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How the Financial Crisis Affects Pensionsand Insurance and Why the ImpactsMatter

Gregorio Impavido and Ian Tower

WP/09/151

© 2009 International Monetary Fund WP/

09/151

IMF Working Paper

Monetary and Capital Markets Department

How the Financial Crisis Affects Pensions and Insurance and Why the Impacts MatterPrepared by Gregorio Impavido and Ian Tower

Authorized for distribution by Inci Otker-RobeJu

ly

2009

Abstract

This paper discusses the key sources of vulnerabilities for pension plans and insurancecompanies in light of the global financial crisis of 2008. It also discusses how theseinstitutional investors transit shocks to the rest of the financial sector and economy. Thecrisis has re-ignited the policy debate on key issues such as: 1) the need for countercyclicalfunding and solvency rules; 2) the tradeoffs implied in marked based valuation rules; 3) theneed to protect contributors towards retirement from excessive market volatility; 4) the needto strengthen group supervision for large complex financial institutions including insuranceand pensions; and 5) the need to revisit the resolution and crisis management framework forinsurance and pensions

.

This Working Paper should not be reported as representing the views of the IMF.

The views expressed in this Working Paper are those of the author(s) and do not necessarily representthose of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and arepublished to elicit comments and to further debate.

JEL Classification Numbers: G20, G23Keywords: Pensions, insurance, financial crisisAuthor

’

s E-Mail Address:GImpavido@imf.organdItower@imf.org The authors are grateful for comments received from Barry Johnston, Inci Otker-Robe, AlexTieman and Christian Mulder.

2Contents PageI. Introduction............................................................................................................................4II. The Role of Pension Plans and Insurance Companies..........................................................4III. Key Pensions and Insurance Characteristics........................................................................6IV. The Nature of Assets and Liabilities.................................................................................10V. Sources of Vulnerability.....................................................................................................18Asset shocks.....................................................................................................19Liability shocks................................................................................................26VI. Risk Sharing and Transmission Channels to the Rest of the Economy.............................30A. Pensions..................................................................................................................30B. Insurance Companies..............................................................................................42VII. Policy Conclusions...........................................................................................................45References................................................................................................................................49Tables1. Asset Changes in Corporate Plans (Major Stock Indices)..................................................202. Asset Changes in Mandatory DC Plans..............................................................................213. Insurance Sector Announced Losses and Capital-raising to Date......................................234. Liability Changes in Corporate Plans (Major Stock Indices).............................................275. Funding Ratio Changes in Corporate Plans (Major Stock Indices)....................................336. Composition of Household Financial Balance Sheet in Select OECD...............................367. 2008 Financial Crisis and Multi-funds in Latin America...................................................378. Public Debt, Pension Spending and Implicit Pension Debt for Thirty Five Low andMiddle Income Countries for Various Years During the end-1990s and 2000.................41Figures1. Role of Financial Assets in Overall......................................................................................82. Assets in DB and DC Private Plans (OECD and Latin America).........................................93. Pension Assets as Percent of GDP in OECD Countries (2007).........................................124. Pension Assets as Percent of GDP in Latin American Countries (06/2008)......................135. Asset Allocation of OECD Private Pension plans (2006)..................................................146. Asset Allocation (average) of Latin American Pension Plans (06/2008)...........................157. Pension Fund Returns in Selected OECD Countries (January–October 2008)..................198. Corporate Plan Assets in Major Stock Indices (January 2007–April 2009).......................209. CDS Spreads in the Insurance Sector.................................................................................2410. Bloomberg Insurance and Bank Indices............................................................................2511. Corporate Plan Liabilities in Major Stock Indices (January 2007–April 2009)................27

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