This book focuses on the pension experiences of Chile, a country that pioneered radical reform of its pension system in the early 1980s. The growth and development of this mandatory defined contribution pension system has, in turn, spurred the development of one of the most important annuities markets in the world.
This analysis of the developing annuities market includes five core chapters plus an introduction, a conclusion, and three annexes which provide most of the technical content. The first core chapter describes the Chilean market for retirement products, which, in addition to annuities, includes phased withdrawal and temporary withdrawal plans. This chapter also presents results of econometric studies of the performance of the annuities market from both consumer and provider sides. The second core chapter provides a rather general overview of risks faced by key stakeholders in the annuities market (i.e. workers, pensioners, providers and the government). A third core chapter describes the major risks faced by providers, particularly life insurance companies underwriting annuities. In the fourth core chapter, more detail is provided regarding the menu of retirement products. Finally, the fifth core chapter deals with the regulation of market participants with emphasis on solvency rules for annuity providers.
The authors deliver a complete and up-to-date book which covers not only Chile's annuity market structure but also its performance and regulatory evolution over the past decade. The analysis also includes empirically-founded comparisons of key variables including the menu of retirement products, market structure, suppliers and intermediaries of these products, and the availability of financial instruments in the market. The book has a clearly delineated line of reasoning which helps the reader new to annuitant issues. The volume also includes policy recommendations at the end of each chapter.
Of particular interest to readers are the several perspectives offered, including viewpoints of workers, annuity providers, and the government. Not only is their behavior analyzed but also their attitude towards risk, which defines contribution and pre-retirement issues, annuity product demand, the demand for financial instruments, and the evolution of legislation over time. This makes the report a dynamic approach to a developing and growing financial market. It is interesting that no actual opinions of pensioners or annuitants are included to complete the perspective on trends in annuities. The authors' discussion of the Money's Worth ratios (MWR) provides interesting insights regarding market dynamics, and is useful in comparative cross-national analysis. Perhaps more prominence could be afforded this work, as it is relegated to an appendix. The authors do provide one chapter dedicated to issues that arise when trying to develop a retirement product market; they also offer lessons for other countries including insights on what an annuities market might look like after 25 years of constant change and development.
Very valuable is the discussion of why Chile has become one of the biggest annuities market in the world, with one reason being that brokers have substantial power tiling demand toward annuities even if a Phased Withdrawal strategy (PW) might be more attractive. It must be noted that recent regulation has expanded the range of products in the market, including not only PW and traditional annuities but also variable annuities. Moreover, providers can now offer more fairly priced products, splitting between companies providing the annuity products and the pensioner the longevity risk borne by retirees taking the PW and the early death risk borne by annuities. We believe that the range of products could be extended further, with the objective of making the market more competitive. For instance, with-profit annuities, unit-linked annuities, or annuities whose price is determined based on the characteristics of the individual might be an interesting development, if diversification is among the government's objectives regarding the development of the annuities market.
Another way to diversify risks borne by key agents derives from the perspective of the life insurer, which due to declines in mortality have seen longevity risk rise over the last decade. Such firms could transfer the risk to the financial market if a longevity bond or a mortality-linked financial product (e.g. survivor swaps or annuity futures) were available. Developing a market for this new set of instruments might give the Chilean pension providers a chance to reduce the longevity risk they bear, while permitting more complex products for their portfolios. Such products would, of course, need to be assessed thoroughly due to the fact that the government is mixing macroeconomic with social policy, and that there might be supply constraints which might hinder the development of such instruments.
Chile currently has a wide range of investment restrictions for the pension market (particularly on international investments). These imply that the pension portfolio is probably suboptimal in terms of minimum risk allocation. The book also develops information on what changes would be required in terms of regulation over retirement rules and products, supply and demand issues, capital rules for providers and mortality assumptions, and mortality tables as well as interest rates. The authors suggest that legislative reforms would be needed to develop the annuities market with the aim of making it more liquid, diversified, and transparent. While firms must gradually update their mortality tables used in calculating PWs and annuities, they are not required to make public the assumptions they employ when developing premiums and monthly payments. Further transparency would be useful.
In sum, this book ties together recent major developments in the Chilean marketplace for annuities and the unresolved problems of the pension system along with different perspectives in the marketplace. The volume is a highly recommended reference for how to develop annuity markets in other countries with private account pensions.
