Pensions Finance Midterm Review

OAFS

1. Summarise the three scenarios, identified by the World Economic Forum in its report on the twin challenges of longevity and healthcare. Provide your assessment of Canadian policy response towards increasing longevity and healthcare costs in light of these scenarios.

Answer: Winners and the rest(High individual responsibility): - Highly global growth largely driven by emerging economies - Employers provide benefits but shift cost/risk to employees - Improved benefits for a few, but not all - Social attitude:individualism

We are in this together(High collective accountability): - Medium global growth - Employers provide benefits and share cost/risk with employees - New risk-sharing pension arrangements - Social cohesion and solidarity

You are on your own(Low individual responsibility): - Prolonged recession - Employers reduce benefits and shift cost/risk to employees - Acceleration of DB to DC - Minimal social security provision

the value of hiring mature workers includes lower turnover rates, higher levels of employee engagement and higher skill levels particularly basic skills like math, reading and writing.

Three key requirements to maximize the opportunities presented by ageing:
- Effective collaboration among key stakeholders
-Transformational change in thinking is required. Thinking towards incentive structures that reward long-term planning and societies that value and honour old age as a productive life phase
- Integrated retirement and healthcare solutions are needed

2. What is an ‘opportunity mindset’ as opposed to a ‘challenge mindset’ as discussed in the paper summarising the World Economic Forum report? Explain with examples.

Answer:
|Domain |Conventional Mindset |Alternative Mindset |
| |(Challenge Mindset) |(Opportunity Mindset) |
|Population ageing |the ageing of our societies is a challenge |the ageing of our societies is both a challenge and an |
| |older workers are les productive |opportunity |
| | |older workers are productive and healthier than ever before |
|Time Horizon |there is still time to solve pension and healthcare financing |the window of opportunity to solve pension and healthcare |
| |challenges in a rapidly ageing world |financing challenges is closing fast |
|Work |work in old age is burdensome |work in old age can be enjoyable and fulfilling |
| |a person’s career ends with a hard stop at retirement |a person can have multiple careers and flexible working |
| | |arrangements at an older age |
| | |work, rewards and career progession can be adjusted to life |
| | |stages |
|Solutions |change must be incremental and be bound by established concepts of |change can and should be transformational, with a fundamental |
| |roles and responsibilities |re-conception of roles and responsibilities |
| |the pension and healthcare financing challenge can be addressed |the pension and healthcare financing challenge can be |
| |with siloed pension and healthcare solutions |simultaneously addressed with integrated solutions |
| |individual interests, single-stakeholder perspectives and risk |collective interests, multi stakeholders perspectives and risk|
| |shifting will predominate |sharing will predominate |
| |Healtchare is curative and reactive |healthcare is preventive and proactive |

4. They are critical because individuals are increasingly expected to take responsibility for management of risks and determining their level of savings, and must bear the consequences of wrong or inappropriate decisions. However, policy-makers and pension pzlan sponsors and providers must also acknowledge that fi nancial education alone may not be suffi cient to overcome behavioural biases such as a tendency to procrastinate about retirement savings decisions. Moreover, the complexity of investment decisions is such that complementary regulations on investment choices and default options such as automatic enrolment are criticalzs. Challenges and innovation in implementing this strategic option The main challenges include: For many individuals, especially younger people, fi nancial planning for retirement seems a complex and far-away concern. Even if they are aware and informed about the need to save more, people tend to remain passive. Individuals tend to underestimate the level of savings needed to provide future pension income. Seeking planning advice from independent, professional agents can be very costly, especially for middle and low-income earners. Even educated individuals can overestimate their ability to make wise and rational decisions. Employers may face risk of litigation from plan participants for ‘ poor advice ’ .

5. Compare and contrast Singapore’s contributory provident Fund with the 401(K) plan of the United States. Provide a balanced assessment of the relative merits(pros) and demerits(cons) of the two approaches to old age financial security.

Answer: - The CPF has enabled every active member to save regularly to provide for his retirement needs - CPF to provide financial security for workers in their retirement or when they are no longer able to work - which not only takes care of CPF members’ retirement needs, but also their housing, healthcare and family protection needs. - CPF board’s mission is to enable singaporeans to have a secure retirement - The CPF Board is established by legislation as a statutory authority under the purview of the Minister for Manpower and is the trustee of the Central Provident Fund - Mandatory CPF contributions are tax-exempt, as are the returns on CPF balances - CPF savings earn a minimum guaranteed return of 2.5% p.a - Retirement Account (RA) is opened for members when they reach the age of 55. - Members will receive monthly payouts from the cash portion of the MS starting from the drawdown age of 62 - CPF savings may be withdrawn before age 55 under various approved schemes for assetenhancement and to support various social objectives - CPF savings can be used to pay the premiums of four insurance schemes

401(K) - retirement is America’s top financial worry - shifting responsibility for growing retirement income from employers to individuals ahs proved problematic for many American workers - 401(K) were never designed as the nation’s primary retirement system - 401(k)'s changed two things: you could choose not to participate, and you chose your own investments, which a lot of people, I think, screw up - Another problem is that when 401(k) savers retire, they often opt to take their savings in a lump sum and roll the money into IRAs, which may entail higher fees and expose them to conflicted investment advice

Financial Advice: does it make a difference?

6. Wealth is far and away the strongest predictor of using a financial planner, followed by high income, a college degree, and self-employment. Most common reason they chose a financial adviser was a major life event such as the receipt of an inheritance or the sale of a business. Higher wealth was strongly related to the probability of opting to receive financial advice.
- 10% of high school educated respondents consulted a financial planner
- those who attended or graduated from college are more likely to consult a financial planner
- respondents with higher self esteems were also more likely to seek professional advice
- those most likely to seek advice are not those who are most prone to make financial mistakes (they are most aware of the potential benefits from advice and have sufficient wealth to justify the psychic and time cost of seeing an adviser
- financial sophistication increases demand for professional advice
Benefits:
- Advised accounts were better diversified - Recommend more efficient investment choices that clients do not follow - In order for advice to be effective, a client must be motivated to seek it - One is that by simply sitting down, articulating goals, and developing a financial plan, a household is forced to apply a cooler, more rational decision making process to help it make better decisions that involve intertemporal tradeoffs - Second is that, by delegating some financial decisions to another person, such decisions are now distanced from the client’s emotions. If a client feels an emotional response to a market decline, an adviser can remind the client to focus on his long-term investment policy by providing a ‘voice of reason’ - Can reduce losses from behavioural investment mistakes by delegating some decision making to professional advisers - Consulting a financial planner is positively related to net worth and retirement wealth even when controlling for income, education, and cognitive ability - Financial planning process can force households to acknowledge tradeoffs between present consumption and future goals, and the use of a planner appears to help clients select investment vehicles (such as tax sheltered accounts) that are best suited to meet these goals

7. Incentives and investment advice:
- Fees that are automatically deducted are attractive to sellers because they often go unrecognized by consumers, reducing customer sensitivity to pricing

Compensation and agency costs: - Agency costs occur in any transactions where a principle hires an agent to act on his behalf. Agents superior information creates an opportunity to provide advice leading to decisions that can favor the advisor’s interest over the client’s - In a market where price is less visible advisers have an incentive to maximize commission compensation constrained by suitability requirements and the risk of losing future revenues from the clients through excess rent extraction - Commission compensation incentivizes an adviser to sell financial products but does not provide incentives to invest passively - Charging of commissions remains a controversial practice. It does not require that they act in best interests of their clients as registered investment advisors, as fiduciaries must - Advisors charging flat fees have an incentive to add more clients and potentially do less work for each one - Commission compensation is generally opaque since many investors are unaware of how much they pay for investment loads and how he gets paid. Therefore increased transparency can lead to lower agency costs. People can monitor advisers by periodically assessing the quality of their advice.

Potential regulatory alternatives:
- One way of reducing increased agency costs that arise from commission compensation might be to eliminate commissions and apply a uniform fiduciary standard among financial advisors

Age and Financial Advice:
- Unwillingness to hand over control of investment decisions
- Belief that they all have the knowledge they need to invest on their own
- confidence increases significantly in old age

Financial Capability #8,9,10

8. Financial literacy: ability to use knowledge and skills to manage financial resources effectively for lifetime financial security. - people who are not literate are more vulnerable to economic hardship - people need financial literacy to make effective decisions - financial literacy will make people more capable of managing their finances

Financial Capability: people’s knowledge and skills to understand their own financial circumstances, along with the motivation to take action - Financially capable consumers plan ahead, find and use information, know when to seek advice and can understand and act on this advice, leading to greater participation in the financial services market - Requires both the ability to act and opportunity to act

9.Financial Inclusion: when financial products are available to everyone, especially low income people - When financial products are affordable, accessible, financially attractive, easy to use, secure, ad reliable, they are more likely to appeal to low-income households and can shape quality financial products and improve financial inclusion - Lower fees, less confusing fees and lower minimum balances in order for them to open bank accounts - Electronic banking affordable easy to use - Earned income tax credit - Design products and services that reach low-income households with checking and savings accounts

10. Financial literacy: financial education(financial literacy(financial products(financial stability and well being

Financial Inclusion:
Financial Products(financial inclusion(financial knowledge and skills(financial stability and well-being

Together both build financial capability in low-income households. Increase in financial capability lead to greater financial well-being, and more opportunities for financial development - over time feedback effects may generate even more learning (higher financial literacy) and lead to more beneficial financial products and services (more financial inclusion) and greater financial capability. - Financial education without access to financial products and services or access to financial products without financial education is less effective and potentially harmful

11. KYC
- indicate the client’s annual income • What are the sources of income? • Is this income gross or net? • Do clients contribute to a company registered pension or retirement plan? • What was the client's income in the past two years? • Is there a fluctuating bonus structure? Is any bonus discretionary? • Does the client expect his or her bonus this year to be consistent with that of previous year(s)? • Is the industry the client works in growing, flat, or shrinking? • Is the company the client works for firing or hiring employees? Is it growing, flat or shrinking? • Does the client feel secure in his employment?

All these questions go beyond what the KYC form requires. Take notes when the clients answer the questions above. You can develop the client’s risk tolerance. A summary of the information obtained that necessary for supervision of the account.

The KYC document is nothing more than a summary of what should be a much more thorough discovery and profiling process applied to each new client relationship

Conversation about what your clients want their wealth to accomplish - i.e., you need to have a goals-based discussion.

Risk profiling questionnaire and retirement planning questionnaire and inheritance tax questionnaire, make investment recommendations, understand high level goals