_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 3, No. 24: December 19, 2002
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Publisher: LSN Employment, Labor, Compensation & Pension Journals
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Editor: PAMELA PERUN
Urban Institute
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Topic of This Issue:
Annuity Issues
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T A B L E of C O N T E N T S
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NEW and FORTHCOMING ARTICLES
"An Evolving Pension System: Trends in Defined Benefit and
Defined Contribution Plans"
EBRI Issue Brief, No. 249, September 2002
DAVID RAJNES
Employee Benefit Research Institute (EBRI)
"A Federal Charter Option for Insurance Companies: Lessons from
the Bank Experience"
FINANCIAL MODERNIZATION AFTER GRAMM-LEACH-BLILEY, Pat
McCoy, ed., Lexis Nexis, 2002
LISSA LAMKIN BROOME
University of North Carolina at Chapel Hill
School of Law
"The Transformation of the U.S. Financial Services Industry,
1975-2000: Competition, Consolidation and Increased Risks"
University of Illinois Law Review, Vol. 2002, No. 2,
Forthcoming
ARTHUR E. WILMARTH
George Washington University Law School
WORKING PAPERS
"The History of Annuities in the United States"
JAMES M. POTERBA
Massachusetts Institute of Technology (MIT)
Department of Economics
National Bureau of Economic Research (NBER)
"Annuities Markets Around the World: Money's Worth and Risk
Intermediation"
ESTELLE JAMES
Consultant, Washington DC
World Bank
XUE SONG
Institute for Women's Policy Research, U.S.
"The Moral Hazard of Insuring the Insurers"
BRIAN HALL
Harvard Business School
National Bureau of Economic Research (NBER)
JAMES G. BOHN
Board of Governors of the Federal Reserve System
"Developments in Decumulation: The Role of Annuity Products in
Financing Retirement"
OLIVIA S. MITCHELL
University of Pennsylvania, Wharton School
National Bureau of Economic Research (NBER)
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"An Evolving Pension System: Trends in Defined Benefit and
Defined Contribution Plans"
EBRI Issue Brief, No. 249, September 2002
BY: DAVID RAJNES
Employee Benefit Research Institute (EBRI)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=341100
Other Electronic Document Delivery:
http://www.ebri.org
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Contact: DAVID RAJNES
Email: Mailto:rajnes@ebri.org
Postal: Employee Benefit Research Institute (EBRI)
Suite 600
2121 K Street, NW
Washington, DC 20037-1896 UNITED STATES
Phone: 202-775-6329
Fax: 202-775-6312
Paper Requests:
Contact Alicia Willis at Mailto:publications@ebri.org, or 2121 K
St., NW, Suite 600, Washington, DC 20037-1896.
Phone:(202)572-7422, Fax:(202)775-6312. Full-Text downloads are
available from SSRN Online for $7.50.
ABSTRACT:
This Issue Brief examines trends in employment-based defined
benefit (DB) and defined contribution (DC) pension plans since
1975. The analysis relies extensively on Form 5500 reports
submitted by plan sponsors and published by the Department of
Labor, although other sources of information are used.
The Issue Brief goes beyond a general description of trends in
the number of qualified private-sector plans, participants, and
plan contributions and assets to examine why DB plans have
steadily lost ground as the preferred plan type in recent
decades. It explores several explanations for the increased use
of DC plans and cites the research and lines of reasoning used
to support them. These reasons include government regulation;
changes in the work place; business environment and risk
associated with funding and managing pension plans; firm size;
increased global competition; and the successful marketing
efforts of consultants and DC plan service providers.
Developments in the public sector--on the federal and state and
local levels--are discussed.
The report addresses public policy implications raised by the
movement away from DB toward DC (and hybrid) plan designs.
Important issues in this context include possible sources of
future retirement income; the impact of job stability on the
portability of retirement benefits as well as benefit
preservation and decumulation; and the extent to which
alternative retirement plan designs satisfy the needs of both
employer and employee. A closing section examines two topics of
importance to retirement plans: changes in the tax code
resulting from the Economic Growth and Tax Relief Reconciliation
Act (EGTRRA) of 2001 and recent developments in corporate
governance reform and financial disclosure.
The report updates information contained in a 1997 EBRI
analysis of the same subject, and includes sections on plan
design and operational issues that are combined into an appendix
to provide basic background on how retirement plans work.
Keywords: 401(k) Plans, Defined Benefit Plans, Defined
Contribution Plans, Employment-based Benefits
JEL Classification: J32
______________________________
"A Federal Charter Option for Insurance Companies: Lessons from
the Bank Experience"
FINANCIAL MODERNIZATION AFTER GRAMM-LEACH-BLILEY, Pat
McCoy, ed., Lexis Nexis, 2002
BY: LISSA LAMKIN BROOME
University of North Carolina at Chapel Hill
School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=334440
Paper ID: UNC Public Law Research Paper No. 02-11
Date: September 2002
Contact: LISSA LAMKIN BROOME
Email: Mailto:lissa_broome@unc.edu
Postal: University of North Carolina at Chapel Hill
School of Law
Van Hecke-Wettach Hall, 100 Ridge Road
CB #3380
Chapel Hill, NC 27599-3380 UNITED STATES
Phone: 919-962-7066
Fax: 919-962-1277
ABSTRACT:
Professor Broome discusses the interest following the enactment
of the Gramm-Leach-Bliley Act in establishing a federal charter
option for insurance companies. She summarizes previous efforts
to obtain a federal insurance charter. The paper attempts to
draw some lessons for the insurance industry from the bank
experience with dual chartering. Professor Broome cautions that
the dual banking system is not the product of a carefully
crafted balancing of powers between state and federal
regulators, but rather an historical accident, and suggests that
creating a new federal bureaucracy to mimic this system would,
at this juncture, be premature.
Keywords: Banking Law, Finance, State Chartering, Insurance
______________________________
"The Transformation of the U.S. Financial Services Industry,
1975-2000: Competition, Consolidation and Increased Risks"
University of Illinois Law Review, Vol. 2002, No. 2,
Forthcoming
BY: ARTHUR E. WILMARTH
George Washington University Law School
Paper ID: GWU Law School, Public Law Research Paper No. 41
Contact: ARTHUR E. WILMARTH
Email: Mailto:awilmarth@main.nlc.gwu.edu
Postal: George Washington University Law School
2000 H Street, N.W
Washington, DC 20052 UNITED STATES
Phone: 202-994-6386
Fax: 202-994-9811
ABSTRACT:
The structure of the U.S. financial services industry has
fundamentally changed during the past quarter century. Rapid
improvements in information technology and the creation of
innovative financial instruments have produced a dramatic
increase in competition and spurred deregulation, thereby
eroding traditional barriers that separated banks from
securities firms and life insurance companies. In response to
these trends, major banks, securities broker-dealers and life
insurers have aggressively expanded by merging with their direct
competitors and by acquiring firms in other financial sectors.
The Gramm-Leach-Bliley Act of 1999 has encouraged this
consolidation trend by authorizing the creation of financial
holding companies that engage in a full range of banking,
securities and insurance activities. The Act's proponents claim
that the new "financial supermarkets" will produce favorable
economies of scale and scope, offer convenient "one-stop
shopping" to customers, and achieve a safer diversification of
risks.
This article contends that the motivations for and probable
outcomes of financial conglomeration are very different.
Managers of large, diversified financial firms have sought
growth in order to build personal empires, to increase market
power and to secure membership in the exclusive club of "too big
to fail" (TBTF) institutions. By virtue of their TBTF status,
major financial holding companies are largely insulated from
market discipline and regulatory oversight, and they have
perverse incentives to take excessive risks at the expense of
the federal "safety net" for financial institutions. Based on
past experience, the new financial megafirms are likely to
encounter diseconomies of scale and scope, shrinking profit
margins, increased customer dissatisfaction, and greater
vulnerability to sudden disruptions in the financial markets. In
addition, current policies create a near-certainty that federal
regulators will prop up these gigantic financial firms during
economic crises.
In light of the challenges posed by financial holding
companies, federal regulators have tried to strengthen capital
regulation and increase market discipline. However, these
incremental regulatory initiatives cannot control the potential
risks of financial conglomerates, because they do not solve the
problems of supervisory forbearance and moral hazard created by
the TBTF doctrine. This article calls for more far-reaching
reforms to our financial regulatory system in order to compel
financial conglomerates to internalize the costs of their
risk-taking.
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"The History of Annuities in the United States"
BY: JAMES M. POTERBA
Massachusetts Institute of Technology (MIT)
Department of Economics
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=226412
Paper ID: NBER Working Paper No. W6001
Date: April 1997
Contact: JAMES M. POTERBA
Email: Mailto:poterba@mit.edu
Postal: Massachusetts Institute of Technology (MIT)
Department of Economics
E52-350
50 Memorial Drive
Cambridge, MA 02142 UNITED STATES
Phone: 617-253-6673
Fax: 617-253-1330
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
This paper summarizes the development of private annuity markets
in the United States. Annuities constituted a small share of the
U.S. insurance market until the 1930s, when two developments
contributed to their growth. First, concerns about the stability
of the financial system drove investors to products offered by
insurance companies, which were perceived to be stable
institutions. Flexible payment deferred annuities, which permit
investors to save and accumulate assets as well as draw down
principal, grew rapidly in this period. Second, the group
annuity market for corporate pension plans began to develop in
the 1930s. The group annuity market grew more rapidly than the
individual annuity market for several decades after World War
II. The most recent development in the annuity marketplace has
been the rapid expansion of variable annuities. These annuity
products combine the investment features of mutual funds with
the tax deferral available for life insurance products. Variable
annuity premium payments increased by a factor of five in the
most recent five years for which data are available.
JEL Classification: G2, D9
______________________________
"Annuities Markets Around the World: Money's Worth and Risk
Intermediation"
BY: ESTELLE JAMES
Consultant, Washington DC
World Bank
XUE SONG
Institute for Women's Policy Research, U.S.
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=287375
Contact: ESTELLE JAMES
Email: Mailto:ejames@estellejames.com
Postal: Consultant, Washington DC
Co-Auth: XUE SONG
Email: not available
Postal: Institute for Women's Policy Research, U.S.
1400 20th Street, N.W. Suite 104
Washington, DC 20036 UNITED STATES
ABSTRACT:
Annuities markets around the world are small. However, they have
been growing in recent years and are likely to grow further as a
result of reforms in public social security systems and private
pension plans, that partially replace defined benefit plans with
funded defined contribution plans. When people retire they may
choose, and are sometimes required, to annuitize these defined
contribution savings. Therefore, it is important to learn
whether or not annuities markets exist, how they operate and
what kinds of market failure can be anticipated. Several papers
have already analyzed US annuities markets. This paper extends
that analysis by examining annuities markets in other countries.
We present evidence from Canada, the UK, Switzerland, Australia,
Israel, Chile and Singapore - a variety of high and
middle-income countries - and replicate the results from the
US.
This paper focuses on analyses of the expected present
discounted value (EPDV) of cash flows from the annuity, and the
money's worth ratio (MWR), which is the EPDV divided by the
initial premium cost. We find that, when discounting at the
risk-free rate, MWR's for annuitants are surprisingly high -
greater than 95% in most countries and sometimes greater than
100%. MWR's for the average population member are lower but
still exceed 90% in most cases. We show that differential
interest rate structures largely explain differential monthly
payouts across countries, while differential mortality rates,
especially projected improvement factors, help explain
differences in measured MWR's, given these monthly payouts and
interest rates.
The high MWR's raise the question: How do insurance companies
cover their costs despite these high MWR's? We hypothesize that
for each annuity sale, insurance companies get a large sum of
money up-front that they invest in a portfolio of corporate
bonds, mortgages, and some equities, earning a rate of return
that exceeds the risk-free rate by 1.3% or more per year. They
turn this "risky" portfolio into a safer annuity by a variety of
risk-intermediation, term-intermediation techniques. This allows
them to sell a product that is nearly risk-free, while earning a
"spread" that covers their costs. We present data on cost and
investment returns that are consistent with this hypothesis. The
limited opportunity to earn this spread may help explain why
price indexed annuities in the UK charge higher loads to cover
their costs and risks. For consumers who would prefer to accept
this investment risk and capture this spread themselves, the
appropriate discount rate is higher and the MWR is lower,
helping to explain the low demand for annuities in voluntary
markets.
______________________________
"The Moral Hazard of Insuring the Insurers"
BY: BRIAN HALL
Harvard Business School
National Bureau of Economic Research (NBER)
JAMES G. BOHN
Board of Governors of the Federal Reserve System
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=225693
Paper ID: NBER Working Paper No. W5911
Date: January 1997
Contact: BRIAN HALL
Email: Mailto:BHALL@HBS.EDU
Postal: Harvard Business School
Negotiations, Organizations & Markets
Soldiers Field
Boston, MA 02163 UNITED STATES
Phone: 617-495-5062
Fax: 617-496-4191
Co-Auth: JAMES G. BOHN
Email: not available
Postal: Board of Governors of the Federal Reserve System
20th and C Streets, NW
Washington, DC 20551 UNITED STATES
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
State guaranty funds are quasi-governmental agencies that
provide insurance to policyholders against the risk of insurance
company failure. But insurance provided by guaranty funds, like
all insurance, creates moral hazard problems, especially for
companies that are insolvent or near-insolvent. The key insight
of this paper is that because of the time lag between premium
payments and losses (which is especially lengthy in long-tail
lines), writing policies is one way for insurance companies to
borrow money (i.e., from policyholders). Moreover, the existence
of guaranty fund insurance enables insurance companies, even
very risky ones, to borrow from policyholders at rates that do
not reflect the insurer's default risk. Thus, one way for
insurance companies to game the guaranty fund system is to
engage in excessive premium writing. Consistent with this idea,
we find that insolvent P&C insurance companies tended to have
very high premium growth before they failed. More than one-third
of the failed insurance companies had premium growth of more
than 50 percent in the two years before failure. Moreover, this
excessive premium growth was more pronounced in long-tail lines
than in short-tail lines. We also find evidence that greater
regulatory resources are associated with less gaming of the
system.
______________________________
"Developments in Decumulation: The Role of Annuity Products in
Financing Retirement"
BY: OLIVIA S. MITCHELL
University of Pennsylvania, Wharton School
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=288480
Paper ID: NBER Working Paper No. W8567
Date: October 2001
Contact: OLIVIA S. MITCHELL
Email: Mailto:mitchelo@wharton.upenn.edu
Postal: University of Pennsylvania, Wharton School
Wharton Financial Institutions Center
3641 Locust Walk
Philadelphia, PA 19104-6365 UNITED STATES
Phone: 215-898-7620
Fax: 215-898-0310
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
Longer lifespans are generally seen as a positive outcome of
economic growth. Yet life extension also means that more people
face the risk of living too long - that is, outliving their
assets and means of support. A range of financial products
exists currently or can be envisioned for the future that would
be useful in helping to protect people against having to
dramatically curtail consumption in old age. This paper reviews
the usefulness of life annuities in providing protection against
longevity risk.