Readiness Indicators
10. Historical Context
Two factors relating to a country’s economic history may have a direct bearing on the receptiveness of its population to a funded pension reform and the likelihood of the reform’s successful implementation. The first fac-tor is whether vibrant financial markets, including securities exchanges,
154 Appendix
existed prior to the beginning of the economic transformation in 1990. In the CESE region this could only have been the case before the communist takeover shortly after World War II. The existence of stock exchanges, issuers, and institutional investors in a country indicates, to some degree, how far advanced it was as a market economy before history forced it onto a different route. A legacy of regulations, forms of enterprise, and basic notions may positively influence how complex financial products and services are now viewed by the general public and to what extent one can rely on historical analogies.
The second factor is whether a country has experienced a major crisis or scandal attributable to insufficient financial market regulation or enforcement or to poorly conceived or incomplete conceptual underpin-nings of the processes governing the country’s economic transformation.
Failed voucher privatizations, pyramid schemes, poorly regulated or fraudulent undertakings parading as legitimate financial services, prob-lems with accounting and auditing standards, or a lack of transparency surrounding trading—just to mention a few potential pitfalls—can under-mine popular faith in the capital markets and hinder the active participa-tion of individual investors in those markets. Indeed, these sorts of problem can slow the withdrawal of the public sector from the manage-ment of the economy. Forcing people to invest their pension savings with privately managed financial service providers can be politically difficult under such circumstances.
Applied Methodology for Rating
The indicators for the 10 assessment areas have been applied to five coun-tries that have introduced mandatory funded pension schemes (Bulgaria, Croatia, Hungary, Poland, and the Slovak Republic) and to four countries that have introduced only voluntary or supplemental funded pension schemes (the Czech Republic, Romania, Serbia, and Slovenia). For the for-mer group, the criteria are evaluated both in the year of their reforms and five years later (or in 2006, whichever came first). Some of the weights changed in importance across these two periods. For the latter group, the ratings reflect conditions in 2006, with, at times, different weights and with some indicators excluded on grounds of relevance.
In appendix table A.1 the codes for whether criteria have been met cor-respond to standard traffic light colors: green (G) means that criteria have been met, yellow (Y) means there are doubts, and red (R) indicates that cri-teria have not been met. Because the cricri-teria are not all equally important,
Readiness Indicators 155
a second dimension is included: the importance of the readiness condition, ranging from high (H) to medium (M) to low (L). Situations where an item is not applicable are designated X.
To calculate an overall (normalized) score across all the indicators, a three-by-three matrix was used to weight the relative importance of dif-ferent combinations of flags and the relative importance of readiness con-ditions. Weights were chosen to elevate the importance of extreme observations. The normalization of scores between 0 and 100 percent of readiness is based on the minimum and maximum scores observed.
To refine this rudimentary assessment and make it more dynamic, the middle group of column-heads in appendix table A.1 contains data indi-cating whether changes are perceived as being positive or negative. This differentiation is important in cases where a country’s overall assessment did not change but changes were nevertheless observed.
For the indicators related to quantitative measures of supply, demand, liquidity, depth, and transactions, the assessments reflect relative meas-ures. Although the overall supply of domestic equities may have increased substantially since a reform was launched—for example, because the growth of pension assets outpaced the growth in the supply of financial assets—the situation will have worsened when observed from the point of view of the pension industry.
References
Blake, David, Andrew Cairns, and Kevin Dowd. 2008. “Turning Pension Plans into Pension Planes: What Investment Strategy Designers of Defined Contribution Pension Plans Can Learn from Commercial Aircraft Designers.” Presented at the Fourth Contractual Savings Conference, “Supervisory and Regulatory Issues in Private Pensions and Life Insurance,” World Bank, Washington, DC, April 2–4. http://www.pensions-institute.org/workingpapers/wp0806.pdf.
EBRD (European Bank for Reconstruction and Development). 2006. Transition Report 2006: Finance in Transition.London: EBRD.
Rudolph, Heinz, and Roberto Rocha. 2007. “Financial Preconditions for Second Pillars.” Draft, World Bank, Washington, DC.
H M L
G 8 4 2
Y –8 –4 –2
R –32 –16 –8
156 Appendix
A
adequacy, 20 affordability, 20 annuities, 64, 72, 73, 148
fixed indexed, 76 life, 77
pricing, 75
annuity markets, 64–72 Chile, 69
developing, 77
assessment, purpose, 24–25 asset prices, 79, 119, 124
aging and, 68
conceptual issues, 128–129 efficient market, 125–126 empirical evidence, 126–128 meltdown, 93n.7, 124–125 population age structure and, 126 questions, 129–130
US population age and, 123 asset-liability term risk, 77, 80n.7 assets
accumulation, 64, 80n.1 aging and GDP and, 65 allocation, 50, 130 availability, 87
demand for, 50 holding, 126
per capita income and, 67 selling, 125
auctions, 80n.6
Australia, annuitization, 73, 75
B
baby boomers, 64–65 saving, 119
bank assets, per capita income and GDP, 66
bank-based systems, 51–55 bank deposits, 44–45, 46,58n.2 banking reform, 16
transition indicator scores, 31–32 banking sector, 30
size, 52
socialism and, 67–68 banking systems, 35, 57
resources, 50 benchmarking, 58
benefits payout. See payout phase bonds, 49, 93n.3
categories, allocation of assets, 37 corporate, 93n.3
Index
157
emerging markets,114n.4 longevity, 78–79 market, 53
mortgage,59–60n.14 prices, 65, 122 supply, 42 borrowing, 129–130
Brazil, pension fund investments,60n.15 Bulgaria, 25–26, 27
C
capital asset pricing model (CAPM), 85 capital inflow, 110, 112
capital markets, 41–42 development, 47, 57 domestic, 54 reaction, 53 reforms, 113 size, 52
capitalization regimes, 46
Central, Easter, and Southern Europe (CESE), 2
Chile
financial structure, 54–55 investment guidelines,59n.13 mortgage bonds,59–60n.14 pension system, 69–72 commission-to-salary ratio, 93n.8 company owners, 53
competition, 48
conflict, expectations vs reality, 125 conglomerates,58n.4
corporate debt, returns on, 84 corporate governance
emerging markets, 106, 108 standards, 109
corporate investment,59n.10 costs
administrative, 90 transaction, 89, 91 Croatia, 25–26, 27 cross-listing, Europe,59n.11 currencies, 106
D debt
financing, 48–49
government, 35–36, 46, 48,58n.5, 84, 148
issuing, 49
management, 69, 78 public, 72
decentralized model, 77 demographics, 5, 65, 79, 120–123 Denmark, 80n.4
derivatives, 80n.7 diversification, 98,115n.8
E
economic and institutional playing field, 48
economic growth, 6 economic transition, 13–14 education, 10–11
efficient market view, 125–126 elderly, per capita income and, 66 emerging markets, 7, 97–117
investing in, 7, 90–91, 92, 105–112, 113–114n.1
productivity, 105–106
rights, protection, and governance, 106–109
risks, 106
small markets, liquidity, and trading, 109–112
time-varying returns, 106 volatility, 106
equity, 85, 86, 87 corporate, 48–49 demand for, 72 indexes, 107
markets, ownership, 113,115n.12 outside, 53
returns, 88
EU15 countries,135n.1
Europe and Central Asia (ECA), 38n.1 excess demand, 42–43, 51, 57,58n.1 exchange rate volatility, 107 expectations, optimistic, 98, 99
F fees, 89
fertility rates, 2, 120–121 financial assets, 66–69
demand for, 48 financial conglomerates, 47 financial flows, 129–130 financial globalization, 54 financial instruments, availability,
145–146, 152–153 financial literacy and education,
10–11, 147, 153–154 financial markets, 14, 46, 57 158 Index
development, 4, 10, 41–62 domestic, 1
Hungary,59n.12 meltdown, 123–130 Peru,59n.12
financial readiness. See readiness financial returns, gross, 84–88 financial sector, 3–4, 29–37
criteria, 23–24 development, 4, 16, 38 readiness, 23–29
financial services, availability and quality, 144–145, 151, 152
financial structure, Chile, 54–55 financing, captive sources, 56–57 firms, 53
listed, market capitalization and trading volume, 49
first-pillar schemes and reform, 19 fiscal approach, prudent, 140, 149–150 fiscal sustainability, 15
fixed-income assets, 68
fixed-income instruments, 64, 69, 72 fixed-investment financing,59n.10 foreign assets, 7, 99, 102, 112
efficiency, 103
emerging countries, 101, 104,114n.3 household portfolios, 99
OECD countries, 101, 104 pension portfolio share, 100, 101 regulations, 99–100
returns, 104
foreign investment, 104–105 funded components, 73 funded pensions, 1, 3
ability to support, 30–31 contributors, 68 pillars, 25, 30, 16 futures markets, 57
G
governance, 146, 153
government debt, 35–36, 46, 48, 148 Peru,58n.5
returns on, 84
government fiscal situation, 148 gross domestic product (GDP),
2, 92, 133 growth, 6
emerging markets, 109 growth per capita, 93n.9 pension as a percentage of, 15
H
health care schemes, 120 historical content, 147, 154–155 home bias, 98–100
households, 53 Hungary, 26,59n.12
I
implicit partial equilibrium, 48 incentives, 46, 47–48
indexation, 69 indexed instruments, 78 indicator weights, 148 information
asymmetries, 106, 108
availability and quality, 143, 151 barriers, 98–99
instability, macroeconomic, 113 institutional infrastructure, 24, 54, 64,
76–77, 141–142, 150–151 institutional investors, 48 insurance companies, 64, 77 insurance policies,58n.4 interest rates
liberalization, transition indicator scores, 31–32
real vs bank,114n.5
international diversification, 7, 102–105, 112 vs domestic, 97–101
international financial markets, 1 investment
assets, demand for, 112 banks,115n.9
opportunities, securitized assets, 55–56 options, 55–57
strategies, 68
investment guidelines, 47, 93n.4,114n.3 Chile,59n.13
investors
protection, 50–51, 57 rights, 49–50,59n.6, 106
K
Kazakhstan, 19 Kosovo, 19
L
labor force, 129 growth, 131–132 projected change, 124
Index 159
legal framework, 24, 141–142, 150–151 protections, 108, 109
rights, 108 lending, 129–130
life cycle considerations, 128 life expectancy, 120, 129, 130, 133 life insurance, 72
Chile, 71 companies, 75
pension assets and, 71–72 liquidity, 109
longevity risk, 10, 65, 75–79
long-term fixed-income instruments, 69 lump-sum payments, 73, 75
partial, 76
M
market-based instruments, 88 market-based systems, 51–55 market capitalization, 27, 54–55, 113,
115n.10
OECD vs emerging economies, 111 pension fund assets and, 42–43, 46 volume and turnover, 110 market transparency, 73, 77
meltdown view, 93n.7, 124–125, 134 migration, 14, 131–132
mortgage bonds, Chile,59–60n.14 multipillar pension systems, 16
introduction, 23 objectives, 46
reforms in transition economics, 14–23
transition economies, 17–19 mutual funds, 85,115n.11
N
net returns, annual, 89–90, 91 nonbank financial institutions (NBFI)
assets, 68 GDP vs, 66
per capita income and, 67 transition indicator scores, 33–34 nonfinancial pension schemes, 131 notional defined contribution (NDC)
pension schemes, 131
O
OECD countries, 93n.2 options, 57
P
pay-as-you-go pension systems, 15, 46, 76, 83, 120, 121 payout phase, 5, 63–82
benefit formulas, 15 challenges and options, 73–79 design, 73, 74
financial instruments, 77–79 issues, 64, 73
procedures and mechanisms, 10 pension assets, 63
OECD vs emerging countries, 111 pension contributions, diverted, 149 pension expenditure, gross, as a
percentage of GDP, 21–22 pension fund assets, 42–43,58n.2, 88
allocation, 84–88
pension fund managers, 47, 50, 80n.3 pension funds
benefits, 89 Chile, 69–72
financial market and, 43, 46 GDP, percentage of, 15 growth,59n.7 investments,60n.15 management, 76–77
mandatory defined contribution, 68–69
net returns, 89–91 objective, 19–20 participants, 68, 80n.2 pay-as-you-go, 6, 7 portfolios, 35, 72 real returns and risks, 104 reform, 14–15, 47, 51, 121
regulatory limits and actual shares, 44 replacement ratios, 103
restrictions, 47 per capita income
bank assets and, 66 elderly and, 66 NBFI and, 67 total assets and, 67
performance, uniformity, emerging markets, 106
Peru, financial market development, 59n.12
Poland, 25–26
policy, 8–9, 53, 57, 58, 73, 75 ill-conceived, 46
policy makers,115n.9 160 Index
population aging, 1 CESE, 2
portfolio allocation, 70–72, 79, 85–86, 107
Chile, 71, 72
emerging countries, 86 OECD countries, 85 theory, 97–98
volatility, minimizing, 103–104 premiums, high-risk/low-risk, 6 preparedness. Seereadiness prices, 5, 9
asset, 42 priorities, 8–9
private pension funds, 19, 68, 80n.2 private sector, 130
privatization, 58 privileges, 15
productivity, 93n.7, 133 emerging markets, 105–106 marginal,114n.5
protection, emerging markets, 106, 108 prudent person standard, 93n.4
R
rates, variation, 129 rates of return, 1, 9, 92, 120
aging population and, 119–137 explicit, 8, 135
implicit, 8, 134–135 internal, 134
population aging and, 7–8, 130–131
real net, 6
rating, applied methodology, 155–156 readiness, 9, 37, 73
assessment, 148, 149–155 financial sector, 3–4, 23–29 indicators, 26, 29, 139–156 quantifiable, 148
real financial asset returns, population age structure vs, 126
reforms, 3, 37–38
regulatory framework, 47, 56, 64, 68–69, 72, 73, 76–77, 93n.5, 114n.3,115n.9
foreign securities, 99–101 risk-based, 58
retirement, 1, 64 income, 84–85 savings, 50
retirement products, 68, 79 market, 73
menu, 75–76 returns
annual gross real pension fund, OECD countries, 87 assets, 93n.11
debt, 84
emerging markets, 106 equity, 84
estimation, 89 excess, 92 implicit, 130–134 investment, 92n.1 real, 84
real net rate, 92 risk vs, 104 stocks, 93n.6 sustained, 5–6, 83–97 volatility vs, 107
risk management, 77, 113-114n.1, 114–115n.7
S
savers vs dissavers, 8–9, 120, 121–122 saving behavior, 128–129
second pillar, 80nn.4,5 annuities, 75
assets volume and structure, 36 pension funds, current status, 37 schemes, 19
securities,59n.8 captive demand for, 57 coupon, 78
domestic, 93n.3
nontraditional and unlisted, 58 ownership, 65
Peru,58n.5
trading volumes and turnover,59n.9 securitization, 55–56
security markets, transition indicator scores, 33–34
self-financing, 49 shareholder rights, 108 Slovak Republic, 26 sovereign debt
investments, 48 maturities, 57 stocks
emerging markets,114n.4 pension funds, 44–45
Index 161
prices, 65, 122, 127
returns, 87–88, 93n.6, 102–103 supply, 42
trading volume, 27–28 UK vs US, 87–88 stock markets, 51, 54
capitalization, as percentage of GDP, 27
sustainability, 20, 23 Sweden, 76–77, 80n.5
T
tax administration and collection, 24, 57, 141, 150
trading
emerging markets, 109–112 volumes, 53
transaction security, 143–144, 151–152 transition deficit, 149–150
transition economies, 15–16 transition indicator scores, 30, 35
banking reform and interest rate liberalization, 31–32
security markets and nonblank institutions, 33–34
transparency, 106
U
unfunded pension schemes, 19 implicit returns, aging and, 130–134 see also pay-as-you-go pension systems United Kingdom, equity returns, 88 United States
equity returns, 88
pension fund investments,60n.15
V
venture capital, US,60n.15
volatility, emerging markets, 106, 107, 108 voluntary schemes, 11n.1
W
wage growth, per capita, 132–134 wealth accumulation, 125 withdrawals, phased, 75–76
Y
yield, reduction, 89
Z
zero-pillar schemes, 19 162 Index
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