III Conference on Insurance Regulation and Supervision in Latin America

1
III Conference on Insurance Regulation and
Supervision in Latin America

• Private Pensions in OECD countries
• Juan Yermo, OECD
• Santiago, Chile, 9 October, 2002

2
Problem Pensions are complicated

• Confusion between social and economic objectives
• Confusion between plan and fund
• Confusion between fund and entity
• Confusion between defined benefit and defined
  contribution
• Confusion between occupational and personal plans

3
Private Pension Plans in OECD countries

• Occupational Plans two distinct funding
  mechanisms
• Pension fund different legal forms of
  administering entity
• Insurance contract personal or group policies
• Personal Plans multiple funding mechanisms
• Occupational and personal plans raise somewhat
  different principal-agent concerns
• In occupational plans members are captured by
  employer in personal plans they may be
  captured by financial institutions
• Employers may bear investment and longevity risk
  in occupational plans insurance companies are
  main risk bearers in personal plans
• Interaction with financial institutions is
  intermediated through employers in occupational
  plans no intermediation in personal plans

4
Occupational versus Personal Plans

• Pro Occupational Plans
• Employer can use plan to attract and retain
  valuable employees, hence may contribute more
  than to personal plans
• No marketing costs as in personal plans
• Group negotiation with financial institutions
  leads to lower administration costs than in
  personal plans
• Employer staff (e.g. treasury department) can
  assist in pension plan management
• Fixed costs are lowered if employer facilities
  can be used (e.g. for account management)
• Pro Personal Plans
• Member is not captured as in occupational plans
  (though in Latin America they often are
  switching restricted)

5
Main Trends in Private Pensions

• Mainly introduced as complements to public, PAYG
  systems Chilean type reform only pursued in a
  handful of OECD countries
• Most OECD countries would prefer to encourage
  occupational rather than personal plans (and
  within these industry-wide schemes, e.g. Belgium,
  Finland, Germany) but personal plans are growing
  fastest
• Most new schemes are DC, but definition not
  always clear (e.g. employers may guarantee
  investment returns ? DB under IAS)

6
Regulating and Supervising Private Pensions

• Regulatory principles should be common to all
  countries
• OECD Basic Principles
• OECD-INPRS Methodology for Basic Principles
• Supervisory model depends on system structure
• Occupational plans Anglo-Saxon model with
  thousands of plans and funds does not permit fund
  by fund supervision. Industry-wide model on the
  other hand allows close supervision (e.g.
  Netherlands)
• Personal plans supervision should rely as much
  as possible on existing framework for financial
  institutions.

7
Regulating Occupational plans OECD-INPRS Basic
Principles

• Despite many differences in risk allocation and
  legal traditions, most occupational pensions have
  common principal-agent issues.
• 15 Principles can be grouped according to
  objective --
• Functional regulation of pension plans from a
  consumer protection or beneficiary right
  perspective.
• Institutional regulation of pension plan
  administrators, from a financial security
  perspective (prudential regulation).

8
Functional regulation

• Eligibility and access to schemes
• Avoid exclusion based on age, gender, salary,
  etc, and ensure equity in distribution of tax
  benefits
• Vesting, portability and indexation
• Mainly an issue in DB schemes, where portability
  losses (vesting and pension annuity losses) are
  much more significant
• Disclosure and education
• Mainly an issue in defined contribution plans,
  and where members exert choice
• Disclosure of benefits, returns, fees
• Transparency is not enough, comparability is
  necessary

9
Prudential regulation

• Governance
• Regulatory policies
• responsibilities, accountability, and suitability
  of plan administrators
• delegation
• redress
• Pension concerns
• voting with ones feet (leaving the plan) often
  not possible, member representation as monitors
  necessary
• if employer bears risk he has an interest in
  control of pension entity - arm-length
  relationship between employer and entity may not
  be entirely feasible (e.g. with respect to
  investment strategy)
• cost effectiveness of using employer staff in
  pension entity vs. conflicts of interest

10
Prudential regulation (cont.)

• Funding
• Regulatory policies
• pension assets should be legally separated from
  plan sponsor
• minimum funding rules
• actuarial techniques based on transparent
  standards
• Pension concerns
• if funded through an insurance policy, assets no
  longer property of members special safeguards
  in case bankruptcy may be needed
• for pension funds, is winding-up or on-going more
  important as a solvency measure?
• how much smoothing of returns should be
  permitted?
• plan members should have priority creditors
  rights in case of employer bankruptcy

11
Prudential regulation (cont.)

• Investment regulation
• Regulatory policies
• principles of diversification, dispersion, and
  maturity and currency matching
• both quantitative and prudent person limit
  self-investment
• Pension concerns
• DB plans have liabilities indexed to salaries
  (unlike liabilities of insurance companies),
  which cannot be matched perfectly before
  retirement (bonds are best match once salary is
  known) equity may make sense for young schemes
• alternative investments can be twisted by
  interest groups (ETI)
• individual choice can lead to conservative asset
  allocations

12
Concluding remarks

• Pensions are complex, they have both social and
  economic functions
• OECD-INPRS Basic Principles are universal, but
  regulations need to be tailor-made for each
  country
• Pension entities raise special governance,
  funding and investment concerns.