Pension Fund Management: Implications For Sound Financial And Economic Management

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Pension Fund Management Implications For Sound
Financial And Economic Management
By M. K. Ahmad Director General
National Pension Commission
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Outline

• Characteristics of Pension Funds
• Pension Fund Management
• Impact on Financial and Economic Management
• Lessons from Nigeria

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Characteristics of Pension Funds

• Sponsorship of Pension funds
• contribution by employers and/or employees
• wholly by employers
• Pension Funds as Institutional investors
• collect, pool and invest funds for future pension
  entitlements of beneficiaries
• ensure sound financial and economic management
  through financial intermediation, which affect
  financial markets in particular and economic
  activity in general

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Characteristics of Pension Funds Contd

• Returns to members of pension plans
• may be purely dependent on the market or may be
  overlaid by a guarantee of the rate of return by
  the sponsor
• Portfolio diversification to mitigate against
  risk
• spread of domestic securities
• international investment
• Pooling of risk for small investors
• Long term liabilities allowing holding of
  long-tenured and high yielding instruments

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Characteristics of Pension Funds Contd

• Ability to absorb and efficiently process
  information on capital market operations
• Large size and thus economies of scale, which
  result in lower average cost for investors
• The countervailing power of pension funds that is
  often used to reduce transaction costs and
  custodial fees

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Pension Fund Management

• Pension Funds are managed by
• Pension Fund Administrators take investment
  decisions
• In some jurisdictions, pension fund management
  can be by asset management and insurance
  companies
• Some management decisions may be the
  responsibility of Boards of Trustees in some
  corporate organisations
• Pension Fund Custodians keep custody of pension
  funds
• Custodial services may be provided by Central
  Banks in some jurisdictions
• In the UK, Pension Protection Fund provides
  compensation to contributors where employers
  become insolvent

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Pension Fund Investment... Contd

• Regulations required to promote both the
  performance and the financial security of pension
  assets
• Regulations of pension funds require
• the appointment of a custodian, depository
  institution or trustee
• standards of conduct and minimum suitability of
  the operators of pension funds
• the rights of investors to withdraw funds
• the right of investors to full, timely and
  accurate information disclosure

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Pension Fund Management contd

• The main goals of pension investment are to
• Ensure adequate, affordable and sustainable
  benefits to contributors
• Secure safety security of funds
• Ensure adequate liquidity to pay all pension
  benefits of contributors as and when due
• Achieve an optimal trade-off of risk and return
  through strategic asset allocation

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Pension Fund Investment contd

• Risk Management for pension assets established on
• Quantitative limits maximum limits for
  individual, class or class of mix assets
• Principle of Prudent Man - the preservation of
  capital, while obtaining a reasonable income
• Benchmark indicator of market, sub-market or a
  mix of assets commonly traded and used as a point
  of reference

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Pension Fund Management... Contd

• In practice, 60 of pension funds invested in
  local markets
• Foreign investment might not overcome collective
  systemic risks to world capital markets
• Investment of pension funds in international
  market
• International diversification may reduce risk
  since shocks to equity markets tend to be country
  specific

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Impact on Economic Management

• Pension funds can have positive impact on the
  economy through
• generation of savings that leads to capital
  accumulation and hence promotes investment
• transfer of resources in favor of long-term
  assets would have significant impact on GDP
  growth
• Shift to long-term assets tend to reduce the cost
  of capital and increase the availability of
  equity and long-term debt financing to companies,
  and hence promotes growth

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Impact on Economic Management ... Contd

• Increase in capital investment and labour
  productivity
• Development of labour intensive, low productivity
  informal sector to a capital intensive, high
  productivity formal sector
• Availability of long-term financing will simplify
  government deficit financing through the issuance
  and purchase of government securities

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Impact on Economic Management ... Contd

• Promotion of infrastructural development
• Development of other institutions
• Insurance
• Annuity
• Life insurance
• Rating
• Mortgage
• REITs

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Impact on Financial Management

• Development of the Capital Market
• Increased demand for new investment outlets would
  stimulate innovation and development of new long
  term instruments
• Increased market integrity/transparency and
  corporate governance
• Re-enforcement of Improved regulation and
  supervision of the market and its efficiency
• Creation of domestic institutional investors
  (PFAs/CPFAs), with long term focus, would
  moderate stock market and price volatility
• Trigger the modernisation of capital market
  infrastructure such as clearing and settlement

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Impact on Financial Management ... Contd

• International portfolio of investment
• risk reduction to pension funds
• reduction of volatility of returns
• Qualitative developments in the financial markets
  
• financial innovation
• development of corporate bonds market
• development of indexed instruments
• better accounting and auditing
• better information disclosure
• Efficient provision liquidity and price
  formation

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Lessons from Nigeria

• Rationale for Pension Reform
• Defined benefit (DB) Pay As You Go (PAYG)
• Largely dependent on budgetary provision for
  funding
• Unstainable pension liabilities
• Weak inefficient administration
• Demographic shifts and ageing make DB schemes
  unstainable
• Low compliance ratio due to ineffective control
  
• regulation
• Many workers in the private sector were not
  covered by
• any form of retirement benefits arrangement
• Existence of diversified arrangements which were
  largely unregulated in the private sector

Public Sector
Private Sector
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LESSONS FROM NIGERIA Contd

• Characteristics of the Contributory Pension
  Scheme in Nigeria
• contributory Contributions by both employer and
  employee
• fully Funded Funds set aside for retirement
• individual Accounts Nature of the account,
  portability and withdrawals (Lump sum, Annuity
  Programmed withdrawal)
• privately managed by PFAs, CPFAs and PFCs
• life Insurance Cover
• coverage and exemptions
• strictly regulated and supervised by PenCom

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LESSONS FROM NIGERIA Contd

• Pension Fund Investments managed by two
  institutional investors
• Pension Fund Administrators
• Closed Pension Fund Administrators
• Investment Instruments
• subjected to both quantitative and qualitative
  regulations
• all instruments must have rating grades as
  stipulated in the Regulations
• rating carried out by Risk Rating Institutions
• performance benchmark stipulated for each asset
  class

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LESSONS FROM NIGERIA Contd

• Securitization Listing
• Pension fund investments assets must be
  securitized and listed for trading on the floor
  of the NSE or Electronic Platform of MMAN
• Pension Fund Assets
• Generated pool of long term investible funds for
  the first time in Nigeria
• The industry has approximately N679.55 worth of
  assets as at 31 October, 2007
• RSA assets N159.05 billion
• CFPA assets N195.01 billion
• AES assets N325.50 billion

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LESSONS FROM NIGERIA Contd

• Quantitative limits and performance benchmarks
  stipulated
• Assets invested in various instruments - FGN and
  State Governments securities, equities, money
  market instruments, mutual funds, corporate debt
  instruments
• Offshore investments and derivatives are future
  developments

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LESSONS FROM NIGERIA Contd

• Development of other institutional operators
• Enhancement of the skills of rating agencies
• Development of mortgage industry
• Development of insurance industry
• Provision of group life insurance policies
• Developments of annuities market
• Anticipated fall in premium rates
• Provision of statistics for national development
• National databank
• Pensioner verification exercise

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Thank You! National Pension
Commission Plot 174, Adetokunbo Ademola
Crescent Wuse II, Abuja 09 4138736 40
info_at_pencom.gov.ng www.pencom.gov.ng