Regulation and Supervision of Public and Government Pension Funds: Risks and Regulatory Responses5

Public pension plans are schemes, social security or similar, whereby the government administers the payment of pension benefits. The basic goal is to provide benefits for the population at large. Traditionally, public plans have been PAYG, although some countries have prefunded pension liabilities or private plans.

Oversight of government-run plans is required for numerous reasons, particularly the fiscal implications of mismanagement. The risks associated with DC schemes managed by the public sector arise namely from the government’s control over a large pool of funds. Such control can be problematic because those funds are frequently subject to political manipulation and pressures to, among other things, increase benefits, lower contributions, and hide problems. Moreover, government officials can be tempted to direct the invest­ment of such funds either into government securities to help fund the budget or into politically attractive projects, disregarding the interests of pension investors. Risks also arise when fund management is outsourced to the private sector, including the possibility that the funds will not be optimally managed.

Under-funded pension systems can impose a heavy fiscal burden. Recent Financial Sector Assessment Programs have found that many government plans are under-funded and sometimes insolvent. The main culprit is the mismatch of funds, whereby often gen­erous benefits are not matched by adequate contributions. Short working years and early

Table H.1. The Core Principles of Occupational Pension Regulation (OECD 2004)

1. Conditions for effective regulation and supervision

 

Legal and regulatory framework should be comprehensive and flexible to protect soundness of pension plans and overall stability.

Financial Market infrastructure should be developed to support diversified investments of pension funds..

The regulatory framework should promote a level playing field between different operators and not impose excessive burdens on pension markets, institutions or employers

Pension funds must meet proper legal, accounting, technical, and financial criteria.

A clear statement of pension funds objectives, parameters, responsibilities, and beneficiaries rights needs formal documentation.

Pension plan assets need to be legally separated from the assets of plan sponsor.

Adequate funding of pension liabilities is required for defined benefit pension plans. Appropriate calculation methods to measure liabilities and value assets, including actuarial techniques are necessary.

Proper winding-up mechanisms must be put in place to recognize creditors’ rights and to ensure payment of contributions due from employers in the event of insolvency.

Proper disclosure is necessary for valuation of pension assets.

Pension fund governing body should be subject to prudent person standard.

Pension funds must mitigate risk by imposing portfolio limits that maintain the proper diversification of assets.

Self-investment and investment abroad should be prohibited.

A governing body is required to set and follow investment policy.

There should be nondiscriminatory access to private pension schemes, regardless of age, race, salary, gender, and terms of employment.

The portability of pension rights and beneficiary protection should be ensured in the event of early departure.

Adequate disclosure and education should be given to a beneficiary with regard to fee structure, plan performance, and benefit conditions.

Effective supervisory bodies need to be established with appropriate powers to conduct on and off – site supervision and examine individual plans when relevant.

The supervisory body should have comprehensive investigatory and enforcement powers to obtain relevant data, take action to ensure compliance, impose sanctions, and initiate matters for criminal prosecution.

 

2. Establishment of pension plans, pension funds, and pension fund managing companies

 

3. Pension plan liabilities, funding rules, winding up, and insurance

 

4. Asset management

 

5. Rights of members and

beneficiaries and adequacy of benefits

 

6. Supervision

 

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Source: OECD (2004).

retirements, which are common and sometimes encouraged, contribute to the mismatch problem.

A range of appropriate regulations can be established to oversee public pensions:

• Profitability rules (or minimum return requirements) can be imposed on private suppliers to reduce the risk that the funds will under-perform the industry aver­age. This regulation also reflects the moral obligation imposed on a government to ensure an adequate pension income for individuals with no control over their investments.

• Restrictions on portfolio composition of pension funds can ensure a high probabil­ity that their performance will fall within a narrow range.

• A guarantee fund can be established to supplement shortfalls.

• A strong government commitment is needed to the disclosure of both the composi­tion and performance of the portfolio.

• A strong and publicly disclosed set of internal governance standards should be required.

• Public pension schemes must show a commitment to regular audit for compliance and efficiency by an independent audit agency.

• Public pension schemes must report against publicly agreed benchmarks for perfor­mance.

Strong regulatory standards are also necessary for DB schemes to ensure that the promise of a specific payout is honored, especially when management is privatized or contracted to the private sector. Regulation usually takes the form of periodic actuarial reviews of the funds to assess the capacity of the fund to meet its payment obligations.

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