Transcript Slide 1

Demography, Capital Markets and
Pension Risk Management
Adair Turner
IMF Seminar
Washington, 7th February 2007
Demographic factors at work
• Increasing longevity
• Lower fertility
• Retirement of Baby Boom
1
Estimates of cohort life expectancy: Male at 65
UK Government Actuary’s principal projections
Cohort life expectancy at 65
30
25
20
15
10
1950
1960
1970
1980
1990
2000
2010
2020
2030
Historical
Principal Projection
1983-based Projection
1992-based
Projection
(2003)
2040
2050
2
Increasing longevity – The non-problem
Possible problem
PAYG
Funded
Solution
Increased % of life beyond
post retirement ages
Increase retirement ages
proportionally to keep % stable
Increased ratio of pensioners
to contributors
Unchanged affordability at
unchanged contribution rate
Increased saving to fund
longer retirement
No/minimal charges in K/L ratio for
unchanged real income in
retirement
• Long-term effect
 K/L rises
 Return on capital falls
• Transitional effect: asset
prices rise
3
From pyramids to columns
Age Group
100 +
95 - 99
90 - 94
85 - 89
80 - 84
75 - 79
70 - 74
65 - 69
60 - 64
55 - 59
50 - 54
45 - 49
40 - 44
35 - 39
30 - 34
25 - 29
20 - 24
15 - 19
10 - 14
5-9
0-4
B
B
B
A
A
A
4
People over SPA to those aged 20 – SPA*
0.6
With SPA fixed
at 65
0.5
0.4
With SPA rising
proportionally (to
68.5 in 2050 and
70.2 in 2070)1
0.3
0.2
0.1
0
2006
2020
2030
2040
2050
2060
2070
* SPA: State Pension Age
(1) This proportionate adjustment maintains the proportion of life over 20 years old which is spent in retirement at 27.5%
5
Lower fertility – The inherent challenge to pension
systems
PAYG
Increased ratio of pensioners
to contributors
Lower pensions relative
to average earnings
Higher contribution rates
Increase Pension Age more
than proportionally with life
expectancy
Funded
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
* Smaller can mean either absolutely smaller than G1 (if fertility  2.0) or “smaller than would be the case if fertility had not
fallen”
6
Possible de facto demographic effects on funded
systems and capital markets
Lower
Fertility
Transitional asset price fall
effect (at sale)
Inherent effect of
shift to lower fertility
K/L rises: return on capital falls
Increased
Longevity
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
7
Demographic impacts on returns to capital
Model Results
•
Garry Young:
Baby-boom generation
Increased longevity
Falling fertility
•
David Miles:
Given future actual trends in UK
demographics, returns fall:
-0.1%
-0.1%
-0.3%
 4.56% (1990) to 4.22% (2030)
 4.56% (1990) to 3.97% (2060) if PAYG
phased out
8
Real S&P500 price index and % of 40-64 year olds
among total U.S population 1950-2003
34
1800
33
1600
32
1400
31
1200
30
1000
29
800
28
600
27
400
26
200
25
0
24
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Real S&P500 (LHS)
Percentage of 40-64 Population
Real S&P500 Price Index
Forecast
2000
40-64 population/ total population (RHS)
Source:: Poterba (2004), with additional data to 2006
9
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”
10
Global glut of savings hypothesis
In China and other East Asian
countries
• Fewer children enable
higher savings rate
• Awareness of greater
longevity, fewer children and
lack of social welfare net,
require a high savings rate
Developed countries save more
to cope with their
demographic/pension
challenges
Global glut of
savings relative to
investment
Long-term, not
just cyclical, fall in
real interest rates
Transitional
positive asset
price effects
11
01/01/2005
01/01/2004
01/01/2003
01/01/2002
01/01/2001
01/01/2000
01/01/1999
01/01/1998
01/01/1997
01/01/1996
01/01/1995
01/01/1994
01/01/1993
01/01/1992
01/01/1991
01/01/1990
01/01/1989
01/01/1988
01/01/1987
01/01/1986
Percent
Real yields to maturity on UK index-linked gilts
1986 – 2004
5
4.5
4
3.5
3
2.5
2
2.5 Year
5 Year
10 Year
20 Year
1.5
1
0.5
0
12
UK Long-term real interest rates
11%
Real interest rate
9%
Long-term average (1700-2004)
7%
Estimate for 2005
5%
3%
1%
-1%
-3%
-5%
Estimate for
2005, as of 02
March 2005
-7%
1700 1716 1732 1748 1764 1780 1796 1812 1828 1844 1860 1876 1892 1908 1924 1940 1956 1972 1988 2004
Source: Morgan Stanley Research
13
Whole world gross savings rate
1981 - 2005
25
20
15
1981
1986
1991
1996
2001
2006
Source: IMF World Economic Outlook database
14
Gross savings rates: developing Asia and the US
% of GDP
1981 - 2005
40
35
Developing
Asia
30
25
20
15
USA
10
5
1981
1985
1989
1993
1997
2001
2005
Source: IMF World Economic Outlook database
15
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
16
Profit share of GDP – U.S.
% of GDP
1970 - 2004
35
30
25
20
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
17
So why are real interest rates historically low?
• Not Rise in the global supply of capital relative to
labour
• But Particular asset allocation preference of
major national savers
18
Demographic challenges to funded pension
systems
•
Increasing longevity
Not inherent problem but
possible de facto
•
Lower fertility
Overwhelmed in shortterm by globalisation
effect
•
Uncertainty of longevity
forecasts
19
Estimates of cohort life expectancy: Male at 65
UK Government Actuary’s principal projections
Cohort life expectancy at 65
30
25
20
15
10
1950
1960
1970
1980
1990
2000
2010
2020
2030
Historical
Principal Projection
1983-based Projection
1992-based Projection
2040
2050
(2003)
20
Mortality rate declines & UK G.A. principal 2003
projection
Cohort life expectancy at 65
40
35
30
25
20
15
10
1980
1990
2000
2010
2020
2030
1% pa Mortality Decline
2% pa Mortality Decline
3% pa Mortality Decline
Principal Projection
2040
2050
Historical
21
Male cohort life expectancy at 65
Uncertainty in 2003 forecasts if already apparent 1983 errors/changes are the maximum
possible and if error potential is symmetrical
Cohort life expectancy at 65
30
25
20
15
10
1980
1990
2000
2010
2020
2030
Historical
Possible Maximum
Possible Minimum
GAD Principal Projection
2040
2050
22
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?
23
Male cohort life expectancy at 65: range of possible
uncertainty around 2004 - based principal projection
30
Years
25
20
15
10
1980
1990
2000
2010
2020
2030
2040
Historical
GAD Principal 2003-based
Upper 90% bound?
Lower 90% bound?
2050
GAD Principal 2004-based
Source: Government Actuaries Department (GAD) and Pensions Commission estimates, UK
24
Longevity risk in UK pension provision
£bn of total liabilities – broad estimates at April 2005
Insurance Companies
Annuities
80
Pension Funds
800
Unfunded Public
Employee Pensions
450*
Legal liabilities or
close to legal
liabilities
State Pensions
•
Basic
870
•
Earnings-related
260
Total
Political promises
Can theoretically be
changed
2460
* Latest figures (2006) suggest unfunded public employee liabilities now about £550bn
25
Longevity risk in UK pension provision
£bn of total liabilities – broad estimates at April 2005
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
26
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
annuities if private savings rise.
demand for post-retirement
27
Possible long-term annuity or longevity bonds
stock?
Present Stock £bn
Overt Annuities
(Life Companies)
Post
Retirement
Pre
Retirement
70
10
Annuity Promises
(DB Pension Fund)
400?
400?
Total
470
Required stock to
replicate annuity
promises given by
final salary schemes
410
Required to
manage legacy
DB promises
28
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.
29
The search for yield uplift
•
Hedge funds: alpha without beta
•
Complex yield enhancing strategies: credit derivatives
•
Infrastructure finance
30
Conclusions
Macro-Effects
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
Pension Fund
Management Effects
Decreasing willingness of corporates /
governments to absorb longevity risk
 Increased demand for liability matching
assets
 Increased demand for yield enhancement
at low (?) risk
31