The Decumulation (Payout) Phase of Defined Contribution Pillars: Policy Issues in the Provision of Annuities and Other Benefits

32 Pages Posted: 20 Apr 2016

See all articles by Estelle James

Estelle James

Consultant

Dimitri Vittas

World Bank - Financial Sector Development

Date Written: Novmeber 30, 1999

Abstract

The provision of annuities and other benefits during the decumulation phase of defined contribution (DC) pension plans raises major policy issues. Because private markets for annuities and disability benefits are not well developed even in the most advanced OECD countries, the resolution of these issues is likely to be a gradual process, with both countries and markets learning through experience.

Most countries reforming their pension system focus more on the accumulation phase than on decumulation (payout), because the number of beneficiaries is likely to be small initially, especially if older workers are discouraged from joining the new system. Policymakers place a priority on the new accumulation system being administratively efficient and well regulated.

But the decumulation phase must also be well organized and efficient. The purpose of pension systems is, after all, to pay retirement benefits—old age, survivor, and disability pensions. James and Vittas argue that:

- Payout arrangements are likely to evolve gradually, through trial and error, as problems are discovered and tackled.

- Adverse selection may not be as great a problem as is sometimes thought.

- Many other annuity and insurance market problems have yet to be solved, and policies must be formulated to make these markets work as well.

The underdevelopment of voluntary annuity markets is only partly explained by adverse selection, argue James and Vittas. Other factors are also at work: the bequest and precautionary motives for saving; individuals' myopia and ignorance; mistrust of insurance companies; the "luxury good" nature of annuities; tax policies that favor lump sum withdrawals; and last but not least public policies (such as the offer of social security pensions and the encouragement of occupational pension plans) that tend to crowd out individual annuities.

The long-term success of pension reform depends on vigorous efforts to develop the insurance industry. Weak and underdeveloped in most developing countries, the insurance industry should play a central role in providing old age, survivor, and disability benefits.

Many policy issues require careful thought and extensive empirical analysis: Should annuitization be mandatory, and at what level? Should indexed (or "real") annuities be required? Should variable annuities be permitted or encouraged? Should joint annuities be required? How much "group rating" and "risk classification" should be permitted?

This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to study the implications of pension reform programs. The authors may be contacted at ejames3@worldbank.org or dvittas@worldbank.org.

Suggested Citation

James, Estelle and Vittas, Dimitri, The Decumulation (Payout) Phase of Defined Contribution Pillars: Policy Issues in the Provision of Annuities and Other Benefits (Novmeber 30, 1999). World Bank Policy Research Working Paper No. 2464. Available at SSRN: https://ssrn.com/abstract=632534

Dimitri Vittas

World Bank - Financial Sector Development ( email )

Washington, DC 20433
United States

HOME PAGE: http://www.worldbank.org/wbi/banking/insurance/contractual/vittas.html

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