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Ageing population and
demography: the role of
financial institutions
José Luis Escrivá
Chief Economist
BBVA Banking Group
bbvaresearch.department@grupobbva.com
Europe’s
competitiveness:
how financial institutions
can help deliver it
1st EPFSF Annual Conference
Brussels, May 15, 2007
1st EPFSF Annual Conference 1
Ageing population and demography: the role of financial
institutions
1. The need for an European pension market
2. The need to address the risks of an asset “meltdown”
effect
3. The need for more marked-oriented pension systems
1st EPFSF Annual Conference 2
Ageing population and demography: the role of financial
institutions
1. The need for an European pension market
2. The need to address the risks of an asset “meltdown”
effect
3. The need for more marked-oriented pension systems
1st EPFSF Annual Conference 3
The challenges of demographic ageing: economic growth and
public finances
Demographic ageing will accelerate in the coming decades as the baby-
boom generation reaches retirement age
… and will have a significant impact on European economic growth
Cause: reduction in the size of the labor force:
Population aged 15-64. Average growth rate (%)
19 … Holding
16 productivity growth,
13 participation rates
10 and unemployment
7 constant, GDP pc
4 growth will
1 slowdown by 3 p.p.
-2 over the next two
-5 decades in Europe
1950/55 1975/80 2000/05 2025/30 2045/50
Europe Northern America Latin America Africa World
Source. United Nations & BBVA
They could be partially offset by higher participation rates, longer
work life, and greater productivity…
1st EPFSF Annual Conference 4
Ageing will require greater labor mobility across European
countries
… This requires a more efficient use of the labor factor. The low
labor mobility across European countries makes difficult to
improve the efficiency
Currently 1.5% of EU-25 citizens live and work in a different member state
form their country of origin. Interstate mobility rate in the US is three times
bigger
Every year, 7.2% of EU-25 citizens change their place of residence, but
only 1.1 p.p. due to a change in jobs (2.8 p.p. in the US) (Eurostat & US
Labor, 2002)
Department of Share of people moving depending on work-related
reasons
3.0 2,8
2.5
2.0
1.5
1,1
1.0
0.5
0.0
B I P GR IRL E D L NL A UK S F DK FIN EU15 USA
Source. Coomans, G. (2002)
Are the current European pension systems a barrier for mobile
workers?
1st EPFSF Annual Conference 5
Portability of pension rights of migrant workers is essential
to increase mobility
First Pillar
Although EU regulation ensure that pension rights are maintained
when a European worker moves across European countries…
[EU Regulation 1408/71, implementing Regulation 574/72, and
later Council and Commission Regulations]
… Most European countries do not refund pension contributions if
worker moves to another EU country
Contribution records are kept until workers reach retirement
age contributions paid in one country can neither be
transferred to another country nor reimbursed to workers
This is a suboptimal solution: public pensions portability between
European countries is very limited
1st EPFSF Annual Conference 6
Portability of pension rights of migrant workers is essential
to increase mobility
Second and Third Pillars:
The European Commission Directive on Institutions for
Occupational Retirement Provision (2003) has not been
translated in most countries (14 out of 25 member states). Why?
The gap between EU regulation of pension institutions and
the national regulation of pension products
Therefore, the development of Pan-European Pension Plans
(PEPP) should be a priority
An alternative solution to this problem, focusing on 3rd pillar:
“Pan-European Pension Plans. Deepening the concept” (EFR
Pensions Steering Group, 2005)
1st EPFSF Annual Conference 7
Ageing population and demography: the role of financial
institutions
1. The need for an European pension market
2. The need to address the risks of an asset “meltdown” effect
3. The need for more-marked oriented pension systems
1st EPFSF Annual Conference 8
Old-age dependency ratios in Europe will increase
exponentially…
Holding macro and regulation constant, pension expenditure will rise
as the old-age dependency ratio,
Old-age dependency ratio
(Population aged 65 and over / Population aged 15-64)
0.5
0.48
0.4
0.3 … European social
0.23 security systems
0.25
0.2 have a problem
0.13
0.11
0.1 0.09
0.11
0.06 0.06
0
1950 1975 2000 2025 2050
Europe Northern America World Latin America Africa
Source. United Nations and BBVA
1st EPFSF Annual Conference 9
… giving rise to the risk of an “asset meltdown”
Higher dependency ratios mean lower overall savings, inducing
potential capital losses to those who retire
The asset “meltdown” problem:
A massive liquidation of past savings by the retiring baby-
boomers will cause a rise in interest rates and a fall in the
price of bonds (“asset meltdown”)
Estimation Results. 70 - 80 basis points drop in bond
prices spread over five decades (Krueger and Ludwig,
2006)
Is this problem manageable?
What can the financial system do?
1st EPFSF Annual Conference 10
Asset meltdown problem is manageable. Financial institutions
can help to provide more income security among the elderly
The problem is manageable with the involvement of financial
institutions:
1. Older societies can transfer part of the burden to younger ones,
if financial markets are integrated
2. Investment strategies for pension fund managers focused on
lifetime earnings: Longevity Bonds
3. Development of instruments to make more efficient use of non-
financial wealth after retirement: Reverse Mortgages
The “meltdown effect” may still be small and spread over a
very long
1st EPFSF Annual Conference 11
Financial institutions can help to provide more income security
among the elderly: longevity bonds and reverse mortgages
2. Coverage of longevity risks in private-DC pension markets,
Solution: to implement bonds indexed to life expectancy, i.e.,
longevity bonds
• Difficulties to implement since no obvious counterpart exists
• Difficulties to asses uncertainty and associated risks
adequately
Comparing realized gains in life expectancy at birth with past projections (years)
United Nations Eurostat
OECD Average 0,8 -
A positive sign means that EU-15 Average 0,7 0,4
life expectancy in 2003 hasCanada 0,2 - Life expectancy
France 0,6 -0,3 projections by
already by-passed projectedGermany 0,6 0,3
Italy 1,1 0,7
international orgs.
life expectancy for the and actuaries
Japan 1,5 -
average 2000-05 (UN) and Mexico 1,9 -0,1 have consistently
2005 (Eurostat) United Kingdom 0,5 - underestimated
United States -0,2 - improvements
Source: Antolín (2007)
1st EPFSF Annual Conference 12
The potential size of the RM market is huge...
3. Instruments to make more efficient use of non-financial wealth
after retirement: Reverse Mortgages (RM)
A significant proportion of the wealth of individuals (especially in
Southern European countries) is tied to housing
Home equity conversion products may be useful to all those who
are “house-rich but cash-poor” (not limited to the elderly)
The development of RM could play a central role
Demographic projections indicate that elderly people is the fastest
growing segment all over the world, especially in Japan and Europe
Literature on RM is unanimous on its huge market potential
(Püntner & Röhrs, 2006). Reality has not been up to expectations
though…
1st EPFSF Annual Conference 13
…but the actual size of the RM markets is nowhere near its
estimated potential…
United States, Reverse Mortgages United Kingdom, Reverse Mortgages
90000 120000 250000 25000
Number of RM (left) Number of RM (left)
75000 100000 196148
Pop. over 60 years in thousands (right) 200000 Pop. over 60 years in thousands (right) 20000
60000 80000 150952
131716 139753
150000 15000
45000 60000 122087
105073
30000 40000 100000 83728 10000
15000 20000
50000 5000
0 0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2010 (p)
2015 (p)
2020 (p)
2050 (p)
0 0
2004 2005 2006 2010 (p) 2015 (p) 2020 (p) 2050 (p)
Source. HECM, Census Bureau and BBVA
Source: CML Research, Census Bureau and BBVA
Number of RM/Million Inhabitants over 60 years
Year United Kingdom United States Spain
Spain, Reverse Mortgages
2004 6704 757 0 14000 16000
11,528
Number of RM (left) 14000
2050 (p) 9537 805 805 12000
Pop. over 60 years in thousands (right) 8,818 12000
Source: CML, HECM, Census Bureau and BBVA 10000
10000
8000
Assuming that the development of 8000
6000
the RM market in Spain will be 6000
4000
similar to that of the U.S. and the 1,474
4000
2000 921 2000
population projections, in 2050 there 35
0 0
will be 800 RM per million 2007 (p) 2010 (p) 2015 (p) 2020 (p) 2050 (p)
inhabitants over 60 in Spain Source: Census Bureau and BBVA
1st EPFSF Annual Conference 14
... for a variety of reasons from the demand, supply and
regulatoriy considerations
What are the reasons for the gap between potential and actual RM
volumes?
Supply side
RM complexity exposes a lender to several risks:
mortality, interest rates and real estate markets
Moral hazard problems: once a RM loan is taken, the
homeowners may have no incentive to maintain the
house to preserve or enhance it’s market value
Demand side
It is an unusual product for a typical elderly borrower,
creating fears of debt burden, eviction and inability to
bequeath property
Regulatory uncertainties
Still novel (or non-existent) legislation in most
European countries
1st EPFSF Annual Conference 15
Ageing population and demography: the role of financial
institutions
1. The need for an European pension market
2. The need to address the risks of an asset “meltdown”
effect
3. The need for more-marked oriented pension systems
1st EPFSF Annual Conference 16
First pillar, generally Pay-As-You-Go pension scheme, is the
most important in Europe
Evolution of the public pension expenditure and the size of pension funds,
2004
Pension funds
Public Pensions
(occupational & personal)
Expenditure Total investments
Share Share
(% of GDP) (% of GDP)
Italy 14.7 85.1 2.6 14.9
Germany 13.3 77.9 3.8 22.1
France 13.1 68.6 6.0 31.4
United Kingdom 10.7 13.5 68.8 86.5
Spain 9.2 50.5 9.0 49.5
EU-15 12.3 69.9 5.3 30.1
Source. Eurostat, OECD Global Pension Statistics,and BBVA
Countries where private pension plans started decades ago have
the largest pension markets (Anglo-Saxon countries)
The size of private-pension asset accumulation is reduced in
countries where public pensions play a dominant role (France,
Germany, Italy,…)
1st EPFSF Annual Conference 17
Increased longevity and falling fertility rates are major
factors making pension systems unsustainable
From a fiscal perspective, system sustainability requires reforms of
the public social security systems (parametric or structural)
Not-reformed PAYG pension systems accumulate commitments
between one and three times the current GDP level
Estimates of implicit pension debt and central
government debt (% of GDP)
Central government Implicit pension debt
debt, 1999-2000 (4% discount rate)
Germany 50 186
Italy 129 207
Spain 63 129
France 48 112
United Kingdom 46 92
Brazil 33 330
Polonia 43 261
Hungary 59 203
Argentina 53 85
Source. Holzmann, Palacios & Zviniene (2001)
What will happen if European countries do not reform their pension
systems? The Latin American experience
1st EPFSF Annual Conference 18
Countries that moved from PAYG to DC systems had to face
large fiscal transition costs, but will benefit from lower pension
debt
Counterfactual:
What if Latin American economies had not reformed their
pension systems?
Implicit pension debt (% of GDP)
Reformed If not reformed…
2001 2020 2001 2020
Argentina 74.6 89.1 87.3 125.1
Chile 40.3 10.1 22.0 44.0
Mexico 14.9 18.0 130.1 179.6
Source. Zviene & Packard (2002)
1st EPFSF Annual Conference 19
Countries that gradually move towards DC schemes will make the
pension system more sustainable
Chile will have large fiscal savings in the future, despite persistent
transition costs
Fiscal committments with civilian pensions
4.0%
3.5%
3.0%
… Fiscal savings will
2.5%
make possible a major
(% of GDP)
2.0% upgrade of the solidarity
1.5%
pillar
1.0%
0.5%
0.0%
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Old system deficit Recognition Bonds PASIS Minimum Pension
1st EPFSF Annual Conference 20
Conclusions
Demographic ageing will have a significant impact on public finances
and will put the European households under strain
Solutions: reforming pensions, improving the efficiency of pension
systems, and developing home equity conversion products:
1. Improving the efficiency of European pension markets requires
facilitating public and private pension portability between European
countries. The development of Pan-European Pension Plans should be
a priority
2. Financial institutions can contribute to address the pension challenge.
They can help to provide more income security among the elderly by
means of longevity bonds and reverse mortgages
3. A more marked-orientation of the European pension schemes, with
more DC components, will make the system more sustainable over the
long run
1st EPFSF Annual Conference 21
