Why Prudential Sells the Most VAs
When Prudential Financial introduced its Highest Daily variable annuity design in 2007, not a few annuity industry insiders scoffed that Prudential was just repackaging a familiar structured product idea called constant proportion portfolio insurance, or CPPI.
A CPPI product typically combines upside exposure to a risky asset with a principal guarantee. By definition, it’s conservative. During a market downturn, the issuer shifts money from the risky asset to the safe asset to protect the guarantee. That deprives the owner or his advisor of control.
Financial advisors would never go for that, skeptics said. The conventional wisdom was that advisors were buying variable annuities only because they offered control over investment choices and lifetime income guarantees. Why would they want a product that took away their control?
“In all honesty, prior to the financial crisis it was a tough sell, and it was easy for others to sell against it,” said Harvey Blake, vice president, Market Risk Management, at Prudential.
Then came the financial crisis. While other popular VA contracts lost up to 35% of their account values, exposing their issuers to huge potential losses, HD7 accounts fell by only about half as much. The perceived weakness of the Prudential product suddenly became a source of strength. (Yesterday, however, Prudential filed to reduce the product's benefits. See accompanying article.)
Having survived the crisis in relatively good shape, Prudential didn’t have to cut back as much on contract benefits or sales capacity after the crash. Along with MetLife and Jackson National, it benefited from the flight to quality and security that occurred in the market rebound of the past 18 months.
In the first three quarters of 2010, Prudential sold $15.55 billion worth of variable annuities. That success has sparked new interest in CPPI. Indeed, at the Society of Actuaries’ annual conference on equity-linked insurance guarantees in New York at the beginning of November, CPPI was the star of the show.
“At the SoA conference, [CPPI] was a topic that got a lot of attention,” Deutsche Bank’s Cornelia Spiegel, who spoke about CPPI at the conference, told RIJ. “Most of the conversation in the past has been around hedging techniques. This was the first year where the product design was the highlighted topic. Issuers are trying to find ways to offer these products without incurring too much risk. It’s a tempting environment for CPPI.”
Indeed, the SoA stacked the conference in CPPI’s favor. “Our meeting planners thought it would be useful for the program to offer content on this issue and designed the program to reflect so,” noted the SoA’s Kim McKeown. “[We] intentionally offered more content on CPPI-type products because they are becoming popular with insurance companies.”
How CPPI works
Different types of CPPI-driven products have reported been around since the 1980s. Principal-protected, bank-issued savings products in Europe use a form of it as a risk management technique. In perhaps CPPI's simplest form, the issuer will put 80% of the assets in a zero-coupon bond and the rest in risky assets. At worst, a client's principal is guaranteed. In the U.S., fixed indexed annuities, an insurance product, does much the same thing.
The version of CPPI that was discussed at the recent Society of Actuaries meeting works a bit differently. Instead of putting 80% of the assets in the risk-free investment, the issuer might put as much as 80% of the money in the risky asset. If the risky asset loses value, the issuer moves money to the safe asset. The amount in the risky asset, added to the value of the safe asset at maturity, will always equal the principal.
Here’s a simplified example. Suppose someone bought a principal-guaranteed investment for $100. Suppose it would take $80 worth of zero-coupon bonds to return $100 at maturity. The client could then afford to lose $20 of his or her investment and still break even. By definition, the “cushion” is 20%.
To decide how much of the assets to risk, the issuer selects a factor, called the “multiplier,” which is based on the riskiness of the desired risky asset and the prevailing interest rates. Suppose that the multiplier is 4. Four times 20% equals 80%. So $80 goes into the risky asset and $20 goes into the safe asset.
If the value of the risky asset drops 10% (to $72), the account value is now $92. The cushion narrows to 13% (92 – 80/92). The new risky allocation will be 52% (4 x 13%). Of the remaining $92 account value, only 52% ($48) will stays in the risky asset. The rest ($44) will be in the safe asset. To rebalance, the issuer moves $24 from the risky asset to the safe asset.
This technique has a couple of vulnerabilities, however. In a market panic, the value of the risky asset could fall through its floor ($80) before the issuer could get sell it all. To honor the guarantee, the issuer would take a loss.
“One of the main risks for the manager of a CPPI strategy is “gap risk” when the price of the risky asset drops through the bond floor without enough time for the portfolio manager to reallocate enough funds into the riskless asset to maintain the guaranteed value of the strategy,” said Deutsche Bank’s Spiegel.
For the investor, there’s the danger of “knockout” or “lock-in.” If all the money goes into the safe asset during a downturn, it can’t easily get out. The investor can’t take advantage of an ensuing market upswing, and ends up with the equivalent of a very expensive bond or money market investment.
How Prudential uses CPPI
Prudential’s VA/GLWB embeds a version of CPPI inside a variable annuity. The margin of safety provided by the CPPI, along with hedging strategies, enables the insurer to offer the product’s seductive features at competitive prices. Those include as many as 16 different investment options, a potential daily mark-up in the benefit base, and the ability for those who avoid withdrawals for 10 years to double their minimum retirement payout, regardless of market performance.
“It’s not pure CPPI,” said Santosh Nabar of Barclays Capital, which works with insurance companies on managing variable annuity risk. “It’s approximately CPPI.”
When the contract’s mutual funds lose value, an automated process reallocates money to the safe asset. The mechanism puts no more than 90% of the account value in the safe asset, leaving 10% exposed to risky assets. The 10% exposure is a critical feature that protects clients from knock-out. But it isn’t necessarily enough to let them fully participate in a market rebound or for their account value or reach a new high water mark.
Prudential concedes that there’s nothing revolutionary about their technique, which it inherited, along with a platform for administering it, when it acquired American Skandia. “CPPI is a broad concept that’s been used for decades,” said Harvey Blake. “We use an algorithmic solution on a policy-by-policy basis. We’ve been doing it since 2001. It was an American Skandia product at the time. There’s no one single CPPI out there. If there are others similar to what we do, we’re not aware of it.”
“Part of the execution of our product involves lower control over asset allocation,” Blake said. “You’re giving up some control in return for downside protection.” That’s a drawback in a bull market, but an advantage in volatile markets. “Since the crisis, that aspect of the product has resonated in the retail space. People put a high value or premium on loss aversion, and that has played very well with our design.”
Offering CPPI inside a variable annuity isn’t necessarily easy. Prudential has to treat every one of its 80,000 or so in-force HD7 or HD6 contracts as a separate, micro-CPPI product, automatically fine-tuning the allocation to each client's choice of risky assets and the safe asset every day.
To copy Prudential or not
Insurers who have pulled back from the VA market since the financial crisis are now wondering how they might safely reenter the game. CPPI would be one route to take.
Prudential thinks it would be difficult for other VA issuers, especially those whose wholesalers sold against CPPI in the past, to follow its example.
“Our algorithm is in our prospectus, people have easily replicated it just for fun to see how it works," said Tom Diemer, Prudential's head of annuities financial management. "It’s not the ‘Coke secret formula.’ But from what I’ve heard, there’s still a philosophical objection to it around the issue of control. Folks who have sold against this in the past might be able to pivot, but it would be a big change.”
“Companies have sold against it for years and for the distribution it would be difficult to turn around and try to promote it," added Blake. “And it would take time to build even if you wrote the check today. We’ve estimated that it would take 18 months to two years.”
© 2010 RIJ Publishing LLC. All rights reserved.
An Entrepreneur Tackles Decumulation, with TIPS
Six months ago, Manish Malhotra was a senior vice president at beleaguered Citigroup, tinkering with retirement income planning software. Now, as CEO of New York-based Fiducioso Advisors, he’s an entrepreneur who’s promoting his own decumulation tool.
A formal launch of his Fiducioso Investment Analytics Platform is months away. But last week Malhotra demo-ed it for the Retirement Income Industry Association.
The platform is intended to help advisors build guaranteed income streams out of annuities and a Maturity Matched Portfolio (MMP) of Treasury Inflation Protected Securities (TIPS), with withdrawals from a portfolio of stocks and bonds when needed.
“With the MMP, we can build inflation-protected income out of laddered TIPS that should be sufficient to meet the needs for a specific year,” Malhotra told RIJ in an interview this week. “If the TIPS don’t mature in a given year or if inflation expectations change, we take money from the SWP (systematic withdrawal program) account. We look at everything together, and all of the buckets are feeding money at the same point.
“We can build a plan for any degree of risk that the investor is comfortable with,” he added. “The first thing you can choose is the goal risk. You can choose a worst case for how long your money lasts. We will find a plan that gives you the maximum income within the constraints that you give us. In our next demo, to make life a little easier, we’ll have five default plans.
“Our core business will be licensing. Our client base is primarily financial advisors and wealth management firms. We won’t be going to retail retirees. The current direction is to license it on a per plan basis—that is, the license includes a financial plan based on the software—but if there is interest in an annual subscription we’re open to that.”
Taking FIAP for a spin
In short, FIAP is a “bucketing” tool. It creates income from several sources at once (like Briggs Matsko’s E.A.S.E. system) rather than assigning specific assets to specific time segments in retirement (like David Macchia’s Income for Life Model or Curtis Cloke’s THRIVE program).
Malhotra says time-segmentation didn’t appeal to him. “We could set up 30 lock boxes, one for every year of retirement. But if you wanted a 90% confidence level of success from that method, the sustainable payout rate would be only 3.48%. By pooling the money [the way we do], your payouts are improved,” he said.
The maturity-matched ladder of TIPS is the keystone of Malhotra’s approach. The ladder can stretch for five, ten or more than 20 years into retirement. Each rung can consist of zero-coupon or coupon-bearing bonds. The client liquidates a set of bonds each year, supplementing the income with semi-annual interest payments from the remaining bonds if desired.
The client’s remaining assets can be put into at-risk investments and income annuities. The allocation depends in part on what degree of portfolio failure risk—the risk of running short of money—he or she can tolerate. The tool spits out a variety of allocation options, singling out (with a green dot among competing red dots) the one that produces the highest income at the lowest tolerable risk.
A Schematic of the Financial Investments Analytic Platform
Source: Fiducioso Advisors, 2010.
The tool is product neutral, so money managers who use the software can plug in the kinds of funds, ETFs, or annuity products that they already use or like. Advisors can use ready-made tools like the PIMCO TIPS payout fund as a substitute for a custom-made TIPS ladder, Malhotra said.
A ladder of TIPS can produce more income with less risk than a conventional systematic withdrawal plan, Malhotra claimed. A 23-year TIPS ladder, he said, can safely produce a 4.6% annual drawdown from age 65 to age 95. That beats the traditional 4%. On a $2 million portfolio, that would mean an annual income of $92,000 versus $80,000.
This week, I took the demo of the FIAP for a spin. The tool let me choose my desired retirement income (from $35,000 to $80,000 from my hypothetical $1 million portfolio), tolerance for “goal risk” or portfolio failure (10% or more), the length of my TIPS bond ladder (zero years, five years or 10 years), the bond allocation of my investment portfolio (20% to 100%) and my desired allocation to a joint life fixed immediate annuity (0%, 25%, 50%, 75% or 100% of my assets).
As a baseline scenario, I chose a 0% chance of running out of money over 30 years, no TIPS ladder, a 60% stock/40% bond investment allocation, and no annuities. Given those constraints, the tool allowed me a safe withdrawal rate of $39,000 (very close to the traditional 4% rate), plus $30,000 from Social Security.
Then I tried turning a few of the dials. If I raised my acceptable risk of portfolio ruin to 10% (introducing the chance that I might run short of money after 23 years in retirement), the tool bumped my income to $74,000. If I introduced a 10-year TIPS ladder (which would absorb $430,000 of my $1 million) and put 80% of my SWP money in bonds, the tool suggested a safe income of just $67,000.
That was just the demo. There are more demos to come before the formal commercial launch next year. “In our next demo, to make life a little easier, we’ll have five default plans,” Malhotra told RIJ. The tool will also allow for tax-efficient withdrawals from taxable accounts, tax-deferred accounts, and Roth accounts, in that order. At a time when more and more advisors are thinking about retirement income, and about establishing guaranteed income floors for their clients, Malhotra expects his product to find a niche.
© 2010 RIJ Publishing LLC. All rights reserved
Prices Rise, Benefits Shrink for America’s Most Popular VA
Prudential Annuities will scale back the benefits of three of the guaranteed lifetime withdrawal benefits on its industry-leading variable annuity contracts, according to SEC filings yesterday by its insurance units, PRUCO Life and PRUCO Life of New Jersey. The change is effective January 24, 2011.
Insurers are not permitted to comment on new filings prior to SEC approval.
Prudential is the top seller of variable annuities in the U.S., with $15.55 billion in sales through the first three quarters of 2010. It is the only VA issuer that uses the CPPI method of risk management, which automatically reallocates account assets to a safe investment when equities markets fall. (See this week’s cover story.)
The riders in question are the Highest Daily Lifetime Income Benefit (formerly the Highest Daily Lifetime 6), its joint-and-survivor version, the Spousal Highest Daily Lifetime Income Benefit, and the version called Highest Daily Lifetime Income Benefit with Lifetime Income Accelerator, which doubles the lifetime withdrawal payout if the owner requires certain types of long-term care (not available in New York).
The new filing put the cost of the Lifetime Income riders, single and joint, at 95 basis points, up from 85 bps, with an allowed maximum of 1.50%, to be levied on the greater of the account value or the benefit base. On the Advisor version of the contract, which has a combined mortality and expense risk and administrative fee of only 55 bps (leaving room for an advisors 1% or 1.5% fee), the current cost of the contract and rider would rise to 1.50% from 1.40%. The expense ratios of the investment options under the existing contract ranged from 0.62% to 2.59%. The cost of the accelerated version will rise to 1.30% from 1.20%.
Assuming an average investment charge of 1.50%, the sum of all the charges, including a 1% advisor’s fee, could easily reach 4% a year or more on a product that yields a guaranteed annual income of, in most cases, 5% of the benefit base.
After January 24, 2011, the payout rates at various age bands will be 3% (for those ages 45 to 54), 4% (for those 55 to 59½), 5% (for those 59½ to 84), and 6% (for those over 84). In each band, the spousal version of the product pays out a half-percent less per year. For most people who choose to begin taking guaranteed payments in their 60s and 70s, the payout rate was and will remain 5%.
Prudential will also stop discontinue new sales of two Guaranteed Minimum Accumulation Benefit (GMAB) riders, GRO Plus II and Highest Daily GRO, on January 24.
The annual compounding rollup on all versions of the GLWB rider will be just 5%--down from the previous 6%, which was reduced after the financial crisis. The product’s original pre-crisis, “arm’s race” era rollup was 7%. The rider promises that the benefit base of the contract will rise every business day at an annual rate of 5%, or to the daily account value, if higher.
The contract promises that the benefit base will at least double in 12 years, as long as no non-permitted withdrawals are taken. In the past, the benefit base could double in 10 years and quadruple in 20 years. The 20-year quadrupling guarantee has been eliminated.
As an example, an investor who put $100,000 into the Prudential HD Lifetime Income VA at age 55 and didn’t touch the money until he or she reached age 67, could then draw $10,000 a year for life (5% of two times $100,000).
Under the previous iteration of the contract, he or she could have taken out at least $10,000 a year starting at age 65 and at least $20,000 a year starting at age 75, provided he or she hadn’t taken any unapproved withdrawals before then.
© 2010 RIJ Publishing LLC. All rights reserved.
Sun Life executive writes about retirement income planning
Stephen L. Deschenes, Senior Vice President and General Manager, U.S. Annuities, Sun Life Financial Inc. has written a new article in which he discusses the significant challenges that would-be retirees need to be aware of as they begin to plan for a financially secure retirement.
In the paper, Deschenes demonstrates that in order to overcome the risks and obstacles to funding a successful retirement, it is crucial investors and their advisors must first understand what they face.
According to “What is Retirement Income Success,” a strong retirement income plan must adapt to changing lifestyle needs, withstand up and down markets and last for more than 30 years or more now that people are living longer lives. Deschenes spells out the risks as well as the components that investors should understand and the solutions advisors should be discussing with their clients.
Genworth’s ClearCourse adopted by BB&T
BB&T Corp., the Winston-Salem, NC-based financial services company, announced that it would add ClearCourse, the guaranteed lifetime income investment option from Genworth Financial, to its retirement plan investment options.
ClearCourse is a group variable annuity issued by Genworth Life and Annuity Insurance Company and is available to BB&T's Institutional Services client companies that elect it as an investment choice for their employees.
ClearCourse is designed to protect 401(k) plan participants from retirement risks such as outliving assets, retiring during a down market, and the effects of inflation. ClearCourse provides a guaranteed source of lifetime income.
BB&T is a holding company that operates some 1,800 financial centers in the U.S., with about $157.2 billion in assets and market capitalization of $16.7 billion, as of Sept. 30, 2010.
New J.P. Morgan share class let plan sponsors report investment and administrative fees separately
J.P. Morgan Asset Management today announced that new Class R6 Shares will be available on 18 of its funds. The new shares, formerly called Ultra Shares for certain funds, allow plan sponsors to report their investment management expenses and their recordkeeping, administrative and marketing expenses separately.
The Class R6 Shares will have an investment advisory fee and other traditional fund expenses, but not 12b-1 or shareholder servicing fees. “Plan sponsors will have the ability to simplify participant communication through separate disclosure of the applicable fees,” said David Musto, head of J.P. Morgan's Defined Contribution Investment Solutions business.
Defined contribution and defined benefit retirement plans, 529 plans, and certain direct investors and discretionary investment management accounts within J.P. Morgan Investment Management and its affiliates will be eligible for Class R6 Shares if they meet minimum and eligibility requirements.
The Class R6 Shares include 18 funds across the spectrum of J.P. Morgan investment capabilities. J.P. Morgan Asset Management has approximately $51 billion in defined contribution assets under management as of September 30, 2010.
MetLife forecasts financial results for 2010 and 2011
MetLife expects its operating earnings to increase 38% in 2011, to between $5.1 billion and $5.5 billion ($4.75 to $5.15 per share),” chairman, president & chief executive officer C. Robert Henrikson said this week.
“We plan to grow premiums, fees and other revenues 30% next year to between $45.8 billion and $47.0 billion,” he added. He predicted “an improved operating return on equity (ROE) of approximately 11% for 2011 and further ROE improvements in the years that follow.”
Premiums, fees and other revenues for 2010 are expected to be between $35.6 billion and $36.0 billion, up approximately 5% from $34.0 billion in 2009. Operating earnings for 2010 are expected to be $3.8 billion to $3.9 billion ($4.26 to $4.36 per share) compared with $2.4 billion ($2.87 per share) in 2009.
Book value per share at year-end 2010 is expected to be between $44.50 and $45.85, up 19% from $37.96 at year-end 2009. The company expects a 62% increase in operating earnings compared with 2009.
MetLife expects full year 2010 net income to be between $2.8 billion and $3.2 billion ($3.13 to $3.57 per share), reflecting net investment and net derivative gains and losses. For 2009, MetLife reported a net loss of $2.4 billion ($2.89 per share), including $3.3 billion, after tax, in derivative losses. MetLife uses derivatives to hedge a number of risks, including changes in interest rates and fluctuations in foreign currencies. Movement in interest rates, foreign currencies and MetLife’s own credit spread – which impacts the valuation of certain insurance liabilities – can generate derivative gains or losses.
Premiums, fees and other revenues for the fourth quarter of 2010 are expected to be between $9.5 billion and $9.9 billion, up 4% from $9.3 billion in the fourth quarter of 2009. Operating earnings for the fourth quarter of 2010 are expected to be between $1.1 billion and $1.2 billion ($1.04 to $1.14 per share), up 39% from $793 million ($0.96 per share) in the fourth quarter of 2009.
For the fourth quarter of 2010, MetLife expects net income to be between $170 million and $570 million ($0.17 to $0.56 per share), compared with $289 million ($0.35 per share) in the fourth quarter of 2009.
Per share calculations for full year and fourth quarter 2010 are based on 890.2 million and 1,014.2 million shares outstanding, respectively. Per share calculations for 2011 are based on 1,066.3 million average shares outstanding.
Hedge Funds Receive $16.0 Billion in October
The hedge fund industry posted an estimated inflow of $16.0 billion (1.0% of assets) in October 2010, the fourth straight inflow as well as the heaviest since November 2009, TrimTabs Investment Research and BarclayHedge reported.
“Flows are doubtless following performance,” said Sol Waksman, founder and President of BarclayHedge. “Hedge funds returned 1.95% in October and 7.10% in the four months following the May-June skid. Also, our preliminary data shows that hedge funds are outperforming the S&P 500 by about 21 basis points through November.
Distressed securities funds hauled in $3.8 billion (3.3% of assets) in October, the heaviest inflow of any hedge fund strategy, while emerging markets funds posted an inflow of $2.2 billion (1.0% of assets). Meanwhile, fixed income funds received only $506 million (0.3% of assets), the lightest inflow since April.
“Hedge fund investors are exhibiting a healthier appetite for risk,” noted Waksman. “They are finally venturing into areas like distressed securities after embracing conservative strategies for most of the year.”
Commodity trading advisors (CTAs) received $7.9 billion (2.8% of assets) in October, the eighth straight inflow, while funds of hedge funds took in $3.3 billion (0.6% of assets), the fourth straight inflow. Meanwhile, hedge fund managers are capitalizing on kind conditions heading into 2011.
“Borrowing money to buy assets is virtually costless, investors handed hedge fund managers $32.1 billion in the past four months, and margin debt is soaring,” explained Vincent Deluard, executive vice president of research at TrimTabs. “At the same time, the rolling 12-month beta of hedge fund returns sits below the long-term average, and that of equity long-short funds is dipping below zero. Managers should be especially eager to book fat profits through year-end, but they remain very reluctant to make directional bets on equities.”
Managers are also extremely bearish on the 10-year Treasury note, according to the TrimTabs/BarclayHedge Survey of Hedge Fund Managers. Bearish sentiment soared to 49% in November from 28% in October, while bullish sentiment sank to 13%, the lowest level since the inception of the survey in May.
“Retail investors and pension funds have been pouring money into high-flying fixed income for nearly two years,” noted Deluard. “But now hedge fund as well as retail bond inflows have ground to a halt, and mom and pop are ditching munis and junk. The more the infatuation with bond funds fades the more we fear the fallout will prove particularly ugly.”
Broad adoption of lifetime income recordkeeping standards seen
In a recent SPARK Institute survey, more than 85% of the large retirement plan recordkeepers said they plan to use the Institute’s information sharing standards and data records for the lifetime income solutions in retirement plans, according to Larry Goldbrum, the organization’s general counsel.
More than half of the firms that plan to use the standards expect their record keeping systems to be ready to support them within the next 12 months.
The standards allow customer-facing record keepers to offer one or more products from unaffiliated insurance carriers; will facilitate portability of products when a plan sponsor changes plan record keepers (record keeper portability); and will support portability of guaranteed income when a participant has a distributable event in the form of a rollover to a Rollover IRA or as a qualified plan-distributed annuity (participant portability).
The information sharing standards document, “Data Layouts for Retirement Income Solutions (Version 1.0),” is posted on The SPARK Institute website < http://www.sparkinstitute.org/comments-and-materials.php>, Goldbrum said The SPARK Institute will also maintain a Q&A section on its website to address technical questions that may arise as the standards achieve increased utilization.
The SPARK Institute represents retirement plan service providers and investment managers, including banks, mutual fund companies, insurance companies, third party administrators, trade clearing firms and benefits consultants. Its members serve over 62 million participants in 401(k) and other defined contribution plans.
Guidance offered to plan fiduciaries on revenue-sharing
A new whitepaper from ERISA attorneys Fred Reish, Bruce Ashton and Summer Conley analyzes the obligation of fiduciaries with respect to the proper allocation of revenue sharing among participants and the obligation to disclose information about that allocation to the participants. It is entitled “Allocating Fees Among Participant-Directed Plan Participants.”
“While ERISA does not specify how plan expenses or the revenue sharing that helps pay those expenses should be allocated, it does require fiduciaries to act prudently in making the decision,” the attorneys said in a release.
“There are a number of workable and acceptable approaches, from pro rata based on account value, to per capita, to an emerging possibility that allocates revenue sharing to the accounts of the participants invested in the funds that make those payments.
“We are beginning to see the latter approach be used in larger plans using service providers with the resources to develop these sophisticated systems. The specific allocation method that fiduciaries choose may depend on which methods the service provider can accommodate.
“Whatever allocation method is used, fiduciaries must engage in a prudent process to consider an equitable method of allocation to avoid a breach of fiduciary duty. This likely means fiduciaries have an obligation to consider all available allocation methods when deciding how to properly allocate revenue sharing amounts.”
The whitepaper analyzes the issues related to the decision on how to allocate costs and the offsetting of revenue sharing, and discusses the obligation of fiduciaries to disclose the methodology to plan participants. The disclosure issue has come into sharper focus in light of the DOL’s proposed participant disclosure regulation.
Latest troubles in the Balkans involve pensions
Creating a “second pillar” retirement plan is no longer part of the pension reform plans for Bosnia and Herzegovina, the country’s government told the International Monetary Fund (IMF).
“Costs and complexity” were cited as major reasons for the change in the initial plan for the Republika Srpska, which with the Federation of Bosnia and Herzegovina makes up the country of Bosnia and Herzegovina.
Expenditure on public pensions has been one of the fastest-growing components of public expenditure in the two entities. In the Federation, it rose to 10% of GDP in 2009 from 7.7% in 2005; and in the Republika Srpska, to 9% of GDP from 7.8% over the same period.
“The transition to the second pillar has been ruled out as too costly and difficult in the near term,“ the government said. A third pillar had been created over the last few years and the country will see a major overhaul of the first pillar.
The first pillar overhaul will include a “further increase in the effective retirement age of men and women,” a system of awarding points for every year of employment, and an indexation “in line with the Swiss model,” where increases are pegged to an average of CPI and the wage indexes.
The pension reform strategy for the other part of the divided country, which was approved in summer, “still needs to incorporate an overhaul of privileged pensions” (such as allowing certain types of workers to retire early without loss of privileges), the IMF said.
© 2010 RIJ Publishing LLC. All rights reserved.