Personal Pension Research Articles

Variable Annuities and the Option to Seek Risk - Why Should You Diversify?

We analyze the impacts of an additional rider which is incorporated in recent retirement planning products. The payoff of these products is linked to the performance of a multi asset investment strategy and includes a minimum interest rate guarantee on the contributions.In addition, the buyer receives the option to decide on the investments dynamically. Prominent examples are so called variable annuities, in particular guaranteed minimum accumulation benefits (GMABs). Due to the embedded guarantee, these products are interesting for risk averse investors who, in general, benefit from diversification. However, to stay on the safe side the price setting of the provider must take into account the most risky strategy.This implies that the investor mitigates optimally between the diversification and the worst case strategy. We analyze the distortion and utility effects caused by the additional rider in the presence of background risk and borrowing constraints. A simulation analysis sheds light on the question if the additional rider is worth its costs. We take account of the utility gained by the possibility to adapt to individual preferences and changing personal pension situations. In particular, we illustrate to what extent these gains can compensate the utility loss caused by the upper price setting due to the worst case strategy.

Individual home bias, portfolio churning and performance

This study investigates economic consequences of individual investors’ home bias and portfolio churning in their personal pension accounts. The empirical analysis is carried out within a Heckman style two-stage framework to account for selection bias with respect to individuals’ investment activity, and to allow for an endogenously determined home bias, portfolio churning and performance. Results indicate that home bias induces a worse risk-adjusted performance. Home-biased individuals’ relatively bad performance originates in insufficient risk-reduction, due to a lack of international diversification. A higher degree of portfolio churning also deteriorates performance, despite the fact that churning is not associated with any direct transaction costs. However, home-biased individuals do not churn portfolios as often as individuals with a larger share of international asset holdings, which diminishes the negative effects of home bias on performance. Overconfidence is driven by a return-chasing behavior, where overconfident individuals favor international assets with high historical returns. Individuals with actual skill are more often men than women, are not tempted by high historical returns, and use international assets for the right reason – diversification.

The National Pensions Savings Scheme

The National Pensions Savings Scheme (NPSS) provides a supplementary personal pension for all employees who choose not to opt out. If they do not opt out, their employer is obligated to pay a contribution. The article considers the employment effect of the increase in labour costs implied by the NPSS. It shows how this employment effect is likely to be greatest for small firms since few of them have any supplementary pensions of the quality that is required.The negative employment effect will be reduced to the extent that there is non-compliance or opt-out, but if this occurs, the purpose of extending pension coverage to employees on lower earnings will be defeated.

Coverage in Funded Pensions

This paper presents comparable and standardized data on coverage in voluntary funded pension plans for several OECD countries using household survey data by age, income level, and labor market status for occupational and personal pension plans. The analysis suggests that coverage is unevenly distributed across individuals and there is therefore a need to increase it, at least among the young and the mid-to-low income. The paper ends assessing different policies to increase coverage.

Paying for Pensions An International Comparison of Administrative Charges in Funded Retirement-Income Systems

High charges for personal pensions were one factor in the personal pensions mis-selling debacle in the United Kingdom. They continued to arouse concern among politicians and commentators. The Labour government, with its new flagship ‘stakeholder’ pension, chose to regulate both the structure of charges and their level. This paper assesses the international experience of charges in funded retirement-income systems, drawing on evidence from fourteen countries with very diverse policies. Measuring the price of financial services is more difficult than comparing the cost of other goods or services. Providers can levy many different kinds of charges. These can include one-off and ongoing charges; proportional and fixed-rate fees; some based on contributions, some on the value of assets in the fund and some on investment returns. These different charges accumulate and interact in Complicated ways over the membership of a pension plan. The most familiar summary measure of charges is the ‘reduction in yield’. This adds together all the charges over the lifetime of an example pension policy and expresses them as a percentage of assets. Measuring charges as a proportion of contributions is the alternative. This turns out to be the same as calculating lifetime charges as a proportion of the balance accumulated at retirement. This second measure is known as the ‘reduction in premium’ or the charge ratio. The fourteen countries surveyed (Section 2) adopt very different approaches. At one end of the spectrum, Australia and the United Kingdom (with personal pensions) have completely liberal policies on charge levels and structures, but require providers to set out the effect of charges in a standard format. Most Latin American countries, including Argentina and Chile, restrict the charge structure: in these cases, allowing a fixed fee plus a charge as a proportion of contributions. Poland, too, limits the types of fee that can be levied, but also limits funds to charging 0.6 per cent of assets, while other charges are uncapped. Sweden, Kazakhstan and the United Kingdom (with stakeholder pensions) restrict both the charge structure and the charge level. In the last two, there is a fixed ceiling while Sweden varies the cap using a complex formula based on the amount that providers charge to manage voluntary savings. Finally, Bolivia auctioned the rights to manage its mandatory pension fund assets to international fund managers. The empirical evidence from these countries charge levels. In countries with systems based on individual accounts and individual choice among competing pension providers, average charges vary from under 15 to above 30 per cent. The paper assesses the options and the arguments for ontrolling charges. Measures to increase transparency comprise requirements for providers to disclose the level of charges, public provision of information in charge ‘league tables’ and allowing charges to be levied on top of rather than out of mandatory pension contributions. If governments choose to restrict charge structures, to facilitate comparisons between different providers, the most important policy choice is between contribution-based levies and asset-based fees. Latin American countries have tended to opt for the former, the United Kingdom has chosen the latter for stakeholder pensions. The main issues in this choice are the time profile of providers’ revenues, fund managers’ incentives to maximise returns and the incidence of the charges on different providers. Restricting charge levels raises some important concerns, particularly about governments’ ability to choose the ‘right’ level for the ceiling and the trade-offs in terms of restricting competition and individual choice of fund. Many of these policies to limit charges are aimed particularly at protecting low-income workers. But some countries have adopted alternative policies: for example, excluding low-income workers from the requirement to contribute and protecting them with safety-net pensions in old-age or cross-subsidising low-income workers directly with a minimum contribution from the government. Some commentators have suggested alternative institutional structures for managing funded pension assets to reduce costs. However, empirical evidence shows that publicly managed pension funds have generated poor returns. Also, the evidence on economies of scale in fund management suggests that the minimum efficient scale is relatively small and does not imply the presence of efficiency gains from a monopoly in managing funded pensions except in small economies. Again, there are important trade-offs in these policies, including corporate governance problems and the restriction of competition and individual choice.

Examining the Interaction between Saving and Contributions to Personal Pension Plans: Evidence from the BHPS*

AbstractThis paper analyses the effects of social security reforms on saving in Britain. We use the British Household Panel Survey to investigate the interactions between voluntary additional contributions to personal pension plans (PPP) and saving in conventional forms. In particular, we test whether contributions to the PPP crowd out saving or constitute additional saving. Results suggest that not only have private pension schemes not crowded out private saving, but actually they have increased it too.

The ‘new’ paternalism, consultation and consent: Expectations of UK participants in defined contribution and self-directed retirement savings schemes

Concern about the competence of individual decision-makers has prompted governments and pension plan sponsors to take advantage of the insights gleaned from the behavioural revolution. Auto-enrolment, target-date and related investment strategies may effectively counter behavioural biases such as inertia and the lack of attention paid to financial planning. Nonetheless, some participants may expect consultation when plan sponsors and management implement ‘default’ strategies and the like. Here, we assess the expectations of plan participants drawn from a national representative sample of UK residents who participate in defined contribution and personal pension schemes. It is found that respondents who expressed an interest in a high degree of consultation for the pathway to retirement were older, have higher incomes and recognised the significance of retirement saving schemes for their long-term welfare. A significant number of respondents would not or could not offer an opinion on the desirability of consultation. These respondents can be characterised as discouraged or disenchanted or disaffected, and socio-economic variables were not good predictors of these respondents' opinions of and attitudes towards consultation. Our results support, in part, the ‘new’ paternalism but raise questions about the blanket application of related measures to heterogeneous groups of plan participants.

Do Economic Policymakers Practice What They Preach? The Case of Pension Decisions

This paper examines whether policymakers, economists at the Israeli Finance Ministry, act in their personal pension decisions in accordance with the rational behaviour assumptions underlying the pension policies they advance. We find that while economists' decisions regarding three other important decisions such as buying an apartment, a car and a large appliance, are largely in line with rational models, pension decisions deviate significantly from these models. A large share of these policymakers hardly search for relevant information regarding their chosen pension fund, do not know the most necessary information and consider only one option before choosing the preferred pension fund. A significant difference was found between specialized policymakers (economists in the Pension Division) and general policymakers (economists in all other Divisions) showing that specialized policymakers are significantly less biased.

Income Drawdown Schemes for a Defined‐Contribution Pension Plan

AbstractIn retirement a pensioner must often decide how much money to withdraw from a pension fund, how to invest the remaining funds, and whether to purchase an annuity. These decisions are addressed here by introducing a number of income drawdown schemes, which are relevant to a defined‐contribution personal pension plan. The optimal asset allocation is defined so that it minimizes the expected loss of the pensioner as measured by the performance of the pension fund against a benchmark. Two benchmarks are considered: a risk‐free investment and the price of an annuity. The fair‐value income drawdown rate is defined so that the fund performance is a martingale under the objective measure. Annuitization is recommended if the expected fair‐value drawdown rate falls below the annuity rate available at retirement. As an illustration, the annuitization age is calculated for a Gompertz mortality distribution function and a power law loss function.

Public pension provision: A comparison of the British and Japanese systems, based on their university arrangements

A leading Japanese expert claims that Japan has a generous pensions programme and the OECD, in a just published major report, finds that the Japanese and British pension systems perform fairly close to each other, with Britain offering a relatively better net replacement rate while Japan affords better net pensions wealth. Having been part of the British and then the Japanese university pension systems for two decades, the author's experiences show these revelations cannot be taken at face value. This paper therefore offers a straightforward comparison of what is being provided for British and Japanese academics, but its conclusions can be generalised to the two nations' entire public pension provision systems since what academics are afforded are commensurate with those for the respective civil servants, including the national pensions to which every one is entitled; truly personal pensions obviously fall outside our remit. This paper finds that Japanese academics fare less well relative to their British counterparts in practically every aspect of the provisions for their retirement: they pay higher premiums and receive no tax-deductions on them; their employers do not contribute as much towards their pension arrangements; they receive lower annual national pensions and much lower employer-provided ones; they receive slightly lower lump sums; their dependents fare less well; they have to cover 30 per cent of their medical costs while the British are not charged at all and they are denied the right to make their own arrangements.

What is a Promise from the Government Worth? Quantifying Political Risk in State and Personal Pension Schemes in the United Kingdom

There are three key types of political risk facing pension schemes: those induced by demographic, economic, and pure political factors. The state scheme in the United Kingdom has been susceptible to all three types since 1980, with the result that the annual real internal rate of return on the second‐pillar state pension for the average male worker fell from 5.1% to 1.5% over 25 years. The flat‐rate, first‐pillar Basic State Pension has also experienced a fall in its IRR of 3 percentage points as a result of the indexation basis changing from earnings to prices.

The Effect of Pensions on Job Mobility: Empirical Evidence for the UK

In this paper we study the effect of pension provision on employee turnover in the UK. In Great Britain, there are three forms of pension coverage: the public social security system, occupational pension plans and personal pensions. We focus on the effect of occupational pension plans on job mobility by studying the different patterns formed by workers in Defined Contributions vs. workers in Defined Benefit pension schemes. Using two distinct empirical approaches we find that workers in DB pension schemes are less likely to move jobs than those in DC schemes.

Improving the Personal Pension Provision for Old-Age Income Security

Improving the Personal Pension Provision for Old-Age Income Security

Individual Home Bias, Portfolio Churning and Performance

This study investigates economic consequences of individual investors’ home bias and portfolio churning in their personal pension accounts. The empirical analysis is carried out within a Heckman style two-stage framework to account for selection bias with respect to individuals’ investment activity, and to allow for an endogenously determined home bias, portfolio churning, and performance. Results indicate that home bias induces a worse risk-adjusted performance. Home biased individuals’ relatively bad performance originates in insufficient risk-reduction, due to a lack of international diversification. A higher degree of portfolio churning also deteriorates performance, despite the fact that churning is not associated with any direct transactions costs. However, home biased individuals do not churn portfolios as often as individuals with a larger share of international asset holdings, which diminishes the negative effects of home bias on performance. Overconfidence is driven by a return-chasing behavior, where overconfident individuals favor international assets with high historical returns. Individuals with actual skill are more often men than women, are not tempted by high historical returns, and use international assets for the right reason – diversification.

The 'New' Paternalism, Consultation and Consent: Expectations of UK Participants in Defined Contribution and Self-Directed Retirement Savings Schemes

Concern about the competence of individual decision-makers has prompted governments and pension plan sponsors to take advantage of the insights gleaned from the behavioural revolution. Auto-enrolment, target-date and related investment strategies may effectively counter behavioural biases such as inertia and the lack of attention paid to financial planning. Nonetheless, some participants may expect consultation when plan sponsors and management implement 'default' strategies and the like. Here, we assess the expectations of plan participants drawn from a national representative sample of UK residents who participate in defined contribution and personal pension schemes. It is found that respondents who expressed an interest in a high degree of consultation over the pathway to retirement were older, have higher incomes, and recognised the significance of retirement saving schemes for their long term welfare. A significant number of respondents would not or could not offer an opinion on the desirability of consultation. These respondents can be characterised as either discouraged or disenchanted or disaffected-socio-economic variables were not good predictors of these respondents' opinions and attitudes to consultation. Our results support, in part, the 'new' paternalism but raise questions about the blanket application of related measures to heterogeneous groups of plan participants.

The importance of asset allocation in Spanish equity pension plans

AbstractFollowing the methodological approach taken by Ibbotson and Kaplan (2000), we provide evidence of a major contribution of strategic asset allocation to Spanish equity personal pension plan performance, finding that on average more than 90% of variability of returns over time, and about 70% of the variation of returns among plans, are explained by strategic policy.Furthermore, we also have evidence that survivor and look-ahead bias detected in previous research have very little impact on the conclusions about the importance of asset allocation on the variability of returns over time.The importance of asset allocation to explain the variability of returns over time is quite similar for the different investment vocations considered in our study, Euro zone and global equity. Very similar results are also found when we consider the size of the Spanish plans as an explanatory factor for the contribution of asset allocation to performance.Finally, the value that active management adds to the mere passive tracking of the strategic policy is not statistically different to the management costs of the plans.

Labour Supply of Older Workers in the UK: Is There a Link with Pension Provisions?

Developed countries in general and the UK in particular have experienced a trend towards early retirement over the last couple of decades. As the retirement decision is commonly influenced not only by individual preferences but also by institutional arrangements, changes in pension coverage and design may lead to changes in the nature and time of retirement. In particular, the increasing importance of Defined Contribution (DC) schemes in the UK since the introduction of personal pensions in 1988 may result in alterations of retirement incentives, hence in the labour supply decisions of older workers. This article reviews the potential effect of the recent increase in DC pensions on the labour supply planning of older workers in the UK.

Why do people invest in personal pension plans?

The aim of this article is to identify the variables affecting the decision to make contributions to personal pension plans and the amount of such contributions. For this purpose, we specify and estimate a Tobit model for a sample based on the 1995 Personal Income Taxpayers Panel prepared by the Institute of Fiscal Studies (Spanish Ministry of Economy and Finance) formed by 3041 taxpayers, of whom 358 made contributions to pension plans. Our results suggest that individuals decide to invest in pension plans on complex grounds combining the wish to benefit from tax savings and to ensure they will receive supplementary income upon retirement.

Analysing the Performance of the Pension Fund Industry with a Stochastic Frontier Model: A Case Study for Portugal

The enhanced role of occupational and personal pension plans in providing retirement income raises issues concerning efficiency and performance. This paper evaluates the performance of Portuguese pension fund management companies from 1994 to 2003, using a Cobb–Douglas stochastic cost frontier model to generate their efficiency scores. We conclude that the price of labour, the price of capital-management services and the price of capital-premises, as well as profits, the number of participants, the number of closed funds and the decision whether or not to manage open funds all play a major role in the efficiency of such companies. We also find that the efficiency scores are mixed. The managerial implications of these results are derived.

Disposal Income Elasticity of the Personal Pension Savings and Its Deduction Effect

Disposal Income Elasticity of the Personal Pension Savings and Its Deduction Effect