pension funds introduction how can we define the pension funds? which kind of impact do they have on...

PENSION FUNDS INTRODUCTION HOW CAN WE DEFINE THE PENSION FUNDS? WHICH KIND OF IMPACT DO THEY HAVE ON FINANCIAL MARKETS? THE STRUCTURE OF PENSION FUNDS PENSION FUNDS IN ITALY

PENSION FUNDS:DEFINITION Pension funds are institutions carrying out the collection of contributions of employees and / or employers. Contributions have to provide beneficiaries with a relevant paid-in capital at the end of the working life. Benefits will be paid either in the form of annuity or in the form of full/mixed payment. Institutional investors are having a social security benefit. the shares are the contributions paid during the period of employment which, properly invested, will ensure the provision of future pension benefits. In fact this is a system based on capitalization. Pension funds collect funds which will be returned at the end of employees working life and then the manager is faced with liquidity constraints, which are less strict about the choices of the forms of investment.

THE IMPACT ON FINANCIAL MARKETS In view of the social security purposes, the long-term perspective of investment, and the considerable size of these actors in the global capital markets, the PFs now constitute a category of investors vital to the growth of modern economies. In fact, they contribute : a) to increase the size of financial markets (it helps to increase the capitalization of financial markets) b) to increase efficiency (it improves the international diversification of private savings portfolio) c) to improve the governance of companies they invest in, exerting political activism, because it implies the involvement of investors in the management of investing companies.

TYPES OF PENSION FUNDS Depending on the person establishing the fund, we can identify two types of pension funds: OPEN AND CLOSED FUNDS. Closed funds : closed-end funds are defined as such because they are reserved exclusively for certain categories of workers or firms. They are legal entities of association promoted by trade associations, trade unions, business organizations. (eg, lawyers and doctors) Open funds : are called open because they do not refer to particular categories of workers, in fact you can join all those who are not eligible to enter a closed pension fund.

TYPES OF PENSION FUNDS 2 We can also distinguish pension funds according to different lines of investment: single sector funds and funds with multiple compartments. Contractors are entitled to enter for a predetermined period of time to one of these lines of investment, depending on their risk appetite. in single-sector funds there is only one line of investment, either bonds or balanced; while in multi-sector funds there are several lines of investment and in this case contractor may choose between cash, equity, bond and mixed. the choice is determined by some factors, such as: age (which defines the investment horizon), the total wealth of the worker, marital status, education, gender.

PENSION SYSTEM DESIGN:ITALY Italys pension system consists of a PAYG public pension pillar as well as voluntary occupational and private pension plans. With a total of approximately EUR 350 billion pension assets under management in 2004, Italy is one of the largest European pension markets. Its life insurance market is at the fourth place out of all the European markets and it is set to continue outpacing the European average growth rate. Although Italys invested pension market is still small, the outlook for this sector has brightened with the passing of a new bill that was signed in October 2006. The bill encouraged the transfer of indemnity payments (severance pay, which is compulsory in Italy) to the private pension market. We expect new pension funds to grow at a compound annual growth rate of around 30% until 2015, turning Italy into one of the most important European markets. Total pension assets in the market are expected to grow at an annual rate of 5.9% reaching EUR 914 billion in 2020.

THE AMOUNT OF PENSION BENEFITS Nowdays in the system the amount of pension benefits will not depend on salary levels but on the contribution deposits. At the end, a notional capital stock is formed from the contributions paid in. Calculation of the pension benefit takes into account this notional sum and the recipients remaining life expectancy at the time of retirement. The statistic forecast shows that the average pension level of a 60- year-old is set to sink from 67% today to 48% by 2050. However, means-tested social assistance pensions and supplements to social security pensions will guarantee a minimum income level beyond the age of 65.

OPEN & CLOSED PENSION FUNDS AND IPP(INDIVIDUAL PENSION PLAN) In Italy there are two types of pension funds: Closed or contractual pension funds which are implemented either as company pension funds by a single company or as industry-wide pension funds which are set up by the employers association and by trade unions for a specific group of participants; Open pension funds that are offered by banks, insurance companies or investment management companies for a generic group of participants, i.e. the self-employed. the employee can choose between open and closed pension funds and the individual pension plan PIP. However, it is not certain that it will lead to a real competition between the three core pension products, i.e. closed pension funds, open pension funds and the individual insurance plans. All pension funds have to sign an agreement with an external investment manager that can only be an insurance company, a bank or a registered asset management company (Societ Gestione Risparmio or SGR). Today, all pension funds operate on a defined contribution basis, as this is the only possible type of pension plan.

Termination indemnity payments (TFR) Upon termination of employment for any reason, employers have to pay a termination indemnity (Trattamento di fine Rapporto or TFR) to all employees. In Italy the TFR is used as a backup in the event of redundancy or as an additional pension benefit after retirement. Severance pay is calculated as 6.9% of each years annual salary, revalued on the basis of 75% of inflation plus a fixed rate of 1.5% during the period of accrual, and is paid as a lump sum. Assuming that the TFR benefit is accumulated throughout a full career, it is expected to provide a pension of 10% to 15% of final pay.

Why should be convenient underwrite a pension fund contract???

Countries analysed GreeceValentina Gaddoni GermanyFrancesca Farinelli United KingdomSaverio Monti Scandinavian CountriesTeresa Lamonica New European CountriesSergio Cibotari United StatesElena Paesetti

The case of Greece Pension system: based on a public pension pillar Private pensions plans exist 2008 Government: reform 1.Increase early retirement age 2.More incentives to work longer 3.Less complexity and more clearness in public pension system 4.Decrease number of pension funds available The generosity of the pension system will be a heavy burden on public finances in the years to come. 1

Retirement &Public pensions The official retirement age is 65(men)and 60(women), but retirement is also possible after 30 years of contributions, or based on a combination of age and contribution periods. 1 Pillar: complex and important It covers employees and certain self-employed. One of the main public pension schemes is IKA( Social Insurance Institute). 2

Pension funds Pension funds: Legislation concerning occupational pension funds was introduced in 2002. The pension funds are autonomous, non-profit private entities with own legal personality. They are supervised by the Ministry of Employment and Social Protection. More than 130 funds provided primary and supplementary pension coverage (now only about 13). 3

Pension funds Pension funds are subject to quantitative limits: A maximum of 70% of assets may be invested in equities or corporate bonds No more than 5% may be invested in investment funds Investments in non-EU and non-EEA countries are generally not permitted Taxation of occupational pension funds is unclear 4

Conclusions Life insurance and pensions funds play a subordinate role in Greek household portfolios, accounting for only 3% of assets. Pension fund assets account for less than 1%of GDP. This is a reflection of Greeces underdeveloped funded pensions, but it has a great deal of development potential. (Greek retirement market CAGR:13.9%) 5

GERMANY PENSION SYSTEM: Predominance of the public pillar 2002 RIESTER REFORM: Reduction of public pillar More attention to the occupational pensions Plans with capital preservation guarantees Challenge: the retirement market will grow at a CAGR (Compounded Average Growth Rate) of 4.6% until 2020.

PUBLIC PENSIONS The public pension pillar contributes more than two- thirds of retirement income to people over 65 years of age Public service schemes are financed directly through public budgets German public system is known as pay-as-you-go system and it is mandatory for all employees Some exceptions are provided for certain professions, such as lawyers or architects and for the self-employed

PUBLIC PENSIONS: RETIREMENT AGE REQUIRED:Actually people retire at 65 years. However, recent reforms will increase the retirement age to 67 in the period between 2012 and 2029 TAXATION:Since 2005, at least 50% of pension benefits have been taxed. This share will rise to 100% in 2040. The contribution rate is shared equally between employers and employees and amounts to 19.9% of salary.

OCCUPATIONAL PENSIONS Since 2001, employees have had the legal right to access occupational pensions. Employers can offer occupational pension provision in five ways: 1.Direct pension promises (Direktzusage) 2.Direct insurance 3.Support funds (Untersttzungskasse) 4.Pensionskassen 5.Pension funds (Pensionsfonds)

PENSION FUNDS They were introduced in 2001 and are separate legal entities. They are more return oriented and subject to much more liberal rules than Pensionskassen: there are no limits to equity investments, foreign investments or other asset classes. However, there are limits to investments in single issuers or issues and a 70% currency matching requirement. They guarantee the paid-in capital minus costs.

..PENSION FUNDS.. Since 2005, Pensionskassen and Pensionsfonds and direct insurance have been taxed in the same way. Contributions of up to 4% of the social security ceiling are tax-deductible, up to an amount of EUR 2,544. In addition, while investment income is tax- exempt, benefits are taxed.

HOUSEHOLD PORTFOLIO

FINAL CONSIDERATIONS Occupational pension coverage in Germany has been on the rise in recent years. The recent government decision to extend the social security exemption of pension contributions will also help the funded occupational pillar, that is, pension funds as well.

The pension fund schemes in the UK the most large and challenging pension market in Europe one of the most developed funded pension systems

Quick look at the current pension system: Basic State Pension - Old Age Pension - flat-rate scheme State Second Pension -earnings-related - unlike the Basic State Pension, partecipation to the S2P is voluntary

It is possible to contract out of the S2P by joining: occupational pensions (arrangemetns established by employers to provide pension and related benefits for their employees) Stakeholder pensions (first example of a private pension designed by governament with fixed administrative costs) Personal pension plans (it is also possible for an individual to make contributions under an arrangement they themselves make with a provider). According to estimates, 60% of employees are in contracted-out schemes.

The occupational pension system in the UK is voluntary and plans have traditionally been implemented through pension funds and insurance schemes. Most medium and large-sized companies sponsor their own pension plans; small employers favour insurance schemes. Pension funds

Pension plan can be of the: defined benefit (guaranteed level of pension benefit established in advance) defined contribution (pension determined by the value of the fund contributions) hybrid type The UK is one of the first examples for the shift from defined benefit to defined contribution plans.

Future trends While reforms in Continental Europe often try to encourage funded pensions in general, reforms in the UK strive to provide adequate pensions for lower-income earners. Attention is paid to lower-income earners as these are most affected by the low replacement rate of the public pillar. As for the the future market trends, since the pension funds are still highly exposed to equity markets, they will lose some of their value due to the current market downturn.

The Icelandic pension system The pension system on the three pillar principle: public pension membership in occupational pension funds individual pension saving with tax incentives

The problem of ageing Smaller than among most developed European countries: The Icelandic nation is younger than many other European nations and the problem of ageing will thus be less during the first decades of this century. High labour participation rates of the elderly Mandatory membership of fully funded pension funds (at least 10% of wages)

The Icelandic nation is younger than among most developed European countries and will continue to be so well into this century

Labour force participation

Norway The Government Pension Fund of Norway comprises two entirely separate sovereign wealth funds owned by the Government of Norway: The Government Pension Fund - Global (formerly The Government Petroleum Fund) The Government Pension Fund - Norway (formerly The National Insurance Scheme Fund)

Sweden Unique Public Pension Pillar in Western Europe: Social security contribution is paid into individual investment accounts and a funded pension is build up with independent fund management companies responsible for the asset management.

Finland Pension Reform purpose: improve the structural features in the pension systems. Voluntary occupational schemes and private pension savings are not well developed due to the dominance of the existing compulsory scheme. How to fund the sharp rise in pension?

Could renewable energy change pension funds? Denmark

Denmark: the first direct investment in energy from a pension fund. PensionDanmark is a not-for-profit labour market pension fund established in 1993. It offers defined contribution pension, insurance and health care products on the basis of collective agreements covering 578,000 individuals employed in 27,000 companies within the private and public sector. Contribution rates range from 12.0 to 18.0 per cent of wages with the employers paying 2/3 of the contributions and the employees paying 1/3.

Denmark 26 September 2010, PensionDanmark makes landmark energy deal. This is a model for risk sharing and it protects PensionDanmark from the downside. The risk-return ratio is attractive for us and for Dong Energy: they can reduce their capital to offshore parks and free up funds for other investment areas, where they can see higher returns. Mr Mger Pedersen, PensionDanmarks chief executive officer.

PENSION FUNDS IN THE NEW EU MEMBER STATES During the 1990s many of the Member States that entered the EU in 2004 (Czech Republic,Estonia,Hungary,Latvia,Lithuania,Poland,Malta,Cyprus, Slovakia and Slovenia) or 2007 (Romania and Bulgaria) faced severe problems with the functioning of their statutory pay-as-you-go (PAYG) public pension systems. Particularly the: relatively low retirement ages, high replacement rates and rather high social security contribution rates which provided limited incentives to participate in the system putting the PAYG schemes under pressure as their economies shrank and the informal sector rose. 43

Overview of pension systems in the NMS All NMS have a funded pension pillar in combination with the standard old-age PAYG public pension. While all of these countries apart from Romania have a private pension scheme with voluntary participation, not all of these countries have yet implemented a private pension scheme with mandatory participation. In the Czech Republic and Slovenia a mandatory private pension scheme does not exist at all, while in Lithuania, Poland and Slovakia, participation in these schemes is voluntary for some groups. 44

As next table shows, statutory funded private pension schemes differ significantly across countries. First, the stage of development of these systems differs depending on the year of their implementation. For example, Hungary already introduced its statutory private pension scheme in 1998, while Slovakia implemented it only in 2005. In other words, the Slovak scheme is in this sense less mature than the Hungarian. Second, statutory funded private pension schemes differ both in terms of contribution levels and how these are shared between employers and employees. For example, in Poland and Romania the statutory pension scheme is fully financed by employees, while it is fully financed by employers in Slovakia. 45

As we see, with 13.6 %, Bulgaria saw the largest increase in the employment rate between 2000 and 2008, followed by Latvia 11.1% and Estonia 9.4 %. The increase in unemployment over 2008-10 is projected to be the strongest in Lithuania 10.1 %, followed by Estonia 8.6 % and Latvia 8.5 %. The rise in unemployment also tends to reduce individual pensions accounts. 47

Pension fund performance and risks These risks include in particular the: inflation risk -namely the fact that inflation grows faster than nominal returns on assets financial market risk -which is associated with exposure of the pension assets to stock market developments. 48

The size and structure of private pension fund assets The savings cumulated in the pension funds increased sharply in the NMS, but still remained at low levels when compared to many of the old EU Member States. For example, the pension funds assets as a share of GDP represented only about 4.7 % in the Czech Republic in 2007, 10.8 % in Hungary, 12.2 % in Poland and 4.2 % in Slovakia, while they were about 79 % in the United Kingdom or 138 % in the Netherlands. 49

The impact of inflation and financial market developments on pension fund performance is determined by the structure of pension fund portfolios. Private pension fund assets consist of: (1) bills and bonds issued by the public and the private sector, (2) mutual funds, (3) shares, (4)cash and deposits (5) other investment (e.g. mutual funds). 50

Structure of Pension Funds Assets in 2007 As they should secure income for their members in their post-retirement period, pension funds in the NMS have often (but not always) opted for investing rather conservatively. 51

Structure of Pension Funds Assets in 2007 As we ca see, in 2007, the share of pension fund assets invested in cash and deposits, associated with low returns and low risks, varies from 70 % in Romania to 1 % in Hungary. 52

Structure of Pension Funds Assets in 2007 Also we can see, apart from Estonia and Romania, bills and bonds issued by the public and the private sector formed the largest share of private pension assets in 2007. The majority of these debt securities were issued by the public sector. 53

Structure of Pension Funds Assets in 2007 Source : OECD 54

The OECD estimates that the total investment loss worldwide of private pension plans due to the 2008 turmoil in financial markets was around USD 5 trillion (out of which USD 3.3 trillion in the United States). Next figure shows a declining trend in the nominal yields of pension funds between 2003 and 2006 in the NMS. The nominal yields of pension funds were higher in the NMS than in the old EU Member States; they declined from about 20 % in 2003 to about 16 % in 2006 in the NMS, while they fluctuated in the old Member States. The explanation of higher returns in the NMS may be higher inflation and more profitable investment opportunities in the NMS. Employees and employers contributions to pension funds have been rising sharply in the NMS since 2003; however, their level remained below that in the old Member States in 2007, reaching only 1.2 % of GDP while it was about 1.7 % of GDP in the old Member States. This could potentially be an indicator that the population in the NMS is not accumulating sufficient savings for the post-retirement period. 55

Source: OECD 56

Pension funds US PENSION SYSTEM

Pension funds

PENSION I PILLAR The pay-as-you-go (PAYG) basic state pension scheme II PILLAR Occupational pension provision III PILLAR Personal pension provision

THE FIRST PILLAR: public pensions Pension funds The official name of American state pension system is OASDI (Old.Age, Survivors and Disability Insurance Program). Assets (not negociated in the market) are totally invested in bonds issue by the Government. is financed through social security taxes equally shared between employers and employees. The statutory retirement age lies between 65 and 67

Accumulation of the surpluses in the Social Security Fund to meet future expenditures 1983: increasing of the social security tax 20422042 year of the expected exhaustion of the Security Trust Fund USD2.2 trillion : amount of the surpluses in 2004 Pension funds

THE SECOND PILLAR: occupational pensions Pension funds There are two categories of occupational pension plan: Defined-benefit plans which are relatively heavily regulated and are financed by the employer. Assets and liabilities are put into the property of the firm. Defined-contribution plans the costs of which are more predictable (15.000$ per year) Es:401(k) plan Defined contribution is based on private funds managed by a consultant (external from firm)provided by the employer.

THE THIRD PILLAR: personal provision Pension funds In 401(k) plans, occupational meets personal pension provision

Financial crisis and US pension system Pension funds Less active workers, less capitalLess active workers, less capital Economic recession and public debt growth are risky for the long term payments Their pensions depend from the fluctuactions of financialmarket or banckruptcy of the firm.Their pensions depend from the fluctuactions of financialmarket or banckruptcy of the firm. es. Enron: es. Enron: When Enron failed, its employees lost not only their jobs but also most of their pension. Defined contributions schemes are risky for savers Pensions payed are highly variable from one year to the nextPensions payed are highly variable from one year to the next No stability of the private investment account system

Pension funds President Obama is strongly opposed to privatizing Social Security. Governments Program But the fact is a secure retirement is being threatened today. Part of the reason is rising costs. I dont have to tell you about this. You feel the pinch every time you fill up a tank of gas because the price at the pump has tripled over the past several years. You feel it every time you go to the pharmacy and find that youre paying more for the same drugs than you were this time last year [Barack Obama, 10/27/07] Strengthen Social Security Create Automatic Workplace Pensions Expand Retirement Savings Incentives for Working Families Require Full Disclosure of Company Pension Investments Reform Corporate Bankruptcy Laws to Protect Workers and Retirees

pension funds introduction how can we define the pension funds? which kind of impact do they have on...

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