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III Conference on Insurance Regulation and Supervision in Latin America. Private Pensions in OECD countries Juan Yermo, OECD Santiago, Chile, 9 October, 2002. Problem: Pensions are complicated. Confusion between social and economic objectives Confusion between plan and fund

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Iii conference on insurance regulation and supervision in latin america

III Conference on Insurance Regulation and Supervision in Latin America

Private Pensions in OECD countries

Juan Yermo, OECD

Santiago, Chile, 9 October, 2002

Problem pensions are complicated
Problem: Pensions are complicated Latin America

  • 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

Private pension plans in oecd countries
Private Pension Plans in OECD countries Latin America

  • 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

Occupational versus personal plans
Occupational versus Personal Plans Latin America

  • 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)

Main trends in private pensions
Main Trends in Private Pensions Latin America

  • 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)

Regulating and supervising private pensions
Regulating and Supervising Private Pensions Latin America

  • 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.

Regulating occupational plans oecd inprs basic principles
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).

Functional regulation
Functional regulation Principles

  • 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

Prudential regulation
Prudential regulation Principles

  • Governance

    • Regulatory policies:

      • responsibilities, accountability, and suitability of plan administrators

      • delegation

      • redress

    • Pension concerns:

      • voting with one’s 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

Prudential regulation cont
Prudential regulation (cont.) Principles

  • 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

Prudential regulation cont1
Prudential regulation (cont.) Principles

  • 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

Concluding remarks
Concluding remarks Principles

  • 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.