Referee report on luis viceira: pension fund design in developing economies

October 21th 2011
Referee Report on Luis Viceira:
Pension Fund Design in Developing Economies
By Jose Javier Rojas Colina

Summary of the paper
The main idea of the author in the following paper is to make an analysis of how pension system in developing countries are being managed and which are the strategies to be held, suggestions and even hypothetical scenarios for the Chilean system. Inthe introduction of this paper, it presents us a brief on how developing countries changed through the time their traditionally social security and voluntary or mandatory defined benefit (DB) pension plans for the defined contribution (DC) which is a self financing plan, and impact more heavily on employees as the author said. One of the reasons for this change it’s the fact that, since therewere some recent events that directly affected on most corporate and public DB pension plans, such as the “perfect storm” that occur in the early part of this decade. Other facts are mention as the reason why many developed countries start changing their pension systems. It is well known that the U.S is the developed economy who transition to DC plans is stronger. This makes a direct impact ondeveloping economies because they are considered as open economies liable to global competition in product and capital markets.
It is well known that the DC plans are open to the participants to decide how much they want to contribute in the plan, and sometimes, how and where they want to put their holdings. That can be consider as a weakness in this plans because evidence tell us that people don’tmake good decisions about how to save money for their future and, even worst, where to invest it, suffering from inertia in their investment decisions. One common fact is that usually participants don’t rebalance their portfolios frequently and most of the time they go into the default investment option.
They have been some developments in pension system in order to smoothness the “shortcomings”of the DC plans and those are mention in the paper as the “life-cycle” and “life-style” proposals that where tried and designed in the US. These proposals basically are option strategies that any participant can choose a default contribution and investment option to prevent problems such as the rebalancing and investment diversification. Because it’s well known that if the contribution in the DCplans are optional in many developing countries (most people choose low contribution rates, or even no participation at all), in both “life-cycle” and “life style” are trying to encourage holders to choose a default strategy that can give more benefits to their future savings.
The life-cycle and life-style are proposals that in essence their offer a target asset mix who automatically rebalancetheir holdings toward a target asset mix. This means that the participants can choose between this two options depending directly on their risk aversion. One of the common characteristics that this proposals have its that they have a “target” to reach in order remain constant through time until the holders retirement, meaning that, one its conservative in the target asset mix right from the beginning(life-style) and it target mixing (60% in stocks and 40% in bonds) remain constant over time, and the other one (life-cycle) is a bit more “aggressive” in its target mixing (starting with 90% in stocks and 10% in bonds) and become more conservative until a certain target date, and after achieve this point it remains constant in time. Both agree that in the presence of ageing, people are more riskaverse and have preference to invest in safer holdings (such as bonds) rather than risky holdings (stocks).
As we said the choice between life-cycle and life-style depends on the holders risk aversion but also depends in their financial wealth and human wealth. It comes part of this study that financial wealth increases through time while human wealth decreases as the holder ages. This mean...