Transcript of a Press Conference on the Analytic Chapters of the Global Financial Stability Report

IMF News, April 11, 2012

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Published: April 11, 2012

Overview and themes

Two analytic chapters published ahead of the main Global Financial Stability Report:
- Chapter 3: “Safe Assets, Financial System Cornerstone?”
- Chapter 4: “Financial Impact of Longevity Risk”
Key framing:
- Safe assets: rising demand and declining supply could raise the price of safety; objective is to manage the adjustment smoothly and avoid excessive volatility.
- Longevity risk: people living longer than expected creates large additional financial and fiscal costs for individuals, corporations with defined benefit schemes, insurers, and governments.

Findings on safe assets

Definition: to most investors a safe asset is an asset with low credit and market risks (examples cited: U.S. Treasuries, German bunds, Japanese government bonds).
Demand-side drivers:
- General uncertainty about the economic and financial environment.
- Central bank actions providing liquidity and keeping interest rates low.
- New regulatory reforms requiring more safe assets (e.g., bank requirements, collateral for central counterparties).
Supply-side pressures:
- Creditworthiness of sovereign debt in a number of advanced economies has suffered from fiscal strains.
- Private sources of pre-crisis safe assets (e.g., securitized products) were shown to be less safe than previously thought.
Quantitative estimate discussed:
- “by 2016, 9 trillion safest assets might be removed from the supply.” (question referenced from the report)
Implication:
- Increased demand and reduced supply point to a higher price of safe assets going forward; important to ensure an orderly transition to higher prices.

Policy recommendations on safe assets

Demand-side:
- Regulations should avoid binary labels ("safe" vs "unsafe") and instead differentiate assets along a continuum of safety features.
- Implement regulation so institutions’ holdings of safe assets build up slowly and steadily to avoid destabilizing price effects.
Supply-side:
- Advanced-economy governments whose debt is no longer perceived as safe should commit to strategies of reducing debt levels and strengthening debt management to lower financing costs and rollover risks — this will also help restore safe asset supply.
- Private sector issuance of safe assets should not be impeded; issuance should be transparent and well-conceived so investors can price them appropriately.
- Restart securitization only on a sounder footing than pre-crisis practices; covered bonds and high-grade corporate debt can play roles as safe assets where appropriate.
Design considerations:
- Pooling mechanisms (e.g., pooled sovereign bonds) can produce safe assets if supported by robust frameworks ensuring payment and governance.
- A broader continuum of recognized safe assets can reduce concentration risks and potential bubble dynamics.

Findings on longevity risk

Concept:
- Longevity risk: risk associated with people living longer than expected — financially, this raises the chance of running out of money in retirement.
- Historical observation: “Nearly all countries have continuously underestimated how long people will live by an average of about three years.”
Scope and magnitude:
- Longevity risk is relevant for individuals, defined benefit pension plans, insurance companies providing annuities, and governments providing universal old-age pensions.
- Global estimates presented in the chapter:
- “the size of longevity risk amounts to roughly about 50 percent of 2010 GDP in advanced economies, and 25 percent of GDP in emerging market economies.”
- These dollar amounts run “into the trillions.”
- For U.S. pension plans: data used from form 5500, most recent Department of Labor data available in the study is 2007; trend indicates pension plans have been updating mortality assumptions over time.
- Specific quantitative statements from the discussion:
- “about a 3 percent increase in total liabilities each year” (context: sensitivity/assumptions discussed).
- “in the study we show that there's a 9 percent increase, I believe, in the typical liabilities of U.S. pensions due to a 3-year longevity shock.”
Cross-country observations:
- Longevity risk adds roughly one-half again to the already large cost of aging for both advanced and emerging markets.
- Emerging markets: lower current aging share reduces immediate fiscal costs, but advances in medical care imply potentially larger longevity gains; individuals in emerging markets often bear more of the longevity risk due to less extensive formal retirement systems.
Methodology note:
- Example calculation approach: assume retirement needs of between 60 and 80 percent of pre-retirement income; an additional 3 years of life increases the aggregate resources required and leads to reported estimates.

Policy recommendations on longevity risk

Timing principle:
- Start early — the earlier reforms and adjustments begin, the less disruptive they will be; likened to starting retirement savings in one’s twenties versus forties or fifties.
- While immediate market disruption is assessed as “fairly low,” delayed action increases future difficulty and vulnerability.
Specific measures:
- Encourage longer working lives by linking retirement age to developments in longevity (e.g., if longevity increases by 1 year, raise retirement age by 1 year).
- Consider automatic mechanisms to adjust retirement age with longevity to reduce political frictions.
- Use financial markets to transfer longevity risk via instruments and strategies that allocate risk to parties better able to bear it.
- Improve data collection on mortality and longevity to enable better policy design and allow private markets to price and transfer risks more effectively.
Allocation principle:
- Longevity costs are large enough that the burden cannot be absorbed by a single sector (government, corporations, or individuals) and therefore require sharing across sectors and suitable risk-sharing arrangements.

Scenarios, risks, and implementation considerations

Safe asset price path:
- A smooth transition to higher safe asset prices is desirable; abrupt regulatory or demand changes can destabilize prices.
- Labeling assets on a continuum reduces concentration and bubble risk in a single asset class.
Longevity policy timeline:
- No precise single-year timetable recommended; the chapter emphasizes a continuous, proactive approach and that “the earlier you start the better.”
- Market disruption from longevity risk in the next few years is assessed as unlikely, but vulnerability grows over time.
Country-specific limits:
- Data limitations restrict detailed country-by-country quantification for some emerging markets; Table 4.2 and Figure 4.2 are referenced for country and aggregated results.

Tables and figures referenced in the discussion

Figure 3.13: chart referenced on safe-asset removal estimates (used in the 9 trillion by 2016 discussion).
Table 4.2: longevity risk and fiscal challenges in selected countries.
Figure 4.2: aggregated position of emerging markets on longevity risk.
Table 4.3: mortality tables used by U.S. pension plans over time; discussion notes trend toward updated tables but data availability limited to 2007 in the Department of Labor series.

Transcript of a press conference, April 11, 2012; Global Financial Stability Report analytic chapters discussed by José Viñals, Laura Kodres, Erik Oppers, and Silvia Iorgova.