Dimitri Vittas

The Swiss Multi-Pillar Pension System: Triumph of Common Sense?

The authors provide a detailed study of the Swiss pension system, analyzing its strengths and weaknesses. The unfunded public pillar is highly redistributive. It has near universal coverage, a low dispersion of benefits (the maximum public pension is twice the minimum), and no ceiling on contributions. Low-income pensioners receive means-tested supplementary benefits. Payroll taxes are low, but government transfers cover 27 percent of total benefits. Total benefits amount to 9.1 percent of GDP, equivalent to 15.2 percent of covered earnings. The funded private pillar was made compulsory in a defensive move against the relentless expansion of the public pillar. The compulsory pillar stipulates minimum benefits in the form of age-related credits, a minimum interest rate on accumulated credits, and a minimum annuity conversion factor, aimed to smooth changes in interest rates over time. Low-income workers are not required to participate in the second pillar. The first and second pillars as well as supplementary benefits are admirably integrated. Company pension plans are free to set terms and conditions in excess of these minimums, and most offer benefits exceeding obligatory levels. The second pillar has accumulated large financial resources, equivalent to 125 percent of GDP. Investment returns have historically been low, but a shift in asset allocation in favor of equities and international assets has increased reported returns in recent years. The third (voluntary) pillar covers self-employed workers and others not covered by the second pillar. It plays a rather small role in the system. Many of the positive features of the Swiss pension system are not due to some grand original design but are instead the result of periodic revisions. In large part they reflect the collective common sense of the Swiss people in voting for stable and fiscally prudent social benefits. However, the Swiss system also has some weaknesses. As in many other countries, the public pillar faces a deteriorating system dependency ratio, due to demographic aging and a large increase in disability pensions. The second pillar is fragmented (more than 4000 funds with affiliates), lacks transparency, and has achieved low investment returns.

The Argentine pension reform and its relevance for Eastern Europe

Argentina reformed its pension system in 1974, when it created an integrated, multipillar public-private pension system. Its old system had suffered from a vicious circle of unrealistic promises, high payroll taxes, widespread evasion, and growing deficits. But the reform program, enacted through the democratic process, suffered from many weaknesses, the most important of which were the continuing wage indexation of pensions and the retention of a public, unfunded, defined benefit component in the second pillar. The Argentine authorities were forced to take corrective measures, first by abolishing indexation with the passage of the Pension Solidarity Law in March, 1995, and then by integrating provincial pension schemes into the national system. The author argues that Argentina has undertaken not one but three major reforms of its pension system since 1993. One lesson of the Argentine experience is that pension reform is diluted as a result of democratic debate. This is less crucial than it appears, because reforming governments can rectify any major shortcomings through subsequent reforms. But it is important that the reform program be basically sound and that it move in the right direction. The author compares the new Argentine system with the systems of Chile and Switzerland. He finds that the main difference between the Argentine and Chilean systems lies in the higher levels of targeted pensions and targeted redistribution in Argentina. This is a political and social choice, but it implies a higher financial cost and thus higher contribution rates. The private component of the second pillar shares most of the strengths and weaknesses of the Chilean model, including high marketing and operating costs. The comparison with the Swiss system shows that Argentinas first pillar is less well designed than Switzerlands. But the funded component of its second pillar is more transparent and potentially more efficient than the Swiss funded pillar. Although it has much higher operating costs, it has achieved much higher investment returns. The relevance of the Argentine pension reform for Eastern Europe derives from the similarities in the problems of their public unfunded systems and the political and social acceptability of retaining a highly redistributive pillar. A balanced reform is politically feasible, while prolonged delays can lead to the collapse of the existing weak and unsustainable systems.

Annuities and other retirement products : designing the payout phase

This book examines recent changes in the landscape of retirement products and annuity markets in five countries. All the selected countries (Australia, Chile, Denmark, Sweden, and Switzerland) have mandatory or quasi-mandatory savings schemes. But they also exhibit significant differences in the structure of their pension systems, the relative importance of public pillars, the role and structure of private provision, the level of annuitization, and the structure and focus of their regulatory frameworks. Five studies have been commissioned to examine the state of annuity markets in each of these countries. The findings of these studies are summarized in the last five chapters of this book. The chapters of this book is discusses the various risks faced by pensioners and the risk characteristics of alternative retirement products, and it reviews the risks faced by providers of retirement products and the management and regulatory challenges of dealing with those risks. The chapter then discusses the risks faced by providers and reviews the challenges of various regulatory issues, ranging from the institutional organization of the market for retirement products to the regulation of marketing and pricing policies and the regulation of risk management. The chapter concludes with a brief summary of main points and conclusions.

Reforming financial systems : historical implications for policy

List of contributors 1. Financial history: lessons of the past for reformers of the present Gerard Caprio Jr. and Dimitri Vittas 2. The evolution of central banking Forrest Capie 3. Free banking: the Scottish experience as a model for emerging economies Randall S. Kroszner 4. Regulation and bank stability: Canada and the United States, 1870-1980 Michael Bordo 5. Deposit insurance Eugene White 6. Contingent liability in banking: useful policy for developing countries? Anthony Saunders and Berry Wilson 7. Universal banking and the financing of industrial development Charles W. Calomiris 8. Before main banks: a selective historical overview of Japans prewar financial system Frank Packer 9. Thrift deposit institutions in Europe and the United States Dimitri Vittas 10. The development of industrial pensions in the United States during the twentieth century Samuel H. Williamson 11. The rise of securities markets: what can government do? Richard Sylla Index.

Financial sector policy for developing countries : a reader

The dramatic events of the late 1990s, which followed a wave of financial crises going back to the early 1980s, brought to center stage the issue of financial sector policy in developing countries. Many recent books have presented a chronology and interpretation of the crises, but it is little apreciated that these financial sector problems had been brewing for decades and that a small number of scholars had long been evolving an approach to undertanding the structure and dynamics of these sectors. Spearheaded by a group led by Millard Long, the World Bank began studying more than 20 years ago the problems, risks, and policy solutions surrounding private finance. This volume contains a collection of essays drawing on that accumulated experience and offering a wide perspective based on extensive real-world institutional experience. They are a useful reader on a wide range of the financial policy issues that are central in developing economies today. They reflect also the evolving approach of the Banks financial sector team and represent the knowledge that the team has accumulated over the years.

Credit Policies: Lessons from East Asia

Directed credit programs were a major tool of development in the 1960s and 1970s. In the 1980s, their usefulness was reconsidered. Experience in most countries showed that they stimulated capital-intensive projects, that preferential funds were often (mis)used for nonpriority purposes, that a decline in financial discipline led to low repayment rates, and that budget deficits swelled. Moreover, the programs were hard to remove. But Japan and other East Asian countries have long touted the merits of focused, well-managed directed credit programs, saying they are warranted when there is a significant discrepancy between private and social benefits, when invesment risk is too high on certain projects, and when information problems discourage lending to small and medium-size firms. The assumption underlying policy-based assistance and other forms of industrial assistance (such as lower taxes) is that the main constraint on new or expanding enterprises is limited to access to credit. The authors give an overview of credit policies in East Asian countries (China, Japan, and the Republic of Korea) as well as India, and summarize what these countries have learned about directed credit programs. Among the lessons: 1) Credit programs must small, narrowly focused, and of limited duration (with clear sunset provisions); 2) subsidies must be low to minimize distortion of incentives as well as the tax on financial intermediation that all such programs entail; 3) credit programs must be financed by long-term funds to prevent inflation and macroeconomic instability, recourse to central bank credit should be avoided except in the very early stages of development when the central banks assistance can help jump-start economic growth; 4) they should aim at achieving positive externalities (or avoiding negative ones), any help to declining industries should include plans for their timely phaseout; 5) they should promote industrialization and export orientation in a competitive private sector with internationaly competitive operations; 6) they should be part of a credible vision of economic development that promotes growth with equity and should involve a long-term strategy to develop a sound financial system; 7) policy based loans should be channeled through well-capitalized, administratively capable financial institutions, professionally managed by autonomous managers; 8) they should be based on clear, objective, easily monitored criteria; 9) programs should aim for a good repayment record and few losses; and 10) they should be supported by effective mechanisms for communication and consultation between the public and private sectors, including the collection and dissemination of basic market information.

The global growth of mutual funds

With few exceptions, mainly in Asia, mutual funds grew explosively in most countries around the world during the 1990s. Equity funds predominated in Anglo-American countries while bond funds predominated in most of Continental Europe, and in middle-income countries. Capital market development (reflecting investor confidence in market integrity, liquidity, and efficiency) and financial system orientation were the main determinants of mutual fund growth. Restrictions on competing products acted as a catalyst for the development of money market and (short-term) bond funds.

Financial history : lessons of the past for reformers of the present

Among the lessons financial history offers: Macroeconomic stability - low inflation and sound public finance - is important for creating the right incentives for banks and for facilitating the development of securities markets. High inflation and large fiscal deficits distort economic behavior in favor of short-term speculative projects conducive to sustainable economic development. Central bank independence may contribute to economic stability. One way to increase it is by lengthening the term of central bank governors. There must be incentives for bank owners to behave prudently - a requirement that they have capital commensurate with the risks they assume, for example. Unlimited liability and double liability limits may be less feasible now than in the past, but banks in developing countries that face higher risks should maintain higher capital ratios than banks in the more advanced OECD countries. Effective supervision is also essential. Banks run into solvency problems because they fail to diversify - often because of regulatory (especially geographic) restrictions, but also because of excessive connected lending or genuine mistakes. Regulators must ensure that banks diversify their risks, which means ending geographic or sectoral restrictions (including prohibitions against holding foreign assets) and restricting connected lending. Developing effective supervision (to ensure meaningful and effective compliance with prudential rules) is difficult and time-consuming but essential. The difficulty of supervising universal banks and financial conglomerates is an argument used against them in developing countries. But universal banks may generate efficiency gains as they overcome the problems of inadequate reliable public information on industrial and commercial companies. Holding small equity stakes and being involved in corporate governance may be productive. The risk of overlending to related firms is likely to be small when banks hold small stakes in industrial firms; it is high when firms control banks. Pension funds and other institutional investors have grown in importance in many countries over the past thirty years or so, because of longer life spans and longer retirement. These funds started as labor market institutions and personnel management tools, but have become important financial intermediaries. Pension funds offer developing countries an alternative both for restructuring their public finances and for promoting their capital markets. Pension funds can play the role that thrift deposit institutions - such as savings banks, credit cooperatives, and building societies - played in developed countries in the nineteenth century. But thrift institutions can still contribute to financial and economic development by promoting thrift and facilitating credit rural areas and among low-income groups. They will contribute more if they involve a three tier structure that combines the benefits of local involvement and monitoring with centralized auditing and supervision.

Private Pension Funds in Hungary: Early Performance and Regulatory Issues

Despite the limited scope resulting from the high payroll taxes for the compulsory, unfunded public pillar in Hungarys pensions system, the early voluntary private pensions fund performance has been encouraging. Investment returns have been well above the inflation rate and participation has expanded rapidly. However, the sector is highly fragmented and regulatory weaknesses exist: no compulsory use of custodian and licensed asset managers; use of book values and cashflow accounting rather than market values; costly tax treatment, benefiting high income earners while not providing incentives to non-taxpayers; infrequent statements and inadequate information fund performance disclosure; no minimum relative profitability levels guarantees; and a need for strengthened and more effective supervision. Without systemic reform the private pension fund potential will remain limited. Hungarys pension system suffers from the same problems that afflict most pay-as-you-go (PAYG) systems in Eastern Europe: high system dependency rations, low retirement ages, lax disability pension criteria, increasing evasion, heavy pension costs, and large deficits. In May 1996, Hungarian authorities decided to create a mixed system of two mandatory pillars and one or more voluntary pillars. The first pillar will offer all eligible Hungarian workers a basic PAYG pension, while the second pillar will be a fully funded, privately managed, decentralized system based on individual capitalization accounts. The private pillars should boost economic growth by developing capital markets and removing labor market distortions. Systemic reform faces two challenges: whether to impose the mandate on individual workers or their employers, and how to build a mandatory pillar on to existing voluntary pillar institutions. The author suggests the use of a hybrid mandate combining an employer mandate with the right for workers to opt out and join an independent fund as a compromise. Most other regulatory issues would apply with as much severity under a compulsory private funded pillar as under a voluntary one.

Designing the Payout Phase of Funded Pension Pillars in Central and Eastern European Countries

Over the past decade or so, most Central and Eastern European countries have reformed their pension systems, significantly downsizing their public pillars and creating private pillars based on capitalization accounts. Early policy attention was focused on the accumulation phase but several countries are now reaching the stage where they need to address the design of the payout phase. This paper reviews the complex policy issues that will confront policymakers in this effort and summarizes recent plans and developments in four countries (Poland, Hungary, Estonia, and Lithuania). The paper concludes by highlighting a number of options that merit detailed consideration.