14cis Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 14: Pension funds Insurance companies
Who buys government bonds? Government bonds are bought in large quantities by pension funds and insurance companies Government bonds are considered to be a secure investment Repayment is guaranteed by the government o Very rarely do governments go bust (so-called sovereign default ) The income stream is predictable and long-term UK government bonds in the UK are available with maturities between 30-50 years o Many people start pension savings plans in their early 20s and cash them in at retirement 40+ years later
Pension funds A pension fund is the main way in which individuals make provision for income after retirement The basic state pension is currently worth 95.25 a week Most people find the basic state pension inadequate (in fact, it is lower than the income support threshold) They need to top up the basic state pension with income from other sources usually from an additional pension plan Public sector employees usually get a final salary pension Upon retirement, a proportion of their final salary is paid to them each year until they die Public sector final salary schemes are index-linked (i.e. not vulnerable to inflation) and paid by the tax-payer Some companies still offer final salary pension schemes But the majority have switched to defined benefit With defined benefit, payments are made into the scheme and employees know the size of their pension pot upon retirement
Personal schemes Most pensions involve the payment of a regular sum of money into a retirement fund over the course of a working life The size of the eventual pension depends on how well the retirement fund has been invested and what return has been achieved Pension scheme managers will invest your contributions into a variety of assets Cash deposits, long-term bonds, property Occupational pension schemes The employer pays money into the retirement fund each month The employees pays money into the retirement fund each month Personal pension schemes Stakeholder pension cheap and simple professionally managed Self-invested personal pension (SIPP): you advise yourself o No employer contributions used mainly by the self-employed
Personal schemes What happens to your pension when you retire? The earliest you can retire and withdraw a personal pension is at the age of 55 (state pension is payable from the age of 65) Upon retirement, you can take out up to 25% of your pension pot as a lump-sum, paid tax-free The remaining 75% is used to provide a regular income for the rest of your life, which is taxable Annuities The pension provider undertakes to pay the pensioner a certain income each year an annuity The remaining 75% of the capital in the pension pot becomes the property of the annuity provider Annuity rates The level of income is determined at the time of conversion It depends on two main variables: o Yields on long-term government bonds at the time o Life-expectancy of the new pensioner
How big is the pension fund industry? The pension fund industry is the largest investor in the world In January 2008, it was estimated that pension funds worldwide hold over US$20 trillion in assets, the largest for any category of investor, including, insurance companies, sovereign wealth funds, hedge funds, or private equity Globally, the largest 300 pension funds collectively hold about US$6 trillion in assets. Some 20m people in the UK are members or beneficiaries of an occupational pension fund. Pension schemes in the UK have a combined value of approximately 800bn and represent the largest pool of capital in the UK economy, controlling a third of the stock market With a capital value of 388bn, the top 100 pension schemes represent approximately 47% of the total pension fund market.
Professional pension fund managers Pension funds are owned by the contributors and administered by trustees on their behalf. Very few trustees actually manage the funds themselves. They hire professional pension fund managers to do that for them. External fund management firms hired by the largest 50 pension funds in the UK (2006) Source: LSE In 1981, around 50% of the largest UK pension funds were internally managed. By 2006, only five were internally managed: the remainder all hired professional advisers In 2006, there were over 100 pension management firms in the UK
Are professional pension fund managers doing a good job? Performance of balanced managed pension funds vs the stock-market
Insurance types General insurance Motor Buildings Contents of homes Medical Life and pensions Term life insurance Whole-of-life insurance Personal pensions Group pensions Percentage of UK households buying insurance products and the price they pay each year Source: ABI
Long-term insurance business Life and pensions Term life insurance Whole-of-life insurance Personal pensions Group pensions Long-term business by type, 1998 2008, nominal values Source: ABI
Pensions and insurance companies Pensions are a key product for insurance companies Total funds held in life and pension schemes in real terms, bn, 2003-2008 Source: ABI The UK insurance industry is the largest in Europe and the second-largest in the world after the US
Pensions and insurance companies Insurance companies provide roughly half of all UK pensions Money held in insurer-administered pensions as a percentage of total money held in all pension funds, 1988-2008 Source: ABI The UK insurance industry is the largest in Europe and the third-largest in the world after the US
Pensions and insurance companies Of the top 10 insurance company pension providers in the UK, seven are UK-owned Top 10 UK insurance companies by funds held in insurer-administered pension schemes, bn, 2008 Source: ABI
Insurance companies and the UK economy Annual pension premium income for UK life insurance industry INDIVIDUAL PENSIONS m 2005 2,401 2006 3,535 2007 3,811 2008 3,967 2009 2,808 OCCUPATIONAL PENSIONS 2005 766 2006 753 2007 821 2008 2,185 2009 1,983 Source: ABI Insurance companies employ 313,000 people in the UK That is one third of all financial services jobs in the UK Insurance companies are responsible for investments totalling 1.5trn, or 21% of the UK s total net worth In 2008, they controlled 13.4% of all investments in the London stock market the largest single stake Insurance companies are a major exporter One fifth of the insurance industry s premium income comes from overseas
Insurance companies investment holdings Invested funds by asset class, 2008 Source: ABI
How well are the insurance companies doing when it comes to managing pension funds? Funds invested in insurer-administered pension schemes compared to the FTSE All Share Index, 1998-2008 Source: ABI