Regulation of Private Pension Funds

Transcription

1 Flagship Course in Pension Reform March 6 17, 2000 Washington, D.C. Regulation of Private Pension Funds Dimitri Vittas March 13, 2000

2 The Regulation of Private Pension Funds Dimitri Vittas 2

3 Outline of Paper Basic Policy Issues. Principles of Pension Fund Regulation. Less Controversial Regulations. More Controversial Regulations. 3

4 Basic Policy Issues Mandatory or Voluntary? Worker, Employer or Hybrid Mandate? Centralized or Decentralized? Market Structure, Funds or Accounts? Draconian or Relaxed Regulations? 4

5 Relaxed Regulations Voluntary system. High individual choice. Multiple providers. Multiple accounts- funds. Differential pricing and multiple types of fees. Prudent person concept. Adequate disclosure. No minimum return rule. No state guarantees (other than against fraud). Reactive supervision. 5

6 Draconian Regulations 6 Compulsory system, with worker mandate. Limited individual choice. Specialized providers. One account-one fund. Uniform pricing and limited types of fees. Detailed investment limits. Prescribed extensive disclosure. Minimum return rule. State guarantees. Proactive supervision.

7 Reasons for Draconian Regulations Compulsory system. Weak capital markets. Limited tradition. Lack of familiarity. Offer safeguards. Control moral hazard. Overcome opposition. Prevent early failures. Imperative to relax as markets develop and systems mature. 7

8 Principles of Pension Fund Regulation Security. Transparency. Fairness. Efficiency. 8

9 Modern Financial Regulation Emphasis on Prudential and Protective Regulations. Contrast with Substantive Regulations. 9

10 Less Controversial Regulations 10 Licensing Criteria and Capital Adequacy. Asset Segregation and External Custody. Asset Diversification and Asset Management. Asset Valuation and Rates of Return. Actuarial Reviews and Financial Audits. Transparency and Information Disclosure. Effective Supervision.

11 More Controversial Regulations Controls on Market Structure and Choice. Funding, Vesting and Portability Rules. Investment Limits v Prudent Person Rule. Limits on Commissions and Switching. Profitability Rules and State Guarantees. 11

12 Licensing Criteria More stringent for independent than employer funds. Fit and proper test on owners, managers, and senior professionals. Minimum capital. Fund governance. Business plans. Contracts with custodians, asset managers, auditors, external actuaries. 12

13 Funding Levels and Capital Adequacy Funding levels for DB plans and annuities. Capital adequacy rules for asset managers and fund administrators. Related to assets under management. Ranges between 1% and 3% of assets. Should be invested in same assets as pension fund. 13

14 Asset Segregation 14 Extremely important. Assets belong to workers. They should not be attachable and should not be affected by financial losses suffered by sponsors, asset managers or custodians. Problem with legal ownership of any surplus in employer-sponsored DB plans. Prevailing opinion is to ban asset reversions but permit contribution holidays.

15 External Custody 15 Essential to eliminate possibility of fraud, theft, or misuse. Authorized custodians should be banks with large financial resources and technical capability to keep records, monitor compliance and report on performance. Use of central depositaries. Reports to management of pension funds and to regulators.

16 Asset Management Internal or external managers but professionally qualified and properly licensed. Continuous evaluation. For external managers, need for minimum capital, fidelity insurance, capital reserves. For internal managers, need for fidelity insurance. 16

17 Asset Diversification Asset diversification and segregation are the most important elements in promoting security of pension rights. Investment limits do not always achieve adequate diversification. 17

18 Asset Valuation and Rates of Return Need to adopt mark-to-market valuation rules. Use mutual fund model for calculating rates of return and move away from savings account or endowment insurance models. Avoid the creation of hidden reserves. Any reserves should be transparent. 18

19 Actuarial Reviews and Financial Audits 19 Actuarial reviews are very important for DB plans and for DC plans offering annuities or term life and disability insurance. Audits are essential for all types of funds. Both must be undertaken by independent and reputable professionals. Actuaries and auditors should report to management, board of trustees and regulators.

20 Transparency and Information Disclosure Importance of transparency for building trust and enhancing compliance. Clear communication of plan rules and conditions. Frequent statements to workers. Regular reports to regulators. Audited annual accounts. 20

21 Effective Supervision 21 Independent, pro-active, industryfinanced, professional staff. Vet applications. Undertake off-site surveillance and on-site inspection. Elaborate and issue regulations. Publish reports and statistics. Cooperate with other regulators.

22 Controls on Market Structure and Choice Use specialized providers or all solvent financial institutions. Auction small number of licenses. Permit one or multiple accounts and funds. Allow choice between heavily and lightly regulated institutions. 22

23 Funding, Vesting and Portability Rules More relevant for DB plans. Funding depends on accumulated or projected liabilities, mortality and termination rates, discount rate. Vesting. Immediate or deferred. Full or graded. Proportional. Portability. Own and employer contributions. Investment income. Calculation of present value in DB plans. 23

24 Investment Limits or Prudent Person Rule In OECD countries, prudent person rule with implicit asset class limits and some explicit individual limits. In LDCs, explicit asset class limits. Easier to enforce because of limited supply of instruments. Prudent person rule more flexible and more compatible with sophisticated markets. 24

25 Investment Overseas Perennial Issue. Important for small countries that depend on few industries dominated by few families. Issue exaggerated. Clear home bias in prudent person countries. Use of asset swaps. Locally based international mutual funds. 25

26 Limits on Commissions and Switching Low selling and marketing costs of employer funds but high marketing intensity of open funds. Regulation of types of fees but not level. Collection and payment fees. Transfer fee. No exit, asset or performance fee. Limits on frequency of switching. 26

27 Minimum Profitability Rules Minimum profitability rule needed to protect workers from aberrant managers. Relative ROR better than absolute real or nominal floor. Impact on uniformity of portfolios. Use of SIPOs and benchmarking. Allow individual choice between heavily or lightly regulated funds. 27

28 State Guarantees Make-up shortfall in returns. Guarantee of annuity payments against insurance company failure. Guarantee of minimum pension. State guarantees require effective supervision to prevent moral hazard. 28

29 Conclusions Some regulations are essential but others are more controversial. Security is essential, especially at the start. Effective supervision is of paramount importance. Draconian approach may initially be justified but relaxation of regulations should not be delayed too much. 29