Pension Products Research Articles

The PEPP Regulation (PEPPR): Pepper for the Capital Markets Union?

On June 20 th, 2019, Regulation (EU) 2019/1238 of the European Parliament and of the Council on the subject of a pan-European Personal Pension Product was adopted (hereinafter referred to as “PEPPR”). The object of the PEPPR is to lay down uniform rules on the registration, manufacturing, distribution, and supervision of personal pension products distributed in the European Union under the header of PEPP. This article will concentrate on how the PEPPR presents an added value for both PEPP savers and providers. Therefore, we explore the following: the legislative history and the reasons of the PEPPR, the definition of a PEPP, and its savers and providers. Furthermore, attention will be drawn to the investment options and the matter of consumer protection as well as the so-called “fee cap of 1 %.

Yield curve shapes of Vasicek interest rate models, measure transformations and an application for the simulation of pension products

We consider two aspects of Vasicek interest rate models arising from chance-risk classification of German pension products. First, we show that the two-factor Vasicek model can explain significantly more effects that are observed at the market than its one-factor variant. Among them are humped shapes independent of the interest rate level and the occurrence of dipped yield curves. We further introduce a general change of measure framework for the Monte Carlo simulation of the Vasicek model under a subjective measure. In chance-risk classification it can then be used to avoid the occurrence of a far too high frequency of inverse yield curves with growing time.

The EU’s Regulatory Commitment to a European Harmonized Pension Product (PEPP): The Portability of Pension Rights vis-à-vis the Free Movement of Capital

Abstract European demographic structure and age composition are currently in a state of flux—life expectancy has increased, fertility rates have dropped, and baby-boomers have reached retirement age. The implications of these changes, coupled with the fragmented market for personal pension products throughout the EU are vast and call for close scrutiny of the relationship between financial and pension markets. This article examines the current regulatory efforts aimed at creating a Pan-European Personal Pension Product (PEPP). In doing so, it pursues two primary objectives: firstly, it seeks to explain the relevance of a European harmonized pension product to the overall concept of the single market; and secondly, it aims to explore the looming regulatory challenges stemming from the portability of social and pension rights. This is done by elaborating upon established law and economics scholarship on capital markets, including the Legal Theory of Finance developed by Katharina Pistor. By assessing the costs faced by prospective pensioners against the benefits of legislative harmonization (and other policy-related alternatives), from both a normative perspective as well as a positive one, this article attempts to make a case for an effective and sustainable governance response. The article ultimately seeks to provide a well-balanced, albeit modern outlook to the regulatory endeavours that have more recently been made applicable to the EU personal pension market in virtue of the creation of the PEPP and the wide-ranging effects of such reforms on law, finance, and society.

Forecasting benchmarks of long-term stock returns via machine learning

Recent advances in pension product development seem to favour alternatives to the risk free asset often used in the financial theory as a performance standard for measuring the value generated by an investment or a reference point for determining the value of a financial instrument. To this end, in this paper, we apply the simplest machine learning technique, namely, a fully nonparametric smoother with the covariates and the smoothing parameter chosen by cross-validation to forecast stock returns in excess of different benchmarks, including the short-term interest rate, long-term interest rate, earnings-by-price ratio, and the inflation. We find that, net-of-inflation, the combined earnings-by-price and long-short rate spread form our best-performing two-dimensional set of predictors for future annual stock returns. This is a crucial conclusion for actuarial applications that aim to provide real-income forecasts for pensioners.

Model Risk, Mortality Heterogeneity and Implications for Solvency and Tail Risk

Mortality models used to assess longevity risk and retirement funding have been extended to stochastic models with trends and systematic risk. Systematic risk cannot be readily diversified in an insurance pool or pension fund. It is an important factor in assessing solvency and highlighting the tail risk in longevity insurance and pension products. Idiosyncratic risk can be diversified in typical pool sizes, although less effectively at the older ages. Mortality heterogeneity is not usually taken into account in stochastic mortality models. This is a mortality risk that reduces the effectiveness of idiosyncratic mortality risk pooling. Heterogeneity has been modelled with frailty models and more recently with Markov multiple state ageing models. This paper overviews recent developments in models for mortality heterogeneity and uses a model calibrated to both population mortality and health condition data to consider the impact of model risk and heterogeneity in assessing solvency and tail risk for longevity risk products.

Pension schemes versus real estate

The demographic, economic and social changes that have characterized the last decades, and the dramatic financial crisis that has taken place since 2008, have led to a demand for structural changes in the pension sector and a growing interest in individual pension products. Hence the need, for most elderly people, to liquidate their fixed assets, which are usually the homes in which they live. This highlights products such as reverse mortgages and domestic reversibility plans. Within this context, we propose a contractual scheme where an immediate life annuity is obtained by paying a single-premium in the form of real estate rights (RERs), for example by transferring to an insurer the property title of a house or a similar realty, while keeping its usufruct or a restricted bundle of rights. The level of the installments depends on the fair value of the transferred RER at the contract’s issue, the life expectancy of the insured and the expected growth rate of the real estate market value. The contract design is developed by considering the control of the financial risk inherent in the contract itself, because of the prospective changes in the value of the RERs, and the level of the insurer’s leverage. Finally, we provide some numerical evidence of the proposed contractual structure, in order to compare the level of the installments according to the house return forecasts in different European countries.

Modern tontine with bequest: Innovation in pooled annuity products

We introduce a new pension product that offers retirees the opportunity for a lifelong income and a bequest for their estate. Based on a tontine mechanism, the product divides pension savings between a tontine account and a bequest account. The tontine account is given up to a tontine pool upon death while the bequest account value is paid to the retiree’s estate. The values of these two accounts are continuously re-balanced to the same proportion, which is the key feature of our new product.Our main research question about the new product is what proportion of pension savings should a retiree allocate to the tontine account. Under a power utility function, we show that more risk averse retirees allocate a fairly stable proportion of their pension savings to the tontine account, regardless of the strength of their bequest motive. The proportion declines as the retiree becomes less risk averse for a while. However, for the least risk averse retirees, a high proportion of their pension savings is optimally allocated to the tontine account. This surprising result is explained by the least risk averse retirees seeking the potentially high value of the bequest account at very old ages.

Supporting decision-making in retirement planning: Do diagrams on Pension Benefit Statements help?

AbstractThis paper investigates whether exposure to explanatory diagrams can affect a major financial decision. In a controlled experiment, participants were given Pension Benefit Statements with or without one or two diagrams, before answering incentivised questions that measured recall, comprehension and choice of contribution rate. The diagrams had at best a marginal influence on recall or comprehension. Nevertheless, a diagram relating contributions to income projections prompted more participants to advocate higher contributions, while both diagrams influenced the rationale participants gave for decisions. The implication is that although pension products remain hard to understand, diagrams may alter decisions by reinforcing relevant causal thinking.

EU Pension policy and financialisation: purpose without power?

ABSTRACTThis article asks whether the EU’s pension policy promotes and achieves financialisation of old age security. Financialisation in this context means financial market integration that, in conjunction with pension reforms in member states, creates a market-based mode of governance for old age security. After an overview of how significant private pension funds have become in the EU, the article takes a most-likely case study of financialisation, the Pan-European Pension Product (PEPP), to see how successful the EU’s pension policy proved to be in establishing the PEPP. The findings suggest that EU policymaking in pensions tries to instrumentalise financial market integration for pension provision but this does not necessarily lead to financialisation of old age security. Market integration is a multi-faceted process of creating, emulating and correcting markets that obstructs a single-minded policy thrust like financialisation.

Implications of Money-Back Guarantees for Individual Retirement Accounts: Protection Then and Now

Capital market volatility spurs interest in protecting retirement accounts; one such approach is to require money-back guarantees. Using a lifecycle model where investors have access to stocks, bonds, and tax-qualified retirement accounts, we show that such guarantees alter participant consumption, saving, and investment behavior during times of high interest rates, but impacts are even larger in a low-return environment. We conclude that abandoning guarantees could enhance old-age consumption for over 80% of retirees, particularly lower earners, without harming pre-retirement consumption. Our results are of interest for default investment options in individual retirement accounts such as the Pan-European Personal Pension Products. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

THE RATING OF THE DEVELOPMENT OF NON-STATE PENSION FUNDS IN UKRAINE

Introduction. Rating of private pension funds (PPFs) is an instrument that provides a comprehensive understanding of the results of the activity of funds. Ratings are an important component in business information that contributes to maintaining trust in PPF activities. That's why research into fund rating issues is an actual area of research. The purpose. The purpose of the article is to deepen the scientific and methodical approach to rating PPFs by using the radar method to calculate the integral development index of the PPF and on this basis the allocation of funds-leaders, funds that follow the leaders and funds-outsiders. Results. The interpretation of the rating results becomes objective and accurate in choosing the system of indicators that were used as the basis for the calculation of the rating, the qualitative information base, and the use of sound methodology for calculating the integrative indicator. This approach, in general, allows you to rank the PPF according to the levels of development. Scientific interest is characterized by one of the methods of benchmarking used in economic research – this is a radar method. The advantages of the radar method for rating the development of PPFs are determined. We propose to calculate the integral indicator of NPF development on the basis of quantitative indicators of development, such as net asset value, number of participants, pension contributions, pension payments, income from investing PPF assets,calculated by the expanded result since the beginning of PPF functioning. The results of the analysis of NPF development indicators in Ukraine make it possible to distinguish two main strategies for the development of funds: firstly, a strategy focused on attracting as many participants as possible; and secondly, a strategy focused on obtaining higher investment income. Conclusions. In the article, the methodical approach to the rating of PPFs in the application of the radar calculation method of the integral development index of PPFs is improved. A comparison of the radars of some domestic PPFs with reference radar for the development of funds allowed the distribution of functioning PPFs into three groups: founding foundations, follow-up funds and outsiders funds. The main strategies for the development of PPFs following the leaders were determined. The results of the PPF rating indicated that most of the funds in Ukraine have low development indicators. It actualizes the task of activating the development of domestic PPFs, in particular, in the areas of differentiation of pension products to increase the interest of citizens in participating in funds, and the development of new financial instruments to improve the results of investment activities of the PPF.

Supplementary pension schemes: needs, possibilities and problems with evaluation from the perspective of an individual saver

The purpose of this article is to identify the scope of information (both qualitative and quantitative) relating to pension products, necessary to evaluate their operation by individual saver and subsequently to compare this scope with the information provided to customers by financial institutions. The research relies on an analysis of available literature, documents and reports of pension institutions as well as the legal acts which govern the pension scheme and the financial market. The analysis of the situation in Poland led to the identification, in the final part of the report, of possible future changes in the information policies and of restraints, which follow from the nature of the products offered and the level of complexity of the supplementary schemes.

Dynamic hybrid products with guarantees—An optimal portfolio framework

Dynamic hybrid products are pension products that consist of a dynamic combination of classical with profits participating life insurance contracts (or a bank account) and fund savings plans. To put such products in an optimal utility framework, we derive an optimal combination of a money market account, a CPPI-style fund and a free fund in continuous trading via transforming the original investment problem into a conventional portfolio problem in the presence of a guarantee condition. By this, we obtain (semi-) explicit forms of the dynamic weights for the different ingredients of a dynamic hybrid product.

Communication and personal selection of pension saver’s financial risk

The paper shows how to reform the platform of pension products so that pension savers, professional financial advisors, actuaries and investment experts intuitively understand the underlying financial risk of the optimal investment profile. It is also pointed out that an excellent optimal investment strategy can destroy the future expected utility of a pension saver if the financial communication is wrong. It is shown that a simple system with an upper and a lower bound, originally inspired by Merton (2014), which can be executed easily using fintech, can replace complicated power utility optimization for the pension saver so that everyone can exactly understand the amount of financial risk taken. The paper focuses on investing money as a lump sum because being able to communicate the associated financial risk can serve as the first step towards communicating more complex pension saving structures.

Pan-European Personal Pension Products – Will the Proposed European Tax Recommendation Work?

This article discusses the effectiveness of the PEPP Tax Recommendation and the accompanying PEPP “portability service”. It provides an overview of certain anticipated problems in relation to the future taxation of PEPPs in Europe that led to this initiative, followed by an analysis of the effectiveness of the Recommendation and PEPP “portability service” in eradicating such problems. Finally, it reviews options for an alternative EU-wide PEPP tax regime.

Does an Attractive Pension Product Design Sell by Itself? The Experience of the Czech Republic.

This paper deals with the experience of third pillar reform in the Czech Republic, executed in 2013. The core of our study is formed by a comparative analysis of newly introduced supplementary pension savings and its substitute products (investment funds, life insurance) from two main aspects: product features and distribution features. The outcomes are supported by empirical sales and population penetration of the surveyed products. The results indicate that even a pension product with a very attractive product design, such as supplementary pension savings, will be hampered by its substitutes as long as its distribution features are unattractive. This is an important lesson, particularly for the discussed European solution, the pan-European portable pension product (PEPP).

Can a Dutch IORP Offer a PEPP?

The PEPP is an EU pension product which is governed by EU law. It can serve as an addition to existing schemes and products. There is no EU law definition of pillars. In this working paper authors argue that a Dutch DC IORP (a Premium Pension Institution) can offer a PEPP in conformity with Dutch and EU law. No amendments to national law seem necessary and the system of mandatory participation in the Netherlands is not breached. This finding might be helpful in the ongoing discussion on the PEPP regulation for DC IORPs in other Member States (inter alia the SEPCAV in Luxembourg).

The Thatcher government and (de)regulation: modularisation of individual personal pensions

PurposeThe (de)regulation agenda of the Conservative government, led by Margaret Thatcher, elected in 1979 is an important change point that has attracted only limited attention from management and historical research scholars. Thus, how (de)regulation in this era influenced the evolution of product design remains ripe for exploration. The purpose of this paper is to examine the UK individual personal pensions product market between the mid-1980s and mid-1990s to examine the relationship between (de)regulation – an industry-level factor – and its impact on architectural choices of product design – a product-level factor.Design/methodology/approachA retrospective, oral history research design with 31 senior managers in product development firms with first-hand experience of the change period was adopted.FindingsFindings indicate that the (de)regulation reforms and the context of the financialisation of product markets came to define how products were then designed, evolving product design from non-modular to near-modular, a trajectory that arguably continues until the present day.Originality/valueThe main contribution lies in examining the role of (de)regulation and financialisation as modularisation processes. The increasing modularisation of individual personal pension product design between the mid-1980s and mid-1990s provides further support for the body of scholarly work on modularisation processes and their relationship with industry change.

Nudgen für die Rentenentscheidung im Vereinigten Königreich – Implikationen für die Privatisierung der Rentenpolitik

Zusammenfassung: In den letzten Jahrzehnten hat die Politik in Großbritannien durch verschiedene Reformen den Schwerpunkt der Altersvorsorge von der gesetzlichen Rente hin zu privater und betrieblicher Altersvorsorge verschoben. Im Gegenzug hat die Finanzkompetenz der Verbraucherinnen und Verbraucher sowie für Politiker und für Regulierungsbehörden an Relevanz gewonnen. Die experimentelle Überprüfung der Regulierung von Websiten, die Anlage- und Vorsorgeprodukte vergleichen sowie der Präsentation und Gestaltung von Produktinformationen durch Nudging entwickelt sich in Großbritannien gegenwärtig zu einem neuen Tätigkeitsfeld für Regulierungsbehörden. Wir haben für verschiedene britische Behörden experimentelle Studien zur individuellen Entscheidungsfindung von Verbraucherinnen und Verbrauchern auf dem Markt für Rentenprodukte durchgeführt. Wir nutzten für unsere Studien informationelle Nudges. Ein wesentliches Ergebnis, das wir aus diesen Studien gewinnen konnten, ist, dass personalisierte, auf individuelle demografische Faktoren zugeschnittene Nudges effektiv zum Vergleich von Rentenprodukten anregen. Eine deutliche Beeinflussung der Rentenentscheidung durch die individuelle Finanzkompetenz konnten wir aber nicht feststellen. Summary: Over the last decades, politics in the UK has shifted away its focus from government-managed pensions to privatized pension solutions and services. In turn, financial literacy has become a critical issue for consumers, politicians and regulation agencies. The precise experimental examination of website regulation used to compare investment and pension products, as well as the design and presentation of product information through nudging become new fields of activity for regulatory agencies. We have undertaken a number of experimental projects on consumer decision making on pension product markets for U.K. authorities. These experiments used informational nudges. A key finding that we have gained from these studies is that personalized nudges tailored to individual demographic factors effectively encourage comparison of pension products. However, we were not able to determine a clear influence on the pension decision by the individual financial literacy.

Die Deutschlandrente: Wirksamkeit und Legitimität eines Nudges

Zusammenfassung: Der demografische Wandel wird die umlagefinanzierte gesetzliche Rentenversicherung in den kommenden Jahrzehnten stark belasten. Bisherige Rentenreformen zielten daher darauf ab, durch steuerliche Förderung die zusätzliche kapitalgedeckte Altersvorsorge zu stärken. Diese Möglichkeit wird aber bisher nur unzureichend in Anspruch genommen. Wir machen dafür vor allem zwei Ursachen verantwortlich. Zum einen ist gegenwärtig die private Altersvorsorge nach dem „Opt-In“-Prinzip organisiert. Nur derjenige sorgt zusätzlich vor, der sich aktiv dafür entscheidet. Zum anderen weisen viele private Rentenversicherungen hohe und vor allem intransparente Kosten auf. In der Folge halten sich viele Verbraucher bei der privaten Altersvorsorge zurück. Wir haben einen Vorschlag entwickelt, wie diese beiden Probleme gelöst werden können. Unser Modell der „Deutschlandrente“ sieht vor, bei der geförderten privaten Altersvorsorge vom „Opt-In“ zum „Opt-Out“ zu wechseln. Internationale Erfahrungen zeigen, dass ein solcher „Nudge“ zu einem deutlichen Anstieg der Ersparnisbildung führen kann. Um den Wettbewerb zu stärken, soll ein staatlich organisierter Rentenfonds eingeführt werden, der ein einfaches und kostengünstiges Vorsorgeprodukt anbietet und in fairem Wettbewerb zu privaten Anbietern steht. Die Kombination beider Maßnahmen kann die private Altersvorsorge effektiv und kostengünstig stärken. Summary: Demographic change is projected to impose a substantial burden on the public pay-as-you-go pension insurance in Germany in the next decades. Past pension reforms have thus aimed at encouraging additional private old-age provision in fully-funded pension insurances. A substantial share of the population, however, still has no or only insufficient private retirement savings. Two reasons are responsible. First, private pension provisions follow the „Opt-In“ principle. Only who actively decides to save will do so. Second, many private pension providers charge high and nontransparent fees. This keeps many consumers from saving more for their old age. We have developed a proposal that solves both problems. In our model “Deutschlandrente”, private old-age provision will be organized according to an opt-out- instead of „Opt-In“-principle. International experiences show that such a “nudge” would cause sizable increases in pension savings. To strengthen competition, a publicly organized pension fund will be introduced. This fund will offer a simple and inexpensive pension product and compete fairly with existing private providers. The combination of both measures can strengthen private old-age provision effectively and inexpensively.