of financial literacy Identification of these 154 Appendix minimum skills is the subject of considerable debate in a burgeoning body of literature on financial literacy It also is increasingly apparent that individuals must possess a general appreciation for the basic concepts of life-course planning, in which preparing for retirement is only one, albeit crucial, event As retirement saving is quite likely the most important saving decision (beside the acquisition of housing) that most people ever make, a solid understanding of basic concepts surrounding retirement savings is crucial These include an appreciation for (a) the difference between nominal and real amounts (and hence the importance of indexation); (b) the trade-off between risk and return; (c) the differences between types of financial products, such as bonds and shares, and the implications of investment decisions relating to alternative asset classes; and (d) the nature of longevity risk and the role and characteristics of annuities How best to acquire these skills (through what mechanisms, by which providers, and by what process) remains an open area of investigation For the time being, it is difficult to clearly articulate what educational measures a country should undertake to create readiness for funded pillars Perhaps the best-case scenario is for a country to have a program that begins teaching financial literacy to children, integrates financial literacy into high school curricula, and offers well-monitored and systemically evaluated special programs for crucial life-course decisions (such as decisions on education, housing purchases, and retirement savings) through well-regulated, well-supervised public and private providers The results of these efforts could be measured in financial literacy surveys that would be comparable across time, groups, and countries Very few countries, if any, currently live up to this standard At a minimum, countries introducing second-pillar pension schemes should have begun to develop a financial literacy program and an information campaign to educate participants about the key aspects of the reform and the decisions that will be expected of them The private sector, including financial service providers, civil society organizations, and employers, should have been actively encouraged to provide financial education in support of the reformed pension system and should be able to demonstrate that they actually so 10 Historical Context Two factors relating to a country’s economic history may have a direct bearing on the receptiveness of its population to a funded pension reform and the likelihood of the reform’s successful implementation The first factor is whether vibrant financial markets, including securities exchanges, Readiness Indicators 155 existed prior to the beginning of the economic transformation in 1990 In the CESE region this could only have been the case before the communist takeover shortly after World War II The existence of stock exchanges, issuers, and institutional investors in a country indicates, to some degree, how far advanced it was as a market economy before history forced it onto a different route A legacy of regulations, forms of enterprise, and basic notions may positively influence how complex financial products and services are now viewed by the general public and to what extent one can rely on historical analogies The second factor is whether a country has experienced a major crisis or scandal attributable to insufficient financial market regulation or enforcement or to poorly conceived or incomplete conceptual underpinnings of the processes governing the country’s economic transformation Failed voucher privatizations, pyramid schemes, poorly regulated or fraudulent undertakings parading as legitimate financial services, problems with accounting and auditing standards, or a lack of transparency surrounding trading—just to mention a few potential pitfalls—can undermine popular faith in the capital markets and hinder the active participation of individual investors in those markets Indeed, these sorts of problem can slow the withdrawal of the public sector from the management of the economy Forcing people to invest their pension savings with privately managed financial service providers can be politically difficult under such circumstances Applied Methodology for Rating The indicators for the 10 assessment areas have been applied to five countries that have introduced mandatory funded pension schemes (Bulgaria, Croatia, Hungary, Poland, and the Slovak Republic) and to four countries that have introduced only voluntary or supplemental funded pension schemes (the Czech Republic, Romania, Serbia, and Slovenia) For the former group, the criteria are evaluated both in the year of their reforms and five years later (or in 2006, whichever came first) Some of the weights changed in importance across these two periods For the latter group, the ratings reflect conditions in 2006, with, at times, different weights and with some indicators excluded on grounds of relevance In appendix table A.1 the codes for whether criteria have been met correspond to standard traffic light colors: green (G) means that criteria have been met, yellow (Y) means there are doubts, and red (R) indicates that criteria have not been met Because the criteria are not all equally important, 156 Appendix a second dimension is included: the importance of the readiness condition, ranging from high (H) to medium (M) to low (L) Situations where an item is not applicable are designated X To calculate an overall (normalized) score across all the indicators, a three-by-three matrix was used to weight the relative importance of different combinations of flags and the relative importance of readiness conditions Weights were chosen to elevate the importance of extreme observations The normalization of scores between and 100 percent of readiness is based on the minimum and maximum scores observed G Y R H –8 –32 M –4 –16 L –2 –8 To refine this rudimentary assessment and make it more dynamic, the middle group of column-heads in appendix table A.1 contains data indicating whether changes are perceived as being positive or negative This differentiation is important in cases where a country’s overall assessment did not change but changes were nevertheless observed For the indicators related to quantitative measures of supply, demand, liquidity, depth, and transactions, the assessments reflect relative measures Although the overall supply of domestic equities may have increased substantially since a reform was launched—for example, because the growth of pension assets outpaced the growth in the supply of financial assets—the situation will have worsened when observed from the point of view of the pension industry References Blake, David, Andrew Cairns, and Kevin Dowd 2008 “Turning Pension Plans into Pension Planes: What Investment Strategy Designers of Defined Contribution Pension Plans Can Learn from Commercial Aircraft Designers.” Presented at the Fourth Contractual Savings Conference, “Supervisory and Regulatory Issues in Private Pensions and Life Insurance,” World Bank, Washington, DC, April 2–4 http://www.pensions-institute.org/workingpapers/wp0806.pdf EBRD (European Bank for Reconstruction and Development) 2006 Transition Report 2006: Finance in Transition London: EBRD Rudolph, Heinz, and Roberto Rocha 2007 “Financial Preconditions for Second Pillars.” Draft, World Bank, Washington, DC Index A adequacy, 20 affordability, 20 annuities, 64, 72, 73, 148 fixed indexed, 76 life, 77 pricing, 75 annuity markets, 64–72 Chile, 69 developing, 77 assessment, purpose, 24–25 asset prices, 79, 119, 124 aging and, 68 conceptual issues, 128–129 efficient market, 125–126 empirical evidence, 126–128 meltdown, 93n.7, 124–125 population age structure and, 126 questions, 129–130 US population age and, 123 asset-liability term risk, 77, 80n.7 assets accumulation, 64, 80n.1 aging and GDP and, 65 allocation, 50, 130 availability, 87 demand for, 50 holding, 126 per capita income and, 67 selling, 125 auctions, 80n.6 Australia, annuitization, 73, 75 B baby boomers, 64–65 saving, 119 bank assets, per capita income and GDP, 66 bank-based systems, 51–55 bank deposits, 44–45, 46, 58n.2 banking reform, 16 transition indicator scores, 31–32 banking sector, 30 size, 52 socialism and, 67–68 banking systems, 35, 57 resources, 50 benchmarking, 58 benefits payout See payout phase bonds, 49, 93n.3 categories, allocation of assets, 37 corporate, 93n.3 157 158 Index emerging markets, 114n.4 longevity, 78–79 market, 53 mortgage, 59–60n.14 prices, 65, 122 supply, 42 borrowing, 129–130 Brazil, pension fund investments, 60n.15 Bulgaria, 25–26, 27 C capital asset pricing model (CAPM), 85 capital inflow, 110, 112 capital markets, 41–42 development, 47, 57 domestic, 54 reaction, 53 reforms, 113 size, 52 capitalization regimes, 46 Central, Easter, and Southern Europe (CESE), Chile financial structure, 54–55 investment guidelines, 59n.13 mortgage bonds, 59–60n.14 pension system, 69–72 commission-to-salary ratio, 93n.8 company owners, 53 competition, 48 conflict, expectations vs reality, 125 conglomerates, 58n.4 corporate debt, returns on, 84 corporate governance emerging markets, 106, 108 standards, 109 corporate investment, 59n.10 costs administrative, 90 transaction, 89, 91 Croatia, 25–26, 27 cross-listing, Europe, 59n.11 currencies, 106 D debt financing, 48–49 government, 35–36, 46, 48, 58n.5, 84, 148 issuing, 49 management, 69, 78 public, 72 decentralized model, 77 demographics, 5, 65, 79, 120–123 Denmark, 80n.4 derivatives, 80n.7 diversification, 98, 115n.8 E economic and institutional playing field, 48 economic growth, economic transition, 13–14 education, 10–11 efficient market view, 125–126 elderly, per capita income and, 66 emerging markets, 7, 97–117 investing in, 7, 90–91, 92, 105–112, 113–114n.1 productivity, 105–106 rights, protection, and governance, 106–109 risks, 106 small markets, liquidity, and trading, 109–112 time-varying returns, 106 volatility, 106 equity, 85, 86, 87 corporate, 48–49 demand for, 72 indexes, 107 markets, ownership, 113, 115n.12 outside, 53 returns, 88 EU15 countries, 135n.1 Europe and Central Asia (ECA), 38n.1 excess demand, 42–43, 51, 57, 58n.1 exchange rate volatility, 107 expectations, optimistic, 98, 99 F fees, 89 fertility rates, 2, 120–121 financial assets, 66–69 demand for, 48 financial conglomerates, 47 financial flows, 129–130 financial globalization, 54 financial instruments, availability, 145–146, 152–153 financial literacy and education, 10–11, 147, 153–154 financial markets, 14, 46, 57 Index development, 4, 10, 41–62 domestic, Hungary, 59n.12 meltdown, 123–130 Peru, 59n.12 financial readiness See readiness financial returns, gross, 84–88 financial sector, 3–4, 29–37 criteria, 23–24 development, 4, 16, 38 readiness, 23–29 financial services, availability and quality, 144–145, 151, 152 financial structure, Chile, 54–55 financing, captive sources, 56–57 firms, 53 listed, market capitalization and trading volume, 49 first-pillar schemes and reform, 19 fiscal approach, prudent, 140, 149–150 fiscal sustainability, 15 fixed-income assets, 68 fixed-income instruments, 64, 69, 72 fixed-investment financing, 59n.10 foreign assets, 7, 99, 102, 112 efficiency, 103 emerging countries, 101, 104, 114n.3 household portfolios, 99 OECD countries, 101, 104 pension portfolio share, 100, 101 regulations, 99–100 returns, 104 foreign investment, 104–105 funded components, 73 funded pensions, 1, ability to support, 30–31 contributors, 68 pillars, 25, 30, 16 futures markets, 57 G governance, 146, 153 government debt, 35–36, 46, 48, 148 Peru, 58n.5 returns on, 84 government fiscal situation, 148 gross domestic product (GDP), 2, 92, 133 growth, emerging markets, 109 growth per capita, 93n.9 pension as a percentage of, 15 159 H health care schemes, 120 historical content, 147, 154–155 home bias, 98–100 households, 53 Hungary, 26, 59n.12 I implicit partial equilibrium, 48 incentives, 46, 47–48 indexation, 69 indexed instruments, 78 indicator weights, 148 information asymmetries, 106, 108 availability and quality, 143, 151 barriers, 98–99 instability, macroeconomic, 113 institutional infrastructure, 24, 54, 64, 76–77, 141–142, 150–151 institutional investors, 48 insurance companies, 64, 77 insurance policies, 58n.4 interest rates liberalization, transition indicator scores, 31–32 real vs bank, 114n.5 international diversification, 7, 102–105, 112 vs domestic, 97–101 international financial markets, investment assets, demand for, 112 banks, 115n.9 opportunities, securitized assets, 55–56 options, 55–57 strategies, 68 investment guidelines, 47, 93n.4, 114n.3 Chile, 59n.13 investors protection, 50–51, 57 rights, 49–50, 59n.6, 106 K Kazakhstan, 19 Kosovo, 19 L labor force, 129 growth, 131–132 projected change, 124 160 Index legal framework, 24, 141–142, 150–151 protections, 108, 109 rights, 108 lending, 129–130 life cycle considerations, 128 life expectancy, 120, 129, 130, 133 life insurance, 72 Chile, 71 companies, 75 pension assets and, 71–72 liquidity, 109 longevity risk, 10, 65, 75–79 long-term fixed-income instruments, 69 lump-sum payments, 73, 75 partial, 76 M market-based instruments, 88 market-based systems, 51–55 market capitalization, 27, 54–55, 113, 115n.10 OECD vs emerging economies, 111 pension fund assets and, 42–43, 46 volume and turnover, 110 market transparency, 73, 77 meltdown view, 93n.7, 124–125, 134 migration, 14, 131–132 mortgage bonds, Chile, 59–60n.14 multipillar pension systems, 16 introduction, 23 objectives, 46 reforms in transition economics, 14–23 transition economies, 17–19 mutual funds, 85, 115n.11 N net returns, annual, 89–90, 91 nonbank financial institutions (NBFI) assets, 68 GDP vs, 66 per capita income and, 67 transition indicator scores, 33–34 nonfinancial pension schemes, 131 notional defined contribution (NDC) pension schemes, 131 O OECD countries, 93n.2 options, 57 P pay-as-you-go pension systems, 15, 46, 76, 83, 120, 121 payout phase, 5, 63–82 benefit formulas, 15 challenges and options, 73–79 design, 73, 74 financial instruments, 77–79 issues, 64, 73 procedures and mechanisms, 10 pension assets, 63 OECD vs emerging countries, 111 pension contributions, diverted, 149 pension expenditure, gross, as a percentage of GDP, 21–22 pension fund assets, 42–43, 58n.2, 88 allocation, 84–88 pension fund managers, 47, 50, 80n.3 pension funds benefits, 89 Chile, 69–72 financial market and, 43, 46 GDP, percentage of, 15 growth, 59n.7 investments, 60n.15 management, 76–77 mandatory defined contribution, 68–69 net returns, 89–91 objective, 19–20 participants, 68, 80n.2 pay-as-you-go, 6, portfolios, 35, 72 real returns and risks, 104 reform, 14–15, 47, 51, 121 regulatory limits and actual shares, 44 replacement ratios, 103 restrictions, 47 per capita income bank assets and, 66 elderly and, 66 NBFI and, 67 total assets and, 67 performance, uniformity, emerging markets, 106 Peru, financial market development, 59n.12 Poland, 25–26 policy, 8–9, 53, 57, 58, 73, 75 ill-conceived, 46 policy makers, 115n.9 Index population aging, CESE, portfolio allocation, 70–72, 79, 85–86, 107 Chile, 71, 72 emerging countries, 86 OECD countries, 85 theory, 97–98 volatility, minimizing, 103–104 premiums, high-risk/low-risk, preparedness See readiness prices, 5, asset, 42 priorities, 8–9 private pension funds, 19, 68, 80n.2 private sector, 130 privatization, 58 privileges, 15 productivity, 93n.7, 133 emerging markets, 105–106 marginal, 114n.5 protection, emerging markets, 106, 108 prudent person standard, 93n.4 retirement products, 68, 79 market, 73 menu, 75–76 returns annual gross real pension fund, OECD countries, 87 assets, 93n.11 debt, 84 emerging markets, 106 equity, 84 estimation, 89 excess, 92 implicit, 130–134 investment, 92n.1 real, 84 real net rate, 92 risk vs, 104 stocks, 93n.6 sustained, 5–6, 83–97 volatility vs, 107 risk management, 77, 113-114n.1, 114–115n.7 S R rates, variation, 129 rates of return, 1, 9, 92, 120 aging population and, 119–137 explicit, 8, 135 implicit, 8, 134–135 internal, 134 population aging and, 7–8, 130–131 real net, rating, applied methodology, 155–156 readiness, 9, 37, 73 assessment, 148, 149–155 financial sector, 3–4, 23–29 indicators, 26, 29, 139–156 quantifiable, 148 real financial asset returns, population age structure vs, 126 reforms, 3, 37–38 regulatory framework, 47, 56, 64, 68–69, 72, 73, 76–77, 93n.5, 114n.3, 115n.9 foreign securities, 99–101 risk-based, 58 retirement, 1, 64 income, 84–85 savings, 50 savers vs dissavers, 8–9, 120, 121–122 saving behavior, 128–129 second pillar, 80nn.4,5 annuities, 75 assets volume and structure, 36 pension funds, current status, 37 schemes, 19 securities, 59n.8 captive demand for, 57 coupon, 78 domestic, 93n.3 nontraditional and unlisted, 58 ownership, 65 Peru, 58n.5 trading volumes and turnover, 59n.9 securitization, 55–56 security markets, transition indicator scores, 33–34 self-financing, 49 shareholder rights, 108 Slovak Republic, 26 sovereign debt investments, 48 maturities, 57 stocks emerging markets, 114n.4 pension funds, 44–45 161 162 Index prices, 65, 122, 127 returns, 87–88, 93n.6, 102–103 supply, 42 trading volume, 27–28 UK vs US, 87–88 stock markets, 51, 54 capitalization, as percentage of GDP, 27 sustainability, 20, 23 Sweden, 76–77, 80n.5 U T venture capital, US, 60n.15 volatility, emerging markets, 106, 107, 108 voluntary schemes, 11n.1 tax administration and collection, 24, 57, 141, 150 trading emerging markets, 109–112 volumes, 53 transaction security, 143–144, 151–152 transition deficit, 149–150 transition economies, 15–16 transition indicator scores, 30, 35 banking reform and interest rate liberalization, 31–32 security markets and nonblank institutions, 33–34 transparency, 106 unfunded pension schemes, 19 implicit returns, aging and, 130–134 see also pay-as-you-go pension systems United Kingdom, equity returns, 88 United States equity returns, 88 pension fund investments, 60n.15 V W wage growth, per capita, 132–134 wealth accumulation, 125 withdrawals, phased, 75–76 Y yield, reduction, 89 Z zero-pillar schemes, 19 ECO-AUDIT Environmental Benefits Statement The World Bank is committed to preserving endangered forests and natural resources The Office of the Publisher has chosen to print Aging Population, Pension Funds, and Financial Markets: Regional Perspectives and Global Challenges for Central, Eastern, and Southern Europe on recycled paper with 30 percent post-consumer waste, in accordance with the recommended standards for paper usage set by the Green Press Initiative, a nonprofit program supporting publishers in using fiber that is not sourced from endangered forests For more information, visit www.greenpressinitiative.org Saved: • trees • 23 million BTUs of total energy • 3,497 pounds of CO2 equivalent of greenhouse gases • 11,375 gallons of waste water • 1,342 pounds of solid waste Population aging is placing enormous pressures on the pension benefits governments are able to provide The former transition economies of the countries of Central, Eastern, and Southern Europe (CESE) face unique challenges The growth of their aging populations outpaces other European countries, while the growth of their financial markets (essential to fund pension provisions) lags behind With support and direction from the ERSTE Foundation, an Austrian group focused on Central European policy issues, a World Bank team investigated the challenges faced by these countries against the background of international experience from the OECD countries and Latin America Aging Population, Pensions Funds, and Financial Markets: Regional Perspectives and Global Challenges for Central, Eastern, and Southern Europe examines how well the financial systems in the CESE economies were prepared for the challenges of multipillar pension reform, how ready they are for the approaching payout of benefits to the first participants, whether returns from pension funds can be sustained in an aging population, and how determined policy actions might be implemented to complete financial market development ISBN 978-0-8213-7732-1 SKU 17732 [...]... for the development of capital markets and for supply of and demand for the sorts of financial assets required by funded pension systems Chapter 3: Development of Financial Markets to Support Funded Systems Chapter 3, by Ricardo N Bebczuk and Alberto R Musalem, explores whether financial markets will be able to provide the volumes and varieties of financial assets that pension funds in CESE countries... facing pension systems in both developed and emerging countries: the capacity of the financial markets to deliver sufficiently high net rates of return, the benefits and disadvantages of investment in emerging markets, and the effect of aging on the rates of return afforded by funded and unfunded schemes The authors of the individual chapters collaborated to better manage the flow of ideas and to provide... OECD countries and Latin America under five broad topics: • Multipillar pension reform in CESE countries: were the financial systems prepared for the challenges? • How can the financial markets be developed to better support funded systems? xi xii Preface • Can the financial markets generate sustained returns on a large scale? • Does investing in emerging markets help? and • Will population aging impact... fails to keep pace, both the pension fund industry and the financial markets as a whole will be considerably strained, and policy makers will face the politically painful need to shift pension savings abroad The chapter examines the alleged scarcity of eligible assets for pension funds to buy, analyzes how the structure of bank-based financial systems affects financial markets capacity to cope with... accumulation phase of their newly introduced voluntary and mandatory funded pension schemes This is understandable, given the enormous effort needed to design and implement pension reforms But now is the time for CESE countries to focus on the payout phase of their new pension systems and to provide current and future participants with a clear vision and strategy for how benefits will be paid This is important... implicit rates of return provided by unfunded pension schemes and draws several conclusions: • Although changes in demographic structure are likely to affect the supply of and demand for financial assets and hence their returns, population aging and the increase in dissavers relative to savers across relevant cohort groups are unlikely to lead to a meltdown in financial asset prices Most analyses predict... the return differential between financial markets in developed countries and those in emerging markets will be large enough to compensate for the reduced generosity of national pension systems in developed countries Introduction, Main Messages, and Policy Conclusions 7 Chapter 6: Benefits and Pitfalls of Investing in Emerging Markets Chapter 6, by Ricardo N Bebczuk and Alberto R Musalem, reviews the... challenges raised by funded pension schemes, and looks at alternative investment choices in light of the observed financial structure of CESE countries The main conclusions are as follows: • Excess demand for financial assets by pension funds is not an immediate concern, but it could become a serious problem in the medium term For CESE countries, access to larger, established financial markets in the European... alternative and bank-supplied instruments such as securitization, leasing, and factoring Introduction, Main Messages, and Policy Conclusions 5 Chapter 4: Payout of Benefits In chapter 4, Heinz Rudolph and Robert Rocha survey the main issues that must be addressed as pension systems in CESE countries mature and begin to pay benefits The authors argue that asset accumulation and retirement will increase demand... Republic of Macedonia, Montenegro, Poland, Romania, Serbia, the Slovak Republic, Slovenia, and Ukraine—this creates special challenges because the aging of their populations is well advanced while the development of their financial markets is still in progress At the request of the ERSTE Foundation in Vienna, and with their financial support, World Bank staff and consultants have investigated the challenges