The Ministry of Finance is putting back on the table its plan to reduce the imputed interest for pension savings, a plan that is liable to reduce pensions paid to savers when they retire, said Supervisor of the Capital Markets, Insurance, and Savings Dorit Salinger at the "Globes" Capital Market Conference last Monday.
In August 2013, Salinger's predecessor, Prof. Oded Sarig, said that he would change the imputed interest rate for calculating pensions for workers when they retire.
When a person retires, managers of pension plans and managers insurance are required by the Ministry of Finance to set aside the pensioners' accumulated money in risk-free assets (government bonds), in order to minimize damage from market volatility. To determine a pensioner's monthly pension, the total savings at the time of retirement are taken, which are assumed to bear an average annual interest of 4% under ministry guidelines. The monthly pension is calculated on the basis of mortality tables to estimate the retiree's expected remaining months of life (the "conversion coefficient).
Crudely speaking, the savings accumulated during years of work is divided by the conversion coefficient to calculate the monthly pension. The conversion coefficient rises with the rise in the average life expectancy, and the monthly pension shrinks. The coefficient is important: the conversion coefficient has risen from 140-150 in the 1980s and 1990s to 200-210 or more today, which means that the monthly pension of most savers has been shrinking over the years (except for old policies with a fixed conversion coefficient).
This problem does not exist for all unfunded pensions, because the monthly pension is based on the worker's last salary and does not depend on the conversion coefficient, further highlighting the discrimination between recipients of unfunded pensions and savers with accumulated pensions.
Given the prevailing low interest environment, and recognizing that a 4% interest rate is unrealistic in this environment, the Ministry of Finance planned to lower the imputed interest on pensions to 2.5-3%, but postponed or froze the measure because of furious public criticism.
At the "Globes" conference, Salinger said that the measure had not been suspended. On the contrary, she revealed for the first time that the issue was on the table and that recommendations would be made within weeks. "The issue is under a lot of work, investigation, and review," she said. "We're investing a lot of resources in this, and I hope that we'll finalize it in the coming weeks. I think that this is a very important matter, it's really one of the first things brought to my attention. It is vital and very sensitive, which is why thorough work is being done to think about the right way to deal with it."
"When a person retires, there is a coefficient, which is a function of lifespan and interest rate. This coefficient helps set the pensioner's monthly pension for each year of his retirement," says Salinger to explain the rationale for the measure. "The very low interest rate that has prevailed for a long time, and with no assurance when this environment will change, is a great challenge, and creates a distortion. When the imputed interest for calculating the coefficient is 4%, that is a rate that is hard to impossible to achieve in today's market. What is happening today is that active workers are subsidizing pensioners who are now retiring."
Salinger sounded decisive about the measure, saying, "This is hugely important, and it must be stopped. We're about to end this subsidy because a pension fund is a mutual guarantee; it's not a subsidy. That is why we must end this situation in which active workers subsidize pensioners, and we will end it."
As for the way to act, Salinger said, "We've thought about what to do and how to do it, because we basically want to balance between an appropriately sized pension and the pensioner's need for certainty. If we now take a pensioner's money and invest it at risk-free interest at the current interest rate, we cannot pay a proper pension, because the risk-free interest rate is very low. We therefore concluded, after a long review and after consulting capital market experts, that a proper pension cannot be achieved by investing only in risk-free assets."
Salinger hinted that the solution would be to channel part of pensioners' money into the capital market. "Pensioners with long lifespans - and we know that they are long, because a man who retires at 67 and a woman who retires at 62 will live for another 25-30 years. This means that the period for considering the investment portfolio is long, and to guarantee a proper pension, there should also be exposure to the capital market to some extent. There is no other solution, and this is therefore the direction we're looking at," she said.
Salinger's conclusion is unequivocal. "We cannot keep the 4%, my friends, period. We will create a mix between the need to create certainty and the need for a proper pension."
Asked if she was aware that the result might be a 10% cut in pensions, Salinger said, "The outcome can be arranged in some way that will not harm pensioners' income."
Published by Globes [online], Israel business news - www.globes-online.com - on June 5, 2014
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