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Annuity Markets and Pension Reform
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 (ISBN-13: 9780521846325 | ISBN-10: 0521846323)

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Annuity Markets and Pension Reform
Cambridge University Press
978-0-521-84632-5 - Annuity Markets and Pension Reform - by George A. (Sandy) Mackenzie
Front Matter

Annuity Markets and Pension Reform

This book treats two vital but neglected public policy issues: how should distributions from individual accounts be regulated, and how can the market for private annuities function better? It provides a comprehensive survey of the issues that arise when contributors to individual accounts become eligible for distributions. In particular, the book also addresses the question of whether annuitization or other restrictions on distributions should be mandatory, and if so, whether the provision of annuities should be privatized? Given the diminishing importance of public pensions around the world, the growing number of the elderly, and the increasing importance of defined contributions plans, the voluntary demand for private annuities will continue to grow. Since it is vital that annuities be reasonably priced and that annuity markets be effectively regulated, the book proposes some reforms to enhance the efficiency of the annuity market. Its analytical framework is applicable to a broad range of countries.

George A. (Sandy) Mackenzie is an assistant director, Research Department, International Monetary Fund (IMF) in Washington, DC. He was born in Halifax, Nova Scotia, and educated at Dalhousie University and Oxford, which he attended on a Rhodes Scholarship. Mr. Mackenzie has been a member of the economic staff of the IMF for more than 27 years. His interest in pension issues is longstanding, and his work in the area includes advising South American governments on individual accounts reform, and a number of papers on related issues. He has published in Finanzarchiv, Public Finance/Finances Publiques, the Journal of Budgeting and Finance, and Staff Papers, International Monetary Fund.





Annuity Markets and Pension Reform


George A. (Sandy) Mackenzie

International Monetary Fund





CAMBRIDGE UNIVERSITY PRESS
Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo

Cambridge University Press
32 Avenue of Americas, New York, NY 10013-2473, USA

www.cambridge.org
Information on this title: www.cambridge.org/9780521846325

© George A. (Sandy) Mackenzie 2006

This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press.

First published 2006

Printed in the United States of America

A catalog record for this publication is available from the British Library.

Library of Congress Cataloging in Publication Data

Mackenzie, G. A. (George A.), 1950–
Annuity markets and pension reform / George A. (Sandy)
Mackenzie.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-521-84632-5 (hardback)
ISBN-10: 0-521-84632-3 (hardback)
1. Pension trusts. 2. Life annuities. 3. Retirement income.
I. Title.
HD7105.4.M22 2006
331.25′24–dc22  2006011483

ISBN-13 978-0-521-84632-5 hardback
ISBN-10 0-521-84632-3 hardback

Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party Internet Web sites referred to in this publication and does not guarantee that any content on such Web sites is, or will remain, accurate or appropriate.





To the memory of Paul Hoeberechts and the memory of Leslie Schaffer Physicians and Healers Both



At present we want to encourage prudence in the sense of distributing income through a man's life. When that time comes all sorts of fancy devices possibly with a counter-insurance element in it, e.g., annuities on joint lives …
From the notes of Lord Keynes for the National Debt Enquiry, 1945

***

“Father, I have often thought that life is very short.” – This was so distinctly one of his subjects that he interposed.
“It is short, no doubt, my dear. Still, the average duration of human life is proved to have increased of late years. The calculations of various life assurance and annuity offices, among other figures which cannot go wrong, have established the fact.”
“I speak of my own life, father.”
“O indeed? Still,” said Mr. Gradgrind, “I need not point out to you, Louisa, that it is governed by the laws which govern lives in the aggregate.”
From Hard Times, by Charles Dickens

***

In the strange universe of King Lear, nothing but precipitous ruin lies on the other side of retirement.
From Will in the World: How Shakespeare Became Shakespeare, by Stephen Greenblatt





Contents




 List of Tables page xi
 Acknowledgments xiii
Introduction 1
 Annuities ancient and modern 1
 Renaissance 6
 A guide to the book 12
 Chapter outline 14
PART ONE
1.  The Demand Side of the Annuity Market 21
 Introduction 21
 Private annuity markets: an international comparison 21
 Why the demand for annuities is limited 28
 Annuity pricing 43
 The insurance value of annuities 48
 Annuities and alternative investment strategies 50
 Conclusions 55
2.  The Supply Side of the Annuity Market58
 Introduction 58
 Major risks of the annuity business 59
 A simple model of funding 61
 Relaxing the assumptions of the simple model 62
 Other aspects of annuity pricing 72
 Conclusions 78
3.  The Regulation of Annuity Providers 81
 Introduction 81
 The rationale for regulation 82
 Approaches to regulation 85
 The regulation of investments 87
 Regulation of reserves 93
 Protection of annuitants in the event of the failure of the provider 103
 Regulatory implications of the growth of annuity markets: conclusions 104
4.  Experience with Individual Account Reforms 106
 Introduction 106
 The Chilean reform 106
 Other Latin American systems 119
 Eastern and Central Europe 124
 Similarities and differences between Latin America and Europe128
PART TWO
5.  Individual Liberty versus Security in Retirement, and the Government's Role 133
 Introduction 133
 The case for restrictions on withdrawals and mandatory annuitization134
 Regulation of withdrawals from defined contribution plans 138
 Public sector versus private sector provision 141
6.  Policy Issues with Both Public and Private Sector Provision of Mandatory Annuities 144
 Introduction 144
 The scope for respecting individual preferences 144
 Rules to determine the extent of annuitization 146
 The case for exemptions147
 The form of the annuity 149
 Safety net issues 154
7.  Policy Issues with Privatization of the Provision of Annuities 163
 Introduction 163
 The level and variability of premiums 163
 Premium differentiation 167
 Guarantees for annuity payments 170
 Taxation of annuities 172
 Administrative aspects of private provision 175
8.  Conclusions and Recommendations 177
 Policy issues with either public or private provision of mandatory annuities 177
 Issues with private provision of mandatory annuities 181
 Public versus private provision: a summing up 184
 Making the voluntary private annuity market more efficient and reliable 187
 Appendix 1: The Economics and Financing of Annuities 194
 Introduction 194
 A two-period model 194
 Bequests, lumpy expenditure, and other complications 198
 The cost and funding of annuities 210
 Relaxing the assumptions 214
 Adverse selection 219
 An aside on the timing of annuitization 221
 The insurance value of annuities 222
 Appendix 2: Aging and Its Impact on Pension Systems 225
 A parable 225
 Real-world aging problems 228
 Macroeconomic aspects of an individual accounts reform 229
 Glosssary 231
 References 235
 Index 244




List of Tables




I.1  Elderly dependency ratios of the world’s population and major regions page 7
1.1  Principal forms annuities can take 22
1.2  Money’s worth ratio values for a group of countries: nominal annuities 46
2.1  Period life table, New Zealand, male population 74
4.1  Chile: share of life annuities and programmed withdrawals by class of pension as of March 2004 (in percent except where indicated) 113
4.2  Basic features of Latin American systems (emphasizing the distributional phase) 120
4.3  Basic features of Eastern and Central European systems (emphasizing the distributional phase) 126




Acknowledgments


The basis for this work was a sabbatical at the Urban Institute in 2001–2002, where I wrote two papers covering or touching on many of the issues I deal with here. I want to thank my UI colleagues, in particular Rudy Penner, for providing me with such a hospitable and stimulating environment. I owe a particular debt to Mike Orszag for encouraging me to develop the sabbatical papers into a book. Many colleagues and friends made valuable comments on earlier drafts or helped in other ways, notably: Mike Orszag, Peter Heller, Eduardo Ley, Juan Yermo, Allison Schrager, Linda Mallon, John Mueller, Robert Holzmann, Gordon Funt, and Alain Joustain. My earlier work at the UI benefited from the comments of participants in seminars held there, at the International Finance Corporation, and the International Monetary Fund. I would also like to thank Mark Johannes, Roberto Rocha, Jacob Schaad, and Istvan Szekely for their help on particular country matters. My colleagues in the IMF's research department, Raghu Rajan and David Robinson, contributed with their indulgence of the “book leave” I took at odd times during the year.

Before embarking on this enterprise, I had always been a bit skeptical of the ritual apologies and thanks authors gave their families. Now I understand. Carolyn and Marjorie Mackenzie were wonderfully tolerant of the demands this work made on my time.

Finally, despite all the help and assistance I have received, any errors of any kind that remain in this work are my responsibility, and mine alone. None of the views expressed here should necessarily be taken to represent the views of the IMF, or IMF policy.


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