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Ontario Teachers’ Pension Plan: Asset Allocation Decision

Ontario Teachers’ Pension Plan: Asset Allocation Decision. Evolving Retirement Systems. The Extended Family Working members share income with retirees Defined benefit pensions Workers accept lower salaries Retirees receive relatively fixed payments Defined contribution pensions

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Ontario Teachers’ Pension Plan: Asset Allocation Decision

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  1. Ontario Teachers’ Pension Plan: Asset Allocation Decision

  2. Evolving Retirement Systems • The Extended Family • Working members share income with retirees • Defined benefit pensions • Workers accept lower salaries • Retirees receive relatively fixed payments • Defined contribution pensions • Workers save to provide benefits for their own retirement years

  3. The Extended Family • Workers sacrifice consumption to provide consumption for retired Parents • Bad times are shared by retirees and workers • Retirees have an equity claim on economic output

  4. Defined Benefit Pensions • Workers sacrifice consumption through lower wages to pay for retirement benefits • Retirees are paid amounts that are • fixed in currency terms, or • fixed in real terms • Retirees have relatively fixed claims on economic output • Formally, claims are fixed • But terms may have to be revised in adverse times • Implicit partial equity characteristics

  5. Defined Contribution Pensions • Worker and/or employer make contributions to a retirement account • Amount received by the worker in retirement depends on • Amounts contributed • Actuarial factors • Investment returns

  6. The Swedish Pension System • The Notional Defined Contribution System • 16% of salary contributed • Partially funded • Investment return based on • Increase in an index of average income, or • Approximate rate of return in the system • The Financial Defined Contribution System • 2.5% of salary contributed • Fully funded • Individual can choose as many as 5 of 500 investment funds

  7. Defined Contribution Pensions • Workers and retirees typically have some discretion over types of claims purchased (fixed, equity or both) • Growing use in both private and public retirement systems • More amenable to risk-sharing between workers and retirees

  8. Demography and the Growth of Defined Contribution Pensions • Ratio of retirees per worker increasing • With fixed claims for retirees, worker claims would be highly leveraged • Allocation of risk would be suboptimal • Defined contribution plans can • Provide equity characteristics • Allow workers to choose levels of risk • Facilitate a more optimal allocation of risk among workers and retirees

  9. Risk-sharing in a Simple Economy Economic Output Retirees Workers

  10. Risk-sharing with Few Retirees Economic Output Retirees: 10% Debt Workers: 90% Equity

  11. Risk-sharing with Many Retirees Economic Output Retirees: 25% Debt Equity Workers: 75% Equity

  12. Risk-sharing in the Swedish Pension System • Notional Defined Contribution • Characteristics of both debt and equity • Accumulation phase • Rate of return based on index of average income or approximate rate of retun in the system • Retirement • Annuity amount varies with index of average income or approximate rate of return in the system • Guaranteed minimum pension • Financial Defined Contribution • Accumulation phase • participant can choose debt, equity or combination • Retirement • Participant can choose fixed annuity or variable annuity

  13. Demographic Trends:Disappearing Population Pyramids • Population by age cohort • 0-4 • 5-9 • …. • Males on the left • Females on the right • Source: U.S. Bureau of the Census, International Database

  14. Population: U.S., 1950

  15. Population: U.S., 1975

  16. Population: U.S. 2000

  17. Population: U.S., 2025

  18. Population: U.S., 2050

  19. Population: Sweden, 1989

  20. Population: Sweden, 2000

  21. Population: Sweden, 2025

  22. Population: Sweden, 2050

  23. Why Bother? More pensioners...

  24. Low birth rates mean fewer new workers

  25. Increasing life expectancies mean more retirees to support Future retirees will live years longer than today’s 65-year-olds, and collect thousands more in benefits.

  26. In the future, fewer workers will support more retirees. As a matter of simple math, when the ratio of workers to retirees falls, each worker must bear a greater financial burden. 2030: 2.1 to 1 Today: 3.4 to 1 1960: 5.1 to 1

  27. Social Security taxes are already high… • The Social Security payroll tax is 12.4 percent of wages. That’s… • An eighth of the average worker’s total wages… • The biggest tax the average household will pay. • That’s enough to pay… • Six months rent on a $700 per month apartment, or… • A full year of student loan payments at $350 per month, or… • A keg of Budweiser every weekend (plus chips!). • And if today’s payroll tax seems high, wait ‘til it rises to 18 percent or more!

  28. …and without reform, they’ll only go higher: by 2030, costs will top 17 percent of payroll.

  29. ...supported by fewer wage-earners

  30. Promises, promises...

  31. Financial Assets are set to double in 10 years...

  32. In that context... • What are key objectives of OTPPB? • Who are key stakeholders? • What conflicts can you envision?

  33. Liabilities: sensitive to...

  34. Trends: • People live longer • People work less... • Inflation is low • Wage increases are high • Problems with CPI

  35. Asset side • Efficient frontier analysis • How sensitive is it? • What should be taken into account in diversification strategy?

  36. How to do it? • Let us consider fund’ surplus=Assets-Liabilities, S=A-L • Today S0=A0-L0 • Tomorrow S1=A1-L1 • Pension fund problem is to max S1 • Or..

  37. Optimizing portfolio with liabilities...

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