Transcript IOPS Principles

DC Supervision in Chile:
Design elements to mitigate risks
in a DC scheme
Solange Berstein– Chair IOPS Technical Committee
Pensions Supervisor, Chile
IOPS Regional Workshop
Amman, Jordan
February 2011
www.iopsweb.org
Contents
1) The need for supervision in a mandatory DC context.
2) The Chilean approach: Design elements that
mitigate risk
3) How to measure pension risk?
4) Lessons from Chile
Back to Basics: Concepts behind need for
supervision
 Asymmetric Information:
 Managers vs. Members
 Moral hazard:
 Fiduciary responsibility
 Conflicts of interest
What is different about supervising Mandatory pensions?

Massive membership implies:

Not active involvement

Lack of information

Poor financial education
Need to safeguard member’s interests (not just relying on
market discipline)

Mandatory system = Social Security

Public impact of system’s performance

Close attention by policy makers, parliament, government, etc.

Potential impact on implicit and explicit fiscal liabilities
Need to safeguard state’s interests
4
What is different about supervising DC pensions?
 Under DC arrangement individuals bear risks (investment, longevity)




May restrict/ control investment options
May need to provide information for members
Often competitive systems, so oversight of market discipline is key
May use strict licensing criteria
Supervision of the decumulation phase is also important
May prevent lump sum withdrawals
May provide better transition between phases.
Risk management of the funds themselves important
May provide guidance
Need careful oversight where individuals bear the risks, but don’t have
enough information or education to make sensible decisions
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Design elements to mitigate risks
Default by age and restrictions for choosing riskier funds
Men
Women
A Fund
B Fund
Investment
C Fund
Options
D Fund
E Fund
35 or less
35 or less
O
O Default
O
O
O
36 to 55
33 to 50
O
O
O Default
O
O
56 and older
51 and older
X
O
O
O Default
O
Retirees
Retirees
X
X
O
O Default
O
X
Not available
O
Allowed to choose
O Default Assigned automatically
This scheme have access restrictions for riskier funds and a default
investment strategy for those members who do not select a fund
type when enrolling to the system.
% de Afiliados por Tipo de Fondo
% of Affiliates by Type of Fund
Design elements to mitigate risks
100%
Fondo E
90%
Fondo D
80%
70%
60%
50%
Fondo C
40%
Fondo B
30%
20%
10%
0%
< 20
Fondo A
20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 >= 70
Tramo Etáreo
Age
Design elements to mitigate risks
 Relax Investment Regulation:
 Only 5 limits by type of instrument remain by law
 Investment Regime in Secondary Regulation
 Investment Regulation can incorporate risk measurement norms
 Creation of Technical Investment Council that analyzes and proposes
investment regulation
 Strengthen Corporate Governance of AFPs:
 AFPs must incorporate at least two autonomous directors into their boards
 AFPs must create Investment and Conflict of Interests Committees in their
boards
 AFPs must have Investment Policies and Conflict of Interest Resolution
Policies that they must comply.
Design elements to mitigate risks

Financial Education Fund
 The Superintendence is part of the Committee that selects the projects.
 The first Fund of US$ 2.7 millions has been already assigned on May 28th
to 34 projects.
 2010: New call for projects. Estimated Fund: US$ 2.8 millions.
Adjudication: End of March 2010.

Pension Advisers
 Give a professional service
 5 exam rounds have been taken to candidates. Number of rounds for 2010:
2.
 There are already 476 pension advisers, some are individuals and some are
societies, registered in the Superintendence. These are validated jointly
with the Securities and Insurances Supervisor (SVS).
Design elements to mitigate risks
 Create a wider 1st Solidarity Pillar
 Basic Solidarity Pension for individuals who could not contribute
 Solidarity Complement for individuals who financed small
pensions (graph)
 Bonus per child, equivalent to 18 months of contributions
 Subsidy for contributions of young workers
 Mandatory participation for the self-employed (improve
enforcement)
 Provide equal conditions for men and women
 Survivorship eligibility
 Insurance fees adjusted by risk
 Redistribution of pension savings in case of divorce
Design elements to mitigate risks
Old age Solidarity Benefits
Disability Solidarity Benefits
Total
Pension
Total
Pension
APS
PBS
APS
PBS
Self financed
Pension
Self Financed
Pension
Design elements to mitigate risks
Income Profile
Contribution Profile
With APS
Without APS
Expected Average IncomeLast 3 years
Design elements to mitigate risks
 Focus of regulation and supervision on risks (IOPS
Principle 5: Risk orientation)



Harder to quantify risk with DC funds (DB focus on funding)
Focus on process not returns
Focus on risk management and governance
 The Superintendence has been working on the
implementation of SBR over the last 5 years and it is now in
a very advanced stage. Moving from compliance based
supervision to RBS has been one of the main goals of the
institution.
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How to measure pension risk?

The focus should be on pension risk and not on short term volatility
 Relevant risk factors:

human capital risk
investment risk
Inflation
annuitization risk.



 Take heterogeneity of members into account






Uncertainty in labor income
Education
Gender
Risk aversion
Qualify for other benefits: solidarity pillar, subsidies, guarantees
Life cycle strategies is a relevant mechanism to provide protection against
market risk: Default options are very important
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How to measure pension risk?

The default option provides protection.
 The riskier strategy available increases volatility of replacement rates.
 Restrictions to the riskier strategy provides protection.
120%
LEYENDA
CB:
Default option
AB
CB
Básicoavailable
AB:- Contrato
riskier strategy
AB
Fondo
A
B xx
Cxx: Crisis at age
Cxx - Crisis a los xx años
CC
110%
AB-C30
Promedio
rate
Average replacement
100%
CB
CB-C30
90%
AB-C40
CB-C40
CB-C64
80%
CB-C50
AB-C64
AB-C50
70%
60%
0%
10%
20%
30%
40%
50%
60%
Estándar
Standard deviationDesviación
replacement
rate
70%
80%
90%
0%
CB-C40
Tasa de Reemplazo
AB-C40
CB-C64
Tasa de Reemplazo
AB-C64
90%
80%
70%
60%
50%
40%
30%
20%
200%
120%
110%
190%
0
200%
200
180%
300
190%
400
170%
300
180%
500
160%
600
170%
700
150%
600
160%
800
140%
0
AB-C50
150%
Crisis at age 64
130%
Tasa de Reemplazo
140%
AB-C30
130%
100
120%
CB-C50
110%
100
100%
Tasa de Reemplazo
100%
200
90%
400
80%
700
70%
900
60%
800
50%
1000
40%
900
30%
Crisis at age 40
20%
100
10%
400
Frecuencia
500
0%
200%
190%
180%
170%
160%
150%
140%
130%
120%
110%
100%
90%
80%
70%
60%
50%
40%
30%
20%
700
10%
500
Frecuencia
0%
10%
Frecuencia
Crisis at age 30
0%
200%
190%
180%
170%
160%
150%
140%
130%
120%
CB-C30
110%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
Frecuencia
Probability Density Function
900
1200
Crisis at age 50
800
1000
600
800
600
300
200
400
200
0
0
Lessons from Chile
 Supervisory efforts are justified by market elements that





are even more important in mandatory and DC context.
Design elements in the Chilean Pension systems mitigate
market and financial risks.
As a mandatory DC system evolves, regulation becomes
more flexible. Responsibility is transferred from the law to
the pension fund managers.
This trend increases the need for better supervision.
RBS allows to fulfil these needs.
Pension risk in DC continues to be a challenge
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DC Supervision in Chile:
Design elements to mitigate risks
in a DC scheme
Solange Berstein– Chair IOPS Technical Committee
Pensions Supervisor, Chile
IOPS Regional Workshop
Amman, Jordan
February 2011
www.iopsweb.org