Presentaci

1
Ageing population and demography the role of
financial institutions José Luis Escrivá Chief
Economist BBVA Banking Group bbvaresearch.departme
nt_at_grupobbva.com
Europes competitiveness how financial
institutions can help deliver it 1st EPFSF Annual
Conference Brussels, May 15, 2007
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Ageing population and demography the role of
financial institutions
1. The need for an European pension market
2. The need to address the risks of an asset
meltdown effect
3. The need for more marked-oriented pension
systems
3
Ageing population and demography the role of
financial institutions
1. The need for an European pension market
2. The need to address the risks of an asset
meltdown effect
3. The need for more marked-oriented pension
systems
4
The challenges of demographic ageing economic
growth and public finances

• Demographic ageing will accelerate in the coming
  decades as the baby-boom generation reaches
  retirement age
• and will have a significant impact on European
  economic growth
• Cause reduction in the size of the labor force

Holding productivity growth, participation
rates and unemployment constant, GDP pc growth
will slowdown by 3 p.p. over the next two decades
in Europe
They could be partially offset by higher
participation rates, longer work life, and
greater productivity
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Ageing will require greater labor mobility across
European countries

• This requires a more efficient use of the labor
  factor. The low labor mobility across European
  countries makes difficult to improve the
  efficiency
• Currently 1.5 of EU-25 citizens live and work in
  a different member state form their country of
  origin. Interstate mobility rate in the US is
  three times bigger
• Every year, 7.2 of EU-25 citizens change their
  place of residence, but only 1.1 p.p. due to a
  change in jobs (2.8 p.p. in the US) (Eurostat
  US Department of Labor, 2002)
• Are the current European pension systems a
  barrier for mobile workers?

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Portability of pension rights of migrant workers
is essential to increase mobility

• First Pillar
• Although EU regulation ensure that pension rights
  are maintained when a European worker moves
  across European countries
• EU Regulation 1408/71, implementing Regulation
  574/72, and later Council and Commission
  Regulations
• Most European countries do not refund pension
  contributions if worker moves to another EU
  country
• Contribution records are kept until workers reach
  retirement age ? contributions paid in one
  country can neither be transferred to another
  country nor reimbursed to workers
• This is a suboptimal solution public pensions
  portability between European countries is very
  limited

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Portability of pension rights of migrant workers
is essential to increase mobility

• Second and Third Pillars
• The European Commission Directive on Institutions
  for Occupational Retirement Provision (2003) has
  not been translated in most countries (14 out of
  25 member states). Why?
• The gap between EU regulation of pension
  institutions and the national regulation of
  pension products
• Therefore, the development of Pan-European
  Pension Plans (PEPP) should be a priority
• An alternative solution to this problem, focusing
  on 3rd pillar
• Pan-European Pension Plans. Deepening the
  concept (EFR Pensions Steering Group, 2005)

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Ageing population and demography the role of
financial institutions
1. The need for an European pension market
2. The need to address the risks of an asset
meltdown effect
3. The need for more-marked oriented pension
systems
9
Old-age dependency ratios in Europe will increase
exponentially

• Holding macro and regulation constant, pension
  expenditure will rise as the old-age dependency
  ratio,

European social security systems have a problem
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giving rise to the risk of an asset meltdown

• Higher dependency ratios mean lower overall
  savings, inducing potential capital losses to
  those who retire
• The asset meltdown problem
• A massive liquidation of past savings by the
  retiring baby-boomers will cause a rise in
  interest rates and a fall in the price of bonds
  (asset meltdown)
• Estimation Results. 70 - 80 basis points drop in
  bond prices spread over five decades (Krueger and
  Ludwig, 2006)
• Is this problem manageable?
• What can the financial system do?

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Asset meltdown problem is manageable. Financial
institutions can help to provide more income
security among the elderly

• The problem is manageable with the involvement of
  financial institutions
• Older societies can transfer part of the burden
  to younger ones, if financial markets are
  integrated
• Investment strategies for pension fund managers
  focused on lifetime earnings Longevity Bonds
• Development of instruments to make more efficient
  use of non-financial wealth after retirement
  Reverse Mortgages
• ?
• The meltdown effect may still be small and
  spread over a very long

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Financial institutions can help to provide more
income security among the elderly longevity
bonds and reverse mortgages

• 2. Coverage of longevity risks in private-DC
  pension markets,
• Solution to implement bonds indexed to life
  expectancy, i.e., longevity bonds
• Difficulties to implement since no obvious
  counterpart exists
• Difficulties to asses uncertainty and associated
  risks adequately
• Comparing realized gains in life expectancy at
  birth with past projections (years)
• A positive sign means that
• life expectancy in 2003 has
• already by-passed projected
• life expectancy for the
• average 2000-05 (UN) and
• 2005 (Eurostat)

Life expectancy projections by international
orgs. and actuaries have consistently
underestimated improvements
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The potential size of the RM market is huge...

• 3. Instruments to make more efficient use of
  non-financial wealth after retirement Reverse
  Mortgages (RM)
• A significant proportion of the wealth of
  individuals (especially in Southern European
  countries) is tied to housing
• ?
• Home equity conversion products may be useful to
  all those who are house-rich but cash-poor (not
  limited to the elderly)
• The development of RM could play a central role
• Demographic projections indicate that elderly
  people is the fastest growing segment all over
  the world, especially in Japan and Europe
• Literature on RM is unanimous on its huge market
  potential (Püntner Röhrs, 2006). Reality has
  not been up to expectations though

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but the actual size of the RM markets is nowhere
near its estimated potential

Assuming that the development of the RM market in
Spain will be similar to that of the U.S. and the
population projections, in 2050 there will be 800
RM per million inhabitants over 60 in Spain
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... for a variety of reasons from the demand,
supply and regulatoriy considerations

• What are the reasons for the gap between
  potential and actual RM volumes?
• Supply side
• RM complexity exposes a lender to several risks
  mortality, interest rates and real estate markets
• Moral hazard problems once a RM loan is taken,
  the homeowners may have no incentive to maintain
  the house to preserve or enhance its market
  value
• Demand side
• It is an unusual product for a typical elderly
  borrower, creating fears of debt burden, eviction
  and inability to bequeath property
• Regulatory uncertainties
• Still novel (or non-existent) legislation in most
  European countries

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Ageing population and demography the role of
financial institutions
1. The need for an European pension market
2. The need to address the risks of an asset
meltdown effect
3. The need for more-marked oriented pension
systems
17
First pillar, generally Pay-As-You-Go pension
scheme, is the most important in Europe

• Countries where private pension plans started
  decades ago have the largest pension markets
  (Anglo-Saxon countries)
• The size of private-pension asset accumulation is
  reduced in countries where public pensions play a
  dominant role (France, Germany, Italy,)

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Increased longevity and falling fertility rates
are major factors making pension systems
unsustainable

• From a fiscal perspective, system sustainability
  requires reforms of the public social security
  systems (parametric or structural)
• Not-reformed PAYG pension systems accumulate
  commitments between one and three times the
  current GDP level
• What will happen if European countries do not
  reform their pension systems? ? The Latin
  American experience

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Countries that moved from PAYG to DC systems had
to face large fiscal transition costs, but will
benefit from lower pension debt

• Counterfactual
• What if Latin American economies had not reformed
  their pension systems?

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Countries that gradually move towards DC schemes
will make the pension system more sustainable
Chile will have large fiscal savings in the
future, despite persistent transition costs
Fiscal savings will make possible a major
upgrade of the solidarity pillar
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Conclusions
Demographic ageing will have a significant impact
on public finances and will put the European
households under strain
Solutions reforming pensions, improving the
efficiency of pension systems, and developing
home equity conversion products

1. Improving the efficiency of European pension
   markets requires facilitating public and private
   pension portability between European countries.
   The development of Pan-European Pension Plans
   should be a priority

1. Financial institutions can contribute to address
   the pension challenge. They can help to provide
   more income security among the elderly by means
   of longevity bonds and reverse mortgages

1. A more marked-orientation of the European pension
   schemes, with more DC components, will make the
   system more sustainable over the long run