1. July 4, 2002Minimum Pension Guarantees1 ISSA Seminar Moscow, Russian Federation 3-5 July, 2002 Yvonne Sin The World Bank

2. July 4, 2002Minimum Pension Guarantees2 Context Background: Why are minimum pension guarantees such a hot topic lately? Scope: Guarantees as they pertain to mandatory defined contribution schemes

3. July 4, 2002Minimum Pension Guarantees3 Purpose of a guarantee For social protection For equity For protection against financial market risks For protection against cohort risk

4. July 4, 2002Minimum Pension Guarantees4 Defined as minimum pension level absolute benefit level -- as % of specified income level of the economy relative benefit level -- as % of individual s own wage Defined as minimum return requirement absolute rate of return -- a pre-specified return relative rate of return -- some type of market benchmark or synthetic portfolio Types of guarantees

5. July 4, 2002Minimum Pension Guarantees5 Financing Minimum pension guarantee government -- from general revenues Minimum return guarantee yield fluctuation reserve within the fund cash reserve or capital fund of manager central guarantee fund government

6. July 4, 2002Minimum Pension Guarantees6 Financing Financing mechanism by taxing returns in good years by making additional contributions Cost allocation How costs are allocated can affect intra- and inter-generational transfers

7. July 4, 2002Minimum Pension Guarantees7 Stakeholders Beneficiaries eligibility -- targeted vs. non-targeted Fund managers portfolio restrictions -- affect risk-return frontier for individuals and fund managers public vs. private management -- market based risk and political-economy risk

8. July 4, 2002Minimum Pension Guarantees8 Guarantor Limited liability guarantees -- private sector (including individuals) Unlimited liability guarantees -- government as the ultimate guarantor

9. July 4, 2002Minimum Pension Guarantees9 Cost drivers How guarantee is defined Intervention point -- time horizon Permissible investments

10. July 4, 2002Minimum Pension Guarantees10 Sample costs Non-targeted absolute benefit level -- universal pension Mauritius -- 3% of GDP Targeted absolute benefit level -- means- tested pension Australia -- 3% of GDP Hong Kong -- 1.2% of GDP

11. July 4, 2002Minimum Pension Guarantees11 Sample costs Minimum terminal value 8% of contribution rising to 16% over 40 years In this case, it is the cumulative value, i.e., total return that matters (not the annualized return)

12. July 4, 2002Minimum Pension Guarantees12 Sample costs Guaranteed return of contributions 0.2% of contributions after 10 years and declining to zero thereafter Guaranteed return of real contribution 2% of contributions after 10 years and 0.5% of lifetime contributions after 40 years Guaranteed absolute return over time 2% real return guarantee would cost 4% to 7% of assets

13. July 4, 2002Minimum Pension Guarantees13 Cost drivers Relative return guarantees (Chilean style guarantees) 2% to 4% of assets

14. July 4, 2002Minimum Pension Guarantees14 At a glance

15. July 4, 2002Minimum Pension Guarantees15 Moral hazard Less risk averse Trigger guarantee more often Counter measures monitoring proper pricing and cost allocation regulation

16. July 4, 2002Minimum Pension Guarantees16 Conclusions Customize design to intended purpose Prudent financial management Transparent pricing

17. July 4, 2002Minimum Pension Guarantees17 Lessons learned Providing guarantees without proper costing is risky business Guarantees are not cheap but they should at least be transparent