1

Executive Summary: Research Studies on Developments in Retirement Income Portfolios

Olivia S. Mitchell *

A Report on the Collaboration Project on Aging Economics -“Economic and Social Systems in the 21st Century" Sponsored by the Economic and Social Research Institute Cabinet Office, Government of Japan

Version of January 19, 2002

Professor Mitchell is Research Associate at the NBER and the International Foundation of Employee Benefit Plans Professor of Insurance & Risk Management and Executive Director of the Pension Research Council at The Wharton School [3641 Locust Walk, 304 CPC, University of Pennsylvania, Philadelphia, PA 19104-6218]. Email: [email protected] • http://prc.wharton.upenn.edu/prc/prc.html; Phone: 215/8980424 • Fax: 215/898-0310

Draft Final Report Fall 2001

1

Executive Summary: Research on Retirement Income Portfolios Olivia S. Mitchell

This memorandum summarizes my group’s research work on the project sponsored by the Economic and Social Research Institute, Cabinet Office, Government of Japan over the last two years in collaboration with the National Bureau of Economic Research. We have completed a number of papers and give a number of presentations, as outlined below. I also anticipate that the collaborators as a group will remain actively interested in follow -on work in the future, should such be feasible. Study Objectives The Japanese population is aging more quickly than any other nation in the world, leading policymakers and researchers alike to focus with keen interest on the structures available to provide the aging Japanese population with reliable, sustainable, affordable, retirement income. During this project, my team’s analysis has generated new knowledge on retirement income portfolios around the world and in Japan specifically. We have looked at what has worked well in the past, what requires reform, and asked what lessons from other countries might be useful to those charged with reforming the Japanese old-age system. In order to undertake this research I have visited Japan numerous times with additional trips planned in 2002, and my research collaborators have also visited as well. The research team has carried out a number of studies and produced numerous studies, listed below. We have also participated in several conferences in Japan and elsewhere at which we have shared the findings of this research. We have already forwarded several papers on these topics, and we have submitted additional ones for the Final International Conference in February of 2002. Specific Accomplishments Our research project has generated knowledge about how financial markets are changing as global competition increases, and as financial services become integrated across sectors. My team of collaborators and I have conducted research on several major studies addressing the

Draft Final Report Fall 2001

2

following questions pertinent to the issue of old-age economic security in Japan and around the world: 1. What are the changing roles of annuity products in the retirement portfolio, and how is this relevant to the Japanese case? This research explored links between resources and consumption flows in retirement and characterized the relationship between public provision of pensions and private insurance markets. We analyzed mortality data for annuities in Japan, Australia, Singapore, and the US. In addition we have examined the financial instruments that retirees have available to them in a range of different countries, and we have evaluated how these financial instruments protect against mortality risk in Japan as well as a wide range of other countries. We concluded that though annuitant mortality patterns vary across countries, there is an expected range that may be anticipated in the developed world. 2. How do pension costs affect pension outcomes? This project used statistical methodology to compare administrative expenses in pension plans to examine how design and structure afford opportunities for cost-savings. This information is of help to Japanese pension designers who seek to place domestic costs within the range of international charges. We show that administrative costs are lower for defined contribution than defined benefit plans. In addition we have illustrated how participant choice between mutual funds, versus restricted choice, versus group choice affects cost consequences. Finally our latest work explores the links between pension governance, management, disclosure, and investment strategies. We further ask how pension investment performance is influence by design and structure as well as governance. We use new dataset from Australia to evaluate its potential relevance as a model for future data gathering on Japanese pensions. The results show that governance as well as management structures can influence performance. 3. How will changes in the Japanese pension environment influence retirement security? We undertook a comprehensive assessment of Japanese retirement plans at the beginning of the twenty-first century and then explored how recent economic and demographic changes are shaping the course of retirement policy in Japan. In the last decade, a number of important changes have occurred including the continuation of population aging placing further greater burden on retirement systems; the continued economic slowdown

Mitchell – NBER – Executive Summary Year 2 – 1/18/02

3

that has altered the financial status of employers, pension funds, and the Japanese government; changes in Japanese financial markets that have affected the value of pension funds , the management of these funds, and the introduction of new pension plan types; and important legislative changes in public pension plans to reduce cost burdens. After assessing Japanese retirement plans at the beginning of the twenty-first century, we explored how recent legislative changes are shaping the course of retirement policy in Japan. We concluded that the advent of defined contribution plans in Japan will enhance the development of funded personal account pensions, though the take-up may be slow and limited to more forward-looking firms seeking to reduce pension liabilities. 4. What is the role of housing in the retirement portfolio? We have sought data on Japanese housing values but to date have not gained access to household-level data to explore net equity of the elderly. Discussions with various Japanese academics continue with the hope of collaborating on future survey-gathering of such information. We have successfully devised a model to explore the role of housing equity in the retirement portfolio, on both the accumulation and decumulation fronts. We further explored the extent to which this source of wealth might serve as a form of old-age protection. Our results show that retirees can become “asset-rich but cash-poor”, which will necessitate new financial and insurance products to preserve living standards in old age. Research Collaboration and Research Output In carrying out the research in each of these areas, our group has included a wide range of international colleagues and particularly many fine and helpful Japanese counterparts. We had several visits to Japan, met with a wide range experts at the ESRI and other government agencies, been in close touch and met with dozens of Japanese policymakers and academics, and interacted successfully with a wide range of private-sector experts. To date we have generated several working papers on these topic and expect additional ones to be written in the year to come. ESRI support has been helpful in the preparation of the following studies: n Bateman, Hazel, and Olivia S. Mitchell. “A New Look at Pension Plan Administrative Expenses”. Presented at the International Forum of the Collaboration Projects, Tokyo, March 2001. Submitted for publication.

Mitchell – NBER – Executive Summary Year 2 – 1/18/02

4

n Bateman, Hazel, and Olivia S. Mitchell. “Mana gement and Performance of Pension Systems in Australia”. For presentation at the International Forum of the Collaboration Projects, Tokyo, February 2002. n Clark, Robert L. and Olivia S. Mitchell. “Strengthening Employment-Based Pensions in Japan.” Benefits Quarterly, forthcoming. n Mitchell, Olivia S. “Managing Pensions in the 21st Century: Design Innovations, Market Impact, and Regulatory Issues for Japan.” In Toshihiro Ihori and Toshiaki Tachibanaki, eds. Social Security Reform in Advanced Countries. Routle dge: London, forthcoming. n Doyle, Suzanne, Olivia S. Mitchell, and John Piggott. “Annuity Values in Defined Contribution Retirement Systems: The Case of Singapore and Australia”. Presented at the International Forum of the Collaboration Projects, Osaka, September 2000. Submitted for publication. n McCarthy, David and Olivia S. Mitchell. “Assessing the Impact of Mortality Assumptions on Annuity Valuation”. Presented at the International Forum of the Collaboration Projects, Osaka, September 2000. Submitted for publication. n McCarthy, David and Olivia S. Mitchell. “Estimating International Adverse Selection in Annuities”. In revision. n McCarthy, David and Olivia S. Mitchell. “International Adverse Selection in Life Insurance and Annuities”. September 2000. Submitted for publication. n McCarthy, David, Olivia S. Mitchell, and John Piggott. “Asset Rich and Cash Poor in Singapore? Retirement Provision in a National Defined Contribution Pension Fund.” NBER WP 8091, Jan 2001. Submitted for publication. n Mitchell, Olivia S. “Benefits for the Workplace of the Future.” Pension Research Council Working Paper, Oct. 2001. Submitted for publication. My team and I have also given several talks on this and related research, including the following: 2000 Jan.: Jan.: Jan.: Jan.: Jan.: Feb: Mar: Mar: Mar: Mar: Mar: Mar: May:

“Developments in DC Pensions”. AIMSE, Wharton Exec Ed. “Pension Challenges for Japan”. PRC, Wharton. “Social Security Reform”, Sound Money, MPR. “Developments in Retirement Decumulation”. Financial Inst. Center, Wharton. “Pension Challenges for Japan”. Wharton. “Inflation-Linked Annuities”, NBER, Boston. “The Simple Economics of Pension Reform”, and “The Environment for Pension Reform”, World Bank, Washington, DC. “2020: A Possible Future”, CNN documentary. “Developments in Retirement Accumulation& Decumulation”, and “Changes in Pensions”, Securities Industry Institute, Wharton. “The Environment for Pension Reform”, World Bank, Washington, DC. “Developments in Retirement Accumulation and Decumulation”, Wharton. “Annuity Market Developments”. IRM Department, Wharton. “Mortality Risk, Inflation Risk, and Annuity Products.” Pension Research Council, Wharton.

Mitchell – NBER – Executive Summary Year 2 – 1/18/02

5

June: June: July: July: July: July: July: July: Sept: Sept: Oct: Nov: Dec: Dec: 2001: Jan: Mar: Mar: Mar: Mar: Mar: Apr: Apr: May: May: June: July: July: July: July: July: July: July: July: July: Aug: Sept:

“Pension Design Fundamentals”, “International Annuities Markets”, Pension Efficiency”, HIID Program on Global Pensions in Crisis, Kennedy School, Harvard. “The ABC’s of Pension Design”, and “Global Pension Reform”, Goldman Sachs Program for South Africans in International Banking, Wharton Exec Ed. “Developments in Pensions and Retirement Income”, Pension Theory Group, Tokyo. “Financial Innovations in Retirement Income”. SMU, Singapore. “Mortality Assumptions & Annuity Valuation”& “Financial Innovations in Retirement Income”. Sydney, Australia. “Financial Innovations in Retirement Income”. Singapore Management University, Singapore. “Assessing the Impact of Mortality Assumptions on Annuity Valuation”, and “Financial Innovations in Retirement Income”, 8th Annual Colloquium of Superannuation Researchers, Sydney Australia, July 2000. “Developments in Pensions and Retirement Income”, Pension Theory Research Group, Tokyo, Japan. “Global Developments in Pensions”. SEI Investments, Oaks, PA. “International Developments in Annuity Markets”, and commentary on Burtless/Bosworth project, International Forum of the Collaboration Projects, Osaka, 2000. “Global Pension Challenges”, Brazilian Pension Fund managers, TIAA-CREF. “Annuities in Pension Systems”, “Building an Environment for Pension Reform”, and “Global Issues in Pension Reform”, ADB Conference on Indian Pension Issues, Delhi. “Pension Challenges for the 21st Century”, and “Social Security Reform”, ICSS-TELMAR, Wharton Exec Ed. “Understanding Social Security”, Wharton Business Writers Forum. “Annuities, Mortality Risk, and Inflation”, AEA meetings, New Orleans. “Annuity Markets in Asia and Australia”, SMU, Singapore “New Evidence on Pension Administrative Expenses”, ESRI, Tokyo “Estimating International Adverse Selection in Annuity Markets”, NUPRI, Tokyo. “Annuity Markets in Asia and Australia”, SMU, Singapore “Developments in the US Pension Market”, Pension Fund Administrators, Tokyo. “Public Pensions in the United States”, Hay Group, DC. “Asset Rich and Cash Poor”, Real Estate Dept, Wharton. “Annuity Products & Financing Retirement,” Frankfurt. “Developments in Decumulation: The Role of Annuity Products in Financing Retirement. ”Bundesbank Conference on Aging, Financial Markets, and Monetary Policy, Frankfurt. “ABCs of Pension Reform”, “Pension Decumulation”, “Building Support for Pension Systems”, World Bank Retreat on Pension Reform, Kennedy School, Harvard. “Governance and Regulatory Issues in Pension Reform”, Tokyo. “Annuities in Defined Contribution Pension Systems”, UNSW, Sydney “New Evidence on Pension Costs”, UNSW, Sydney “Public Pension Systems in the United States”, FGV, Sao Paolo, Brazil “New Roles for Pensions in Development”, SMU, Singapore “Governance and Regulatory Issues in Pension Reform: Cross-country Experiences and Lessons”, Tokyo “New Roles for Pensions in Developing Countries”, Wharton Alumni Forum, Rio, Brazil “Prospects for US Social Security Reform”, CPF, Singapore “New Roles for Pensions”, Wharton/Harvard Alumni Associations, Sydney, Australia. “Issues in Social Security Reform”, Editorial Board presentation, Philadelphia Inquirer. “Strengthening US Public Pension Management.” World Bank Public Pension Fund Management Conference, DC.

Mitchell – NBER – Executive Summary Year 2 – 1/18/02

6

Sept: Oct: Dec: Dec: Dec: Dec: 2002 Jan: Feb:

“The Future Role of Employee Benefits”, CEBS Conferment Speech, Boston. “Benefits for the Workplace of the Future.” 47th Annual Employee Benefits Conference, IFEBP, San Francisco. “Risk Management for Resilient Organizations”, Wharton Exec Ec. “Social Security Options”, Wharton Business Writers Forum. “Personal Retirement Accounts in Social Security Reform”. Washington Journal, C-Span. Interview on Social Security Reform. KBO Radio, Portland Oregon. ASSA Session on Retirement Policy, Atlanta. “Management and Performance of Pension Systems in Australia”, and “Strengthening Employment-Based Pensions in Japan.” ESRI, Tokyo

Mitchell – NBER – Executive Summary Year 2 – 1/18/02