Contractual Savings
and
Financial Markets
Alberto R. Musalem,
Thierry Tressel, and
Gregorio Impavido
Definition and Importance of
Contractual Savings

Funded benefit plans:





Retirement savings and Annuities
Life insurance
Funded unemployment benefits, gratuity, end of
service indemnity, severance payments
Funded contingencies: down payment for a house,
education, weddings, funerals
Importance: supply long term savings
2
Financial assets of contractual savings, (% of GDP)
Countries
Switzerland
1970
51
1980
70
43
38.81
17.77
21.04
66.9
21.13
45.77
43.31
17.72
25.59
1.1
life
pension
United Kingdom
life
pension
The Netherlands
45
life
pension
United States
40
life
pension
Chile
life
pension
South Africa
40
life
pension
Malaysia*
18
life
pension
Singapore*
life
pension
17
2.81
14.19
1.1
39.27
17.2
22.07
20.12
3.07
17.05
41.15
6.16
34.99
1990
88.51
32.29
56.22
86.91
36.87
50.04
108.11
36.06
72.05
69.2
25.85
43.35
29.94
5.59
24.35
78.13
43.94
34.19
44.29
5.97
38.32
117.86
11.17
106.69
2000
162.74
60.74
102
176.57
91.57
85
182.82
67.62
115.2
99.79
29.89
69.9
67.49
16.58
50.91
134.92
79.63
55.29
64.18
11.14
53.04
78.11
21.64
56.47
Notes :* Prior to 1990, data do not include funds invested by w orkers in housing and other approved assets.
Source : 1970 data from Davis (1995).OECD:Institutional Inv. Statistical YB, 2001; & Insurance Statistics YB, 2002.
South Africa Reserve Bank, 2002. Malaysia Employees Provident Fund; & Life and General Insurance Funds, 2002.
Chile:Superintendencias de Administradoras de Fondos de Pensiones; Superintendencias de Valores y Seguros. 2002.
Singapore: Employees Provident Fund; and Monetary Authority of Singapore, 2002.
3
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Shares of contractual savings and M2 in financial assets (%, 1996)
100%
90%
80%
70%
60%
50%
m2%
ctr%
40%
30%
20%
10%
0%
4
Economic Impact of Contractual
Savings

Potential positive effects on national saving




Allocation effects due to higher share of long term funds



Requires fiscal adjustment to finance transitional costs of
pension reforms that increase funding
More likely with mandatory funded systems due to credit
constraints faced by low wage earners
Less likely with voluntary plans
Securities market development
Improvement in financial risks management
Growth effects

Due to allocation and potential saving effects
5
Impact of Contractual Savings Institutions
on Securities Market (I)



An increase in CS relative to domestic financial assets
promotes depth of stock and bond markets (MK/GDP)
The impact on stock market depth and liquidity
(VT/GDP) is stronger in countries with more
transparent corporate information
The impact on the stock markets is stronger in
countries where:
1. The financial system is more market based
2. Contributions to pension funds are mandatory
3. Portfolio transactions in the capital account of the
balance of payments are lower
6
Impact of Contractual Savings Institutions
on Securities Market (II)



The impact on the bond market is stronger in countries
with a bank based financial system
The impact of contractual savings institutions on
securities market is not the consequence of a joint
determination of both contractual savings institutions
and financial markets by other slow-moving
characteristics of economies (level of development,
education, demographic structures, legal environment)
Accordingly, policies shaping the institutionalization
of savings do matter
7
Social and Financial
Risk Mitigation Effects




Beneficiaries improve management of longevity, death
and other risks
Reduce debtors refinancing risks, including governments,
by lengthening the maturity of debts
Reduce pressure on banks to engage in excessive term
transformation risks
Reduce enterprise vulnerability to interest rate and
demand shocks due to improved financial structure
(higher equity/debt ratio)
8
Government long-term to total debt ratio
and contractual savings assets, 1996 (% GDP)
DEU
.97
ZAF
GBR NLD
SGP
AUT
JPN
FIN
AUS
ISL
SWE DNK
KOR
NOR
USA
CHE
NZL
FRA
HUN
CAN
GRC
.32
TUR
.003
Financial Assets of CS over GDP
1.482
9
Banks’ Short Term to Total Loans vs Contractual Savings:
Conditional Correlation
Regression Line: STL = -6.03 (4.58) * Log(Csfa,%GDP)+37.5 ( R2=0.18)
STL
Fitted values
96.0695
.00062
-7.48757
.517491
LogCSfa,%GDP(-1)
10
Banks’ Net Interest Margin (NIM) and Contractual Savings:
Conditional Correlation
Regression Line: NIM = -0.60 (-10.78) * Log(Csfa,%GDP)+1.47 (R2=0.35)
NIM
Fitted values
11.8842
.565787
-7.48757
.517491
LogCSfa,%GDP(-1)
11
Banks’ Credit Risk (Loan Loss Provisions to Total Assets) and
Contractual Savings: Conditional Correlation
Regression Line: LLTA = -2.8 E-3 (-3.23) * Csfa,%GDP + 0.6 ( R2 = 0.043)
LLTA
Fitted values
4.17727
.025104
.056
167.781
CSfa,%GDP(-1)
12
Firms’ Leverage (TDTE) vs Contractual Savings:
Conditional Correlation - Market-based Financial
Structure
U n e x p la in e d R e s id u a l ( T D T E )
Residual = -1.16 * (CS Fin. Assets, % Sec. Market) (t-stat = -2.47) Pooled reg., 82 obs.
6.70387
-2.30492
.122694
1.14333
CS Financial Assets, % Sec. Mark
13
Firms’ Leverage (TDTE) vs Contractual Savings:
Conditional Correlation - Bank-based Financial Structure
U n e x p la in e d R e s id u a l ( T D T E )
Residual = 4.0 * (CS Fin. Assets, % Sec. Market) (t-stat = 2.37) Pooled regression, 74 obs.
5.48049
-1.6972
.029634
.608034
CS Financial Assets, % Sec. Mark
14
Firms’ Debt Maturity vs Contractual Savings: Conditional
Correlation - Market-based Financial Structure
U n e x p la in e d R e s id u a l ( L T D T D )
Residual = -0.09 * (CS Fin. Assets, % Sec Mkt) (t-stat = -3.84) Pooled regression, 82 obs.
.1 1 5 2 4
-.1 8 6 2 1
.1 2 2 6 9 4
1 .1 4 3 3 3
C S F in a n c ia l A s s e ts , % S e c . M a rk
15
Firms’ Debt Maturity vs Contractual Savings: Conditional
Correlation - Bank-based Financial Structure
Residual = 0.28 * (CS Fin. Assets, % Sec Mkt) (t-stat = 5.28) Pooled Regression, 74 obs.
Unexplained R esidual (LTD TD)
.180361
-.156052
.029634
.608034
CS Financial Assets, % Sec. Mark
16
Main Issues with Contractual
Savings in Latin America (I)




Except Brazil and Costa Rica, over-reliance on mandatory long term
saving schemes
High administrative costs, high transaction costs (for members and
fund managers due to interaction between pillars on collections and
benefits), high industry concentration and lack of market contestability
High political risk due to dependency of pension fund regulators from
governments
Over-regulated investment policies:
 High exposure to governments
 Restrictions to diversify investments internationally in an
environment where the best companies migrate abroad increases
pension funds portfolio risks
17
Charge ratio in funded pension
schemes
Mexico
Argentina
UK: personal
UK: stakeholder
maximum
Peru
Poland
minimum
Chile
El Salvador
maximum
permitted
Uruguay
Sweden
Colombia
Kazakhstan
Australia
master trust
Bolivia
0
5
10
15
20
25
30
35
charged, per cent of contributions / accumulation
Source: Whitehouse (2000)
18
Main Issues with Contractual
Savings in Latin America (II)

Inadequate opportunities for members to manage
market risks



Limited choices regarding portfolio composition
(although some countries are expanding choices)
Conversion of accumulated balances into
annuities at a given point in time only
Although supervision is gradually shifting towards
a risk based approach, it is still focused on
compliance
19
Recommendations to promote
Contractual Savings in Latin
America (I)


Review regulations and tax treatment to encourage
voluntary long term savings
Review systems design:



Encourage market contestability by allowing opting out to
employer sponsored plans (Australia, Brazil, Hong Kong)
Consider clearing house models (Sweden, Thrift Saving
Plan for federal employees in the USA, Bolivia)
Adopt independent benefit payments between pillars
(Argentina), and restrict switching across pillars (Colombia,
Peru)
20
Recommendations to promote
Contractual Savings in Latin
America (II)



Consider adopting regulators which are independent from
governments and accountable to congresses (central
bank model)
Adopt more flexible investment regulations based on the
prudent person investment rule in tandem with risk based
supervision, and allow gradual opening of investments in
foreign securities
Improve members’ ability to manage market risks:


Increase portfolio options
Allow for multiple and partial conversions of members’
accumulated balances into annuities
21