Optimal investment strategies during the pay-out phase of pensions

Jiri RusnokExecutive Advisor to the Retail Management Committee and Director Pensions, ING Czech and Slovak Republics,

President, Association of Pension Funds of the Czech Rep.

FIAP Conference ‘Pension funds investment policies and strategies’Bulgaria, 1 June 2007

ING 2

People enjoy pension over longer period of time

• Number of years in retirement has increased substantially and will continue to increase

• People play much more active role in retirement

• After retirement they expect to continue their standard of living

60

65

70

75

80

85

1955 1970 1990 2005 2015 2050

Bulgaria Hungary Czech Rep Romania

Life expectancy at birth

Source: United Nations

0

5

10

15

20

1955 2005 2050

Bulgaria Hungary Czech R Romania

Life expectancy at retirement (set at 62 years)

ING 3

Financial implications of ageing

• Especially manifest in pensions and health care/long term care

• Pensions

• PAYG state pensions no longer affordable with current and future demographics

• Defined benefit arrangements under pressure

• Shift of retirement provisions from public to private sector

• Public-private sector cooperation in pension reforms

• Need for new products in build-up and pay-out phase

• Health care/long-term care

• Increased costs of care, especially for senior citizens

• Special product and service packages for senior citizens

• Increased role for private sector

ING 4

Innovation needed in build-up phase

• Worldwide trend from DB to DC

• Many emerging economies introduce individual DC accounts

• Some countries have notional DC accounts (pay-out based on average life expectancy)

• Search for alternatives

• Hybrid: DB to certain level, DC on top

• Collective DC: fairly share risks and returns among all participants

• From bond investments to a worldwide portfolio with various assets

• Emergence of life-cycle investments

• Strike a balance between participants who want freedom to invest and pension provider who has duty to provide care

• Life cycle investment concepts balance the risk over the entire build-up phase

• More equities in initial phase

• More fixed-interest instruments in later phase

• Reduce risk and add protection as the pension date approaches

• Advice on fund selection helps to achieve a solid, well-diversified portfolio

• Mandatory determination of the risk profile for each individual participant

ING 5

Life cycle fund balances risk over entire build-up phase

30 years

20 years

10 years

5 years

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Aandelen LT Bonds ST Bonds Geldmarkt Protected

Average equity %

Equity Liquidity

Rebalance Risk reduction Add protec-

tion

ING 6

The pay-out phase is underestimated

• In pensions attention always focuses on build-up phase

• The pay-out phase is underestimated

• Different pay-out systems • Many countries still have lump sum pay out

• In practice, lump sum payments are often used for other purposes than generating retirement income

• Annuities provide regular income over entire retirement period

• Programmed withdrawals provide regular benefits over estimated lifespan

• Some countries allow early withdrawal of retirement savings

• Will life-long guaranteed pension benefits be sustainable?• People live longer and want to actively enjoy a good pension

• In many countries pay out is insufficient to provide adequate retirement income

• More active management of accumulated pension capital is needed to generate sustainable and adequate retirement income

ING 7

Increased focus on pay-out phase

• More flexibility• Part-time pension• Save for early retirement • Work longer for higher pension

• Guarantees are becoming more expensive• Future perspective:

• A life-long pension to remain!• But life-time guarantees may no longer be affordable• Re-negotiate benefit every 5 or 10 years?

• Roll-over pay-out market• Becomes more and more important• Fierce competition on client assets• Client retention is vital

CRUCIAL ROLE FOR ASSET MANAGERS

40 hrs

30 hrs

20 hrs

10 hrs

0 hrs

55 yr 56 yr 57 yr 58 yr 59 yr 60 yr 61 yr 62 yr 63 yr 64 yr 65yr 66 yr 67 yr

From full-time work via part-time work/pension to full pension

40 hrs

30 hrs

20 hrs

10 hrs

0 hrs

55 yr 56 yr 57 yr 58 yr 59 yr 60 yr 61 yr 62 yr 63 yr 64 yr 65yr 66 yr 67 yr

From full-time work via part-time work/pension to full pension

ING 8

US and Australia: pioneers in pay-out

US

• Individual Retirement Accounts

• Traditional IRA

• Annual contributions up to USD 4,000 (plus additional USD 500 for workers over 50)

• Contributions (partly) tax-deductible, pay-outs taxed

• After age 70.5 mandatory minimum annual withdrawals required

• Roth IRA

• Contributions taxed, benefits tax-exempt (funds must have been in IRA for at least 5 years)

• Only for people with gross annual income below USD 95,000

• No mandatory withdrawals after age 70.5

Australia

• Retirement income streams

• Retirees can spread income and capital across retirement, part of accumulated capital can be retained for further investment

• Allow non-superannuation money to be paid into retirement income streams after retirement

• Promote efficient investment

• Allow flexibility to adjust to individual and changing circumstances

ING 9

Offering annuities in emerging economies

• Benefits

• Annuities are good instruments to provide life-long income stream

• Regular annuity payments to be preferred over lump sum payments

• With their expertise in covering risks and offering guarantees, proving annuities is a natural role for life insurers

• Challenges

• Initial capital base is often low

• Often lack of reliable mortality data

• Capital markets initially underdeveloped: lack of sufficient long-term investment instruments

• Questions

• Who should pay the annuities: centralized institution, pension funds, life insurers?

• Unisex of gender specific tables for life expectancy?

• Strict or lenient government supervision?

ING 10

Different mindset financial industry is needed

• Advisors and financial services providers are accustomed to accumulating wealth rather than distributing it

• Financial services companies want to hold assets as long as possible; customers want to consume their assets over time

• Advice is crucial: the financial industry must understand issues of providing income for life and offer appropriate recommendations

• Focus will be on products that facilitate careful de-cumulation of savings in retirement, along with insurance vehicles that address health-care issues

• Life insurance, long-term care, estate planning, equities, fixed income and annuities must be woven into roadmap that can be adjusted if client circumstances change

• Emphasis on compliance, transparency, simple and straightforward information

• Education of consumers needed to make the right decisions for their retirement plan

ING 11

Offering sustainable retirement income requires cooperation of all stakeholders

Life insurers

• Risk control, guarantees

• Marketing know how

• International expertise

Pension funds

• Execution collective plans

• Administration

• Economies of scale Asset managers

• Investment expertise

• Range of instruments

• Life cycle concept

Intermediaries

• Professional advice

• Tailor-made solutions

• Clear, honest information

Client

• Aware of need to make

retirement provisions

• Seek value for money Regulators

• Not too many, clear rules

• Consumer protection is number one priority

Government

• Offer basic pension (safety net)

• Stimulate retirement savings (tax incentives)

ING 12

Conclusions

• Life cycle investment concepts balance risk and return over the entire contract period

• The pay-out phase of pensions needs more attention

• Annuities are the preferred vehicle to generate regular lifelong retirement income

• More active investment management of accumulated retirement capital is needed

• Learn from forerunners: US and Australia

• Cooperation of all stakeholders and deployment of their specific strengths is essential to offer people sustainable, life-long retirement income

ING 13

Certain of the statements contained herein are statements of future expectations and other forward-looking statements. These expectations are based on management's current views and assumptions and involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those in such statements due to, among other things, (i) general economic conditions, in particular economic conditions in ING’s core markets, (ii) performance of financial markets, including emerging markets, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates (viii) general competitive factors, (ix) changes in laws and regulations, (x) changes in the policies of governments and/or regulatory authorities. ING assumes no obligation to update any forward-looking information contained in this document.

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