Contractual Savings
and
Financial Markets
Alberto R. Musalem, Gregorio Impavido and Thierry Tressel
Financial Sector Development Department
Financial Sector Vice Presidency
The World Bank
Definition and Importance of
Contractual Savings






Funded pensions plans: accumulation period
Annuities: pensions pay out
Life insurance
Funded unemployment benefits, gratuity, end of
service indemnity
Other contingencies - down payment for a house,
education, weddings, funerals
Supply long term savings
2
Financial assets of contractual savings, selected countries
Countries
Switzerland
1970
51.00
1980
70.00
life
pension
United Kingdom
43.00
life
pension
The Netherlands
45.00
life
pension
United States
40.00
life
pension
Chile
40.00
life
pension
Malaysia*
18.00
life
pension
Singapore*
17.00
life
pension
1993
106.82
1998
131.01 /1
32.29
56.22
39.81
67.01
49.44
81.57
38.81
86.91
137.36
167.85
17.77
21.04
36.87
50.04
65.22
72.14
87.79
80.06
66.90
108.11
130.46
166.45
21.13
45.77
36.06
72.05
47.25
83.21
60.34
106.11
43.01
69.20
82.07
113.59
17.72
25.29
25.85
43.35
31.10
50.97
31.85
81.74
1.00
29.28
45.61
54.12 /2
5.59
23.69
8.60
37.01
12.13
41.99
life
pension
South Africa
1990
88.51
39.27
78.13
111.87
109.31
17.20
22.07
43.94
34.19
72.25
39.62
63.49
45.82
20.08
47.18
50.25
59.82
3.26
16.82
7.02
40.16
9.04
41.21
9.17
50.65
41.00
115.13
102.39
116.58
8.44
106.69
12.00
90.39
14.36
102.22
Notes: * Prior to 1990, the data do not include the funds invested directly by individual workers in housing and other approved assets .
/1 1996; 2/ 1997.
Source: 1970 data from Davis (1995) and national central banks, as quoted by Vittas (1998); all other data from World Bank database
and OECD 2000 Institutional Investors Statistical Yearbook
3
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Contractual savings and M2 as percentage of financial assets (1996)
100%
90%
80%
70%
60%
50%
m2%
ctr%
40%
30%
20%
10%
0%
4
CONTRACTUAL SAVINGS % OF CAPITAL MARKETS (STOCKS AND BONDS)
Comparing Two Years During the 1990s
5
Financial Market Effects






Increase demand for shares and bonds, market
capitalization and volume traded: increase depth
and liquidity
Increase demand for long term bonds
Increase supply of long term loans
Improve regulations and transparency
Foster financial innovation, competition and
efficiency
Improve corporate governance
6
Market capitalization and contractual savings assets, 1996 (% GDP)
MC/GDP
2
ZAF
SGP
GBR
1.5
CHE
AUS
USA
1
SWE
CHL
NLD
CAN
JPN
NZL
THA
.5
FIN
BEL
NOR FRA
KOR
DEU
ESP
PRT
ITA
GRC
HUN
DNK
ISL
AUT
0
0
1
.5
1.5
CS/GDP
7
Value traded and contractual savings assets, 1996 (% GDP)
VT/GDP
1.5
CHE
1
USA
NLD
AUS
SWE
GBR
.5
CAN
ESP
SGP
KOR
DEU
THA
JPN
NOR
FRA
HUN
NZL
AUTBEL
ITA
GRC
PRT
ISL
0
0
ZAF
FINDNK
CHL
1
.5
1.5
CS/GDP
8
Causality




In countries with developed capital markets, direction of
causality between contractual savings and either market
capitalization or value traded is not clear.
In countries with underdeveloped capital markets, either
contractual savings causes market capitalization and value
traded, or causality runs both ways.
In developing countries, pension funds cause market
capitalization while life and non-life insurance cause value
traded.
In Malaysia and Singapore there is no causality in either
way between institutions and mkt capitalization or value
traded.
9
Market Capitalization







Estimator: Error Components 2 Stage Least Square
(EC2SLS), N=281, 26 unbalanced panels (21 OECD and 5
non-OECD countries, 1975-97)
Positive impact: contractual savings, non-life ins., value
traded, real return on stocks
Negative Impact: real return on money, real interest rate,
book reserves, stock price index volatility
Step dummy: developing countries with positive coefficient
Endogenous variables: asset returns
Exogenous variables: all other
Diagnostics: various specification tests passed
10
Value Traded





Estimator: EC2SLS, N=233, 26 unbalanced panels (21
OECD and 5 non-OECD countries, 1975-97)
Positive impact: contractual savings share portfolio, nonlife insurance share portfolio, real return on money
Negative impact: real interest rate
Step dummy: developing countries with positive coefficient
Diagnostics: various specification tests passed
11
National Saving Effects






Mandatory plan and credit constraints increase
household saving but watch welfare effects
Non-captive funding for public sector promotes its
saving
Significant shift to funding promotes saving
Transition cost financed by cutting the non-pension
public sector deficit increases Government saving
System coverage and retirement ages are increased
Uncertain effect from voluntary plan (tax incentive)
12
Contractual Savings and Growth






Potential increase in saving
Decline in the cost of capital: equity and debt
Flatten the term structure of interest rates
Reduce the country risk premium
Promote efficiency gains
Virtuous cycle: higher growth increases saving thus
furthering growth
13
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)
Reduce capital markets volatility
14
Debt-equity ratios of listed companies
and contractual savings assets, 1997 (% GDP)
T o ta l D e b t o v e r E q u it y
4 .1 4 34 1
TH A ILA N D
K O R E A (S
FR A NC E
ITA LY
B R A ZIL
S R I LA N K
U N ITE D K
G E R M AN Y
S P A IN
M
EG
X IC
O
R TU G A L
AR
EP
NO
TIN
N E W ZEA L
N E THE R LA
C H ILE
U N ITE D S
C A N AD A
A U S TR A LI
S O U TH A F
.2 3 0 17 1
IN D IA
.0 1 3 97 6
1 .9
C S F in a n cia l A sse ts, % G D P
15
U N IT E D S
.8 0 5 6 0 3
NEW ZEAL
CANAD A
AU STR ALI
M E X IC O
o v e r
T o ta l D e b t
Long-term to total debt ratio of listed companies
and contractual savings assets, 1997 (% GDP)
NE THE RLA
C H IL E
U N IT E D K
D e b t
IN D IA G E R M A N Y
B R A ZP
I LO R T U G A L
FR ANC E
SO U TH A F
L T
IT A L YK O R E A ( S
S P A IN
ATRHGAEILNATNIND
.3 0 5 5 0 7
SR I LAN K
.0 1 3 9 7 6
1 .6 9 4 3 6
C S F in a n c ia l A s s e ts , % G D P
16
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
17
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
18
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
19
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
20
Development of Contractual
Savings Institution

Reform pension systems to increase funding
Mandatory: privately or publicly managed
 Voluntary
 Regulation and supervision of pension funds: allow banks and
life insurance companies to market pension plans
 Tax treatment


Developing life insurance
Regulation and supervision: allow banks to market insurance
 Tax treatment

21
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
22
Portfolios Composition
Pension funds portfolio composition
100%
10
6
8
14
15
15
39
38
37
12
13
11
46
52
11
90%
80%
70%
36
38
36
44
60%
50%
59
8
9
11
7
40%
9
9
8
7
6
30%
3
41
41
38
34
20%
33
34
32
31
28
25
10%
5
0%
1980
6
7
6
5
5
4
3
3
2
1982
1984
1986
1988
1990
1992
1994
1996
1998
Cash and deposits
Bills and bonds
Loans
Shares
Source: OECD Yearbook of institutional investors and WB database
Other
24
Pension funds portfolio composition (Common Law)
100%
10
8
9
15
16
16
41
41
40
90%
13
13
49
51
12
11
80%
70% 39
39
40
60%
50% 4
3
3
3
3
3
41
43
62
3
40%
30%
57
2
2
42
2
35
34
35
20%
31
31
26
23
10%
6
0%
1980
6
7
6
6
6
4
3
3
2
1982
1984
1986
1988
1990
1992
1994
1996
1998
Cash and deposits
Bills and bonds
Loans
Shares
Source: OECD Yearbook of institutional investors and WB database
Other
25
Pension funds portfolio composition (non-Common Law)
100%
8
8
7
7
5
90% 3
4
6
7
13
5
6
8
8
11
10
13
20
80%
23
28
70%
49
60%
50%
75
64
70
61
43
52
35
29
16
40%
30%
41
20%
10%
12
0% 2
1980
32
34
33
36
28
21
23
2
2
2
2
4
4
4
4
4
1982
1984
1986
1988
1990
1992
1994
1996
1998
16
Cash and deposits
Bills and bonds
Loans
Shares
Source: OECD Yearbook of institutional investors and WB database
Other
26
Pension funds portfolio composition (MYS and SGP)
Cash and deposits
0%
Loans
0%
Shares
0%
Other
0%
Other
0%
Shares
17%
Cash and deposits
24%
Loans
27%
Bills and bonds
32%
Malaysia: EPF
Bills and bonds
100%
Singapore: CPF /1
Notes: 1/ 100% of assets are invested in non-tradable govt. securities. Money is channeled through the Consolidated Fund to
investment holding companies of the Singapore Government. No public disclosure of their operations is required or made.
Source: WB database
27
Share of long-term bonds in bonds portfolio
96%
94%
92%
90%
88%
86%
84%
82%
80%
1982
1984
Life
1986
1988
Pension funds
1990
1992
1994
1996
Non-life
Source: OECD Yearbook of institutional investors and WB database
28
Share of foreign bills and bonds in bills and bonds portfolio
25%
20%
15%
10%
5%
0%
1982
1984
Life
1986
1988
Pension funds
1990
1992
1994
1996
Non-life
Source: OECD Yearbook of institutional investors and WB database
29
Share of foreign stocks in stocks portfolio
35%
30%
25%
20%
15%
10%
5%
0%
1982
1984
Life
1986
1988
Pension funds
1990
1992
1994
1996
Non-life
Source: OECD Yearbook of institutional investors and WB database
30
Country List
ARG
AUS
AUT
BEL
BRA
CAN
CHE
CHL
DEU
DNK
ESP
Argentina
Australia
Austria
Belgium
Brazil
Canada
Switzerland
Chile
Germany
Denmark
Spain
FIN
FRA
GBR
GRC
HUN
ISL
ITA
KOR
LKA
LUX
MYS
Finland
France
United Kingdom
Greece
Hungary
Iceland
Italy
Korea, Rep.
Sri Lanka
Luxembourg
Malaysia
NLD
NOR
NZL
PRT
SGP
SWE
THA
TUR
USA
ZAF
Netherlands
Norway
New Zealand
Portugal
Singapore
Sweden
Thailand
Turkey
United States
South Africa
31