«Forthcoming Journal of Pension Economics and Finance Edmund Cannon: University of Bristol, School of EFM, 8 Woodland Road, Bristol. BS8 1TN United ...»
Price efficiency in the Dutch
Edmund Cannon, Ralph Stevens and Ian Tonks
Forthcoming Journal of Pension Economics and Finance
Edmund Cannon: University of Bristol, School of EFM, 8 Woodland Road, Bristol.
BS8 1TN United Kingdom. email@example.com
Ralph Stevens: ARC Centre of Excellence in Population Aging Research,
Australian School of Business, University of New South Wales, UNSW Sydney
NSW 2052. Australia firstname.lastname@example.org
Ian Tonks: School of Management, University of Bath, Bath. BA2 7AY United Kingdom. I.Tonks@bath.ac.uk The authors gratefully acknowledge support for this research from NETSPAR. An earlier version of this paper was presented at a Netspar Panel Session, April 2011, and the paper has benefited from comments by Tim Boonen, Alwin Oerlemans Kim Peijnenburg, Marno Verbeek. The data used in this paper was provided by Money View and the authors are grateful to Hedwig Dros, Henk Don, Arie Perfors, Emile Smits, and Jan-Bert Windhorst for assistance in obtaining and interpreting the data.
1 Price efficiency in the Dutch Annuity Market Abstract We provide the first analysis of annuity rates in the Netherlands for the period 2001-2012. During this period, the number of annuity providers was high and stable and we find that falls in annuity rates can be explained entirely by changes in yields and life expectancy. We show that annuitants could have increased their annuity income by about 5%, by shopping around and purchasing their annuities from alternative providers. Money’s worth calculations show that the market is efficient by international standards, with a money’s worth above 0.9 for the whole period and close to unity by the end of the period. We present conflicting evidence on the existence of adverse selection because although we find money’s worths are inversely related to age of purchase, we find they are positively related to size of purchase.
2 Introduction Annuity markets around the world are playing a growing rôle in pension provision as defined-contribution personal pension systems are introduced and mature (World Bank, 1994; Holzman and Hinz, 2005; European Commission, 2009). In the UK, defined contribution pensions with compulsory annuitization are likely to replace occupational defined benefit pension schemes altogether in the next few decades (Pensions Commission, 2004, chapter 3) and large annuity markets such as those in the UK and Chile have been analysed extensively (e.g. Cannon and Tonks, 2011; Ruiz and Mitchell, 2011). In much of continental Europe, however, generous public pensions are likely to dominate pension provision for a significant period and defined contribution pensions are being introduced to complement existing pension schemes (and to compensate for existing schemes being less generous). For example, Germany has a small voluntary annuities market (Kaschützke and Maurer, 2011) but DC schemes are growing due to the Riester reforms of 2001 (Schnabel, 2004). In Italy the TFR reforms of 2004 have resulted in the birth of a small DC pension system with compulsory annuitization of at least part of the pension wealth on retirement (Aben, 2011; Rinaldi, 2011) and there is continued discussion about how the annuitization option could be improved (Paci et al, 2010). Holzmann and Hinz (2005) describe how many countries in central and eastern Europe introduced defined contribution pensions to complement existing state pensions after the collapse of communism.
Despite theoretical reasons for believing that annuities can be utility enhancing (Yaari, 1965; Sheshinski, 2008), it is well known result that where annuities are purchased voluntarily the market tends to be small (Brown et al, 2001). Cannon and Tonks (2008) suggest that plausible reasons for this market failure are either that adverse selection prevents a market equilibrium or that individuals do not fully understand how an annuity works (since annuity purchase is a once-and-forall decision there is no opportunity for agents to learn about the product). A possible solution to these problems is to make annuitization compulsory, preventing moral hazard, namely individuals deliberately falling back on state benefits, and is a reasonable quid pro quo for tax relief which has been received in the accumulation phase. However, compulsion does not remove all problems and may create additional ones if the market is imperfect (Mackenzie, 2006).
3 Nearly all of these analyses accept that the annuity decision depends upon the institutional details of the annuity market and other features of the pensions system. A corollary of this is that studies of different annuity markets allow economists to get a better idea of what is likely to work in practice and in different contexts. Mitchell, Piggott and Takayama (2011) survey ten countries’ annuity markets in various stages of development. They draw a distinction between countries with compulsory annuitization (UK, Sweden), countries with mandatory accumulation plans but without compulsory annuitization (Australia, Chile, Switzerland), and other countries in which retirement income depends on traditional social security in which the annuity market is small (Germany, Japan).
The Dutch system lies between these, with a pay-as-you-go first pillar and a wellestablished mandatory occupational second pillar, much like Switzerland (Bütler, 2009), but with only a small annuity market more like Germany (Kaschützke and Maurer, 2011), even though in the Netherlands annuitization of the small DC pension market is compulsory. Life insurers providing DC pensions and annuities, are also typically involved with the management of the occupational second pillar, so that even though the annuity market is small, these providers will have a sufficient large pool to make idiosyncratic longevity risk negligible.
In this paper we provide the first empirical analysis of prices in the Dutch annuity market. 1 Although this market is growing, it is currently a good example of a small mature annuity market existing alongside a large defined benefit public and occupational pension system. As with the UK, annuitization of personal pensions is compulsory, although participation in a personal pension is voluntary, making it more similar to the system enacted in Italy from 2004 In section 1 we introduce the Dutch pension system and describe the institutional and qualitative features of the annuity market. Section 2 reports annuity price data for the Netherlands in the last decade and section 3 reports our money’s worth calculations.
1 For Dutch attitudes to pension provision and annuitisation see Alessi, van Rooij and Lusardi (2011) and Teppa (2011).
1. Description of the Dutch Annuity Market The Netherlands has a three-pillar pension system. Pensions in the Netherlands are financed by a PAYG scheme for the state pension and capital-based schemes for the mandatory occupational pension and voluntary retirement savings. The aim of many employees is to have a gross replacement rate at retirement of approximately 70 per cent, which is approximately a net replacement rate of 90 per cent due to tax incentives. The Dutch have a long history in saving for retirement, with the first private pension funds founded in the nineteenth century.
The first pillar is the state pension (General Old Age Pension Act, or AOW) with a yearly premium income of €21 billion in 2011, financed on a Pay As You Go basis.
Eligibility for benefits is based on residence and is independent of working history.
After living in the Netherlands for 50 years (between age 15 and 65) every citizen receives a full state pension (€1,501 per month for couples and €1,085 per month for individuals in 2013).2 The retirement age is due to increase gradually to 66 by 2019 and 67 by 2023. 3 The second pillar is the mandatory collective occupational pension scheme, which is based on work history. This second pillar is funded. The yearly premium income of pension funds was €30 billion in 2009 and in 2010 there were a total of 514 pension funds. Pension funds can either manage the pension fund and portfolio management themselves or contract it out to an external implementing body, usually a specialized pension scheme administrator or an insurer. In 2010, 93 per cent of pension fund members belonged to a defined benefit pension scheme.
Only 4.5 per cent of members had a defined contribution scheme and 2.
3 per cent of members had a combination of a defined benefit and a defined contribution plan. Dutch law prohibits the commutation of pension entitlements, except for small entitlements (€417 per annum in 2009) which is due to the relative high administrative cost associated with it. Members in DC pension plans are required to use their DC pension capital to purchase annuities, i.e., a lump sum withdrawal is not allowed.
2 http://www.svb.nl/int/en/aow/hoogte_aow/bedragen/index.jsp 3 http://www.pensioenkijker.nl/home/aow-anw/verhoging-aow-leeftijd. There are further proposals to bring these changes forward to 2018 and 2021.
5 The third pillar is voluntary pension insurance, mainly provided through insurers, although since 2008 tax-exempt accrual pension saving has also been possible through a bank, called “banksparen”. 4 Individuals purchase a capital sum insured before retirement and then convert this to an annuity upon retirement. In the last years of the past decade some of the capital sum insured products received negative press coverage because of high costs, especially for the included insurance components. After public and political pressure the insurers reached an agreement with the insured to pay back the excessive fees which had been charged. Another noteworthy change was the introduction of the tax favoured “Levensloop” scheme in the Netherlands in 2005. This scheme allowed for a reduction in savings during periods of low income arising from being in education or having to take care of one’s dependant, etc. Although indented otherwise, in practice it was mainly used to finance early retirement through this scheme, which led to regulatory changes to the scheme to reduce that possibility in 2012. Those schemes were mainly managed by pension funds.
Life insurance companies play a rôle in the Dutch pension system in both the second and the third pillar. Insurance companies manage approximately 20 per cent of the pension contracts. The third pillar has been managed by insurers only.
The yearly gross life insurance premium income is given in Figure 1.1., and has been around €25 billion during the past decade.
Figure 1.1 about here
Of the €21 billion gross direct life premium business income around €15 billion was from individual policies, and around €6 billion was from group policies. These group policies are mainly due to the management of second pillar pensions.
Although the total value of the annuities is almost €36 billion (about four per cent of GDP), it is much smaller than the total sum of capital sum insured, which was €658 billion in 2009. Over €29 billion of the annuities are in group insured contracts, of which 44 per cent is unit-linked and 56 per cent is euro insurance.
For individual contracts the value of the annuities was over €6 billion Euros in 4 Article 1.7 Wet inkomstenbelasting 2001 (income tax law 2001) is applicable to pension decumulation via banksparen and via insurance products. The law mandates that an individual should purchases a product which provides a lifelong income with certain constraints on the level of payments. For banksparen, because it has no insurance element in it, this lifelong income has been interpreted as an income for at least 20 years..
6 2009, of which only 11 per cent was unit-linked, the other 89 per cent was euro insurance.
The Dutch life insurance market is dominated by 6-8 insurance concerns, which have a market share of around 85 per cent. Figure 1.2 illustrates the market share of the premium income of the largest insurance concerns during 2002-2007.
During that period there have been two mergers between large insurance concerns, namely in 2004 the insurance part of Rabobank merged with Achmea to form Eureko and in 2007 SNS Reaal took over SwissLife. Aside from these mergers, the fluctuations in the share of premium income do not fluctuate too much.
Figure 1.2 about here
In Figure 1.3 the distribution of the market share of premium income of the top 25 life insurance companies in the Netherlands is given from 2002 to 2009. From this we see that the top 10 life insurance companies have 70-80 per cent of the market share and the top 25 have a combined market share of 88-94 per cent. Moreover, we see that the market share is becoming more concentrated, suggesting the possibility of increased market power.
Figure 1.3 about here
2. Description of Annuity Price Data All of the annuity prices we analyse here are from the Dutch compulsory purchase market and are for men only (data for women are unavailable). The data were provided by Money View, which is an organisation collecting annuity rates for price comparisons. (see http://www.moneyview.nl/). Annuity prices are reported for a total of 32 different named companies throughout the period, but because some of the companies merged or changed name the total number of actual companies is only 28 and one of these (Univé) only quoted for a short period: the total number of price quotes that we have is illustrated in Figure 2.1.
Figure 2.1 about here
For each firm we have data on purchase prices for men aged 60 and 65 for amounts of €50,000 and €125,000. There are two small structural breaks in 2002 and 2010: before 2002 the annuity rates were for purchase prices in Dutch Guilders, with purchase prices of ƒ100,000 (€45,378 given an exchange rate of
The annuity rates before and after the two potential structural breaks are almost identical, so we do not make further adjustments.
Many life insurance company quotes two prices, an internal price for annuitants who have also saved their pension fund with the company (called “maatschapp ĳ”) and another external price for annuitants who are transferring their pension fund from another company (called “elders”). With annuity prices for two ages, two purchase prices and two types of purchase this means that we have eight annuity prices per firm.