Payout Phase Research Articles

A buy-hold-sell pension saving strategy

We propose a ‘buy, hold, sell’ (BHS) deterministic lifecycle strategy that involves buying and holding assets until they are sold to generate income. Savings are invested entirely into a risky portfolio until a pre-specified ‘switch age’ and then entirely into a risk-free portfolio after the switch age, followed by withdrawing during the payout phase from both portfolios based on annuitization factors that vary with age. We also allow for access to mortality credits through an insurance market. We analytically derive the dynamics of the investment strategy and show that the strategy is optimal for a range of investors with HARA risk preferences. We demonstrate numerically that the BHS strategy delivers limited loss of utility versus an optimal solution for investors with CRRA preferences and low-moderate levels of risk aversion while significantly outperforming deterministic strategies commonly seen in practice. The BHS strategy offers an attractive alternative for practical applications as it is straightforward to apply while avoiding the need for dynamic optimization and portfolio rebalancing.

Payout Phase of Defined Contribution Systems: the Case of Slovakia

The paper aims to assess various aspects concerning the payment phase of the old-age pension scheme, the socalled second pillar of the pension system in Slovakia. However, the conclusions may also be useful for other pension systems. Using the Lee-Carter model and standard actuarial methods, we conclude that the second pillar is advantageous for the high-income groups or in case of high performance of pension funds. We also address the issue of deferring the purchase of a lifetime annuity. Deferral can be beneficial when the yield of the pension fund exceeds a certain threshold value. This threshold usually raises with increasing age. We argue that the temporary pension is a disadvantageous product and its recent cancellation is correct. The main contribution of the paper subsists in a three-state model of long-term care insurance, using which we calculate corresponding replacement rates. Combined with a lifetime annuity, long-term care insurance can be beneficial.

Investing Pension Savings in Russia: Results and Lessons for the Future

A mandatory savings pillar was added to the Russian pension system in 2002, but by 2022 the Ministry of Finance terminated it and transformed it into voluntary pension savings. Because it was in effect for much less time than the typical life-cycle horizon, mandatory pension savings never had a chance to show its potential for increasing the pension benefits of future pensioners. The successful implementation of a mandatory savings pillar requires that general rules and regulation remain stable over at least a 40-year time horizon for the accumulation phase and a 20-year time horizon for the decumulation or payout phase. In addition to the brevity of its existence, the mandatory savings pillar also faced several other obstacles. The state prioritized the welfare of existing pensioners, and this bias eventually led to the introduction of more and more restrictions on the pension savings pillar and its coverage. Many problems arose in the administration of pension savings and in coordinating the actions of various government departments involved in its regulation. Low investment efficiency for pension savings, irrational asset allocation in non-state pension funds’ portfolios, and poor active management decisions were among other issues. Based on the problems outlined, the authors have formulated basic proposals for the future of the pension savings system

A Critical View on Pension Savings in Slovakia

In almost all countries around the world, pension systems are based on several pillars. This is also the case of Slovakia with its three-pillar pension system. The paper presents a case study underlying the risks that can seriously affect the amount of future pensions. The case study clearly indicates that current pensions in Slovakia paid under all three pillars do not correspond with the expectations from the implementation of the three-pillar pension system. The aim of the paper is to the risks that can seriously affect the amount of future pensions. Our own contribution is the determination of the amount of pension for a specific pensioner specified in the presented case study. Within the saving phase of pension contributions the development of investment fund returns, the amount of future pensioner´s contributions, as well as administrative costs are analyzed on a monthly basis. The payout phase is modelled using actuarial functions applying the mortality tables of Slovakia.

AUM-Based Compensation and Financial Advice

Usually financial advisers are paid primarily or entirely according to the value of the assets they manage—that is, the assets under management (AUM). Increasingly, they have a fiduciary duty and use AUM-based fees. This compensation model results in an incentive to maximize AUM, which is widely considered to be a desirable feature. This article examines a class of situations in which that incentive may cause a conflict of interest and lead to advice, or the lack of advice, that is not in the clients’ best interests. Advisers have an incentive to avoid recommending actions that would decrease their AUM. The Securities and Exchange Commission (SEC) relies on an outmoded economic model that views disclosure as an adequate remedy to conflicts of interest. However, the SEC does not require disclosure of the types of conflicts discussed here. This article examines alternative compensation models, such as by the hour. Recognizing that information and the ability to process it are scarce and valuable resources, a more efficient use of resources may be to provide specialization in financial literacy through advisers, rather than to expect widespread financial literacy, at least in some areas. Changing the way the SEC regulates financial advice could improve that approach. This article examines effects of the new SEC rules in those types of situations. Changes in the SEC regulatory approach are recommended. <b>TOPICS:</b>Long-term/retirement investing, pension funds, retirement, social security, wealth management <b>Key Findings</b> • Financial advisers’ AUM-based compensation may affect the advice they provide if it concerns the scope of assets they manage; for example, a failure to advise beneficial options that would result in reducing the adviser’s AUM. • The AUM-based model of adviser compensation may not result in the best advice concerning the payout phase. • It may be more efficient for financial literacy to be a specialized skill in some areas, such as pension investing, but clients who are not financially literate may not be able to evaluate whether they are receiving good advice.

The Chilean Electronic Market for Annuities (SCOMP): Reducing Information Asymmetries and Improving Competition

The Chilean electronic market for annuities was created in 2004 in order to correct several malfunctions of the market for annuities. The Chilean pension system is composed of two phases. During the accumulation phase, savings are collected and managed by asset managers. The payout phase consists of pension payments mainly in the form of annuities and programmed withdrawals (offered by life insurance companies and pension fund administrators, respectively). The SCOMP or Electronic Consultations and Offers System for Annuities and Phased Withdrawals replaced the traditional way pensioners looked for and bought retirement products in the Chilean market. This electronic quotation system was created to help reduce search costs, as well as to allow pensioners to choose the best available deals offered by providers. Overall, this paper finds that, after controlling for other regulatory changes and the main determinants of annuity rates, the new quotation system raised annuity payments by 15 per cent. The database used for the econometric analysis goes from January 2001 to June 2008, with the implementation of the SCOMP located at the middle of the sample, and considering all 131,226 annuity policies sold during this period. The exogenous variables explaining the level of the annuity rates are a combination of individual and provider characteristics, given that the estimated equation corresponds to a reduced-form representation of the underlying structural supply–demand model for annuities.

Personal pensions with risk sharing

AbstractTo improve the design of the pay-out phase of DC plans, this paper proposes a new approach to structure pension products: the Personal Pension with Risk sharing (PPR). By unbundling and valuing the investment, (dis)saving, insurance and risk-sharing functions of pensions, PPRs allow risk management and (dis)saving to be customized to the specific features of heterogeneous individuals. Unlike variable annuities, PPRs allow investment risks to be combined with longevity insurance without giving rise to high year-on-year volatility in consumption streams or opaque and rigid valuation and smoothing rules. The synthesis of a PPR structure provides new opportunities for product innovation and for the comparison of retirement products.

PENSION PAY-OUT OPTIONS FOR DEFINED CONTRIBUTORY SCHEME IN NIGERIA: PROGRAMMED WITHDRAWAL OR LIFE ANNUITY?

In this study, we evaluate the concept and elements of contributory pension scheme in Nigeria, both at the accumulation phase and the pay-out phase under the new Pension Reform Act 2014 and the repealed Pension Reform Act 2004. This study further examines the two basic forms of retirement pay-out options available to employees at retirement, that is, programmed withdrawal and life annuity. Two case studies of a medical service employee and a teaching service employee working for Lagos State Government were used as illustrative examples. The concept of income replacement ratio is then used under certain calculation assumptions to compare both cases. In our analysis, we consider withdrawal of 25% and 50% from the balance of the retiree’s Retirement Savings Account (RSA) as a lump sum payment at retirement. Despite the fact that programmed withdrawal is the most sought-after and common pay-out preference of employees at retirement in Nigeria, our analysis concluded that based on the comparison of the income replacement ratio, the life annuity is a better pay-out option than the programmed withdrawal. Our final result shows that the replacement ratio is highest for a teaching service employee who received a 25% lump sum withdrawal under the Pension Reform Act 2014. However, even the best case analysed in this study still did not meet the two-thirds income replacement ratio recommended by many researchers. The result of this study provides a better understanding for Nigerian retiree to choose between a programmed withdrawal and life annuity payment.

The determinants of annuitization: evidence from Sweden

Despite the fact that the increasing involvement of the private sector in pension provision has brought more flexibility to the pay-out phase of retirement, little is known about the characteristics of those who choose to annuitize their pension wealth and those who do not. I combine unique micro-data from a large Swedish occupational pension plan with rich national administrative data to study the choice between life annuities and fixed-term payouts with a minimum payout length of 5 years for 183,000 retiring white-collar workers. I find that low accumulation of assets is strongly associated with the choice of the 5-year payout. Consistent with individuals selecting payout length based on private information about their mortality prospects, individuals who choose the 5-year payout are in worse health, exhibit higher ex-post mortality rates and have shorter-lived parents than annuitants. Individuals also seem to respond to large, tax-induced changes in annuity prices.

Welfare implications of product choice regulation during the payout phase of funded pensions

AbstractIn many countries, governmental support for funded old-age programmes comes at the cost of at least partial mandatory annuitisation of accumulated assets in retirement. We survey regulatory frameworks for the payout phase of funded pension systems in seven European countries and the US and study the influence of mandatory annuitisation on the welfare of both rational and behaviourally influenced individuals using a dynamic life-cycle model. We show that mandatory immediate full annuitisation of retirement assets will reduce rational individuals’ certainty equivalent pension wealth by up to 54%. Softening the strict immediate annuitisation requirements along the line of regulatory realities in some of the surveyed countries reduces utility losses considerably. Behaviourally restricted individuals can benefit from full annuitisation at retirement, but generally they will also prefer more flexible regulation.

A comparison of three different pension savings products with special emphasis on the payout phase

AbstractThe purpose of this article is to illustrate how the pension benefits a pension saver will (expect to) receive will depend on the type of pension scheme chosen. We compare three widely different pension savings products: the “traditional” with-profits scheme involving bonus entitlement (average interest rate product), a market-based Unit Link scheme and, finally, a formula based smoothed investment-linked annuity scheme – TimePension in short – which is on many points a cross between the two prior-mentioned types of savings products.The three product types mentioned above have been analysed in previous literature, but those comparisons were based almost entirely on the values of pension savings accounts at the expiry of the accumulation period. This article will include the payout phase (decumulation phase) in the analysis, enabling us to analyse the size of paid-out pension benefits themselves as well as the possibilities of adjusting these benefits periodically. Compared to earlier articles, we have also improved the underlying model for the uncertainty of the underlying financial market.The article demonstrates that expected pension benefits from the three schemes are an increasing function of the allocation to shares in the underlying investment portfolios. TimePension involves the highest allocation to shares and therefore offers, on average, the highest pension benefits, followed by the Unit Link scheme. In the third and last place comes the traditional with-profits scheme, which has a relatively low allocation to shares, but which, in return, also provides relatively safe and stable pension benefits. We also show, however, that the stability of pension benefits from a TimePension scheme is completely level with the stability of benefits from the traditional scheme. Unit Link-based pension benefits, on the other hand, vary far more, and pension savers in this product segment will experience much higher annual adjustments – in a both negative and positive direction – than savers in the other product segments.

European pension reform: A way forward

This article discusses the main challenges facing earnings-related pension systems in Europe and explores the roles of the financial sector, employers, national governments and the EU in addressing these challenges. The internal market and a deeper European capital market can help create a richer set of building blocks to build greater retirement security for European citizens. Governments should facilitate intergenerational risk sharing by issuing wage-indexed and longevity bonds. The financial sector must provide better retirement products. In particular, during the accumulation phase, interest rate and inflation risks should be managed with the pay-out phase already in mind. During the pay-out phase, annuity, health and care insurance should be optimized, using various securities supplied by governments. Employers can provide a valuable platform for transforming human capital in financial capital during the accumulation phase. They can also help to treasure the human capital of workers and to reinvent the retirement process.

Payouts in Switzerland: Explaining Developments in Annuitization

Switzerland is one of the few countries with long-term experience on withdrawal decisions made by retirees in fully-funded pension plans. Switzerland is also atypical in its unusually high annuitization rates, and indeed, a majority of retirees covered by mandatory occupational pension plans chooses an annuity at retirement. This chapter revisits the historical role of occupational pension plans in the provision of old age income, and examines the role of regulation in the payout phase. Recent developments in both market conditions and regulations are used to assess the impact of certain determinants of the annuitization decision, such as money’s worth ratios, means-tested benefits and behavioral factors.

Assessing Default Investment Strategies in Defined Contribution Pension Plans

This paper assesses the relative performance of different investment strategies for different structures of the payout phase. In particular, it looks at whether the specific glide-path of life-cycle investment strategies and the introduction of dynamic features in the design of default investment strategies affect significantly retirement income outcomes. The analysis concludes that there is no “one-size-fits-all” default investment option. Life-cycle and dynamic investment strategies deliver comparable replacement rates adjusted by risk. However, life-cycle strategies that maintain a constant exposure to equities during most of the accumulation period, switching swiftly to bonds in the last decade before retirement, seem to produce better results and are easier to explain. Dynamic management strategies can provide somewhat higher replacement rates for a given level of risk than the more deterministic strategies, at least in the case of pay-outs in the form of variable withdrawals. The length of the contribution period also affects the ranking of the different investment strategies with life-cycle strategies having a stronger positive impact the shorter is the contribution period.

Private pensions and the financial crisis

The current economic and financial crisis has shaken confidence in funded pension systems in general and in defined contribution (DC) pension plans in particular. The crisis has highlighted the impact of market conditions on retirement savings accumulated in DC pension plans and the uncertainty as to whether those retirement savings may prove adequate to finance retirement – particularly for those close to retirement. The purpose of this paper is to provide recommendations on how to ensure adequate retirement income from DC pension plans. In this context, this paper addresses three main questions: 1) How much do people need to save? 2) How can the effects of market risk on DC pension plans be alleviated? 3) How can retirement income be protected during the payout phase? The analysis concludes that in order to deliver adequate retirement income from DC pension plans with a certain degree of certainty, there is a need for comprehensive measures which include: higher contributions; increasing the contribution period by postponing retirement; setting as default options relatively conservative investment policies including life-cycle strategies; and managing risk in the payout phase with inflationindexed life annuities.

Retirement saving and the payout phase

In the wake of a dramatic financial crisis and with the first waves of baby boomers approaching retirement we hardly need to think about how best to arrive at the pension funds&apos; payout phase. This paper argues that there is an urgent need to raise retirement saving, to reduce defined contribution plan members&apos; exposure to investment risks and to provide the financial industry with cheap and safe payout instruments. These challenges are also likely to call for a more active government role.

Ageing and the Payout Phase of Pensions, Annuities and Financial Markets

This paper reviews the impact of aging on private pensions, in particular on the payout phase, assesses the part that annuities can play in financing retirement, and examines the role of financial markets in facilitating the allocation on assets accumulated in defined contribution pension plans. A comprehensive set of recommendations for discussion is provided at the end of the paper.

Ageing and the payout phase of pensions, annuities and financial markets

This paper reviews the impact of ageing on private pensions, in particular on the payout phase, assesses the part that annuities can play in financing retirement, and examines the role of financial markets in facilitating the allocation on assets accumulated in defined contribution pension plans. A comprehensive set of recommendations for discussion is provided at the end of the paper. Le vieillissement de la population et la phase de versement des pensions, rentes viageres et marches financiers Ce document examine l’impact du vieillissement de la population sur les pensions privees, specialement sur la phase de versement des pensions, evalue le role que les rentes viageres peuvent jouer pour financier la retraite, et examine le role de les marches financiers pour faciliter l’allocation des actifs accumules dans les plans de retraite a cotisations definies. Un ensemble de recommandations pour discussion est fourni a la fin du document.

Transparency and Competition in the Choice of Pension Products: The Chilean and UK Experience

The growing importance of defined contribution (DC) pension plans is focusing attention on the decumulation or payout phase of pension systems. Where annuitization is encouraged or mandatory, how to ensure that individuals get the best price for annuity products is key. The complicated nature of these decisions means that purchases are highly dependent on the information and advice provided by the sellers of these products. This can be a problem where annuity providers are already involved in the preretirement, accumulation phase, leaving individuals open to abuse if ‘locked-in’ and not able to ‘shop around’ to find a better annuity rate from alternative providers. This paper discusses two countries building centralized information and quotation systems for annuity products to help individuals select the right retirement product at the right price. The SCOMP system in Chile is examined and developments around the Open Market Option (OMO) in the UK are discussed, with lessons drawn for other pension supervisory authorities contemplating introducing such centralized systems.

Policy Options for the Payout Phase

This paper assesses how countries‘ pension arrangements and regulation shape the appropriate structure and flexibility of retirement payout options. The paper aims at providing a guide to policy makers on how to address the diverse questions posed when designing the payout phase or promoting DC pension arrangements, as well as encouraging a market for annuities. The paper addresses questions concerning the type of retirement payout options for accumulated assets in DC plans a country should allow, which entities should provide annuities, and the type of annuity products that could be allowed. The main recommendation is for policy makers to consider mandating deferred life annuities that start paying at very old ages (e.g. at age 85) and allow for the remaining assets accumulated in DC accounts to be allocated as programmed withdrawals (preferably with flexibility to face contingencies). Options s'offrant aux pouvoirs publics pour la phase de versement des pensions Ce document examine comment les dispositions et reglementations prises par les pays en matiere de pensions influent sur la structure et la flexibilite des options qui s‘offrent en phase de versement, une fois la retraite venue. Il vise a servir de guide pour les responsables publics en leur montrant comment aborder les diverses questions qui se posent au moment de fixer les modalites de la phase de versement, ou pour promouvoir des dispositifs de pension a cotisations definies, et aussi encourager un marche de rentes. Le document examine les options qui peuvent s‘envisager en phase de versement des avoirs accumules sur les plans a cotisations definies, quelles entites devraient etre habilitees a servir des rentes et le type de produits de rente qui peut etre autorise. La principale recommandation a l‘intention des responsables publics est d‘imposer des rentes viageres differees qui ne commenceront d‘etre servies qu‘a un âge tres avance (par exemple a partir de 85 ans) et de prevoir que le solde des actifs accumules sur les comptes a cotisations definies pourra etre percu sous la forme de retraits programmes (de preference avec une marge de flexibilite pour faire face a des imprevus).