Let's call a spade a spade. The Chilean model, or age-based investment plans, that the Ministry of Finance wants to introduce into Israel's pension market, will probably reduce the pensions that savers receive in the future. The model will reduce rights, because of the overly high, long-term, and fixed price in terms of the potential return, in exchange for reduced volatility in the savings of old savers, which is the idea unpinning the model.
The real issue at the heart of the Chilean model, and its adaptation to the Israeli market, is the problem of shortfall in the return upon retirement, which will continue after retirement. This shortfall will be reflected in lower accumulation, resulting in lower pensions.
According to conservative estimates by a financial institution, which "Globes" has obtained, the fall in projected returns will be 7-10% during the saving period, under normal market conditions. This gap will continue into the pension period. In other words, looking at the long term, the public's savings will shrink as the result of a switch to the Chilean model.
The problem begins at age 55-60, when there is already accumulation from years of deposits, and the cumulative return on them. Considering that these are the most important years for accumulation, the years with the highest accumulation (hence the importance of a different and more cautious approach to veteran savers) then the shortfall is considerable, and will be reflected in the monthly pension that the savers will receive.
For many people, the loss of NIS 400 a month is significant and hard felt, and will affect the quality of their lives.
Pension calculations for customers of their expected pensions are currently based on an annual gross real interest rate of 4%. Ignoring the prevailing low interest rate (which will temporarily make it more difficult to achieve high returns), then given the Chilean model and the low levels of risk for at a more advanced age, then, taking the long-term view, savers will not achieve this return. In other words, expected pension payout calculations will probably change and shrink immediately, and probably also in the long-term average. This will increase the exposure in insurance liabilities, and create problems beyond the pension funds.
As a result of the severe economic crisis of 2008, regulation reduced by too much the risk for not-so-old savers who still have a long investment horizon. It seems that the Ministry of Finance has gone too far, as people in the industry tell me from time to time. These people expect that the Chilean model will simply result in fewer rights being accumulated by the public, alongside which fewer assets will be accumulated by the insurance companies relative to their commitments.
The Chilean model has further problems and consequences. One is its effect on the capital market - a problem that can be solved, and that is in any case probably not large or stratetgic in the long term - arising from the sale and purchases of securities to adjust portfolios to the current age structure. There is another question: What to do with the liquid money in the provident funds, which people over 60 can withdraw at any time?
A far more acute problem is the lack of transparency and the inability to compare financial institutions, contradicting the Ministry of Finance's plans to increase transparency and mobility. The Chilean model will result in a lack of clarity, which will harm the ability to provide in-depth advice, and will later also harm the ability to move between pension providers.
Published by Globes [online], Israel business news - www.globes-online.com - on January 5, 2011
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