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Private Pensions Series
Supervising Private Pensions INSTITUTIONS AND METHODS
Supervising Private Pensions
Private pensions are long-term contracts that comprise a sizeable share of workers’ income. Pensions operate in markets subject to potential failures stemming from asymmetric information, adverse selection and moral hazard. Government intervention is crucial to design regulations to protect the interests of participants, avoid systemic crises, and guarantee the financial and actuarial sustainability of the private pension system. Regulations have to be implemented by supervisory institutions, which must be insulated from political pressures – from either the government or the pension industry – and endowed with reasonable resources and enforcement capacities. Supervisory agencies’ procedures for market engagement should be constantly improved and updated to follow market dynamics and ensure compliance with regulations. Institutional structures and methods vary widely throughout the world and this is the first book intended to analyse and compare international experiences on these issues.
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INSTITUTIONS AND METHODS
No. 6
-:HSTCQE=UV[^\W:
INSTITUTIONS AND METHODS
Supervising Private Pensions
This volume offers detailed and comparable information on the supervisory agencies, institutional design and methods in over 40 countries in the OECD area, Latin America, Eastern Europe and Southeast Asia. It is a valuable and practical contribution for policy makers who wish to benefit from pension supervision experiences across countries.
Private Pensions Series
www.oecd.org ISBN 92-64-01697-X 21 2004 03 1 P
No. 6
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ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT
Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which came into force on 30th September 1961, the Organisation for Economic Co-operation and Development (OECD) shall promote policies designed: – to achieve the highest sustainable economic growth and employment and a rising standard of living in member countries, while maintaining financial stability, and thus to contribute to the development of the world economy; – to contribute to sound economic expansion in member as well as non-member countries in the process of economic development; and – to contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations. The original member countries of the OECD are Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countries became members subsequently through accession at the dates indicated hereafter: Japan (28th April 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29th May 1973), Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary (7th May 1996), Poland (22nd November 1996), Korea (12th December 1996) and the Slovak Republic (14th December 2000). The Commission of the European Communities takes part in the work of the OECD (Article 13 of the OECD Convention).
© OECD 2004 Permission to reproduce a portion of this work for non-commercial purposes or classroom use should be obtained through the Centre français d’exploitation du droit de copie (CFC), 20, rue des Grands-Augustins, 75006 Paris, France, tel. (33-1) 44 07 47 70, fax (33-1) 46 34 67 19, for every country except the United States. In the United States permission should be obtained through the Copyright Clearance Center, Customer Service, (508)750-8400, 222 Rosewood Drive, Danvers, MA 01923 USA, or CCC Online: www.copyright.com. All other applications for permission to reproduce or translate all or part of this book should be made to OECD Publications, 2, rue André-Pascal, 75775 Paris Cedex 16, France.
FOREWORD
Private pension supervision has been one of the core activities of the OECD Working Party on Private Pension (WPPP) and of the International Network of Pension Regulators and Supervisors (INPRS). The area of private pensions is particularly dynamic due to the accelerated process of financial innovation. Pension supervisors are constantly required to assimilate new trends on the design of financial products, financial market structure, investment alternatives and governance in order to strength supervisory institutions and strategies oriented to ensure compliance with regulations and protect the interests of the participants. In this respect, supervisors can benefit from a continuous process of exchange of experiences’ exchange, and from the identification and dissemination of good practices and standards-setting promoted by the OECD and INPRS. In the December 2002 meeting of the WPPP, the OECD delegates approved a proposal to study the institutional structures for pension funds supervision. An informal task force was established to orient the work and discuss pension supervisory methods in selected OECD countries. During the July 2003 meeting of the WPPP, preliminary reports were discussed and revised for the end of 2003. In the meantime, OECD and INPRS conferences with specific panels on pension supervision were organised in Hyderabad, India (May 2003); San Jose, Costa Rica (July 2003); Prague, Czech Republic (December 2003); Manila, Philippines (April 2004) and Rio de Janeiro, Brazil (May 2004) as part of a strategy to engage nonmember countries in the discussion of this subject. The World Bank has also collaborated in this process by designing a distance learning course on pension supervision, conducting research on supervisory methods and providing the two country reports on Hong Kong, China and Bulgaria. This book on pension supervision, released under the Private Pension Series no. 6, brings together selected articles prepared by supervisors and pension experts and discussed in the above mentioned conferences. It includes both the regional perspective and country cases aiming to provide valuable inputs for policy makers and experts on the international comparative experience regarding pension supervision. It was prepared by Mr Vinicius Carvalho Pinheiro from the OECD Financial Affairs Division. The views expressed are the sole responsibility of the authors and do not necessarily reflect those of the WPPP, the Insurance Committee, member and nonmember countries.
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TABLE OF CONTENTS
I.
SUPERVISING PRIVATE PENSIONS: AN INTRODUCTION by Ambrogio Rinaldi.............................................................................9 Supervisory structures.........................................................................10 Supervisory methods...........................................................................13 Further work........................................................................................17
II.
SUPERVISORY STRUCTURES FOR PRIVATE PENSION FUNDS IN OECD COUNTRIES by Vinicius Carvalho Pinheiro ...........................................................21 Background .........................................................................................21 Institutional framework of private pension fund supervision .............21 Organization of the Supervisory Agency............................................41 Conclusion ..........................................................................................62 Annex II.1. Primary supervisor for pension funds......................67 Annex II.2. Questionnaire on supervisory structure for private pension funds.........................................70 Annex II.3. Distribution of supervisory responsibilities.............75
III.
SUPERVISION OF PENSION FUNDS: THEORY AND PRACTICE by Richard Hinz ..................................................................................77 What is pension supervision?..............................................................77 Rationale for the supervision of private pensions ...............................78 Distinctive features of funded pension systems ..................................81 Primary elements of pension fund supervision ...................................83 Characteristics of supervisory systems ...............................................90 Factors associated with different styles of pension supervision .........92
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IV.
INTEGRATED FINANCIAL SUPERVISION AND PRIVATE PENSION FUNDS by Edgardo Demaestri and Gustavo Ferro ..........................................97 Introduction.........................................................................................97 The regulation of financial intermediaries and pension funds ............99 Integrated or specialized supervision? ..............................................105 Analysis of the advantages and disadvantages of consolidating pensions under an integrated regulator ........................................110 Specific aspects of pension regulation ..............................................117 Extending the analysis of advantages and disadvantages of integrated supervision, taking into account the peculiarities of pension funds ................................................128 Conclusion ........................................................................................132
V.
THE EXPERIENCE OF CENTRAL AND EAST EUROPEAN COUNTRIES ON FINANCIAL SUPERVISION by Tibor A. Párniczky .......................................................................139 Changes of supervisory agencies ......................................................140 Functions and responsibilities...........................................................141 Legal mandates of the supervisor......................................................142 Political and institutional independence ...........................................143 Financing ..........................................................................................144 Transparency.....................................................................................146 Human resources...............................................................................147 Organisation......................................................................................148 Conclusions.......................................................................................149
VI.
SUPERVISORY AGENCIES IN LATIN AMERICA by Ana Patricia Morera Martinelli.....................................................153 Introduction.......................................................................................153 General comments on the pension systems.......................................154 Efficacy and efficiency of the superintendencies of pensions ..........162 Main functions of the Superintendencies..........................................174 Conclusions.......................................................................................176 Annex 1. Mission and vision of the superintendencies of pensions..............................................................180
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VII. PRIVATE PENSIONS SUPERVISORY METHODS IN AUSTRALIA by Greg Burner ..................................................................................183 Introduction.......................................................................................183 Types of superannuation entities.......................................................184 Supervisory framework.....................................................................185 Organisation and management of APRA..........................................187 Supervisory methods: entry requirements.........................................191 Supervisory methods: on-going supervision.....................................197 Supervisory examination ..................................................................203 Compliance enforcement and sanctioning ........................................207 Conclusion ........................................................................................211 Annex VIII.1. Explanation of some terms used to describe various arrangements and structures ..............212 Annex VIII.2. Divisional structure of APRA ...........................215 Annex VIII.3. APRA key result areas and key performance indicators .....................217 Annex VIII.4. Disclosure requirements ....................................219 Annex VIII.5. Annual reporting requirements to commence from 1 July 2003 ............................................222 Annex VIII.6. PAIRS/SOARS..................................................225 VIII. PRIVATE PENSIONS SUPERVISORY METHODS IN HUNGARY by Erdos Mihály ................................................................................227 Institutional framework, market structure and general approach to supervision...............................................................................227 Entry requirements............................................................................231 On going supervision ........................................................................237 Compliance, enforcement and sanctioning .......................................243 Conclusions.......................................................................................245 IX.
PENSION FUND SUPERVISORY METHODS IN IRELAND by Mary Hutch...................................................................................247 Introduction.......................................................................................247 Supervisory framework.....................................................................248 The Pensions Board ..........................................................................249 Entry requirements............................................................................251 On going supervision ........................................................................254 Compliance enforcement and sanctioning ........................................262 Conclusions.......................................................................................264
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X.
PENSION FUNDS SUPERVISORY METHODS IN MEXICO by Isaac Voulin..................................................................................269 Introduction.......................................................................................269 Summary of the supervision scheme ................................................271 Supervision scheme ..........................................................................272 Conclusions.......................................................................................278
XI.
SUPERVISION OF PRIVATE PENSION PLANS IN THE UNITED STATES by Morton Klevan, Carol Hamilton and David Ganz........................279 Introduction.......................................................................................279 Department of labour supervisory, compliance and enforcement structure............................................................282 IRS supervisory, compliance and enforcement structure..................294 The supervisory role of the Pension Benefit Guaranty Corporation ..................................................................300 Conclusion ........................................................................................301
XII. THE STRUCTURE AND FUNCTIONS OF THE SUPERVISORY REGIME OF RETIREMENT INCOME PROVISION IN THE REPUBLIC OF BULGARIA by Bozhidar Parvanov .......................................................................303 Overview of the Bulgarian pension system: Institutional framework and market structure..............................303 The organization and scope of authority of the Supervisory Agency ..........................................................310 Entry requirements............................................................................314 On-going Supervision .......................................................................316 Compliance enforcement and sanctions............................................318 Conclusions.......................................................................................320 XIII SUPERVISION OF PRIVATELY MANAGED, DEFINED CONTRIBUTION PENSION SCHEMES IN HONG KONG by Hong Kong Mandatory Provident Fund Authority (MPFA) ........323 Overview of the private pension system ...........................................323 General information about the financial system and culture ............325 Summary of supervisory practices in Hong Kong ............................330 Organization and scope of authority of the Supervisory Agency: ....331 Entry requirements and administration:............................................334 On-going supervision:.......................................................................336
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I.
SUPERVISING PRIVATE PENSIONS: AN INTRODUCTION by Ambrogio Rinaldi*
In many countries, an ageing population and high (and growing) public spending on social security programmes have led to structural reforms of the pension system. Privately-managed plans, both occupational and personal, play an increasingly important role in supplementing state-run mandatory schemes and in compensating the reduction in benefits they will be able to secure to beneficiaries. Public confidence in the fair and correct functioning of privately-managed plans is a crucial prerequisite for assuring political consensus for pension structural reforms. Appropriate regulation and effective supervision of private pension plans are crucial factors to reinforce confidence, protect beneficiaries and guarantee the financial security of pension plans. Regulation of private pensions has thus received increasing attention in recent years. OECD has played a leading role in this area, first in the context of a research project on ageing societies and then through the activity of the Working Party on Private Pensions (WPPP), established in 1999. Since then, a set of principles and guidelines has been developed, setting standards for appropriate regulation, for the protection of the rights of members and beneficiaries and for the governance of pension plans and funds. Guidelines on further profiles of private pensions are currently being examined and will be issued in the near future. In July 2004, the OECD Council issued a Recommendation on core principles of occupational pension regulation, that is based on the work developed so far in the WPPP. There has been little work until recently, however, in the specific field of supervision. Even amongst those responsible for pension fund supervision in *
Chair of the OECD Working Party on Private Pensions and Director, Covip, Italy.
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different countries, their knowledge of supervisory structures, strategies and practices put in place elsewhere is limited. This is in contrast to other fields of financial intermediation (i.e. banking, insurance, etc.) where the development of cross-border activity and the need for a level playing field has encouraged, since the 1970s, agreement on a set of rules leading to similar regulations and supervision between countries. Although cross-border activity in the area of pension funds is still limited, ensuring and maintaining confidence in the proper functioning of private pensions is increasingly viewed as a public policy priority. As such, knowledge of other countries’ supervisory frameworks is an important opportunity to identify good practices and to learn from other countries’ experiences. In 2002, the OECD Working Party on Private Pensions initiated work in the field of supervisory structures and methods. A detailed questionnaire on supervisory structures was completed by OECD Delegations. In addition, a small, informal task force was set up to examine supervisory practices and methods. The work of this taskforce has been undertaken jointly by the International Network of Pension Regulators and Supervisors (INPRS), an informal worldwide network established with the support of OECD. This partnership has made it possible to extend the scope of the analysis to a much larger group of countries. This book brings together the work accomplished so far on supervisory structures and institutions, and supervisory methods and practices. The first six chapters part contains survey papers that offer a comparative analysis of different profiles of supervisory structures and methods in OECD countries, and/or in specific regions or groups of countries. The following chapters second part contains five seven “country-case-studies” describing in detail the supervisory structure and methods put in place in the five different countries. It provides a wide variety of situations as well as different "styles" of supervision. The authors of the papers are, in almost all cases, officials personally involved in defining strategies and/or carrying out day-to-day managing day-byday operations in national supervisory agencies. This book represents, therefore, a unique, first-hand source of information on how pension fund supervision is organized and conducted across countries. Supervisory structures The Fifteen principles for the regulation an supervision of private occupational pension schemes, approved by the OECD WPPP in 2000, contain the following principle concerning supervisory structures:
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Effective supervision of pension funds and plans must be set-up and focus on legal compliance, financial control, actuarial examination and supervision of managers. Appropriate supervisory bodies, properly staffed and funded, should be established in order to conduct when relevant off and on site supervision, at least for some categories of funds and in particular when problems are reported. Supervisory bodies should be endowed with appropriate regulatory and supervisory powers over individual plans, in order to prevent mis-selling cases arising from irregularities in the distribution and expenses methods. On the basis of the information that has been collected, it is possible to be confident that in almost all OECD countries the institutional design of supervision is very much in line with the above stated principle. However, two main observations can be made. First, while the requirements identified in the principle are all very important, other features of supervisory structures should also be considered as crucial, such as: x
the provision for a well-defined mission statement for the supervisory authority. This should be accompanied by sufficient financial means and a not too detailed legal definition of specific tasks and controls to be performed. An appropriate mission statement provides for adequate flexibility, allowing the supervisor to effectively adopt a risk-based approach and concentrate his activity and resources on the factors that are most important for the protection of beneficiaries and the security of funds;
x
the recognition of the need for co-operation and for information sharing arrangements between different supervisory authorities, or between departments within the same authority in the case of integrated supervisory structures;
x
the design of the governance of the supervisory authorities. In the composition and the functioning of the governing boards, while it is crucial to ensure operational independence and professional expertise, it is also important to provide for accountability mechanisms, not only with respect to the government and/or the Parliament, but also to the interested parties from the pensions industry. In fact (as well as the top managers of the supervisory authority), representatives of employers, trade unions and the financial industry are sometimes included in the governing boards.
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Secondly, the findings presented here show a large degree of diversity between national institutional structures of the private pension funds supervision in OECD countries as a function of different factors. These include the institutional history of supervision, the political and administrative organisation of the state (federal, unitary, centralised, decentralised); characteristics the pension scheme (mandatory, voluntary, occupational, personal, defined contribution or defined benefit); and market structure (number of funds/plans, type of fund/plans, market concentration degree). Three private pension supervisory structure models have been identified: (i) a specialised pension model, with one or more agencies dedicated exclusively to pension fund supervision; (ii) a partially integrated model, with one agency responsible for insurance and private pension supervision; and (iii) an integrated model, with one institution responsible for the overall financial sector supervision, including banks, securities, insurance companies, and pensions funds, and sometimes also banks. None of these three models currently holds a general position of dominance. In the 28 countries examined in the paper by Carvalho-Pinheiro, there is an even spread of these three models (Table II.2). In several of the country replies quoted in both this study the mentioned paper and the one by Demaestri and Ferro, several arguments are presented in favour of integration. These include the expansion of financial conglomerates, economies of scale and scope in supervision, avoiding the problem of overlapping authority, consistency between supervisory objectives in different sectors, and efficiency of information flow. Arguments in favour of specialisation are related to the specificities of private pension arrangements with important social profiles and specific tax treatments, which require a different approach regarding the supervision of their risks and their relations with members. This seems particularly to be the case as regards occupational schemes, where the role of employers and often of trade unions is crucial, and the pension fund frequently is a non-profit institution that serves as an intermediary between its members and financial markets. In fact, there are countries with integrated agencies for the financial sector that maintain separate, segregated agencies for occupational pension plans (Japan, Sweden and the UK). A single case (Australia) is also reported as having two agencies competent for all financial sectors/intermediaries (included pension funds), and functions specialised by objectives (prudential supervision vs consumer protection). More recently, also the Netherlands decided to adopt a similar model. 12
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The observed diversity suggests that the final objectives of supervision (protection of members, security of funds and plans) may (and probably should) be sought by means of different institutional frameworks in different countries as a function of the institutional context and the structure of the pension system. This finding is in line with the conclusion already reached by other OECD studies (Lumpkin, 2002) for the supervision of the financial services industry. In fact, when the peculiarities of pension funds are considered, the case for a variety of different possible approaches to supervisory institutional design seems even more convincing than in the case of the financial industry stricto sensu. Supervisory methods The OECD WPPP initiated work on supervisory methods by establishing a small, informal task force in 2002. Two meetings, in December 2002 and June 2003, were held under the joint aegis of OECD WPPP and the INPRS. The work aimed to review and describe supervisory procedures used in different countries in order to improve mutual knowledge and provide international comparative information, with the possibility of identifying good practices. The objective to set standards and define guidelines seemed too far away and was not considered during this first stage. It was decided to produce a set of country-case-studies that would cover a variety of situations and possible approaches to supervision. The comparison of country cases would show how different practices and techniques are used in different situations and would lead to the identification of regularities, and possibly "good" practices as a function of circumstances. The focus of the analysis was the operational management of the supervision in the context of its customization to the market, legal framework and supervisory structure. It was agreed to give attention to the operational and day-to-day aspects of the management of supervision, and to the changes in the supervisory methods that occur in response to changes in the economic conditions, legal framework, government philosophy, supervisory structure, and/or market conditions. The primary attention was put on occupational pension plans, although treatment of personal pension plans was demanded where such schemes are important. On the other hand, the scope of the study excluded insurance contracts as such (although they may be used in both occupational and personal pension plans) in so far as the supervision on insurance is a topic that already receives attention in other contexts.
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Despite their potential and actual diversity, national supervision systems were to be analysed using as a reference the model proposed by the Basle Committee for the entire financial sector, that comprises three components: ex ante, on going and ex post supervision. Authors from five countries volunteered to produce and actually delivered their own case-studies: Australia, Hungary, Ireland, Mexico and United States. Other two case-studies (Bulgaria, Hong Kong) were later added in collaboration with the World Bank. The seven country papers are reproduced in this book. The country papers offer a synthetic, introductory description of their approach and of the main elements of the actual organization and management of supervision (i.e. reactive vs. proactive, risk-based, etc.). Primarily as a function of the institutional and market context, the general approach to supervision and its organization and procedures varies significantly. Countries characterized by a very large number of pension funds (Ireland, United States) – have a reactive approach, while countries with a smaller number of funds (Mexico, Hungary) are able to choose a proactive stance. A mixed reactiveproactive approach is followed by Australia, the country (among those covered in the country papers) that shows most distinctly a risk-based approach. As regards ex ante supervision, the necessary entry requirements are described: licensing procedures, registration processes and any other methods of restricting and controlling entry in the private pension market. A description is also given of the procedures and documents required for licensing and registration of the fund and of the internal rules related to corporate governance. Where relevant, requirements for pension fund managing companies, and minimum capital and reserve levels are also considered. Moreover, the bureaucratic requirements to qualify for tax advantages are examined. In countries where the number of schemes is large, these rely on registration and self-compliance, while countries with a small number of entries can afford detailed licensing procedures. It should be noted that licensing procedures are required where funds or fund managing companies compete on the retail market offering personal plans (e.g. Mexico, Hungary). On the other hand, the need for a prior authorization is not obvious in the case of occupational plans, where fund members are not offered any alternative vehicle for their supplementary pension and there is no risk of mis-selling practices. On-going supervision, i.e. the organization and the day-by-day conduct of the oversight of fund operations, was requested to be a central topic of country
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studies. In particular, country studies provide a description of the mix of instruments and techniques that are used in order to collect information and to check the compliance with regulation: off-site monitoring, on-site inspections, meetings and interviews with pension funds’ directors and managers, contacts with external and internal auditors and actuaries (whistle-blowing), complaints from members/beneficiaries. In countries characterized by a reactive approach, whistle-blowing is the main source of information for supervision. For example, actuaries and auditors in Ireland have a statutory duty to report the supervisor of any irregularities they encounter. In general, this source of information may be very effective and reliable for supervisory purposes, as it is entrusted to well-trained professionals who are in the best position to detect problems at an early stage when they arise. However, recent developments in another country (the United Kingdom) which relies very much on whistle-blowing, suggest that there might also be pitfalls. This is the case when regulations do not offer the possibility to discriminate between futile and serious irregularities, thus exposing the supervisory authority to the risk that whistle-blowers exaggerate reporting, blowing the whistle also when there is no material danger for members or beneficiaries. In countries where pension funds are relatively recent, reliance on frequent (even daily), electronically-based flow of information is observed. This is the case of Mexico, Hungary and Bulgaria. In the case of Mexico, the approach tries to address the problem of building confidence in the initial stage of the system. The Mexican country paper, in fact, declares the intention to gradually ease direct control, allow a degree of self-regulation, and make fund managers more responsible. Specific attention is addressed to on-site inspections, their periodicity and the way subjects to be inspected are identified, time and resources allocated. Although the power to make on-site inspections is considered essential in all country studies, the actual utilization varies. Ireland (where the balance between the number of funds or plans to supervise and the staff available is less favourable) has not used this instrument so far. Hungary is planning to reduce on-site inspections in favour of off-site monitoring which is less resource intensive and often just as effective. Country studies focus also on the way the supervisory authority processes and analyses the data, and the criteria it uses to evaluate performance of supervised pension funds/plans (i.e. rating, informal methods, etc.). In a riskbased approach, such as the one followed in Australia, the analysis of data is central to the assessment of risks that characterize the activity of the fund; the
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estimates that are thus created are then supplemented by the assessment – judgemental in nature – of the ability of the pension fund to manage its risks. The papers provide information on compliance assistance programs that are incorporated into the supervision process in order to assist funds in understanding the requirements and facilitating compliance. Countries with a large number of funds tend to rely more on communication and guidelines made available to trustees and fund administrators. Reliance on communication and advice prevents the emergence of problems and is generally considered an effective way to save resources otherwise to be spent on ex post investigation and remedial action. Finally, country studies describe compliance enforcement methods and sanctioning. Administrative remedies, punitive or compensatory sanctions, are described, as well as civil monetary penalties and criminal sanctions, and the intervention and liquidation procedures. In countries with a reactive approach, correction mechanisms are very important, as supervisory action typically starts when the irregularity has already occurred. In mature systems such as the United States corrective measures often take the form of voluntary compliance, aiming more to remedy the consequences of the failure to comply with rules than to punish the misbehaviour. This approach favours a cooperative stance between the supervisory authority and the pension entities, although it requires a high level of integrity of the financial and administrative environment, and the credible threat of effective and timely penalties/redress mechanisms should voluntary compliance not occur. Richard Hinz, former Chairman of the OECD WPPP, presents an original methodological framework for evaluating the characteristics of private pension supervision with a view to obtaining initial observations on the way in which the supervision is organised and conducted, and how it relates to the environment in which it operates. He identifies six primary elements of pension fund supervision – licensing, monitoring, communication, analysis, intervention and correction. The manner in which different systems implement the basic elements defines what may be viewed as the "style" of pension supervision. He then lays down the scale of intensity of private pension supervision along a spectrum of attributes and identifies the factors that influence the degree of intensity of supervisory oversight. He argues that mandatory systems require more intensive supervision due to greater reliance on pension for subsistence, whereas more developed economies with a large number of funds and with high per capita GDP seem to lower the intensity of supervision. This correlates with a stronger social safety net, better capacity of the population to exercise individual oversight, and greater reliance on communication and market-based competition to create discipline in the market. Financial market development 16
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and an effective “rule of law” facilitate less intensive supervision as more financial products enhance competition and allow greater reliance on market forces. The respect of rule of law implies greater reliance on negotiation processes and litigation, thus diminishing the need for public intervention. As a final summary, a large diversity of supervisory methods and practices is observed, even within the small sample of country case studies conducted so far. If a single common ground has to be identified, one could point to the need to organize supervision in such a way that there is consistency between the endowment of resources available for supervision and the extent of tasks entrusted with the supervisor, which is primarily a function of the number of funds and plans to be supervised, but it is also connected with the regulatory approach. In cases where the need to build confidence in private pension system is the main concern, and the financial environment is not fully developed, there is a tendency for supervisory authorities to carry on a sort of monopoly in the exercise of regulatory and supervisory powers. In this case, the centralization of controls is felt to be necessary, and the flow of information requested and collected by the supervisory authority may be very detailed and frequent. This approach often goes hand-in-hand with quantitative limits set on pension funds' investments. In cases where the financial and the private pension systems are more mature, controls tend to be decentralized to parties that are closer to the entities to be supervised and are therefore in a better position to appreciate specificities of a single plan or fund and the materiality of potential threats to the interest of members and beneficiaries (this is consistent with the trend for a risk-based approach that makes efficient use of scarce supervisory resources). Supervisory functions are therefore distributed in the system and their effectiveness depends largely on the appropriate functioning of the “regulatory space” as a whole and not only on the way the supervisor is able to perform his tasks. In such a context, more flexible rules are provided for (as the prudent person approach to pension funds’ investments), and self-regulation and appropriate governance of pension funds are central elements of the supervisory strategy. Further work Contributions collected in this book represent a unique, first-hand source of information on how supervision of pension funds is organized and conducted across countries. However, this should be considered as a starting point. Mutual understanding and recognition of national regulatory and supervisory frameworks continue to have a long way to go, as does the careful identification of good practices and eventually the elaboration of guidelines.
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In the future, several international fora will be involved concurrently in the analysis of regulatory and supervisory systems for pension funds. This is already the case in several instances. The International Organization of Pension Supervisors (IOPS), established in July 2004 as an evolution of the OECD-connected INPRS, constitutes a natural forum for the continuation of the analyses collected in this book. The discussion that took place in the INPRS Technical Committee between 2002 and 2003 led to an agreed solution on the way to define the scope of the new organization and to differentiate it from the OECD WPPP. IOPS will be an institutional-based organisation with members coming from supervisory agencies and not countries. It will focus on supervision and regulatory issues linked to supervision. It will be a world-wide organization, with regional committees put in place. The European Union also became active in the field of private pensions, adopting a directive concerning the supervision and the activity of occupational and professional pension funds. In the context of the so-called Lamfalussy approach to financial regulation in the European Union, committees were created to co-ordinate work between the competent ministries (EIOPC) and the supervisory authorities (CEIOPS) of member states competent in the field of insurance and of occupational pensions. In the framework of CEIOPS, a permanent working group on occupational pensions was established. The International Association of Pension Fund Supervisors (AIOS) will continue to constitute an important forum for supervisory institutions from countries where, as in Latin America, pension systems are based on mandatory personal pension plans. The OECD WPPP, while focusing more on policy and regulatory issues, will also continue to consider supervision within the scope of its activity when it is linked to regulatory issues. The activity of the above-mentioned fora will certainly stimulate rapid progress in mutual understanding of supervisory structures and practices and in cooperation between competent authorities of different countries. A degree of specialization between the different fora will certainly emerge. Co-operation will be favoured by the fact that in most cases the same national institutions are represented in the diverse fora. Let me conclude this introduction pointing out the topics regarding pension fund supervision that I foresee as among the most useful to analyse in the future. In my view, the three following topics deserve particular attention.
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Risk-based supervision is already receiving increasing attention by supervisory authorities in many countries. It is a way to concentrate scarce resources on the factors with the largest expected impact on members’ interests. It goes hand-in-hand with a more proactive stance with respect to the funds most at risk. Risk-based supervision is already standard practice in other fields of financial intermediation (i.e. banking, insurance). It is not obvious, however, how methods and tools that are used in these fields can successfully be applied to private pensions, especially in the case of occupational schemes. One example is capital requirements, as the non-profit nature of most pension funds may change their impact fundamentally with respect to the case they are applied to profit-making financial intermediaries.
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In many countries, there is the intention to ease or abandon quantitative limits to pension fund investments and substitute them with the prudent person approach. While pros and cons of the two different approaches have been discussed at length, it is less obvious how supervisory authorities will manage the transition between the two approaches, in terms of day-by-day supervisory practices, including the development of appropriate skills of the supervisory staff.
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The general trend in favour of defined contribution schemes implies the diffusion of member-directed schemes, as it is fair that those who bear the risk of investments are also offered the possibility to make choices on their risk profile. However, even in the case where adequate information is supplied to them, the actual ability of pension fund members to make knowledgeable choices may be inadequate anyway Therefore there is an urgent need to empower fund members with effective programs improving their financial literacy, as well as to keep offered investment options as simple as possible. In particular, the risk of allowing the mis-selling of high-cost pension products to workers that do not fully perceive those costs and do not in fact need unduly sophisticated products should be minimized. Also, the provision of carefully designed default options in all cases where fund members are not able or willing to make their choices is going to be a crucial element in the design of a successful framework. In my view, the development of supervisory practices that help minimize the risk of ill-based individual choices will be one of the most challenging tasks for private pension supervisors in the coming years.
Mutual exchange of information on the experience gained by pension fund supervisory authorities in different countries in addressing these issues will be very helpful.
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II.
SUPERVISORY STRUCTURES FOR PRIVATE PENSION FUNDS IN OECD COUNTRIES by Vinicius Carvalho Pinheiro*
Background The study of the supervisory structures for private pension funds is a core activity of the OECD Working Party on Private Pensions (WPPP) and the International Network for Pensions Regulators and Supervisors (INPRS). This study develops a comparative analysis of the institutional environment of private pension funds supervision. It begins with a review of the different types of organisational arrangements according to market structure and the relationship between regulatory and supervisory agencies1. It then proceeds to analyse the operational independence, governance, accountability and enforcement capacities of supervisory agencies as well as the internal organisation of the latter. This analysis focuses on the primary supervisors as identified in Appendix 1. The information presented is based on the responses to a questionnaire on supervisory structures for private pensions (Appendix II.2) provided by twenty OECD countries (Australia, Canada, Czech Republic, Denmark, Germany, Hungary, Iceland, Ireland, Italy, Japan, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Turkey and the United Kingdom). The responses provide a unique cross-country comparison of the information available on this issue. Further information from other OECD countries, collected from different sources, is also provided. The information is updated until 2003. Institutional framework of private pension fund supervision Private pensions are long-term contracts that compromise a sizable share of the worker’s income and operate in markets subjected to failures related to asymmetric information, adverse selection and moral hazard. Government *
OECD Consultant seconded by the Brazilian Government.
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intervention is crucial to design regulations oriented to avoid systemic crisis and to guarantee the financial and actuarial sustainability of the private pension system. Regulations have to be implemented by supervisory institutions, which ought to be properly staffed and financed, insulated from political pressures — from either the government or the pension industry — and endowed with reasonable enforcement capacities. Objectives and functions The main objective of the private pension supervision is to ensure compliance with regulations in order to protect the interests of the members and safeguard the stability of the system. These elements are presented in the stated missions of the majority of the surveyed supervisory agencies, as listed in Table II.1. Table II.1. Selected OECD Supervisory Agencies’ Stated Missions APRA (Australia)
“…to establish and enforce prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions we supervise are met within a stable, efficient and competitive financial system”.
OSFI (Canada)
“…to safeguard policyholders, depositors and pension plan members from undue loss”.
FSA (Denmark)
“…maintain confidence in the financial sector - both in relation to society and to the individual person - by: ensuring that financial legislation is observed. This includes the prevention of offences that may arise in specific areas, for instance the areas of solvency and liquidity; participating in the elaboration of financial legislation, and collecting and publishing information relating to the financial sector”.
BaFin (Germany)
“…to ensure that the interests of the insured are adequately safeguarded and that liabilities under insurance contracts can be met at all times (…). The objective of legal supervision is the proper operation of insurance business including observance of the supervisory provisions, provisions concerning the insurance contracts and any other provisions concerning the insured as well as of the legal bases of the operating plan.”
HFSA (Hungary)
“…to facilitate the smooth operation of the financial markets and promote the protection of clients of financial organizations, and their consumers; to maintain and strengthen confidence in financial markets; to contribute to the transparency of the markets, provide for the improved awareness of consumers and to the regulation of fair competition in the market.”
FSA (Norway)
“ensure that the institutions it supervises operate in an appropriate and proper manner in accordance with law and provisions issued pursuant to law and with the intentions underlying the establishment of the institution, its purpose and articles of association”
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FME (Iceland)
“...to ensure that these (parties subject to official supervision) are in accordance with laws, regulations, rules and by-laws governing such activities, and that they are in other respects consistent with sound and proper business practices.”
Pension Board (Ireland)
“…to promote the security and protection of members of occupational pension schemes and contributors to Personal Retirement Savings Accounts, in accordance with the Pensions Act, 1990; to promote the development of efficient national pension structures; to promote a level of participation in the national pension system which enables all citizens to acquire an adequate retirement income; and to provide information and authoritative guidance to relevant parties in support of pension security, structures and participation”.
COVIP (Italy)
“…aiming at the safe and transparent management of pension funds and at the appropriate functioning of the supplementary pensions system”.
CONSAR (Mexico)
“…to protect the interest of the workers and their beneficiaries by an efficient management of their retirement savings.”
PVK (Netherlands)
“…to ensure that insurers and pension funds fulfill their obligations to policyholders, pension scheme members and pension recipients.”
KNUiFE (Poland)
“…to protect the interests of members of the funds and members of the employee pension plans.”
Finansinspektionen (FI) (Sweden)
“…promotion of financial stability and efficiency in the financial sector and promotion of consumer protection goals.”
Source: Replies to the OECD Secretariat questionnaire. In most cases, the quotations are legal provisions or mission statements.
In most surveyed countries, the stated mission is defined in the legislation and is the basis for the organisation of the supervisory agency. It provides guidance for the institutionalisation of values and the creation of corporate culture. A clear definition of objectives and mission is also important for the delimitation of tasks between agencies and for designing supervisory functions. The objective “protecting the plan member’s interest and safeguarding the stability of the system” effectively means assuring compliance with regulations to mitigate risks and to guarantee that liabilities under pension contracts are met. Additional concerns arise when pension funds are set up. If plans use existing financial products as funding vehicles, then financial sector supervisors can normally be relied upon to provide adequate protection. The risks involved in private pension activities are mainly related to the inadequate organisational structure and operation of the pension fund, mismanagement, inaccurate actuarial and asset evaluation, investment portfolio, annuity fund and liquidity mismanagement, improper accounting, high SUPERVISING PRIVATE PENSIONS – ISBN-92-64-01697-X © OECD 2004
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administrative costs and market structure. External risks related to the functioning of financial and insurance markets, to economic performance and to political stability should also be considered. In order to implement mission statements effectively, it is necessary to establish functions and design an institutional framework with one or more agencies to operate them. Typical supervisory functions include implementing regulation related to: licensing/registration; qualification for tax benefits; compliance to governance rules; contributions and regularity of payment; membership and portability (enrolment process, transfers and compliance); benefits eligibility; financial literacy; conditions and access to plans; investments, asset allocation, performance, minimum capital and reserves; custodian procedures; financial, actuarial and accounting methods; administrative costs, fees and marketing; disclosure procedures; and merger and liquidation processes. Governments organise institutional structures designed to implement supervisory functions according to the administrative organisation of the state, the distribution of competencies between different levels of government and between institutions, the development of financial markets and services, the features of pension plans and the nature of the regulatory approach applied to these schemes. Political organisation of the state In federative or decentralized countries, the action of the central supervisory agency may be quite limited. The Canadian Office of the Superintendent of Financial Institution (OSFI) is responsible for only 8% of the country’s regulated pension plans, covering 10% of plan membership. Almost all of Canada’s provinces have separate local agencies that are responsible for provincially regulated pension plans within their jurisdictions. The Australian public servants’ superannuation schemes are not implemented under the same rules and supervisory procedures as are applied to the private sector. They are subject to Commonwealth, State or Territory government supervision under their enabling acts. A federative agreement requires these funds to comply with the spirit of the general regulation. In the US, states also have federative autonomy to regulate and supervise pension funds for their public servants. In Sweden, Finansinspektionen (FI) is the primary supervisory agency for all financial institutions, including “friendly societies”2, but excluding the pension foundations3 which are monitored by the parties to the agreements.
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County administrative boards may supervise occupational plans sponsored by employers seeking to establish a pension foundation according to the region where they are located. Since there are twenty four counties in Sweden, the rules of supervision and practices can vary significantly. Institutional and functional structure Private pension supervision involves complex interactions between social security, tax, financial and insurance sectors. Generally, pension fund supervisors are located in an institutional environment, including social and economic institutions such as Ministries of Finance, Labour and Social Security, Central Banks or other financial sector supervisory authorities. Tax authorities also supervise private pensions since they are often in charge of granting tax exemptions. However, with the exception of a few countries (e.g. US), tax authorities are not responsible for prudential supervision or for protection of members and beneficiaries’ rights. Supervisors customise their organisation and activities to suit the complexity of the pension fund industry. According to OECD taxonomy, pension funds may support public or private pension plans. From a functional perspective, pension plans may also be mandatory or voluntary, defined contribution (DC) or defined benefit (DB), and occupational or personal. A description of the main characteristics of the surveyed countries’ private pension schemes is provided in Appendix 2. Similarly, the structure of supervisory authorities should adequately address the institutional form of the pension funds, designing procedures for autonomous and non-autonomous funds, as well as for group, collective, related members, and individual pension funds. It is also necessary to distinguish between two main legal forms of autonomous pension funds: pension entities and separate accounts. Pension entities can be trusts, foundations or corporate entities that own and may control the pension fund on behalf of the plan members. They are the most common type of autonomous pension fund in OECD countries. Separate accounts, on the other hand, are autonomous pension funds without legal personality or capacity that are managed by financial institutions (sometimes special-purpose institutions, pension fund managing companies). Generally, the institutional structure of private pension supervision can be classified into three main approaches according to the extent to which the authority responsible for pension supervision is also competent to supervise other financial institutions: (i) specialized pension model, with one or more agencies dedicated exclusively to pension fund supervision; (ii) partially
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integrated model, with one agency responsible for insurance and private pension supervision and (iii) integrated model, with one institution responsible for the overall financial sector supervision, including banks, securities, insurance companies and pensions funds. Table II.2 shows how OECD country supervisors currently fit into this classification.
Table II.2. Private Pension Funds Supervisory Structures in OECD Countries Integrated (Banks, Securities, Insurance Companies, Pension Funds) Australia
Partially Integrated (Insurance Companies and Pension Funds)
Specialized (Pension Funds)
Belgium(*)
Ireland
Austria
Czech Republic
Italy
Canada
Finland
Japan
Denmark
Luxembourg
Mexico
Germany
Netherlands (**)
Slovak Republic
Hungary
New Zealand
Sweden
Iceland
Poland
Switzerland
Korea
Portugal
United Kingdom
Norway
Spain
United States
Turkey (*) A new integrated agency starts to operate in 2004. (**) The country is in process to consolidate the financial supervision. Source: Replies to the OECD Secretariat questionnaire and INPRS database.
Historically, in many countries, private pension supervision has been based either on insurance/financial/pension arrangements linked either directly or indirectly to Ministries of Finance or on specialised arrangements under Ministries of Labour, Social Security and/or Social Affairs. Ireland, Italy, Japan, Mexico, Slovak Republic, Sweden, Switzerland, the United Kingdom and the United States all organise their supervision around specialised supervisory authorities. This model is characterized by the segregation of supervisory functions and the fragmentation of supervision for different private pension schemes or products. Generally, distinct agencies conduct the supervision of occupational and personal plans and there are more than three institutions involved in the overall process, which reinforces the necessity for effective co-ordination and co-operation mechanisms.
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In Ireland, the Pension Board is the primary supervisor for occupational schemes, whilst personal pension plans are overseen by of the Department of Enterprise, Trade and Employment. Japan follows the same model. The Pension Board, linked to the Ministry of Health, Labour and Welfare, supervises most of the occupational pension funds and another agency is in charge of voluntary plans. The Financial Service authority in Japan and the Central Bank in Ireland are also involved in the process related to custodian and investment procedures. In Italy, COVIP (Commissione di vigilanza sui fondi pensione) is the primary pension fund supervisor. It supervises all the new pension funds (closed and open) set up under the new legislation and the pre-1993 “old” autonomous and non-autonomous pension funds internal to undertakings other than banks and insurance companies. The Bank of Italy and the Institute for Private Insurance Surveillance (ISVAP) supervise pension plans instituted as book services respectively within banks and insurance companies. As part of its general supervisory powers, ISVAP also supervises life insurance products that can serve as individual pension plans. In Mexico, the supervisory functions for personal mandatory plans are divided between the National Institute of Social Security —Instituto Mexicano de Seguridad Social (IMSS) — and the National Commission for Retirement Savings System – Comision Nacional del Sistema de Ahorro para Retiro (CONSAR). IMSS performs supervisory functions related to: contributions and regularity of payment; membership and portability; benefits eligibility conditions and access to plans. CONSAR is responsible for licensing; compliance with regulations on governance; asset allocation; financial, actuarial and accounting methods; disclosure, merger and liquidation. The Ministry of Finance is in charge of supervising personal voluntary pension plans. In the United Kingdom, occupational pension funds are subject to surveillance by the Inland Revenue, the Occupational Pensions Regulatory Authority (OPRA), the Pension Compensation Board, the Department of Social Security and the Financial Service Authority (FSA). The United States has several agencies in charge of the supervision of private pension occupational schemes. The US Department of Labor, Pension and Welfare Benefits Administration (PWBA) primarily supervises the protection of employee benefit rights and fiduciary obligations for corporate and multiemployer voluntary pension plans. The Pension Benefit Guaranty Corporation (PBGC) provides protection for the termination of defined benefit schemes. The Internal Revenue Service (IRS), overseen by the United States Department of Treasury, operates and supervises the tax treatment related to pensions and, in that role, is responsible for the registration (tax qualification) of pension plans.
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The partially integrated perspective is in use in a number of OECD countries, namely Belgium, Czech Republic, Finland, Luxembourg, the Netherlands, New Zealand, Poland, Portugal, Spain and Turkey. They have combined the supervision of insurance and pension funds under an integrated agency which is separated from other financial supervision tasks, or which resides in a specific department of the Ministries of Finance, Labour or other ministries. In all these surveyed countries, occupational and personal plans, contracted out under voluntary or mandatory basis, are under the oversight of the same agency. However, in Poland, one possible form of a voluntary occupational pension plan is to establish an agreement with an investment fund. The pension plan is registered by the insurance and pension supervisory body, but the fund itself is supervised by the Securities and Exchange Commission In Portugal, the Netherlands and Spain, both occupational and personal voluntary pension plans, as well as insurance companies, are supervised by a single agency: the General Directorate for Insurance and Pension Funds (Dirección General de Seguros y Fondos de Pensiones), under the Ministry of Economy in Spain, and in the Netherlands by the Pensions and Insurance Supervisory Authority (Pensioen & Verzekeringskamer), an independent Dutch agency with specialised departments. In Portugal, the Portuguese Insurance Institute (Instituto de Seguros de Portugal – ISP) is a public autonomous body linked to the Ministry of Finance. In Poland, there are only voluntary occupational pension programs, which can be established in a form of agreement with life insurance companies, investment funds or in a form of separate employee pension fund. Under certain circumstances, personal (individual) contracts with life insurance companies (unit linked products) or with investment funds, for purposes of practice, may be considered as a personal pension operation but the law does not distinguish them as a separate legal institution. The pension funds are overseen by the Commission of Insurance, and Pension Fund Supervision (KNUiFE). Recently, some OECD countries have adopted an integrated supervisory perspective in their financial sector, reforming their supervisory framework to build a unified supervisory authority. This process started during the 80’s and in early 90’s in Scandinavian countries (Norway in 1986; Denmark in 1988; and Sweden in 1991) and in Canada in 1987. These countries had unified their previously specialised agencies in order to adapt the institutional regulatory and supervisory structure to the market structure dominated by financial conglomerates delivering banking, insurance and pensions services and products.
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In recent years, Australia (1998) has adopted an integrated approach as part of the pension reform process. Nonetheless, agencies which integrate the supervision of all of the financial sectors into a single organization do not necessarily embrace all of the supervisory functions. Australia has an integrated sector model, but the supervisory functions are divided between the Australian Prudential Regulatory Authority (APRA) and the Australian Securities and Investment Commission (ASIC). APRA is responsible for licensing and prudential supervision of the plan and pension fund rules and investments. ASIC is responsible for pension fund market conduct. Korea (1999) has also unified its supervisory agencies in a package of measures to strengthen the financial system after the 1997 economic crisis. This pattern was followed by Iceland (1999), which has several financial conglomerates in the market structure and therefore implemented a unified agency. Hungary established the integrated Hungarian Financial Supervisory Authority (HFSA) in April 2000, consolidating the supervision of banks, credit institutions and co-operatives, financial enterprises, investment funds and service providers, insurers, health and income replacement funds, as well as mandatory and voluntary pension funds. Since 2001, Austria has also established a similar agency in order to adapt the supervision structure to fit the shape of the market, (banks and insurance companies hold the control of several pension funds). Germany was the last OECD country to adopt this integrated model in 2002. The integrated approach has been proposed as a way to adapt the supervisory framework to the development of financial conglomerates and to address the blurring of differences across financial products. Experts in different products working together in a unified agency would improve the risk assessment taken over by financial conglomerates. Some surveyed countries argue that the main advantage to moving to a single supervisor is the adoption of an integrated supervisory approach. According to the Australian Delegation’s response to the questionnaire: “the integrated nature of APRA enables its approach to supervision to be more holistic with a view to the operation of the superannuation industry within the context of the broader financial services sector”. For the Hungarian Delegation, integrated supervision has led to a comprehensive control activity – “(…) within this framework, different business lines and transactions can be assessed with the involved partners at the same time. This integrated approach allows for consolidated supervision. The legal
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and supervisory arbitrage of the market players could be limited”. The consolidated supervision can standardize actuarial, accounting and financing parameters for financial entities, thus avoiding differences and inconsistencies of supervision between financial sector as well as addressing discrepancies between regulatory issues. Nonetheless, Hungarian Financial Services Authority (HFSA) representatives remind us that “an effective integrated supervision requires a coherent and well-developed institutional culture.” Another argument for financial integration is related to economies of scale and scope, and to the simplification of the system. The Canadian Delegation replied to the questionnaire affirming: “the simplicity of this system reduces the regulatory cost and burden, while encouraging compliance and new entry”. In fact, the consolidation of various specialized agencies may decrease the overall supervisory administrative cost, thereby increasing efficiency. The integration of supervisory procedures may reduce and simplify the amount of documents usually sent by entities to supervisors; eliminate duplications and authority overlapping; optimise licensing procedures and facilitate the integration between off-site monitoring and on-site supervision. Furthermore, integration would enable the use of joining supporting services that are multiplied in various institutions in the specialised model. A single complaint-handling regime and a single compensation scheme can be established. This would save scarce government human and material resources and reduce operational burden over supervised entities Additionally, financial supervision decisions require the on-line availability of strategic information. The specialised model may delay data consolidation or reduce the quality of the information, since they are collected and recorded in fragmented databases under different labels. The agencies’ integration may improve the information provision efficiency to avoid systemic crisis, identify illegal procedures and safeguard the credibility of the system. Others consider that actual integration is not a prerequisite to achieve these objectives. The Italian Delegation reports, for instance, “problems due to the separation of supervisory activities over the financial sector between many different bodies may be overcome with a timely and open exchange of information and an effective cooperation”. The effectiveness of the integrated approach to financial supervision is a controversial issue which does not benefit from any conclusive evidence. Proponents of financial integration argue that a single agency would work with greater efficiency at a lower cost for supervisors, pension funds and other supervised financial institutions due to “economies of scale and scope, reduction in the reporting requirements, consistency in the treatment of different sectors, capacity to solve conflicts, accountability, and capacity to 30
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implement a risk-based supervision model”.4 Nonetheless, Lumpkin (2002) argues that the effect on costs of the reduction in the number of supervisory agencies remains unclear and the question of whether the organisational structure of supervision needs to mirror the structure of the financial system remains controversial.5 The arguments against integration and in favour of the specialised model for private pension supervision are based on the differences between the pension service and product business and other financial business. Pensions are long-term contracts with specific tax treatments and social aspects, which would require a different approach regarding the supervision of their assets, liabilities and risks. This seems to be the case as regards occupational schemes where employment relationship must be considered and where the employer frequently serves as an intermediary between members of the pension plan or fund and the financial institution. The Italian Delegation reports that a specialised agency can better concentrate expertise and knowledge on the pension funds sector. They raised the following point: “the supervision on pension funds is carried out from a distinct perspective with respect to the supervision of other financial intermediaries, in order to fully take into account their differences from other financial intermediaries (contractual pension funds are on the buying side of the market for financial services; they are non-profit organizations; they are run on a parity basis by employers and trade unions and their establishment is part of the system of industrial relations).” In the case of Swedish pension foundations, it is reported that “the number of supervisory authorities (one for each county) may lead to very diverse supervision, but also to flexibility.” In the case of Latin American reforms, Demarco et al. (1998) mention that a new specialised agency might be more effective than other arrangements. The authors justify their position in relation to the lack of tradition on the supervision of new products, suspicion on the lack of transparency in preexisting agencies and the absence of experience on supervising complex interactions which combine capital markets, insurance and social security.6 For the Mexican Delegation, the institutional and the functional specialisation are considered an advantage. According to Mexico’s reply: “since CONSAR does not oversee the payment process nor the eligibility of the retirees, it can focus its efforts on the surveillance of specific processes of the pension system. CONSAR has developed state–-of–the–-art technology to oversee the pension funds operation.”
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The particularities of pension fund supervision may explain why Japan, Sweden and the United Kingdom have created unified financial services authorities, excluding the supervision of the occupational pension funds and maintaining segregate agencies dealing with it. In Japan, the Financial Services Authority is in charge of the personal pension plans and the Pension Bureau oversees, for the most part, the occupational scheme. Similarly, the British Financial Services Authority, created in 2000, oversees the marketing of personal pensions, including stakeholder pensions, with particular emphasis on promotion, selling and advice. The specialised agency (OPRA), established in 1995, is the primary supervisor of most of the regulations of the occupational and personal pension schemes. In Sweden, one of the pioneers of the financial services authority consolidation, the responsibility to supervise the pension foundations remain with the county supervisory boards and the FI oversees only the mutual benefit companies offering insurance solutions similar to life insurance. Moreover, there is a crucial distinction in these countries between the organisational integration of supervisory institutions and the functional integration of supervision procedures. The existence of an integrated supervisory authority does not necessarily imply consolidated supervision. More generally, it should be noted that in most integrated and partially integrated models, the supervision of pensions is actually conducted by a specialised department/division. In the Netherlands, there is an on-going initiative to reform the supervisory framework by building an integrated agency, but maintaining a specialised approach for the pension funds supervision. In March 2003, the Dutch Parliament decided to merge the Central Bank, responsible for banks and investment institutions, and the Pension and Insurance Supervisory Board (PVK). The integrated agency will be overseen by the Finance Minister, and the pension supervisory body will be politically accountable to the Ministry of Social Affairs and Employment, which is legally responsible for the implementation of the Pension and Savings Fund Act. The latter will have extensive powers on the budget process and on the appointment of the governing board for pension supervision. Specialised agencies can co-ordinate their activities in order to achieve economies of scale, greater efficiency, and eliminate overlapping duties.7 Therefore, it is important to look beyond the institutional structure of supervision and analyse the distribution of responsibilities and functions not only between authorities and within authorities, but also the co-ordination and co-operation mechanisms between agencies or between departments in the same agency.
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A complete survey on the distribution of supervisory responsibilities between agencies is provided in Annex 3. Generally, unified agencies, as for example in Canada, Germany and Sweden, comprise all the supervisory functions related to pension funds, excluding the qualifications for tax benefits, which falls under the responsibility of the tax authorities. On the other hand, in countries with specialized agencies, like Ireland, Italy, the United Kingdom and the United States, the functions and responsibilities for pension fund supervision are divided between several agencies. Australia is an exception because it has adopted an integrated institutional approach for all financial sectors, but the supervisory functions are divided in three specialized agencies. Co-ordination with other regulatory and supervisory authorities The surveyed countries reported various levels and arrangements for cooperation, co-ordination and information sharing, as shown in Table II.3. In both specialized and integrated model countries, the procedures vary from informal arrangements and regular meetings to legal provisions establishing obligations to agencies. Agreements or memorandums of understanding are also important as are flexible instruments to promote exchanges and co-operation. The participation of other agencies’ representatives in the governance structure of the supervisory agency, e.g. in Australia, Germany, Iceland and Poland, is the most complex instance of institutional co-ordination. Table II.3. Co-Ordination, Co-operation and Information Sharing Mechanisms between Supervisory Agencies in Selected OECD Countries
Australia
Canada
Czech Republic
Memorandums of Understanding with ASIC, Commonwealth Treasury, Reserve Bank of Australia (RBA – Australia’s central bank, ATO, Motor Accidents Authority of NSW (MAA), Private Health Insurance Administration Council (PHIAC) and ACCC. Regular liaison meetings. Legal mandate for information sharing procedures. Governance structure includes members from other agencies. No explicit formal co-ordination/co-operation arrangements. There is a legislated committee (Financial Institutions Supervisory Committee - FISC) made up of senior representatives of federal financial regulatory agencies with a mandate to share information in respect of financial institutions Co-operation and sharing information agreement between Securities Commission and the Czech National Bank. Sharing information agreement between the Ministry of Finance, Securities Commission and the Czech National Bank.
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Germany
Hungary
Iceland
Ireland Italy
Japan
Mexico
Netherlands New Zealand Norway
Poland
Portugal Spain
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No explicit formal co-ordination/co-operation arrangements. Legal mandate for information sharing procedures. BaFin’s governance structure includes members from other agencies. Co-ordination and co-operation agreements between the HFSA and The National Tax Authority; Hungarian National Bank; Directorate of Consumer Protection; National Health Insurance Fund; Central Administration of National Pension Insurance. No explicit formal co-ordination/co-operation arrangements. Regular consultative meetings. Legal mandate for information sharing between Central Bank and FME. FME’s governance structure includes members from Central Bank. No explicit formal co-ordination/co-operation arrangements. Legal mandate for information sharing with other agencies. Legal provision for cooperation and sharing information between authorities according to their respective tasks in order to strengthen the supervisory activity and to avoid duplications. In particular, COVIP and ISVAP cooperate in the analysis of the contracts arranged by pension funds with insurance companies for the payment of annuities and the coverage of biometric risks. No explicit formal co-ordination/co-operation and information sharing arrangements, but the rules of each supervisory agency are clearly divided. No explicit formal co-ordination/co-operation arrangements. Sharing information in regular meetings official gazette and annual report. Council of Financial Supervisors co-ordinate the co-operation and sharing information on the No explicit formal co-ordination/co-operation arrangements. Information is treated as public documents. The FSA has no explicit formal co–ordination/co–operation arrangements with other domestic supervisory agencies, but there are regular meetings with the Ministry of Finance, the Competition Authority, and the Central Bank and (to some extent) the consumer protection authorities and the central tax authorities. Moreover, there is a general Memorandum of Understanding (MoU) between the Central Bank and the FSA. KNUiFE ’s governance structure includes members from other agencies. Legal mandate for sharing information between KNUiFE, National Bank of Poland, Securities and Exchange Commission. National Council of Financial Supervisors (CNSF - Conselho Nacional dos Supervisores Financeiros) Legal mandate for co-ordination, co-operation and information sharing arrangements.
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Sweden
Turkey
UK
Legal provisions on exchange of views with other authorities on matters decided by a county administrative board that may affect the operations of the other authority. In the case of the Finansinspektionen, there are also provisions regarding exchange of views with the Central Bank in case of systemic or other crises. Legal mandate for co-ordination, co-operation and information sharing between the Undersecretariat of Treasury and the Capital Markets Board and. Banking Regulation and Supervision Agency (BRSA) Memorandum of understandings and direct co-operation between OPRA, FSA, Revenue and Pension Ombudsman. Legal mandate for information sharing.
Source: Replies to the OECD Secretariat questionnaire.
Australia is a good example in terms of issuing co-operation, co-ordination and information sharing statements. The Memorandums of Understanding signed by various government agencies announces information-sharing activities amongst the various bodies and the division of supervisory activities. This reduces duplication and compliance costs for the industry as well as achieves effective enforcement and compliance outcomes for the industry and the agencies involved. There is a legal obligation for information sharing, and regular liaison meetings are held between APRA and other financial supervisory and industry bodies. Furthermore, APRA’s Board includes ex officio members from other supervisory authorities. Canada is an interesting case of federative co-ordination. In the absence of formal explicit national arrangements, provincial and federal supervisors have organised an inter-jurisdictional association of pension supervisory authorities — the Canadian Association of Pension Supervisory Authorities (CAPSA). It discusses pension regulatory issues of common interest and develops policies aimed at simplifying and harmonizing pension laws in the country. Although there are no formal co-ordination/co-operation arrangements between supervisory agencies, there are regular consultative meetings among federal supervisory agencies, and there is co-operation and information sharing among federal and provincial regulators through CAPSA. In addition, under the legislation, the Minister may enter into agreements with the appropriate authority of a designated province respecting the administration, application and enforcement of pension legislation, and the establishment and operation in Canada of an association of pension supervisory authorities. In the Netherlands, the Council of Financial Supervisors coordinates the actions of PVK, Dutch Central Bank and the Netherlands Authority for Financial Markets. The mission of this council is to coordinate the creation and implementation of consistent rules, regulations and policies in cross-sector areas
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of financial supervision — areas such as integrity supervision, consumer affairs and financial conglomerates. In Portugal, the National Council of Financial Supervisors (Conselho Nacional dos Supervisores Financeiros (CNSF) institutionalizes and organizes co-operation between the three financial supervision authority representatives: ISP, the Bank of Portugal (banking supervisor, and Securities Market Commission), – and the Securities Market Commission (Comissão do Mercado dos Valores Mobiliários, CMVM ), which is the securities supervisor). The aim of this body is to allow better communication of relevant information that will permit the coordination of future action and the elimination of conflicts of authority, lacunae in regulations and multiple uses of own funds. Additionally, it is important to mention the efforts to internationalise cooperation, co-ordination and information sharing between agencies from different countries, and strengthening the national capacity to supervise international financial conglomerates. For example, the Scandinavian countries’ financial service agencies have agreements to conduct supervision of financial companies operating in their territories. Regulatory responsibilities of pension supervisors In most countries surveyed (Czech Republic, Germany, Hungary, Iceland, Italy, Japan, Mexico, the Netherlands, New Zealand, Poland, Portugal, Spain, Turkey and the United Kingdom), the main regulator is the relevant ministry (generally the ministry of finance or of social affairs). The only exceptions are the integrated agencies in Canada and Denmark and the specialised Irish agency, which are primarily both supervisors and regulators of the private pension system. In some countries, although the main regulatory power is assigned to the ministries, supervisory agencies hold complementary and supplementary responsibilities on regulations. In Italy, the legislation entrusts the regulatory powers to COVIP, the Ministry of Labour and the Ministry of the Economy. COVIP regulates: accounting procedures and balance sheet schemes; disclosure and transparency; benchmark in the investment performance evaluation; criteria for selecting and appointment of asset managers by contractual pension funds. It also participates in the establishment of standard contracts for asset management and for the relationship between pension funds and insurance companies for the provision of annuities and biometric risks coverage. Finally, it may issue guidelines on all aspects related to the conduct of pension funds. The Portuguese ISP is also responsible for enacting subsidiary regulations and
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often presents proposals to the Minister of Finance, which holds the primary regulatory responsibility. In Iceland, the Financial Markets Authority (FME) is endowed with regulatory capacities and it is authorised to issue general directive requests regarding the activities of the parties subject to supervision. The Swedish FI has delegated powers (provided by law or decree) to issue regulations aimed at covering technical details and guidelines. In Australia, APRA is considered to be the main regulator of the superannuation system, despite its not having direct responsibility for supervisory legislation. This function rests with the Federal Department of Treasury. APRA both regulates entities in the superannuation sector and develops the administrative practices and procedures to be applied in performing that regulatory role. This includes the development of regulatory and supervisory policies and relevant prudential standards. Consequently, APRA is perceived by the Australian financial sector as both a supervisory and a regulatory body. Similarly, the Government Actuary in New Zealand has statutory powers to regulate the superannuation scheme. Germany, Hungary, Mexico, Poland and the UK reported quite limited regulatory powers. In the case of Hungary, when asked if the supervisory authority is satisfied that its powers are adequate in enabling it to fulfill its statutory responsibilities, the HFSA declared that it “would like to have the authority to write and develop decrees”. The Dutch PVK applies existing regulation but has its own powers in the form of Regulations, Policy Rules and Recommendations. In Norway, the Ministry of Finance is the main regulator of pension funds. In general, all regulations regarding (the activities of) pension funds are issued by the Ministry. The FSA has only limited regulatory powers. For example, it can issue supplementary regulations regarding pension funds’ asset management. In the Czech Republic, Japan, Spain and Turkey, however, the relevant ministry (the main regulator) is also the main supervisor. In general, the main regulator should be consulted or involved in important supervisory initiatives. In most of the surveyed countries (Canada, Denmark, Germany, Hungary, Iceland, Ireland, Italy, Mexico, New Zealand, Spain, Sweden, Turkey, United Kingdom, United States) the supervisory agencies, whether independent or not, are generally accountable to (or supervised by) the relevant governmental ministry. Ministers are also frequently responsible for the designation of members of the supervisory board. If main regulatory and supervisory functions are generally performed by different institutions in OECD countries, it is clear that they are interrelated, each category being to some extent involved in the work of another.
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Private pension fund supervision and market structure The private pension market structure and the resources available for supervision vary widely. The supervisory costs are related to a large extent to the regulatory and supervisory approaches, as well as to the characteristics of the pension system. Given the pension scheme’s particularities and the institutional diversity, it is difficult to compare accurately the agencies’ performance indicators. For example,, the survey shows the cases of Mexico, where 170 employees are in charge of 11 pension funds, and New Zealand, where 808 funds are overseen by three persons (Table 3). This discrepancy is explained mainly by the differences in the regulatory and supervisory approaches. Mexico adopts quantitative regulations with pro-active supervision. The pro-active model is a labor-intensive and more expensive approach. It requires a frequent activities overview, involving high administrative costs on reporting, recording, monitoring, disclosure and evaluation. In this model, the administrative costs are sensitive to the number of participants. As the Mexican pension scheme is mandatory for all private workers, the system covers some 29.4 million participants, the second largest number of participants in all of the surveyed countries. New Zealand implemented a prudential self-supervision approach. The Government Actuary runs the registration regime and the pension funds trustees hold the responsibility for nearly all of the supervisory functions, assuring compliance with government rules, regularity of payment, membership and portability, benefits eligibility conditions and access to plans investments, asset allocation, performance, minimum capital and reserves and custodian procedure, administrative cost, fees and marketing, merger and liquidation process. The entire supervisory structure was built under the principles of trustees’ freedom of action, responsibility and transparency. Trustees are required to act in the best interests of the scheme members and beneficiaries at all times, in accordance with the trust deed and general law. Nonetheless, a recent report indicates that too much flexibility could cause problems for beneficiaries, and more regulation and standardization would be required on the funding adequacy of the defined benefit schemes, actuarial valuation assumptions and disclosure.
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Table II.4. Supervisory agencies’ resources and size of the market (2001/2002) Country
Number of Employees
Number of plans/funds
Participants (thousands)
Assets (¼ELOOLRQ
-
249 262 funds/plans
24 800
281.5
OSFI - PPPD (Canada) (2)
20
1 195 plans
557
56.1
OSIPF/MF (Czech Republic) (3)
20
14 funds
2 473
1.7
FSA (Denmark) (3)
15
80 funds
720
32.2
BaFin (Germany) (4)
29
156 funds
3 402
70.7
HFSA (Hungary) (5)
-
100 funds
3 407
3.2
FME (Iceland)(6)
APRA (Australia) (1)
7
82 funds
228
7.7
Pension Board (Ireland)
34
99 987plan s
630
44.0
COVIP (Italy)(7)
60
534 funds
1 907
27.7
Pension Bureau (Japan) (6)
30
1 807 funds/plans
14 116
692.6
CONSAR (Mexico)
170
11 funds
29 421
40.8
Government Actuary (New Zealand)
3
808 funds
701
5.1
FSA (Norway) (2)
80
140 funds
264
11.6
KNUIFE (Poland) (3)
208
14.4
ISP (Portugal) (3) DGSFP (Spain) OPRA (UK)
17 funds
11 060
412 funds
323
29
917 funds
6 448
49.3
260
103 588 plans
40 000
1 050.0
61
0.4
(1) APRA has 472 employees for all financial sector supervision. (2) Employment information refers to pension fund supervision. Plans, participants and assets information refers to federal plans. (3) Employment information refers to insurance and pension funds supervision. (4) Employment information refers to pension fund supervision. (5) HFSA has 541 employees for all financial sector supervision. (6) Employment information refers to pension fund supervision. In addition to Pension Bureau, 8 Regional Bureaus of health and welfare are in charge of supervision of pension funds in each region. (7) Information on assets, funds/plans and participants refers to those funds/plans supervised by COVIP. Source: Replies to the OECD Secretariat questionnaire DAFFE/AS/PEN/WD (2002)26 and OECD database.
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Risk-based prudential supervision is the only way to deal with a large number of small funds as is the case in Australia, Canada, Ireland and the UK. In Australia, 246 670 funds (99% of the total) have less than five members and supervision is primarily conducted by the tax authority, although there is an ongoing initiative to increase APRA’s supervisory capacity over small pension arrangements. Supervisory structures and methods: integration of on-site and off-site supervision Countries with a single supervisory agency for all financial sectors reported more integration with regard to off-site and on-site supervisory procedures. Australia, Canada, Denmark, Germany have fully integrated both types of supervision. In Italy, Mexico, Spain and UK, where the supervisory agencies are partially integrated or specialized, there are different departments dealing with this the permanent exchange of information and with staff. In Ireland, Japan and New Zealand, there is no regular on-site supervision, but this could change should the need arise. Czech Republic is the only country with a partially integrated agency that reports having completely integrated on and offsite supervision. In Poland, the Inspection Department, linked to the Office of the Insurance and Pension Funds Supervisory Commission, performs on-site inspection of both insurance companies and pension funds. The Investments Department and the Supervisory Department pursues off-site supervision over both insurance companies and pension funds. There is no formal integration of on-site and offsite supervision but these same departments cooperate closely. Moreover, the internal structure of the Office changed in January 2004, with separate departments for life insurance companies, non-life insurance companies, and for mandatory pension funds and voluntary pension plans. These departments will perform both on-site and off-site supervision. Each institution supervised by APRA has a dedicated person who is responsible for choosing the most appropriate supervision strategy and building a strong working knowledge of the institution they oversee. The supervision strategy for each institution is designed to project the intensity of supervision required to attend to the issues identified by the risk assessment processes. How long such supervision lasts will vary according to the institution’s overall risk profile. In addition to on-site and off-site reviews, APRA’s supervisors liaise with external parties that have detailed knowledge of individual institutions, such as external auditors, actuaries and administrators. Supervisory actions are directly linked to specific areas of concern or areas that require further scrutiny, and which have been identified by APRA’s risk assessment processes. This 40
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framework promotes a more precise concentration of resources on those institutions that exhibit greater risk and subsequently require more intensive supervision. In Hungary, participants involved in on-site and off-site supervision are divided into departments. The Inspection Department conduct the off-site inspections, continuously examining documentation and other relevant information provided by the funds. The on-site inspections are conducted by the Supervisory Department for Pension Funds. The integration of the on-site and off-site inspections is wide. The information gathered during off-site inspections is used while planning the on-site inspections. Most staff members are involved in both types of supervision. Integration of on-site and off-site supervision is rather straightforward as information flows easily between the two. In Norway, the responsibilities for on–site and off–site supervision are allocated to separate sections within the FSA’s Finance and Insurance Department. However, the supervisory activities are integrated and, in general, persons from two or three sections participate in the on–site inspections. This is the case especially for on–site supervision of pension funds. COVIP conducts annual programs of on-site examinations defined by both the inspection unit and the supervisory units, indicating types and number of inspections to be conducted. Besides the annual plan, on-site inspections may be urgently set up as a result of information collected during ordinary off-site supervisory activity. On-site exams may be general or focused on specific aspects. They are prepared by a thorough off–site analysis of the information and documentation available in order to minimize the costs and length of the on-site inspections. They are ordinarily executed by specialized staff together with staff of the supervisory unit that is responsible for the monitoring of the fund to be inspected. Organization of the Supervisory Agency In order to protect the interest of the members and safeguard the long-term stability of the system, supervisory agencies must be properly staffed and financed, insulated from political pressures exercised by the government or the pension industry, and endowed with reasonable enforcement capacities. This section analyses the degree of financial, political and operative independence of the supervisory agency as well as the mechanisms used to avoid principal-agent problems.
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There are many types of supervisory agencies and their characteristics vary widely. They differ in size, function, rationale for creation, funding, legal and organisational status, internal governance structure, accountability mechanisms and reporting. Legal status The majority of OECD countries’ supervisory authorities are autonomous bodies, created and regulated by law and that provide institutional stability. According to the features of the national administrative legislation, they can be non-departmental public bodies, such as the United Kingdom’s Occupational Pension Regulatory Authority (OPRA), institutes, superintendence, agencies, commissions or boards. They are created as isolated institutional structures with complete or partial legal identity. Dependent structures, on the other hand, are vertically integrated into the Ministries as secretaries, departments or directorates linked to Central Banks, Ministries of Finance, Labour, Social Security, Social Affairs or other ministries. This is the case of the Czech Department of Insurance and Pension Funds under the Ministry of Finance and the Pension Bureau of the Japanese Ministry of Health, Labour and Welfare. Only five countries have formally dependent supervisory structures: Czech Republic, New Zealand, Japan, Spain and Turkey. The formally independent agencies have a different governance structure, a distinct control environment and some management autonomy. In OECD countries, they have been created to improve efficiency and effectiveness of government entities focusing on client needs. These agencies may have more policy independence and continuity, incorporating the private sector and civil society in the decision making process. In Australia, APRA is a statutory authority with the legal status of a corporate body with perpetual succession that has relative autonomy from the Commonwealth Government. APRA is the unique agency that is ultimately accountable directly to the Parliament and to regulated industries. APRA regularly consults with industry regarding its prudential supervisory approach and levying structure, however it is not strictly accountable to these industry groups and entities. APRA is accountable to the Commonwealth Parliament via the following means: (i)Regular appearances before parliamentary committees, Senate estimates hearings and an annual review by the House of Representatives Committee on Economics, Finance and Public Administration; (ii) Annual financial and performance audits conducted by the Australian National Audit Office; and (iii) tabling of an annual report in the federal Parliament.
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Table II.5. Legal Status and Accountability of Selected OECD Supervisory Agencies Legal Status
Accountable to:
APRA (Australia)
Statutory authority formally independent
Commonwealth Parliament and supervised industries
OSFI (Canada)
Office of the Government of Canada formally independent
Ministry of Finance
OSIPF
Body formally dependent
Ministry of Finance
FSA (Denmark)
Government body formally independent
Minister for Economic Affairs
BaFin (Germany)
Federal institution formally independent
Ministry of Finance
HFSA (Hungary)
Legal entity formally independent
Parliament
FME (Iceland)
State authority formally independent
Minister of Commerce
PENSION BOARD (Ireland)
Statutory Body formally independent
Ministry for Social and Family Affairs
COVIP (Italy)
Autonomous public institution formally independent
Ministry of Labour and the Ministry of the Economy
PENSION BUREAU (Japan)
Public body formally dependent
Ministry of Health, Labour and Welfare
CONSAR (Mexico)
Public entity formally independent
Ministry of Finance
PVK (Netherlands)
Independent governmental agency
Ministry of Finance and Ministry of Social Affairs and Employment
Gov. Actuary / ISU (New Zealand)
Public body formally dependent
Ministry of Economic Development.
FSA (Norway)
Government agency formally independent
Ministry of Finance
KNUiFE (Poland)
Public entity formally independent
Council of Ministers
ISP (Portugal)
Public body formally independent
Ministry of Finance
DGSFP (Spain)
Public body formally dependent
Ministry of Economy
FI (Sweden)
Government agency formally independent
Government
UT (Turkey)
Public body formally dependent
Ministry of State
OPRA (UK)
Non Departmental Public Body formally independent
Prime Minister
(Czech Republic)
Source: Replies to the OECD Secretariat questionnaire.
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The German BaFin operates within the ambit of the Ministry of Finance as a legal body which is functionally and organisationally separate from the Ministry in its decision-making and the exercising of its functions and powers. BaFin’s independence and accountability is addressed in its enabling legislation. The Ministry of Finance exercises supervisory control via an Administrative Council and is required to ensure that BaFin executes its tasks according to the law and in an effective and adequate way. For this purpose, in exceptional cases, the Ministry may give instructions to the agency. Regularly, BaFin consults the Ministry regarding new regulations, guidelines or other fundamental policy matters. However, the independent legal status of the supervisory agency is neither a necessary nor a sufficient condition to guarantee its institutional insulation and autonomous operation. There are several institutional mechanisms that can be used to avoid or, at least minimise, external interference — both from the government and from the pension industry — in the control of compliance with regulations. These mechanisms are related to the financing of the agency, human resource policy, criteria to nominate and remove directors, mandate, constraints to the movement of the workforce from the government to the market and vice versa, disclosure and enforcement capacity. Financing In the majority of surveyed countries, supervisory agencies are financed exclusively by levies charged to supervised entities. This is the case of some formally independent agencies as APRA (Australia), OSFI (Canada), HFSA (Hungary) and ISP (Portugal). There are also many countries with mixed arrangements combining general budget and fees paid by private sector as CONSAR (Mexico) and OPRA (UK). Formally, dependent public bodies are always funded by the general budget. COVIP is the only case of a formally independent agency that depends exclusively on the government transfers, but they plan in the near future to activate a contribution from the pension industry. The Italian Delegation reported that “a levy on pension funds is needed because public funds are not sufficient to carry out effectively the required tasks”. In Sweden, both FI and county administrative boards are financed indirectly by the private sector because levies on supervised entities are part of the general revenue and the supervisory agencies receive resources from the general budget. Public budgets are political allocations of resources made under fiscal constraints. Sometimes this process can limit the ability of the supervisory agency to remain up to date technologically and professionally with developments in the private pension market. A market-oriented approach to the
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financing of the supervision is likely to be more effective in guaranteeing resources for the agency and avoiding political pressure from the government. Moreover, the private pension fund supervision is a service often provided to high-income groups. Under these circumstances, the general budget financing would appear as a perverse cross-subsidy transfer imposed on all taxpayers. According to basic principles in public finance, those who benefit should be the ones who pay the taxes. Therefore, the direct or indirect participation of the pension industry covering the expenses of the supervisory activities could be identified as a good practice.
Table II.6. Financing the Supervisory Agency General Budget
Mixed (Government and Supervised Entities)
Supervised Entities
Czech Republic Italy Japan Spain Turkey
Mexico New Zealand Sweden United Kingdom
Australia Canada Denmark Germany Hungary Iceland Ireland Netherlands Poland Portugal Norway
Source: Replies to the OECD Secretariat questionnaire.
When the financing is exclusively based on private fees, however, there is a “captured agency” risk. Supervised entities affected by agencies’ decisions and policies could influence the budgetary process bargaining which shapes supervisory procedures and policies primarily to their benefit at the expense of the participants or government. In order to avoid the supervisory “capture” it is important to have a well defined budget implementation process so as to avoid interference by the pension industry in the supervisory activities, conflicts of interests, and to ensure that their independence is not compromised by any funding arrangements. In Australia, levies imposed on institutions regulated by APRA are determined through a consultative process between APRA, ASIC, ATO, industry and the Commonwealth Treasurer, although the latter ultimately
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determines the fees. Levies are spread across all the supervised industries — banks, credit unions, building societies, general insurance, reinsurance, life insurance, friendly societies, and superannuation funds, and are paid into the Commonwealth Consolidated Revenue Fund. The overall budget for APRA is determined by its Board in consultation with the Commonwealth Treasurer and takes into account the resources required to conduct effective supervision for the forthcoming year for each industry under supervision. In Hungary, the HFSA supervisory fee is calculated out of the payments of the members and employers’ contributions and is regulated by law. The HFSA budget is determined by the budgetary law and submitted to Parliament. The frame numbers are calculated by the HFSA, according to the documentation accepted by the Government, relating to the planning of the central budgetary system. In Canada, OSFI is financed by a levy on plans based on the number of plan members, with a set minimum and maximum amount payable annually. In Poland, the financial annual plan of the supervisory body is included in the state budget, but the cost is completely covered by the entities supervised. The Portuguese ISP is financed by fees charged on the undertakings subject to its supervision. The agency is also financed by incomes from the sale of assets and from services provided, as well as from rights over the former, by returns on assets and income from its activities, returns on financial investments, subsidies, donations or contributions from Portuguese or foreign entities, costs of proceedings for infringements and breaches of regulations and by any other income or return to which it is entitled under the law, under a contract, or in any other manner. In Norway, the costs of supervision are distributed among the various groups of financial institutions according to the extent of the supervision based on the size of the institution’s total assets at the beginning of the year. Nonetheless, the Ministry stipulates for each year a minimum and a maximum amount which can be levied on the individual institution in each group. Levying shall be carried out by FSA, but shall be approved by the Ministry.” Supervisees also finance the Dutch PVK through an apportionment system. Pension funds and insurance companies pay a statutory contribution according to size and the PVK budget requirements. Annually, PVK’s Governing Board, based on the Executive Board’s proposal, submits a budget for the approval of the Ministries of Finance and of Social Affairs and Employment. Criteria for nominate directors Besides the appropriate funding, the criteria used to nominate agency directors, establish their mandates and regulate the relationship between them
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and the private sector, are also issues relevant to the analysis of the institutional independence of the supervisory authority. In some countries, directors are nominated by political authorities and can be replaced without any restrictions. In other jurisdictions, the names of the directors have to be submitted to Parliament or to specific councils. They are required to have experience, an established reputation, a university degree and mandates that protect them from political pressure. Table II.7. Supervisory Agencies: Appointing Directors WHO APPOINTS?
LEGAL SPECIFIC REQUIREMENTS
MANDATE
Australia
Federal Treasurer
No
5 years
Canada
Governor in Council
No
7 years
Czech Rep.
Minister of Finance
No
No
Denmark
Prime Minister
No
No
Germany
President
No
No
Hungary
Parliament upon Prime Minister proposal
Yes – high academic qualification in relevant fields (political sciences, law, economics, state administration, finance and accounting) and at least five years of managerial (executive) working experience acquired in a financial organization or in public administration in the regulation or controlling of financial organizations, or equivalent working experience acquired abroad.
6 years
Iceland
Board
Yes – a university degree and extensive knowledge and experience in the financial market
4 years
Ireland
Board and Minister of Social Affairs
No
5 years
Italy
Government
Yes – members of the Board must be chosen among experts in the field and be of undisputed integrity and independence
4 years
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WHO APPOINTS?
LEGAL SPECIFIC REQUIREMENTS
MANDATE
Japan
Minister of Health, Labour and Welfare
No
No
Netherlands
Royal decree upon Minister of Finance and Minister of Social Affairs and Employment proposal
Yes – members of the Boards should be independent, have confidence of the supervised institutions and have outstanding ability in the field of finance, management and socioeconomics.
6 years for Governing Board and 5 years for Executive Board
Mexico
Ministry of Finance
Yes – have renowned experience in economics, finance, law or social security. Have no money or family links with the shareholders, the first or second-tier employees of the industry participants subject to CONSAR’s supervision. Must have never been prohibited to trade or work in the Mexican financial system or in the government and be recognized as a highly ethical person.
No
New Zealand
Ministry of Economic Development
Yes – must be an actuary.
No
Norway
Formally the King in Council, but in practice the Ministry of Finance
No
6 years (renewable for more 6 years)
Poland
Prime Minister
Yes – minimum four years experience in financial, insurance or banking sector of industry and proper educational background as a mathematician, lawyer or economist. It refers only to the Chairman of the Commission (KNUiFE). The other members of the Commission are representatives of public bodies (Minister of Finance, Minister of Social Affairs, Securities and Exchange Commission, Office for Protection of Competition and Consumers).
5 years
Portugal
Council of Ministers
Yes – recognized ability, independence and competence.
5 years
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WHO APPOINTS?
LEGAL SPECIFIC REQUIREMENTS
MANDATE
Spain
Ministry of Economy
Yes – public servant with high qualification
No
Sweden
Swedish Government
No
6 years
Turkey
Prime Minister
Yes – public servant with minimum 12 years
No
UK
Board
No
No
Source: Replies to the OECD Secretariat questionnaire.
In Australia, Canada, Ireland, Iceland, Italy, Hungary, Netherlands, Portugal, Poland and Sweden, the supervisory agencies’ heads have mandates ranging from four to seven years. Mandates are important institutional tools to avoid political interference and instability in the agencies and assure policy continuity. The appointment can be terminated during the mandate, generally for reasons as set out in the regulations; these include misbehaviour, incapacity, corruption and conflicts of interests. In Germany, the mandate is not defined in legislation, but since the nominated persons are political civil servants, a removal from office is possible only within the narrow restrictions of sections. Normally, the head retires on grounds of age. Removal because of disciplinary proceedings is also possible. In other countries, the decision concerning the permanence of agencies’ directives falls within the discretionary powers of the high officials. In general, formally dependent agencies are more vulnerable to political instability. Human resources and procurement policies Supervisory agencies need the flexibility to operate human resources policy in order to be able to pay competitive salaries, in line with those paid by pension funds, or at least competitive with other agencies. It is fundamental that the agency is able to compete with pension fund managers for scarce human resources. Furthermore, it would be desirable to have some flexibility in the procurement procedures. This issue is related to the legal status of the supervisory body and to the type of work contract given to employees. Departments linked to Ministries are generally less independent than separated agencies.
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APRA is a case of complete autonomy regarding human resources policy and procurement procedures. The Board determines the terms and conditions of appointment, although this is subject to general public service guidelines. Private sector remuneration is constantly monitored to ensure that the authority’s remuneration is competitive. APRA has reached a remuneration level comparable with the general private and public sector and is currently addressing parity with the finance market. APRA is not required to follow the procurement guidelines of the Federal administration, but they are considered on a reference basis. Table II.8. Pension Fund Supervision Agencies in Selected OECD Countries: Human Resources and Procurement Policies Autonomy to define salaries
Autonomy to contract and fire staff
Autonomy on procurement procedures
Australia
Yes
Yes
Yes
Canada
Partial
Partial
No
Czech Republic
No
No
No
Denmark
Yes
Partial
No
Germany
Partial
Partial
No
Hungary
Partial
Partial
Partial
Iceland
No
No
No
Ireland
Partial
No
No
Italy
Partial
Partial
No
Japan
No
No
No
Mexico
Partial
No
No
New Zealand
No
No
No
Norway
Partial
Partial
Partial
Poland
Partial
Partial
Partial
Portugal
Yes
Yes
Yes
Spain
No
No
No
Sweden
Yes
Yes
Yes
Turkey
No
No
No
United Kingdom
Yes
No
No
Source: Replies to the OECD Secretariat questionnaire.
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The ISP (Portugal) also has total autonomy to manage human resources policy as long as it is in line with the budget approved by the Minister of Finance. Private sector workers’ rules are applied to the labour contracts and the agency is not required to follow the procurement procedures of the national administration. The FSA of Norway has the autonomy to define salaries (within limits set by the budget), and to contract and fire staff without prior approval from the Ministry of Finance. However, FSA employees are in legal terms “ordinary” state employees, and the FSA cannot take actions contradictory to acts and agreements of civil service. Italy, Mexico and Poland are examples of partial autonomy for human resources policy. In Italy, COVIP has autonomy to define policy concerning the level of salaries and the structure of careers for its employees. However, the level of salaries for the different qualifications is linked to other public authorities. In Mexico, the Ministry of Finance sets the level of salaries, but the career structure of the employees depends on each department of CONSAR. General rules concerning all civil servants apply to the supervisory authority on hiring, firing and salaries. In Poland, the Minister of Finance shall specify the rules of KNUiFE employees’ remuneration taking into consideration salary levels paid in the supervised institutions. Agencies with financial and human resources management autonomy are able to pay higher salaries compared to the private sector or, at least, they are able to offer similar or better employment term and conditions. It means that they have more capacity to recruit and retain qualified workers. Except in the case of Ireland, all autonomous agencies financed by levies on the supervised agencies reported relative good salary conditions compared to the private sector. Despite its autonomy, the Irish Pension Board is subject to the pay scales that operate within the public sector. In the last year, a benchmarking exercise has been completed in order to correct distortions. Although not specific to the Pension Board, it has recommended increases in the salary scales to ensure a level of parity with the private sector. The Italian COVIP, although formally independent is financed by the general budget. It also reported that the terms and conditions of employment currently offered are, in general, lower than those available to employees in the private sector. This agency has a certain degree of autonomy in defining the level of salaries and the structure of the careers of its employees. However, the level of salaries for the different qualifications is linked to other public services. In Canada, OSFI offers terms and conditions of employment similar to those of the Government, which, in some instances, are more generous than the private sector (e.g. vacation and other types of leave, maternity benefits, etc.). But,
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unlike private sector employers, public agencies are not in a position to offer any type of at-risk compensation plans (e.g. stock option or profit-sharing) that could have a significant impact on the direct compensation. In the Danish Financial Services Authority (Finanstilsynet), the level of remuneration is largely determined by collective agreements between the Ministry of Finance and the relevant trade unions of civil service employees. Finanstilsynet may design its own structure of careers for its employees, within the limits set by these agreements. Autonomy of human resources policy provides more flexibility and dynamism to design and implement training programs informing staff of new supervisory technologies and approaches. APRA has training programs reflecting a risk-based supervision approach. In Canada, OSFI conduct a training program oriented to encourage the use of the skills needed to implement a risk-focused approach to supervision; ensuring that supervisors receive the knowledge required to keep pace with recent and expected changes in the Financial Services Industry; integrated training program with on-the job responsibilities; and fostering an environment for self-directed learning. In Italy, there are regular training initiatives set up together with other supervisory authorities. However, most of the supervision skills are developed directly in the field as methods and procedures are still in the process of being established. Occasional staff movements from private to public sector, and vice versa, are desirable to exchange experiences and views between supervisor and supervised. It is necessary, however, to establish strict regulations on information disclosure and conflict of interests. These regulations are likely to be more effective than prohibitions. It is also interesting to have a mixed composition of staff, combining personnel from other agencies, from the private sector as well as public servants from the supervisory field. In Australia, there are no restrictions on movement into the superannuation industry. However, there are provisions on confidential information disclosure. Ninety per cent of employees leaving APRA join the private financial sector. Thirty per cent of APRA’s staff was previously employed by its organizations which preceded it, including the Insurance and Superannuation Commission. The remainder of the staff is drawn from within the finance sector (e.g. banking, superannuation, insurance), accountants, graduates and other government agencies such as ASIC and the ATO.
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Table II.9. Staff of Supervisory Agencies: Private Sector X Public Sector Terms of employment: public x private sector
Restrictions for movements from public to private sector
Frequency of movements from public to private sector
Australia
Similar
No restrictions, but penalties for inside information disclosure
Frequently
Canada
Agency
Yes – one year of prohibition to work in supervised entities
Occasionally
Czech Rep.
Private sector
No
Rarely
Denmark
Similar
No restrictions for movement, but penalty for inside information disclosure
Occasionally
Germany
Agency for middle management and private sector for high level
No
Occasionally
Hungary
Agency
No
Occasionally
Iceland
Similar
No
Never
Ireland
Private Sector
No
Rarely
Italy
Private Sector
No
Rarely
Mexico
Similar
No
Occasionally
NZ
Private Sector
No
Occasionally
Norway
Private Sector
No
Occasionally
Poland
Similar
Yes – one year of prohibition for the chief management to work in supervised entities
Occasionally
Portugal
Similar
No
Rarely
Spain
Private sector
No
Rarely
Sweden
Agency salaries are lower, but its terms of employment are often better
No
Rarely
Turkey
Private Sector
No
-
UK
Similar
No
Rarely
Source: Replies to the OECD Secretariat questionnaire.
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In Canada, former employees shall not, within a period of one year after leaving the office, accept an appointment to a Board of Directors of, or employment with, an entity with which they had official dealings during a period of one year immediately prior to their departure. They shall not make any representations for, or on behalf of, any other person or entity relative to OSFI. Occasionally, there are former supervisors employed by pension industry. The main source of recruitment for the pension supervisory group is the industry, with the exception of the policy role, which is often filled by public sector employees, and actuarial expertise, which comes from actuarial consulting firms and the insurance industry. In Italy, COVIP’s staff comes from other supervisory authorities (5%), government departments (50%) and the private sector (45%). BaFin operates under an open recruitment policy and the staff is mainly from the private sector. In the past, the main source of the HFSA’s staff was the public sector (other supervisory agencies, Ministry of Finance, government departments).Today, however, the number of staff coming from private sector is increasing. There is also a growing number of new entrants to the labour force who choose HFSA to be their first employer. This can be considered as a comparative advantage for entry afterwards into the private labor market. In Norway, the salaries are, for most professionals, higher in the private sector than in the public sector. This largely explains why movements from public to private sector are quite frequent (that is, occasional). There are no restrictions on such movements, but civil servants are legally obliged not to reveal inside information after having left office. Dispute settlement procedures Generally, in formally dependent agencies, superior authorities, such as Ministers or Vice-Ministers, have direct power to approve, revise, cancel, pursue or intervene in any act of the supervisory body linked to the ministry (Table II.9). In some formally independent agencies, such as OSFI (Canada) and BaFin (Germany), Ministers have the final authority on some matters related to public policy. For example, OSFI’s Superintendent is required to report to the Minister on the administration of statutes falling within OSFI’s jurisdiction. He is responsible for providing certain approvals and taking specified action under these statutes. In certain instances, ministerial approval or action is required when operating decisions have public policy implications. In BaFin, the Minister of Finance exercises his authority indirectly though the Administrative Council.
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Table II.10. Who Can Revise Agencies’ Decisions and Acts? Australia
Administrative Appeals Tribunal and Federal Court
Canada
Minister of Finance
Czech Republic
Court of Justice
Denmark
Court of Justice
Germany
Minister of Finance and Administrative Council
Hungary
Court of Justice
Iceland
Appeals Committee
Ireland
Court of Justice
Italy
Court of Justice
Japan
Minister of Health, Labour and Welfare
Mexico
Appeals Committee and Court of Justice
Netherlands
Court of Justice
New Zealand
Court of Justice
Norway
Ministry of Finance
Poland
Administrative Court
Portugal
Court of Justice
Spain
Court of Justice
Sweden
Administrative Court or Swedish Government (depending of the type of decision)
Turkey
Ministry of State
United Kingdom
Court of Justice
Source: Replies to the OECD Secretariat questionnaire.
APRA (Australia) has substantial powers for perform its functions. Although ultimately accountable to the federal government, APRA’s operations, including day-to-day supervision of superannuation entities, is largely independent from the government. In the event that the Commonwealth Government disagrees with APRA’s policies, the dispute may be settled by agreement with the Commonwealth Treasurer, and failing this, by order of the Commonwealth Governor-General. In certain circumstances, APRA may only act with the Treasurer’s written consent. Powers to grant financial assistance to funds also resides with the Treasurer. The legislature has the power to change the agencies’ procedures through amendments to the regulations and disallowance of associated regulations under which APRA operates, as well as
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those it administers. The Minister may also give directions on the performance or exercise of its functions or powers. In addition, certain decisions are defined as “reviewable decisions”. A person affected by a “reviewable” decision may request reconsideration of the decision. If APRA confirms or varies the decision upon receipt of such a request, the decision is reviewable by the Administrative Appeals Tribunal. Federal Courts may also review an administrative decision made by APRA. In Portugal, all supervisory powers are delegated by legislation to ISP and no superior authority can revise its procedures and decisions. The FME (Iceland) has considerable powers in its supervisory operations. Firstly, the FME decides which supervisory projects are executed in the pension fund market as well as which methods are used in the execution of these projects. Secondly, the FME has unlimited access to information, data and valuables from pension funds. Thirdly, the FME has various effective resources under its supervision, such as the permission to grant a certain time period to a pension fund in order to rectify a situation considered to be unsatisfactory, to call and direct a Board meeting of a pension fund, to subject a pension fund to daily fines if it does not respond to the demands, and to announce general directive requests. However, the Minister of Finance grants operating licenses for pension funds, confirms changes of pension funds statutes, and appoints a special supervisory party of a pension fund based on FME’s recommendations. Supervised parties may refer FME’s decisions regarding their rights and responsibilities to a special Appeals Committee. Rulings of the Appeals Committee are final at the administrative level and cannot be referred to the Minister of Commerce. The Mexican CONSAR has technical autonomy and executive faculties to take decisions regarding the participants of the pension system. Such is the case of an administrative intervention of a pension fund, a removal of license, etc. The agency must report to the Ministry of Finance about the decisions it takes in a timely fashion. In Italy, almost all supervisory powers are delegated to the supervisor authority that holds the responsibility for final approval of actions. In some cases (applications of sanctions and pension funds, compulsory winding-up, for example) the Ministry of Labour, according to COVIP’s recommendations, adopts the action. The agency is entrusted with reasonable capacities to fulfil its statutory responsibilities. However, sanctioning is now restricted to certain specific irregular behaviour and should be extended to a wider range of cases. Some ex ante authorizations could be overcome and more generous funding should be provided for.
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Governance boards In agencies with a high degree of financial, political and operational independence, it is important to design mechanisms to mitigate principal-agent problems. Institutional independence may incite the people who are placed in control over resources to use these resources to feather their own nests at the expense of those whose interests they are supposed to be serving. The most effective mechanisms implemented by the countries that have been surveyed are related to the establishment of boards, auditing and disclosure policies. As public institutions, pension supervisory agencies are submitted to external auditing. In all of the surveyed countries, the national audit offices periodically review the financial statements. Additionally, parliaments may require further examination. The majority of the surveyed countries are governed, advised or supervised by boards (Box 9). These boards include high-level authorities, officials from other agencies, representatives of members and supervised entities and from Legislative and Judiciary Branches. They are important institutional locus for external surveillance of the agencies’ activities and performance, co-ordination with other government areas, social control and priorities setting. The agencies without boards are those formally dependent on the ministries, excepting Canada, and are governed by single directors. Some agencies adopt governing boards with extensive strategic decisionmaking power on the development of policies, requesting and providing information, ensuring commitment to core values and compliance with legal and financial requirements. They may even appoint the agencies’ directors. Frequently, ministers are responsible for designating board members. There are also administrative boards involved directly in the agency’s management and advisory boards that do not have any decision-making power. In Australia, following the introduction of the Australian Prudential Regulation Authority Amendment Act 2003, APRA has between three and five executive members who oversee the operation of APRA and who are appointed by the Governor-General on the advice of the federal Treasurer. The new regulations changed the composition of APRA’s board, which used to comprise nine members, with representatives from the private sector, RBA and ASIC. In Denmark, the Minister for Economic Affairs sets up the Financial Business Council. It is comprised of eight members appointed for four years: a chairman; deputy chairman; a representative for Denmark National Bank; a consumer representative; a representative for commercial interests; a
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representative for the mortgage-credit institutions; a representative for Danish banks and a representative for insurance companies and pension funds. The Financial Business Council makes decisions regarding supervisory matters of general public importance or that entail significant consequences to financial undertakings and financial holding companies. It also advises the Danish Financial Supervisory Authority on issuing regulations and assists the Danish Financial Supervisory Authority on its disclosure activities. Table II.11. Governance of Supervisory Agencies Agencies oversighted by boards
Agencies without boards
Denmark
Australia
Germany
Czech Republic
Hungary
Canada
Iceland
Spain
Ireland
Japan
Italy
New Zealand
Mexico
Poland
Netherlands
Turkey
Norway Portugal Sweden UK Source: Replies to the OECD Secretariat questionnaire.
In Germany, the Administrative Council monitors the BaFin’s management and supports the execution of its duties. The President is obliged to keep the Administrative Council regularly informed of the conduct of his management activities. The Administrative Council consists of the Chairman and his Deputy, who is seconded by the Federal Ministry of Finance, and 19 representatives from public and private institutions. BaFin also possesses an Advisory Board comprising 24 members. In Hungary, the Supervisory Council is an advisory body with 15 members. The President of the HFSA chairs the sessions and appoints the council members based on consultations with the Minister of Finance for onethird of members and with the professional associations for two-thirds of members representing the supervised entities. The members of the council are 58
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professionals with outstanding theoretical knowledge and practical experience. The Supervisory Council comments on the issues related to HFSA’s strategic and regulatory role and development. The members are appointed for a period of three years. In Iceland, the FME has a Board of three members appointed by the Minister of Commerce for a term of four years. One board member is appointed on the recommendation of the Central Bank. The Minister appoints the Chairman of the Board and decides on the members’ remuneration. The Board should orient the focus of the Financial Supervisory Authority’s work and monitor its activities. Major decisions are presented to the Board for approval or rejection on a majority-voting basis. A special consultative committee composed of representatives from the supervised parties operates in conjunction with the FME. The committee is an arena for parties under supervision, including pension funds, to further their views on the procedures and operations of the supervisory agency. The consultative committee does not have decisionmaking power. The FME’s executives hold meetings with the consultative committee at least twice a year. In Ireland, there is a Representative Board of 17 members. While all its members are appointed by the Minister for Social and Family Affairs, the Board must be comprised of representatives nominated by trade unions, employers, the Government, industry and beneficiaries. Decisions tend to be taken on a consensus basis. In Italy, the COVIP’s Board includes the Chairman and four members. They are appointed by decree of the President of Italy, subject to the advice of the competent Parliamentary Commission, in accordance with the decision adopted by the Council of Ministers and with the designation made by the Ministry of Labour in agreement with the Ministry of the Economy. The decisions of the COVIP Board are taken by majority. The Dutch PVK has a Governing and an Executive Board composed of at least three members and five at the most. Each appointment is made for a period of five years. The Executive Board takes decisions by majority voting. There are no specific criteria of representation. In Mexico, there is an Administrative Council with representatives of other official authorities dealing with social security and the financial sector. In Poland, there is a board of members with a Chairman and two deputies. In Poland, according to the new Act on Insurance and Pension Supervision and the Ombudsman for the Insured, which came into force since 1 January 2004, the Commission shall be under the competence of the Ministry of Finance. In
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Sweden, the Finansinspektionen (FI) board consists of up to twelve members without any specific criteria of representation. The members are appointed by the Swedish Government. In the county administrative boards, the board consists of nine members under the same conditions as FSA. In Norway, the Board of the FSA is comprised of five members. In addition, the Central Bank is represented in Board meetings by an observer. The FSA Board members are appointed by the government (i.e. the Ministry of Finance) for a term of four years. The decisions of the Board are made by majority vote. In order to be able to make decisions at least three Board members have to present in the meeting. The rules of procedure have been established for the activities of the FSA’s Board. These rules (last revised in June 2003) comprise, inter alia, a detailed list of matters to be considered by the Board. In the UK, there is a board with a Chairman and nine other part time members broadly representative of employees, employers and sections of the pensions industry. The members are appointed by government Ministers. Decisions should be taken on majority basis, but usually they are taken by unanimity.
In Portugal, the ISP has a Consultative Committee and an Audit Committee. The Consultative Committee works on matters related to strategic guidelines and co-ordination with other agencies. The Audit Committee controls the financial management of the ISP. It analyses the budget, annual report and annual accounts. Both bodies may take decisions on a majority basis. Disclosure policies Supervisory agencies should work in a completely transparent environment, frequently reporting their main actions and activities, providing disclosure of information to members, enterprises and pension fund administrators. Agencies may disclose information to the general public on a regular basis. All surveyed countries produce annual reports regarding the agencies’ activity, statistics and analysis of the pension fund sector. This information is available on websites containing press releases, publications, penalties applied, lists of managers disqualified, guidance, and reports of board’s meetings. OSFI (Canada) prepares an annual report on its operations to the Minister, who should present it to each House of Parliament (House of Commons and Senate). Additionally, each year OSFI must present its Report on Plans and Priorities that provides increased levels of detail on a business line basis and 60
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contains information on objectives, initiatives and planned results, including links to related resource requirements over a three-year period. The report is tabled in Parliament by the President of the Treasury Board. OSFI also submits an annual report on the administration of the Pension Benefits Standards and the statistics regarding the total allocation of invested pension assets, the distribution of plan membership and assets by plan type, and the source of funds of federally registered plans. Finanstilsynet (Denmark) is required to submit a report on its activities once a year. The agency discloses notifications, technical assumptions, decisions, executive orders and directives to entities and recommendations made. BaFin (Germany) publishes an annual report, a monthly official bulletin containing legal and administrative principles, circulars, guidance notes, and other information transmitted directly to the entities. The Government Actuary (New Zealand) also prepares an annual report to Parliament, which is available on line and in paper form for interested parties. Statistics are available during the year for interested parties. In Sweden, FI and the county administrative board have to submit annual and semi-annual reports to the Swedish government. While observing confidentiality policies, the HFSA (Hungary) is entitled to disclose some of its resolutions in the Financial Gazette and on Internet. In the Financial Gazette, the HFSA regularly (quarterly and annually) discloses the list of entities holding operating licenses issued by the HFSA, as well as the list of foreign supervisory authorities with which the HFSA has concluded cooperation agreements based on mutual recognition. The agency also prepares annual and quarterly reports. The FME (Iceland) discloses an annual account as well as an annual report of its main activities in each financial sector. Once a year, representatives of parties undertaking supervision activities are invited to a meeting where the main activities as well as trends and outlooks in each market of the financial sector are recapitulated. The website contains news and press releases, descriptions of activities, information on consumer services, complaints committees for financial issues, reports and discussion papers. The agency publishes annual pension fund yearbook containing information from the annual accounts of pension funds and special report on pension funds investments for the respective year. The Norwegian FSA submits an annual report on its (supervisory) activities. The annual report contains separate chapters covering the individual supervised sectors. COVIP (Italy) statistical data are regularly collected by COVIP on a quarterly and yearly basis. For each fund, the information collected is mainly
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referred to in the following categories: members, contributions, NAV, performance of pension funds and portfolio managers, asset allocation, income and expenditures. COVIP produces an annual report describing the structure and the most important features of the private pension system, along with the regulatory and supervisory activity carried out during the previous year. In addition, the principal statistical information is made available quarterly on the website. ISP (Portugal) elaborates an annual report published in the Official Journal and also a quarterly review. Conclusion This survey reviewed the different types of institutional organisation of the private pension funds supervision in OECD countries. It argues that supervisory structures for pension funds are a function of the state political and administrative organisation (federalism, unitary, centralised, decentralised); characteristics the pension scheme (mandatory, voluntary, occupational, personal, DC or DB); market structure (number of funds/plans, type of fund/plans, market concentration degree) and regulatory and supervisory approach (qualitative, prudential, quantitative, self-supervision, re-active, proactive). Three private pensions supervisory structure models have been identified: (i) specialised pension model, with one or more agencies dedicated exclusively to pension fund supervision; (ii) partially integrated model, with one agency responsible for insurance and private pension supervision; and (iii) integrated model, with one institution responsible for the overall financial sector supervision, including banks, securities, insurance companies and pensions funds. In countries with integrated financial authorities (Austria, Germany, Hungary), the main arguments in favour of integration are related to the economies of scale and scope, authority overlapping, consistency between supervisory objectives in different sectors, efficiency and transparency of the information flow and institutional adjustment to the expansion of financial conglomerates. Nonetheless, there are countries with unified agencies for the financial sector and segregated agencies for occupational pension plans (Japan, Sweden and the UK). In addition, there are countries with integrated agencies and specialised functions (Australia) and countries where the power of the unified agency is limited by federalism (Canada). In countries with specialised agencies, the survey showed some institutional fragmentation with several agencies sharing the responsibility of the pension supervision according to the product and function (Italy, Mexico and the US). The main argument in favour of specialisation is the particularity of the private pension contracts with 62
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specific tax treatments and social aspects, which would require a different approach regarding the supervision of their assets, liabilities and risks. This seems to be the case as regards occupational schemes where employment relationships must be considered and where the employer frequently serves as an intermediary between the plan or fund members and the financial institution. This survey also showed that different specialized institutions can cooperate and co-ordinate their activities in order to achieve economies of scale, greater efficiency and eliminate overlapping duties as long as they are clearly defined. In this sense, both integrated and specialised models could achieve the same results in terms of efficiency and effectiveness. Despite the diversity and complexity of the national institutional structures, the first “good practice” raised in the discussion is that the private pension supervisory framework should be clearly designed. Each agency involved in the process should have a well-defined mission statement, objectives and responsibilities. Co-ordination, co-operation and information sharing arrangements should be encouraged in order to avoid authority overlapping, promote economies of scale and scope, and improve the overall information quality and availability. The survey also showed that supervisory agencies should be properly staffed and financed, insulated from political pressures coming from the government or the pension industry, and endowed with reasonable enforcement capacities. Several institutional features that could contribute to the design of the supervisory agency were also analysed. Preferably, institutions should possess operational independence, with autonomy and resources to conduct a human resources policy that can offer salaries (including benefit rights and other social packages) and terms of employment that are competitive to those in private sector. Moreover, supervised entities should participate in the financing of the supervisory agency though a transparent budgetary process. The heads of the agencies should be appointed for a pre-defined term. Situations which could lead to early termination should be specified in a transparent manner. Additionally, supervisors should be endowed with adequate powers and its decisions may be ultimately revoked only by them or by administrative and judicial courts. Regulations should address conflicts of interest situations and employment of former supervisors in the private sector should be protected against disclosure of confidential information and create mechanisms to avoid the capture of the agency.
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It is also important to design institutional mechanisms to avoid principal– agency risks. Supervisory agencies should be overseen by boards with representatives of all the sectors involved or affected by the supervisory process (government, entities, participants) and should frequently disclose their actions, as well as information on the private pension system.
NOTES
1.
In this text, the term “supervisory agency” is used in a broader sense to qualify the institution directly responsible for the supervision, including department, directorate, superintendence, secretariat, authority, nondepartmental body, commission and all other specific national legal denominations.
2.
These institutions are a kind of mutual benefit society offering insurance solutions similar to traditional life insurance.
3.
These institutions are pledges for employer’s pension commitment. Founded by employers their sole purpose is to safeguard pensions. The sponsor holds all responsibilities, including financial risks related to asset allocation and decisions on the amount and periodicity of the contributions.
4.
Rocha, R., Richard Hinz and Joaquim Gutierrez (1999), p.11.
5.
Lumpkin, S. (2002), pp. 84-85.
6.
Demarco, G. and R. Rofman, with E. Whitehouse (1998), pp. 3-4.
7.
See Lumpkin, S. (2002), pp. 85-92.
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BIBLIOGRAPHY
Chapman, Keith, (2002) “Supervision of Private Pensions – an Australian Perspective”, OECD Private Pension Series – Regulating Private Pensions Trends and Challenges, 2002. (OECD, Paris). Demarco, G. and Rofman, R with Whitehouse, E, (1998) “Supervising Mandatory Funded Systems: Issues and Challenges”, World Bank Social Protection Discussion Paper no. 9817, December 1998. (Washington). Laboul, André, (1998) “Private Pensions Systems: Regulatory Policies”, OECD Working Paper AWP 2.2. 1998. (OECD, Paris). Lumpkin, Stephen A, (2002) “Supervision of Financial Services in the OECD area”, OECD Financial Markets Trends, no. 81, April 2002. (OECD, Paris). Hungarian Financial Service Authority, (2002) “Hungarian Financial Service Authority Annual Report 2001”, May 2002. (Budapest). Iwry, J. Mark, (2002) “Regulation and Supervision of Private Pensions in the United States”, Paper prepared for the Second Conference on Private Pensions in Brazil, May 2002. (São Paulo). OECD, (2002) “Draft Methodology for the Assessment of the Observance of Basic Principles for Regulation of Private Occupational Pension Schemes”, Document presented to the Working Party on Private Pensions, July 2002. (OECD, Paris). OECD (2002), “Revised Taxonomy for Pension Plans, Pension Funds and Pension Entities”, Document presented to the Working Party on Private Pensions, July 2002. (OECD, Paris). OECD (2001), “Supervision on Private Pensions”, Document presented to the Working Party on Private Pensions, July 2001. (OECD, Paris). OECD (2000), “Comparative Regulation of Occupational Pension Plans”, Document presented to the Working Party on Private Pensions, June 2000. (OECD, Paris). OECD (2001), “Further Work on Supervision”, Document presented to the Working Party on Private Pensions, December 2001. (OECD, Paris). OECD (2001), “Functional Responsibilities of Private Pensions Regulatory and Supervisory Authorities in Authorities in OECD Countries”, Document presented to the Working Party on Private Pensions, June 2001. (OECD, Paris).
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Occupational Pensions Regulatory Authority – OPRA (2002), “Protecting Pensions”. Annual Report 2001/2002, March 2002. (London). Parniczky, Tibor (2002), “Structure of Supervision”, OECD Private Pension Series – Regulating Private Pensions Trends and Challenges, 2002. (OECD, Paris). Parniczky, Tibor (2001), “Supervision of Private Pension and the Hungarian Case Implementation of Private Pension Supervision”. OECD Private Pension Series – OECD Private Pensions Conference 2000, 2001. (OECD, Paris). Pelc, Pawel (2002), “Polish Model Supervision of Funds”, OECD Private Pension Series – Regulating Private Pensions Trends and Challenges, 2002). (OECD, Paris). Queisser, Monika (1998), “Réglementation et contrôle des caisses de pensions: les principles et la pratique”, AISS Revue Internationale de Sécurité Sociale, vol 21, 2/98. 1998. (AISS, Geneva). Rocha, Roberto, Hinz, Richard and Gutierrez, Joaquim (1999), “Improving Regulation and Supervision of Pension Funds: Are there Lessons from the Banking Sector?”, World Bank Social Protection Discussion Paper no. 9929, December 1999 (Washington). Servenay, Christian (2001), “Selected Supervisory and Regulatory Issues”. OECD Private Pension Series – OECD Private Pensions Conference 2000, 2001. (OECD, Paris). Srinivas, PS, Whitehouse, Edward and Yermo, Juan (2000), “Regulating private pension funds’ structure, performance and investments: cross-country evidence”, World Bank, July 2000. (Washington). USDOL - PWBA (2002), “2001 Annual Performance and Accountability Report”. USDOL-PWBA, February, 2002. (Washington). Yermo, Juan (2002), “Pension Fund Governance”, OECD Financial Markets Trends, no. 81, April 2002 (OECD, Paris). Villegas-Caballero, Carmen (2000), “Introduction to Institutional Investors in Latin America”. OECD Proceedings - Institutional Investors in Latin America, 2000. (OECD, Paris). Vittas, Dimitri (2002), “Policies to Promote Saving for Retirement: A Synthetic Oveview”. World Bank Social Protection Discussion Paper no. 9929, March 2002. (Washington).
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Annex II.1. Primary Supervisor For Pension Funds Supervised private pensions schemes Australia
Canada
(1)
Occupational and personal, both mandatory and voluntary plans (voluntary and compulsory superannuations funds) Occupational voluntary plans
Czech Republic
Personal voluntary plans
Denmark
Occupational mandatory plans and personal voluntary plans Occupational and personal voluntary plans Occupational and personal, both mandatory and voluntary plans
Germany
Hungary
Iceland
Occupational mandatory plans and personal voluntary plans
Pension funds supervisory agencies
Primary supervisor
Australian Prudential Regulation Authority (APRA) Australian Securities and Investment Commission (ASIC) Australian Tax Office (ATO) Office of the Superintendent of Financial Institutions (OSFI) Canada Customs and Revenue Agency (CCRA) Provincials Pensions Supervisory Authorities Ministry of Finance / Office of the State Supervision in Insurance and Pension Funds (MF/OSIPF), Securities Commission (SC), Depository Banks (DB) Ministry of Labour and Social Affairs (MLSA) Financial Supervisory Authority (FSA)
Australian Prudential Regulation Authority (APRA) for all superannuations funds
www.apra.gov.au
Office of the Superintendent of Financial Institutions (OSFI) for federal pension plans
www.osfi-bsif.gc.ca Provincials Pensions Supervisory Authorities for pension plans Ministry of Finance / Office of the State Supervision in Insurance and Pension Funds (MF/OSIPF)
Financial Supervisory Authority (FSA)
www.ftnet.dk Financial Supervisory Authority (BaFin)
Financial Supervisory Authority (BaFin)
www.bafin.de Ministry of Finance (MF) Hungarian Financial Supervisory Authority (HFSA) Tax Authority (TA) Ministry of Finance (MF) Financial Supervisory Authority (FME) Internal Revenue Directorate (IRD)
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Hungarian Financial Supervisory Authority (HFSA)
www.pszaf.hu Financial Supervisory Authority (FME)
www.fme.is
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Supervised private pensions schemes Ireland
Italy
Japan
Mexico
Occupational and personal voluntary plans
Occupational and personal voluntary plans
Occupational and personal voluntary plans
Personal mandatory and voluntary plans
Pension funds supervisory agencies Pension Board (PB) Revenues Commission (RC) Central Bank (CB) Department of Enterprise, Trade and Employment (DETE)
Pension Funds Supervision Commission (COVIP) Stock Market and Securities Commission (CONSOB) Bank of Italy ISVAP Ministry of Health, Labour and Welfare (MHLW) / Pension Bureau Financial Services Agency (FSA) Ministry of Finance (MF) National Commission for the Retirement Saving System (CONSAR) Mexican Institute of Social Security (IMSS)
Primary supervisor Pension Board (PB) for occupational pension plans
www.pensionsboard.i e Department of Enterprise, Trade and Employment (DETE) for personal pension plans Pension Funds Supervision Commission (COVIP) for occupational and personal
www.covip.it Ministry of Health, Labour and Welfare (MHLW) / Pension Bureau for occupational plans
www.mhlw.go.jp National Commission for the Retirement Saving System (CONSAR) for mandatory personal pension plans
www.consar.gob.mx
Netherlands
New Zealand
68
Occupational, voluntary plans (some industry-wide plans are mandatory) Personal, voluntary plans Occupational and personal voluntary plans
Pension and Insurance Supervisory Commission (PVK) Dutch Central Bank and the Netherlands Authority for Financial Markets Gov. Actuary at the Insurance and Superannuation Unit (ISU) of the Minister of Economic Development
Ministry of Finance (MF) for voluntary personal pension plans Pension and Insurance Supervisory Commission (PVK)
www.pvk.nl
Gov. Actuary at the Insurance and Superannuation Unit (ISU)
www.isu.govt.nz
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Norway
Poland
Supervised private pensions schemes
Pension funds supervisory agencies
Occupational and personal voluntary plans (Occupational plans are mandatory if a plan is established by his/her employer) Occupational voluntary plans and personal mandatory and voluntary plans
Financial Supervisory Authority – Kredittilsynet Ministry of Finance
Occupational and personal voluntary plans Occupational and personal voluntary plans
Portuguese Insurance Institute (ISP)
Primary supervisor Financial Supervisory Authority – Kredittilsynet
www.kredittilsynet.no
Commission of Insurance and Pension Fund Supervision (KNUiFE)
Commission of Insurance and Pension Fund Supervision (KNUiFE)
www.knuife.gov.pl Portugal
Spain
Portuguese Insurance Institute (ISP)
www.isp.pt General Directorate for Insurance and Private Pension Plans (DGSFP)
General Directorate for Insurance and Private Pension Plans (DGSFP)
www.dgsfp.mineco.e s/dgsfp Sweden
Occupational mandatory and personal voluntary plans
Finanasinspektionen (FI) County administrative boards
Turkey
Occupational and personal voluntary plans
UK
Occupational and personal, both mandatory and voluntary plans
Ministry of Finance (MF) Under-secretariat of Treasury (UT) Capital Markets Board (CMB) Occupational Pensions Regulatory Authority (OPRA) Financial Service Authority (FSA) Inland Revenue (IR)
Finanasinspektionen (FI) for friendly societies County administrative boards for pension foundations
www.fi.se Under-secretariat of Treasury (UT) Capital Markets Board (CMB) for pension mutual funds Occupational Pensions Regulatory Authority (OPRA)
www.opra.gov.uk
(1) In Canada, the OSFI is responsible for federal pension plans. Provinces have separate provincial agencies that are responsible for provincially regulated pension plans within their jurisdiction - Columbia Pension Standards Branch (www.labour.gov.bc.ca/psb/); Alberta Labour, Employment Pensions (www.tras.gov.ab.ca/business/pensions/); Saskatchewan Justice, Pension Benefits Branch (www.saskatchewan.gov.sk.ca/pensions/); Manitoba Pension Commission (www.gov.mb.ca/labour/pen/); Financial Services Commission of Ontario (www.ontarioinsurance.com); Régie de Rentes du Québec (www.rrq.gouv.qc.ca); New Brunswick, Office of the Superintendent of Pensions (www.gov.nb.ca); Nova Scotia Pension Regulation Division (www.gov.ns.ca/enla/pensions/) and Newfoundland /Labrador Insurance and Pensions Division (www.gov.nf.ca/gsf/cca/ip).
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Annex II.2. Questionnaire on Supervisory Structure For Private Pension Funds
1. Supervision of Private Pension Funds: Functions and Responsibilities 1.1. What bodies/agencies are involved in the supervision of private pension funds? 1.2. Which of these agencies is the primary supervisor? Does it differ by type of plan (occupational vs. personal, mandatory vs. voluntary)? 1.3. Please identify the institutional body responsible for the following functions related to the supervision of pension funds: a) Licensing/registration b) Qualification for tax benefits c) Compliance to governance rules d)
Contributions and regularity of payment
e) Membership and portability (enrolment process, transfers and compliance) f) Benefits eligibility conditions and access to plans g) Investments, asset allocation, performance, minimum capital and reserves h) Custodian procedures i)
Financial, actuarial and accounting methods
j)
Administrative cost, fees and marketing
k) Disclosure procedures referring to members and beneficiaries, potential members and accounts l)
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Merger and liquidation process
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1.4. Please describe any explicit co-ordination and co-operation arrangements between pension fund supervisors and other supervisory bodies, including those in charge of banking, insurance and securities supervision. 1.5. What provisions exist for the pension fund supervisory agency to share information with other parties (e.g. central bank, other supervisors)? 1.6. Does the primary pension supervisor have any regulatory authority? If yes, please describe? If not, what entity is the principal regulator? 1.7. Does the pensions supervisory body produce any statistics and/or research? If yes, what types of information and studies are produced and how are they made available? 1.8. What are the main problems and the main advantages of the supervisory framework? 1.9. Is there any on-going initiative to reform the supervisory framework? If yes, please describe it and provide the justification for the proposed changes. 1.10. Please provide available information concerning supervised entities for the year 2001: a) Number of participants (active workers, beneficiaries and dependents) of the supervised pension scheme b) Number of supervised pension funds or plans, by type c) Fund revenues of the supervised entities in domestic currency. d) Reserves of the supervised entities in domestic currency. 2. Political, Institutional and Operational Independence of the Supervisory Body 2.1. What is the legal status of the supervisory body? 2.2. Does the supervisory authority have a board that oversees the operation of the authority? If yes, what is the composition of the Board? (e.g. number of members, criteria of representation) How are the members appointed? How are decisions taken (unanimity, majority voting, qualified majority voting, etc.)?
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2.3. To whom or to what institution is the supervisory authority ultimately accountable to? What are the main means of reporting the authority’s activities? 2.4. How is the supervisory body financed? 2.5. Who determines the overall budget? 2.6. Is the pension industry required to contribute to the financing of the costs of supervision? 2.7. Do the funding arrangements limit the independence?
supervisory agency’s
2.8. Do the funding arrangements provide the supervisory body with sufficient resources? 2.9. How is the head of the supervisory body (and the other directors) appointed? 2.10. Are there any minimum professional requirements for the head of the supervisory body? 2.11. How is the head (and the other directors) of the supervisory body removed? 2.12. How long is the mandate of the head of the supervisory authority? 2.13. Are there any restrictions for the movement of professionals from the supervisory body into the pension industry? Is there a minimum period between the departure from the supervisory authority and subsequent hiring by the supervised entity or pension plan? 2.14. How often are pension fund supervisors employed within the pension industry once they leave their service as supervisors? (Never, rarely, occasionally or frequently?) 2.15. Does the supervisory authority have autonomy to manage the human resource policy concerning the level of salaries and the structure of careers for its employees? 2.16. How do the terms and conditions of the employment currently offered by the supervisory authority compare with those available to staff in the private sector?
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2.17. Is the supervisory body under to the same rules on hiring and firing employees applied to the federal administration? 2.18. Is the supervisory body under the same procurement procedures applied to the federal administration? 2.19. Which national authorities, if any, control and audit the activities of the supervisory body? 2.20. Does legislation delegate all supervisory powers to the supervisory body or does a superior authority retain final approval of certain actions (e.g. intervention in a pension fund, removal of license, etc)? 2.21. Can any superior administrative authority change the decisions and procedures of the supervisory body? 2.22. Please describe the disclosure policy of the supervisory authority (e.g. annual reports, releases, etc). 2.23. Is the supervisory authority satisfied that its powers are adequate in enabling it to fulfill its statutory responsibilities? 3. Organisational Structure and the Performance of the Supervisory Agency. (Please address the following questions to the primary supervisor. If the supervisory authority is not specialised, please address the following questions to the department of the authority that supervises pension funds) 3.1. How many directorates/departments/units in the supervisory authority are in charge of the supervision of pension funds and what are the main tasks of each one? Please provide the organizational chart of the agency. 3.2. What is the total number of staff employed by the supervisory authority? 3.3. In broad terms, what proportion of the staff is involved in: a) Front-line supervision activities (e.g. on-site and off-site supervision, licensing, enforcement, intervention and termination b) Supervisory support functions (e.g. statistics, studies, legal and economic analysis) c) Corporate services (e.g. administration, human resources, budget, etc) 3.4. How many actuaries are working in the supervisory body?
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3.5. How many lawyers are working in the supervisory body? 3.6. How is the integration of off-site and on-site supervision managed? 3.7. How much was the annual budget of the supervisory body for 2001? Please provide the information in domestic currency. 3.8. Is there any participation of pension fund industry’s representatives or members’ representatives in the supervisory structure? If so, how does it operate? 3.9. Does the supervisory agency have a stated mission statement and/or statement of values? 3.10. What has been the main source of supervisory staff? (e.g. other supervisory agencies; other government departments, private sector) 3.11. Does the agency have flexibility and capacity to establish its own corporate culture? What steps has the agency taken to promote it?
3.12. What training programs have been established to develop supervisory skills of the staff?
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OSFI
MF / OSIPF
FSA
BaFin
HFSA
MF
Canada
Czech Republic
Denmark
Germany
Hungary
Iceland
COVIP, BI, ISVAP, CONSOB
Italy
Automatic
TA
IRD
HFSA
TA
TA
MF / OSIPF
CCRA
ATO
b
COVIP
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
ATO
ASIC
c
na
PB
FME
IRD
HFSA
BaFin
FSA
MF / OSIPF
OSFI
ATO APRA
d
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PB
Ireland
FME
APRA
Australia
a
COVIP
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
ATO APRA
e
COVIP
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
ATO APRA
F
COVIP
Na
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
APRA
g
COVIP BI
Na
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
APRA
h
COVIP
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
APRA
i
COVIP CONSOB
CONSOB
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
ASIC
k
COVIP
Na
FME
HFSA
BaFin
FSA
MF / OSIPF
Plan Sponsor
ASIC
j
COVIP
PB
FME
HFSA
BaFin
FSA
MF / OSIPF
OSFI
APRA
l
Supervisory responsibilities related to the implementation of regulation on: a) licensing/registration; b) qualification for tax benefits; c) compliance to governance rules; d) contributions and regularity of payment; e) membership and portability (enrolment process, transfers and compliance); f) benefits eligibility conditions and access to plans; g) investments, asset allocation, performance, minimum capital and reserves; h) custodian procedures ; i) financial, actuarial and accounting methods; j) administrative cost, fees and marketing; k) disclosure procedures referring to members and beneficiaries, potential members and accounts; and l) merger and liquidation.
Annex II.3. Distribution of Supervisory Responsibilities
76
DGSFP
FI
UT
OPRA
Spain
Sweden
Turkey
UK
IR
MF
TA
TA
KNUiF E
TA
na
MF
MHLW
b
OPRA
UT
FI
DGSFP
KNUiFE
FSA
Na
CONSA R
MHLW
c
OPRA
UT
FI
/DGSFP
KNUiFE
FSA
Trustees
IMSS
MHLW
d
OPRA
UT
FI
DGSFP
KNUiF E
FSA
Trustees
IMSS
MHLW
e
Industrial Tribunals
UT
FI
DGSFP
KNUiF E
FSA
Trustees
IMSS
MHLW
F
OPRA
CMB
UT
FI
DGSFP
KNUiF E
FSA
Trustees
CONS AR
MHLW
g
na
CMB
FI
DGSFP
KNUiFE
FSA
Trustees
CONSA R
FSA
h
OPRA
CMB
UT
FI
DGSFP
KNUiF E
FSA
Trustees
CONS AR
MHLW
i
FSA
UT
FI
DGSFP
KNUiFE
FSA
Trustees
CONSAR
MHLW
j
OPRA
CMB
UT
FI
/DGSFP
KNUiFE
FSA
Trustees
CONSAR
MHLW
k
OPRA
CMB
UT
FI
/DGSF P
KNUiF E
FSA
Trustees GA
CONS AR
MHLW
l
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Supervisory responsibilities related to the implementation of regulation on: a) licensing/registration; b) qualification for tax benefits; c) compliance to governance rules; d) contributions and regularity of payment; e) membership and portability (enrolment process, transfers and compliance); f) benefits eligibility conditions and access to plans; g) investments, asset allocation, performance, minimum capital and reserves; h) custodian procedures ; i) financial, actuarial and accounting methods; j) administrative cost, fees and marketing; k) disclosure procedures referring to members and beneficiaries, potential members and accounts; and l) merger and liquidation.
FSA
KNUiFE
GA
New Zealand
Poland
CONSAR
Mexico
Norway
MHLW
Japan
a
III.
SUPERVISION OF PENSION FUNDS: THEORY AND PRACTICE by Richard Hinz *
What is Pension Supervision? There are a variety of activities undertaken by public agencies to establish the security and stability of private pension funds. These may be divided into two primary categories: (1) The creation of a legal basis and set of rules that govern their structure and operation and (2) The oversight of these institutions and enforcement of compliance with the rules. The first of these activities is essentially an organizational and rule making function. The foundation of any pension scheme typically involves a law that defines the basic framework and minimum standards of conduct. In some instances this involves the invention of an entirely new type of institution with certain distinctive features that qualify it to manage retirement savings, an approach characteristic of pension companies created in Latin America and Central and Eastern Europe. In others, an existing legal or institutional framework is adapted to provide the characteristics required for a pension fund. The most prevalent example of this is the utilization of the long established canons of trust law as the foundation for pension funds in Anglo-Saxon countries. These can be roughly grouped under the heading of “regulation” or “rule making”. They involve a range of functions including: the enactment and periodic amendment of statutes, the establishment of case law, the interpretation and application of statutory or other legal foundations to specific circumstances or in the depth that may not be addressed in statutes and the issuance of guidance or application of the law to specific individual circumstances. These activities may be initiated by the relevant authority or occur in response to specific cases in dispute or requests from pension funds. Regulation may be legislated, issued as decrees or be conducted through structured (and sometimes negotiated) administrative procedures. Regulation encompasses all of the *
Senior Economist, the World Bank
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actions having the common objective of delineating the form, rules and standards that will define permissible organizations and activities, essentially establishing the parameters within which institutions will be required to function. The second category of activities that determine the character and operation of pension funds are “supervisory”. These monitor the activities of pension funds to ensure that they remain within the requirements of the regulatory framework, essentially enforcing compliance with the rules. Supervisory activities have a similar breadth of variation depending on the regulatory and legal environment, policy choices and a variety of other factors. In general they may be defined as encompassing any activity that is primarily concerned with ensuring that the requirements and limitations imposed on pension funds are adhered to. There is rarely a clear line of demarcation between the two sorts of activities. Often the same public agency is responsible for both the regulation and supervision of pension funds, with one part of the organization engaging in rule making and interpretive activities while another separate unit enforces compliance. In some instances, however, usually where the regulatory framework is oriented toward standards of conduct rather that structural or outcome requirements, the interpretation and enforcement of the rules may occur simultaneously. This may happen when a supervisor must reach judgments about whether specific behaviour falls within a standard and enforce compliance in a single action. Although some of the theoretical literature on financial supervision distinguishes between two types of supervision (enforcement of the rules and more general monitoring of the behaviour of firms) both are encompassed within the general definition of supervision. Rationale for the Supervision of Private Pensions Two concepts merit discussion as a predicate to considering the characteristics of pension supervision. These are (1) the rationale for strong oversight and control of pension funds and (2) the distinctive features of private pensions that may determine how this is undertaken. Pension supervision is a recent endeavor in most countries and consequently there has been relatively little literature that sets forth a theoretical foundation. There has, however, been extensive consideration of the underlying rationale for the regulation and supervision of other financial institutions, most notably banks. A reasonably complete understanding of the theoretical basis for private pension supervision can be derived from the selective application of the concepts relevant to the regulation and supervision of these other financial institutions.
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In general, supervision is deemed to achieve welfare gains by correcting for several types of risks and deficiencies that characterize private pension funds. There are four closely related concepts that provide this rationale: market imperfections and failures, asymmetrical information, moral hazard and efficiency derived from competition. Supervision is generally justified as a mean to correct for the inability of markets to function effectively and equitably or to achieve the degree of discipline and participant protections required to support privately managed retirement savings. This inability originates from several characteristics of the products and nature of the markets. At the broadest level, markets are perceived to be unable to fully reflect the social costs and risks of pensions in their pricing structure. The potential for the failure of pension savings products has a number of secondary consequences and social costs due to the presence of alternative social insurance programs. In addition, a lack of confidence in private retirement savings institutions may lead to diminished savings and greater reliance on publicly financed programs with associated negative fiscal and macro-economic consequences. The complexity and long-term nature of pension products also limits the capacity of pure market mechanisms to provide the necessary discipline. Pension savings products are very hard to value by consumers at the point of purchase because of their complex structure. This is especially true of defined benefit or annuity arrangements. However, even for defined contribution products, the presence of tax incentives, restrictions on liquidity, complex restrictions on permissible investments and a range of other factors make the products more opaque than transparent for the average consumer. In addition, many pension products represent incomplete contracts with many contingencies attached when the purchaser is faced with decisions to buy and sell, a characteristic that impedes pricing as an effective form of market discipline. Private pensions are also not commonly purchased in a direct or voluntary transaction with open price competition but as the result of a public mandate or through an intermediary. Many countries now require all wage and salary workers to purchase pension products through a limited set of highly regulated institutions. In other countries, access to the pension market comes through choices that are pre-selected by an employer or trade union. Both of these structures severely impede the capacity for transparent price competition and market discipline by limiting the choices and direct interaction of consumers with sellers.
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The primary origin of these market imperfections is generally perceived to be the problem of asymmetrical information. This is a circumstance in which the seller of the products has more information about the products value than the buyer and the incentive as well as the means to utilize this information to an advantage. The purchasers of pension products typically have little capacity or knowledge about them. For example, the typical participant in a pension fund is not able to effectively consider the potential value of a particular portfolio strategy in relation to its risk or the long-term implications of a level of administrative charges and expenses. The vast majority of person entering retirement cannot reliably estimate the present value of an annuity contract much less distinguish the effects commissions, loads or other charges. Asymmetrical information can also manifest itself in problems of adverse selection. The sellers of pension products may exploit their advantage to selectively market products with an inherent mortality risk to individuals they may consider to have shorter life expectancies. They may also direct their marketing to naïve groups that may be unable to discern hidden expenses or structure the products to impose risks that are not commensurate with the returns provided. A primary consequence of asymmetrical information is high potential for moral hazard, when one party to a transaction has an incentive and the ability to engage in behaviour that is adverse to the interest of the others. For pensions, as for most other financial products, the most prevalent type of moral hazard problems are principal-agent issues. Pension funds that accumulate and invest retirement savings over long terms typically function on a fee basis, making them the agents of the fund members. Although some systems impose coinvestment and capital adequacy requirements these only partially address the problem. Asset managers may have the incentive to engage in risky behaviour inconsistent with the interests of fund members to maximize their potential future earnings, or may simply have incentives to divert funds from their beneficial owners. Supervision provides monitoring and evaluation that compensates for both asymmetries of access to information but also the capacity for meaningful analysis and interpretation. Another significant source of moral hazard is the presence of public guarantees for pension funds. The presence of guarantees may make purchasers of pension products indifferent to excessive risk taking on the part of fund managers because that risk is transferred to the broader public. Guarantees are often essential to the introduction and acceptance of private pensions but necessitate regulation and supervision to compensate for the high moral hazard potential they create.
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Supervision by public institutions is also perceived as a type of public good that improves the efficiency of the operation of a private pension system with benefits that accrue to the society at large. Intensive individual monitoring and analysis of the activities of pension funds could theoretically compensate for the problems arising from asymmetrical information and moral hazard but would be prohibitively expensive. This would be likely to limit the capacity of employers or other organizing intermediaries to achieve economies of scale in the purchase of investment products and so impose losses in efficiency. Effective supervision creates conditions in which individuals are willing to engage in long term contractual savings arrangements that limit the likelihood that they will become wards of the state in old age, providing a collective social benefit. Supervision on a common basis by a public institution also can be seen as overcoming inherent impediments to the introduction of a market in private pension products and enhancing the efficiency of that market. Faced with a high potential for moral hazard and principal agent risk consumers would be likely to engage in the market solely on the basis of sound rules if there were no mechanism to monitor and enforce compliance. Supervision serves both as the essential catalyst to overcome this hurdle and as an instrument to confine the behaviour of market participants to a defined corridor that creates the basis for price competition. Principal agent problems and other forms of moral hazard could be overcome through private warrantees or other forms of insurance. These however would simply price the moral hazard and pass this on to consumers as rents on capital or risk premiums on insurance contracts at a higher individual costs than collective public oversight. Distinctive Features of Funded Pension Systems The second important issue is consideration of the distinctive feature of pension funds and how these may affect the way in which supervision is conducted. In essence private pensions are simply one type of financial intermediary. They collect small amounts of money from a large number of individuals, assemble this into large pools of capital, manage the investment of these pools within risk, return and liquidity parameters and distribute the proceeds in accordance with the specific agreements with the investors. This is a description that could apply to banks, insurance companies, mutual funds, credits unions or any number of other institutions that perform the same elemental functions. Privately managed pension funds, however, are distinguished in a number of ways from other institutions performing what on the surface may appear to be identical purposes. Most of these differences contribute significantly to the need for a greater emphasis on supervisory activities for pensions.
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Most basic among these is the level of security that is required for pension funds. In contrast to other similar intermediaries, pension funds typically reach far deeper into the socio economic strata than other types of financial institutions. Many privately managed systems are mandatory. Although there are issues regarding the effectiveness of the imposition of the mandate, a system which reaches 50% of the formal sector workers in a developing or transition economy involves a greater proportion of the population than any other financial institution except perhaps banks. This means that pension systems bring individuals with relatively low levels of experience or sophistication into complex financial transactions that the typical member of a pension fund is only marginally equipped to understand or effectively monitor. Moreover, pensions more typically afford far fewer, if any, choices that would permit reliance on competitive market forces to adjust for differences in security, assuming that this sort of trade-off is feasible or desirable. Occupational arrangements typically involve an employer making unilateral decisions about eligibility and levels of participation, establishing the terms of the plan and selecting the asset management procedures on behalf of workers. Mandatory public arrangements generally offer no more than a handful of alternatives which, due to the design and regulatory constraints are often indistinguishable from one and other to even an astute analyst. Unlike mutual funds, savings products of banks or endowment life insurance products, (especially in circumstances in which there are very small or non existence social security systems providing broad old age income support) pensions involve savings that are essential to subsistence or even survival in old age rather than discretionary savings to facilitate consumption or income smoothing. In many of these circumstances pension savings represents the exclusive financial or any type of asset that will be accumulated during the lifetime of most workers, a circumstance that affords little capacity to manage or absorb risks From the perspective of the individuals who rely on these arrangements for old age income, all of these factors combine to raise the need for the security of pension system to be well above that of financial institutions performing what are otherwise similar functions. This heightened need for security is reinforced in the public domain by the implicit public investment in private pension system through preferential tax treatment, the provision of guarantees and the potential fiscal exposure through the establishment of social assistance programs and support for the indigent elderly. Most funded pension systems are afforded a consumption tax treatment to provide incentives for participation in retirement savings arrangements and to 82
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maximize the accumulation of capital in these funds. This typically involves excluding both contributions to pension funds and the earnings on investments from taxable income when the contribution is made. This tax-deferral represents, for a successful or a mature system, an enormous public investment. Many countries with fully developed funded pension systems have accumulated asset levels that exceed 100% of their current GDP. These assets will usually be taxed at a lower rate after the person retires, therefore implying an investment in deferred taxes that may be equivalent to several years of other public expenditures, the loss of even a portion of which may have severe consequences. Fiscal exposure also originates with public guarantees of private systems. The loss of funds in a private system, regardless of the cause, may trigger immediate and significant increases in the expenditures of pension guarantee programs. Even without an explicit public guarantee of pension funds the fiscal consequences of an insecure system will manifest themselves in greater costs for social assistance and income support for the elderly. The relationship of pension security and public financial exposure leads in both directions. A system that is perceived as secure and reliable can also enhance private savings to a level that will significantly curtail future expenditures in these areas as well. Finally, due to all of the factors discussed in the foregoing sections, private pensions will typically have very complex systems of rules and regulations. The complexity of these rules is due both to the need for security and to the attempt to balance security with efficiency and costs by introducing what are subjective and situational standards into the regulatory framework. The more mature private pension systems are those founded in Anglo-Saxon trust law rely substantially on procedural standards and relationship specific restrictions on conflicts of interest, in part to avoid the rigidities and associated costs of simpler restrictions. This type of approach requires a significant degree of monitoring and supervision to implement. All these factors combine to impose the need for a very high level of security for private pension funds. This security is derived from the interaction of the two primary elements used to manage risks in pension system, regulatory systems that establish the structure and rules within which funds will operate and supervision in which funds are monitored and compliance enforced. Primary Elements of Pension Fund Supervision All system of pension fund supervision are derived to some extent from the underlying nature of the pension arrangements and consequently will vary
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considerably in their form and organization. There are, however, a number of common elements that are characteristics of virtually all supervisory programs that can define the essential components of these programs and provide an organizing framework for considering the way that the underlying characteristics of the pension system are related to the nature of the supervision. These basic elements may be organized into six major categories as outlined below. Licensing Licensing activities restrict and control entry to the pension market through procedural requirements and criteria. These are most commonly applied to pension funds or the entities that are permitted to operate funds but can also be extended to individuals who perform important functions in the pension system, for example trustees, or to firms or individuals to become qualified to provide services, such as the qualification of actuaries to evaluate defined benefit plans. The modalities in which this function is exercised differ widely across different systems but in essence they all make use of a set of predetermined criteria to establish an entry barrier or select a limited number of entrants. Although licensing is generally directed toward managing the risk of incompetent or unqualified entrants to the market or to insure against the results of negligent or risky behaviour by imposing capital or bonding requirements it may also have the purpose of limiting competition or ensuring economies of scale in pension markets. Licensing can also be seen as a mechanism to ensure public confidence in the private pension system by applying transparent standards and establishing security to warrantee the integrity of funds. Licensing is differentiated among pension systems by the restrictiveness, depth and periodicity. Some systems have virtually no entry barrier while others have very complex and strict standards applied by the supervisor. Licensing can be incident to all participants before they enter the market, only to some participants, depending on their size or the structure of their assets, or to none of the participants. Also, in cases where licenses are issued, they can be issued only once, for the life of the supervised entity, or they can follow a process of renewal with a yearly or potentially even greater frequency. Monitoring Monitoring activities collect information to enable the supervisor to track the status and actions of the pension funds within his jurisdiction. Monitoring commonly takes the form of required submissions of information on a regular basis in the form of periodic reports to the supervisor, and it also includes a
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range of other reporting requirements or more active forms of information collection. The common function is the provision of information that will either provide the basis for judgments or actions by the supervisors, or through its provision or disclosure make the activities of the pension funds more transparent. Potential recipients and user of monitoring include supervisors as well as the members of funds. Monitoring activities can be defined in terms of both the scope and content of the information that is collected as well as the mode of collection. Common types of information collected include financial statements, schedules of transactions, information on individuals responsible for important aspects of fund operations (trustees, administrators, Boards of Directors), actuarial analyses and information on the sponsors of pension funds or owners of Pension Companies. Monitoring is often a passive activity on the part of the supervisor in which information is required to be submitted by the relevant institutions or individuals. It may also be a pro-active function in which the supervisor goes on site to collect specific or supplementary information periodically. Supervisors may also monitor the media for information, have regular exchanges of information or consultations with other supervisors, and have regular programs of meetings with pension funds to collect information. An important form of monitoring is establishing venues for individuals or fund members to communicate with the supervisor and to request scrutiny of a particular fund or activity. A strong distinctive type of this is the so called ”whistleblower” requirements of some systems which assign responsibility to certain individuals or parties to report knowledge of improprieties to the supervisor. Some monitoring systems also use independent third parties such as auditors or credit ratings to produce or verify information. Monitoring varies in terms of the type, scope and depth of the information that supervisors seek to utilize, as well as the parties who provide the information and the periodicity of the collection of information. Communication Supervisors engage in a full range of activities to communicate with pension funds. These are essentially the complement to monitoring activities in which the flow of information is from the supervisor to the funds making it very difficult to cleanly separate the two in many instances. Supervisors may communicate with the funds through the provision of regular reports on the industry, by announcing their priorities and compliance strategy, or by publicizing compliance actions. They may also engage in interactive
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communication by placing inspectors on site and engaging in daily communication, by meeting regularly with the funds to discuss issues of mutual interest or through more formal processes in which changes in the activities of the funds are suggested and issues resolved through negotiation. Supervisors may also undertake programs of outreach, education, and training to enhance the knowledge of the legal requirements or operation of pension systems. Supervisors may also seek to communicate with a range of parties including fund managers, service providers, members, and the public. Communication activities of supervisors have a wide range of goals and objectives. Some communication programs may have the purpose of informing pension funds about the intent and nature of the supervisor’s activities to maximize the capacity for cooperation and make the interactions with fund more efficient. Others are intended to advance the understanding of the regulatory structure as well as rights and responsibilities of funds and their members to facilitate compliance with the rules or to advance the exercise of individual rights of action by members. Communication may also be intended to leverage resources and establish a climate of deterrence among funds by publicizing the enforcement actions of the supervisor. Basic types of communication by supervisors are: Disclosure is a means of communication with the public. Supervisors make public a portion of the information they receive, process, or issue, in publications and individual disclosure notes. Disclosure programs are typically designed to provide the basis for individuals to scrutinize the activities of pension funds to support private rights of action, to ensure that funds are exposed to scrutiny to provide a deterrent to prohibited actions or to enhance competition among funds. The utilization and reliance on disclosure and the nature of these programs are key indicators of the degree to which supervisory systems are reliant on indirect forms of compliance enforcement and market forces rather than directive interventions. Outreach and education activities are communication efforts undertaken by supervisors to raise the awareness of the operation and requirements of pension systems. These may be directed to the public and members of the pension funds to educate them about their rights and responsibilities under the law, or to the industry to raise the awareness of compliance issues or understanding of the supervisor standards or operations. These may take the form of publications, websites, or regular programs of consultation with the industry, on an individual or collective basis. Similar to disclosure, the nature and extent of outreach and education programs are indicative of the underlying style and approach of supervision. Systems with few efforts to interact in this 86
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manner will typically have be more directive in nature, relying nearly exclusively on action by the supervisor, while programs with extensive outreach and education activities place greater weight on the role and action of third parties in the supervisory process. These types of programs are also a form of preventive rather than remedial supervision because their ultimate goal is to educate practitioners about how to remain in compliance and to deter problems by enhancing the capacity of third parties to provide oversight. Training. In some countries, the supervisor also provides more formal training to ensure that the managers of pension funds are adequately prepared, or as a specific requirement prior to some form of licensing or entry control. This may be general training on the laws or a response to significant changes or on specific areas of fund operation such as: risk-management and investment practices, criteria to evaluate third-party service providers; and compliance with technical regulatory requirements. Communication is differentiated among pension systems by the scope and purpose of the activities. Supervisory systems that impose strong controls and have little reliance on external or market processes are very directive in their communication with funds regarding compliance issues, and they are likely to engage in few activities designed to facilitate compliance or enhance deterrence. Systems with more procedurally oriented standards or a greater reliance on external processes will engage in a more interactive communication process, and they will have far more extensive outreach and education programs that support more negotiated settlement of compliance issues and rely on deterrence and third party actions to support direct compliance activities. Analysis The manner and extent to which supervisors analyze and evaluate the information they receive from pension funds is usually closely linked with the system’s legal and regulatory approach. Legal frameworks that are based on quantitative standards lead supervisors to extensive measurement efforts that compare funds’ financial status and activities to normative standards. This often involves complex calculations of individual funds that may be undertaken as frequently as daily. Pension system founded in the Anglo Saxon tradition of trust law tend to be more oriented toward comparative analysis, and hence follow a less frequent process of evaluating funds over longer periods against benchmarks or the behaviour of the entire industry. The analysis in these systems
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may also be less focused on the outcome of financial decisions than the process of decision making or in determining relationships among the various parties involved in managing the assets and affairs of the funds. Measurement and analysis elements of supervision can therefore be evaluated on the basis of the purpose, frequency, and intensity of the activity. Systems that are very intensive and proactive undertake analysis very frequently, with the intent to discern as soon as possible, if not in advance, when the fund may drift outside an established standard of behaviour or to engage in a specific action that may represent a violation of the requirements. These attributes may also be associated with risk based approaches to supervision, in which complex algorithms or “scoring” systems based on extensive calculations may be the basis for decisions about supervisory interventions. At the other end of the spectrum, we find systems that are oriented toward keeping funds within a loosely and often situational or relative set of standards. Here analysis is far less frequent or intensive. This represents an approach that relies more on external or market forces, or in some circumstances on the presence of extensive regulation and oversight of other aspects of financial market operation. Intervention All supervisory programs are continually faced with decisions about whether and how to intervene in the operation of pension funds. There is considerable overlap across the different functional elements of supervision. It is often difficult to separate intervention from some of the key aspects of the communication with the funds. Interventions may take the form of explicit requirements for the fund to take or desist from engaging in certain activities that carry the force of law and must be complied with immediately. In other systems they may be in the form of findings that are presented to the funds for a response. The process of intervening in these circumstances is likely to be in the nature of negotiations in which issues are resolved or a process of litigation through the civil courts where the ultimate resolution is reached through a judicial process A key issue that defines the nature of interventions is the force of authority is given to the supervisor and the nature of the process through which interventions occur. In some countries, the supervisor simply has the authority to intervene when a finding is made that a fund is, or may be, approaching noncompliance. Fund managers may in some cases be provided with very little if any recourse to negotiate or appeal. In other countries, the supervisor has little
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capacity to unilaterally impose sanctions and instead intervenes through a far less directive process. Of consultation, notification and perhaps negotiation. The most basic and important feature of the notification of compliance process is the manner in which individual funds are notified by the supervisor when they are deemed to be out of compliance with legal requirements. This can range from regularly scheduled interaction that may occur as often as daily in some countries, to formal notices, or in some cases there are simply directives from the supervisor to the fund to make changes. The manner of this sort of intervention and the nature of the process that follows, whether it is completely directive or a form of negotiated settlement, is perhaps the aspect of the supervisor’s activities that most defines the nature and style of supervision. Another key variation is the involvement of third parties in interventions. Some systems require that all actions be taken through the courts. Others establish a formal process of appeal to a specially constituted group that imposes a formal, although similar, type of check on the authority of the supervisor. Interventions by supervisors are therefore differentiated partially by the degree to which they are pro-active or occur only after conclusive evidence of non-compliance is established. They are also distinguished by the extent to which they are directive and represent the unilateral exercise of authority to which there is little or no appeal, or conversely are a process of negotiation and adjudication. Correction As is the case with any form of compliance enforcement, the ultimate and perhaps most important element of pension supervision is the capacity to take corrective action. Although this element of the program may seem conceptually difficult to separate from intervention, the range of types and purposes of corrective action may vary across supervisory systems that are otherwise quite similar. This variation in the type of corrective actions that a supervisor may take, however, makes it an important element to evaluate on its own. There are essentially three types of corrective actions: punitive, remedial, and compensatory. Supervisory programs may engage in all three types or may be limited exclusively in their authority to only one. Punitive actions are designed to impose penalties on the funds for actions deemed adverse to interests of members. They are distinguished by both form and intent. Penalties are usually fines that are paid to the supervisor and may be retained by the authority or become part of public revenues. Their intent is to establish deterrence and punish behaviour outside of the standards.
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Remedial actions are those taken by a supervisory authority to remedy the consequences of failure to comply with the law. These are essentially a way to reverse the outcome of non-compliance. Remedial sanctions may simply be requiring the fund to return to a prior status or to cease certain actions. In some cases, this may involve financial sanctions limited to any direct result of negligence or malfeasance by responsible parties. They may also be applied to correct for abuses of favoured tax status afforded to pension funds or harm suffered by parties that may have been involved in transactions with the funds. The primary intent of these corrective actions is to rectify any direct negative outcomes and prevent a recurrence. There is of course a deterrent effect of this but it is more indirect. Compensatory corrective actions go beyond the remedial outcomes and seek to compensate aggrieved parties for both the direct and indirect effects of violations. Rather than simply reversing the outcomes, these are intended to compensate affected parties for the direct and indirect consequences of actions determined to be inappropriate. Compensatory damages will typically follow remedial actions and effectively compensate for any damages. These types of actions have a strong deterrent intent, but they also have the purpose of ensuring that harm is minimized. Corrective activities of supervisory are distinguished by the degree to which they are solely focused on remedial outcomes, correcting problems as they occur, or whether they extend into the arena of compensation and punitive provisions that attempt to establish a more self-enforcing regime of deterrence. Characteristics of Supervisory Systems The manner in which these common activities are implemented varies considerably among the many different countries with funded private pension systems. Some countries engage in very intensive supervision programs in which they interact on a daily basis with the funds. Others interact directly with the funds only on an exception basis when there are indications of problems or to advance a specific policy agenda. The manner in which different systems implement the basic elements defines what may be viewed as the “style’ of pension supervision. Supervision styles can be considered as reflecting a set of attributes that represent different positions along a spectrum of attributes rather than choices between discrete alternatives. A set of five attributes represented as scales can be used to define the nature of the various approaches to supervision. This approach is useful because it both describes the full range of the attributes that are observed among supervisory systems but also because it does
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this in a manner that evaluates the elements in relation to the degree to which they represent interventions to address market imperfections or to directly secure the interests of pension fund members. These descriptive scales essentially seek to differentiate on the basis of the depth, intensity, periodicity and intent of the supervisors activities.
Restricted Pro-Active Intensive Directive Corrective
Open Reactive Exception Negotiated Deterrent
The scales are defined by their end points that may be described as follows: Restrictive systems are those that impose high entry barriers in which the supervisor requires the submission and validation of extensive information prior to the licensing or approval of the operation of pension funds and entry into the market is restricted to a small number of entities that meet rigorous standards. Open systems are those in which there is no or minimal involvement of the supervisor in assessing the qualifications of funds and entry to the market is open to all entities that represent that they meet the qualifications established in the law and regulations. Pro-active systems are those in which the supervisor intervenes on a regular basis in order to pre-emptively address violations of standards or to prevent what is perceived to be undesirable behaviour. Pro-active systems typically involve high intensity monitoring and regular intensive interventions by the supervisor. Reactive systems are those in which the supervisor intervenes on a very selective basis and only in response to specific circumstances. These type of systems typically involve supervisory actions that are compensatory in their intent in that they are designed to rectify the consequences of a violation of the standards or requirements after it occurs. Intensive systems are those in which there is a high frequency of regular communication and interaction between the supervisor and the pension funds. These interactions can be in the form of both the collection of information or other monitoring activities or in the imposition of requirements for remedial or preventive actions.
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Exception systems are those in which the supervisor infrequently interacts with the pension funds or only does so on an exception basis when specific circumstances trigger the need to take some action. Directive systems are those in which the supervisor has, and frequently exercises the authority to unilaterally require action or to impose sanctions on the pension funds. It references both the scope of the authority but also the manner in which it is exercised. Negotiated systems are those in which the supervisor engages in a process of proposing actions and negotiating resolution to issues. This may be in the form of the nature and scope of the authority provided to the supervisor, its degree of independence, the availability of venues for the appeal of supervisory actions or in requirements for the supervisor to enforce compliance through judicial processes or litigation. Corrective systems are those in which supervisory authority and methods are primarily oriented to preventing or correcting problems and enhance the security of the system through a reliance on direct actions. Deterrent systems are those that primarily seek to establish a credible deterrent presence through their actions rather than being comprehensive in addressing every incident. These are systems that rely on selective interventions to establish the parameters of acceptable activity by funds and to achieve compliance by the potential threat of sanctions rather than their direct application. Factors Associated with Different Styles of Pension Supervision There are many different ways in which pension supervision programs are organized and managed to achieve these common objectives. The most important of these are the environment and context in which the pension system operates and the basic design and characteristic of the system. Mandatory pension system that operate in developing countries or those with relatively under developed financial systems are typically more directive and intensive in their approach, as is characteristic of the systems in Latin America. Pension systems that operate on a voluntary basis in environments with highly developed financial markets are typically less intensive and exception based, relying on interventions by exception and establishing a climate of deterrence as is typical of the systems in the Anglo-American countries such as Australia, the United Kingdom and the United States. Examples of supervisory system in transition economies that fall between these two models such as Hungary are also present. A review of the supervisory methods and programs from this
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range of these styles yields observations about some of the basic relationships between context and pension supervision. Increasing levels of per capita GDP and the depth of capital markets are generally negatively correlated with the intensity of supervisory practices. The first of these, a broad proxy for overall economic development, provides more of a reference point than explanatory power because of its’ linkage to all of the other potential influences examined. More developed countries nearly always have commensurate development of financial markets and legal institutions and are much more likely to be able to support voluntary pensions or rely on employers to manage occupational programs. The relationship to capital market development, however, provides some insights into the conditions required for supervisory systems to leverage various forms of other primary market oversight and formulate their activities as a form of tertiary supervision. This results in the focus on monitoring and exception only interventions observed in these settings. It also enables supervisors to rely on private third party monitoring mechanisms such as auditors and actuaries. The legal environment exerts a similar influence on the supervisory methods. Conditions in which there is a strong reliance on rule of law and the integrity of governance in public and private institutions create the capacity to relax licensing and other entry barriers and rely on indirect and less frequent forms of monitoring and intervention. Conversely, environments characterized by lower respect for the rule of law require more intervention by public authority. An important factor in this process is likely to be the ability to rely on disclosure of information and private rights of action as a significant adjunct to compliance enforcement by public authorities. The capacity to utilize third parties and rely on private actions through a process of civil justice, perhaps even simply the presence and confidence in a commercial code of conduct and private adjudication is a likely common attribute to both the economic and legal factors at play in this process. Environmental factors exert similar influence on the structure of the pension system that also dictate the form and intensity of supervision. Countries with mandatory individual systems are associated with very restrictive and intensive approaches to supervision. Not coincidently these same countries have systems with a very small number of funds. Countries with strong rule of law and governance have occupational arrangements with a large number of funds. The ability to overcome the agency and moral hazard challenges required to sustained employer managed systems are directly linked to the ability to supervise these in a less pro-active manner. No doubt the imperative to limit regulatory burden and compliance costs in a voluntary system are key factors that strengthen this relationship.
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Taken together these factors suggest the relationship of context and supervision illustrated schematically below:
Figure 1 Intensity of Supervision
This suggests that the conditions shown on the horizontal axis interact to influence the nature of the supervisory style observed on the different countries. Countries with higher levels of per capita income and financial market development are associated with stronger rule of law, governance institutions, voluntary pension system and occupational sponsorship. These factors combine in a variety of ways that lead to supervisory systems that are more open, less pro-active and function in a less directive manner. These factors both influence and reflect the underlying nature of the pension system. The degree to which these factors will enable supervisory systems to function in a less intensive manner however is broadly influenced by the underlying legal and cultural environment as is depicted by the parallel lines for two basic types of legal systems. An equivalent set of conditions in a civil law 94
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environment is likely to lead to more intensive style of supervision than might be present in the alternative. This is both because the common law system are associated with countries that have more developed capital markets and voluntary occupational systems but also because they are more conducive to flexible regulatory regimes, negotiated processes and perhaps most importantly the capacity to utilize third parties and private rights of action as compliance enforcement tools. This framework provides some useful observations about the general nature of these relationships and potentially enables policy makers to assess where they may reside along the range of certain characteristics of the environment that the supervisory system will function. There are, however, key limits to the applicability of thee relationships that may shift significantly the position that a given country may otherwise be expected to occupy. One of the most important of these is the legal culture and tradition. Countries have adopted an Anglo Saxon common law may be far more conducive to more open and less directive systems than might otherwise be anticipated by the economic conditions. Conversely very highly developed countries with a civil code tradition may be constrained in their ability to adopt the more negotiated systems and reliance on private rights of actions that such a model would predict In addition, such a model is relatively static and may provide more insights into the relevance of the initial conditions for a pension system than the dynamics of its evolution. At this point the experience with the way in which supervisory systems evolve with the conditions around them is far too limited to offer any assessment about whether countries will maintain these relationship as their economies and pension systems develop. These relationships provide a useful framework, some relevant points of reference, and valuable insights into the importance of prevailing conditions on the design and implementation of private pension supervision. This illuminates the extent to which the intensity and form of supervisory activities are a function of the matching of methods to environment, directing attention to the this matching process rather than the formulation of normative models in the formulation of guidelines for best practices. By doing so, it provides a useful starting point for the introduction of new systems in the continuing reform process and some guideposts for existing supervisors to consider their future course.
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IV.
INTEGRATED FINANCIAL SUPERVISION AND PRIVATE PENSION FUNDS by Edgardo Demaestri * and Gustavo Ferro *
Introduction This study analyzes the cost and benefits of integrating the supervision of pensions with that of other financial activities and services. The literature has dealt with the integration of the supervision of banking, insurance and securities markets (Llewellyn, 1999, Demaestri and Guerrero, 2003), the joint supervision of insurance and pensions (Davis, 2001), the supervision of pension funds (Shah, 1997, Srinivas et al., 2000, Demarco et al., 2000, Rocha et al., 1999, OECD Working Party on Private Pensions, 2002 and 2003), and the separation of banking supervision from central banking (Demaestri and Guerrero, 2003). This study seeks to expand on these issues, focusing on the integration of pension regulation. In particular, it seeks to make a conceptual contribution with respect to the reforms in financial supervision and pension systems in Latin America. The subject is an important one. The financial problems afflicting pay-asyou-go pension systems have led to the promotion of complementary private capitalization schemes (both voluntary and mandatory) or substitutive ones (mandatory). The reforms that began in Chile in 1980 have been applied in a score of Latin American countries and “transition economies”. Discussion on pensions is also a key theme in Europe and the United States. At the same time, the amount of resources intermediated by pension systems is substantial. In 2000, close to 30% of financial assets of the countries belonging to OECD were accumulated in pension funds.1 *
This paper was prepared by Edgardo Demaestri and Gustavo Ferro while they were Senior Economist and Consultant, respectively, in the Infrastructure and Financial Markets Division (IFM/SDS) of the Inter-American Development Bank. The views and opinions expressed in this paper are those of the authors and do not necessarily reflect the official position of the Inter-American Development Bank.
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Numerous countries have integrated financial supervision.2 There are integrated regulators in Australia, Austria, Canada, Denmark, Estonia, Germany, Hungary, Iceland, Ireland, Japan, Latvia, the Maldives, Malta, Nicaragua, Norway, Singapore, South Korea, Sweden, the United Arab Emirates and the United Kingdom. Countries that are considering or are actively involved in switching to an integrated approach include Finland, the Netherlands, Switzerland and South Africa. Most of these integrated entities regulate banking, insurance and securities (Demaestri and Sourrouille, 2003). Some of them also regulate pension funds (i.e. Australia, Canada, Denmark, Iceland, Norway, the United Kingdom and Sweden). The approach adopted here is conceptual and analytic. A methodology is proposed to analyze the advantages and disadvantages of integrating pension supervision,3 paying attention to the specific nature of private pension systems in Latin American countries. This methodology involves the analysis of the relative efficacy and efficiency of integrated and specialized approaches with respect to the achievement of three objectives of financial regulation: i) consumer protection ii) systemic stability and iii) the efficiency of the financial system.4 Following this introduction, Section 2 looks at the literature to discern why financial intermediaries in general and pension funds in particular require regulation, focusing the discussion about the need to address market failures and to provide merit goods. Section 3 summarizes the discussion over the advantages of integrating supervision of different financial intermediaries in relation to banking, insurance and securities. Section 4 presents a methodology and uses it to analyze the advantages and disadvantages of integrated as opposed to specialized supervision of pension funds. Deepening the analysis on pension markets and specificities of financial intermediaries working in them, Section 5 examines the goals and instruments for regulating pension funds. A distinction is drawn between the “reactive” regulatory systems in operation in OECD countries that focus mainly on prudential regulation and problem solving, and the “proactive” systems common in Latin America and some East European countries which regulate along prudential lines, but are more intrusive with regard to the structure and performance of the industry. Section 6 extends the use of the methodology for analyzing the advantages and disadvantages of integrating pension fund supervision by considering the peculiarities of intermediaries in the pension market. The study ends with some concluding thoughts.
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The regulation of financial intermediaries and pension funds Without an analytical grasp of the logic and goals of regulation, any institutional structure may seem ad hoc and arbitrary. This section discusses the reasons that justify the regulation of financial intermediaries, the objectives, the risks involved and the generic forms that this takes, along with some specific aspects that relate to the regulation of pension funds. Regulation of financial intermediaries In the discussion about the regulation of financial intermediaries, key questions include whether financial markets are different from other markets, whether market failures are relatively pronounced, and whether there are forms of government intervention that improve the functioning of markets and impact positively on overall economic performance. The main functions of financial markets are to transfer resources from those who save to those who borrow; to mobilize capital; to assist with the selection of investment projects; to oversee performance; to transfer, share and spread out risk; to register transactions; and to manage the means of payment. Financial markets not only deal with inter-temporal transactions but basically with risk and information. In the view of some authors, financial products and contracts are different from other goods and services, particularly because consumers determine quality and place a value on a product within an environment of information asymmetries. Others, however, argue that financial products are not so different from other products, stressing that the principal protection for consumers against the risky behaviour of firms is similar to that of other industries: competition, reputation, dissemination of information and legal redress in case of damages. Following Stiglitz (1994), seven failures or characteristics of financial markets can be identified that may justify government intervention in terms of welfare economics. a)
Monitoring by financial markets has some elements of a public good.
b)
Externalities in the evaluation of projects.
c)
Externalities associated with financial crises.
d)
The possibility of market loss because of information problems.
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e)
The existence of imperfect competition arising because of the specialized information that each intermediary has on its client base.
f)
The financial risk market being incomplete.
g)
The financial education of retail consumers could be considered a merit good.
Looking at each in more detail: a) Economic performance depends on the efficiency with which capital is allocated. Financial markets take part in monitoring the activities of those responsible for the management of firms, and this contributes to the more efficient allocation of resources. Monitoring is a public good. For instance, if a lender does something that reduces the chances of a default on the part of a debtor, this benefits all lenders, and vice-versa. As with any public good, there is sub-optimal production on the part of the market. Improved supervision by the relevant authority is likely to be beneficial where the financial system does not adequately oversee financial intermediaries. b) Being able to see that another lender is willing to allocate funds in similar projects is an information signal that underscores the potential for investment. It has an externality for the next investor. Some externalities spread out from one market to another; for instance, problems in credit markets can affect stock markets and vice-versa. c) The bankruptcy of a financial intermediary can have wider effects. Its essential asset is its information capital, which is not readily transferable; such information can be dissipated. To offset this failing, the government may be able to supply insurance protection. However, this can alter people’s conduct by reducing the incentive for the ensured to proceed with due caution (moral hazard). d) Effective transaction costs in small financial markets (securities) or new ones (pensions) can be so high that they limit transactions or result in the loss of such markets. The market cannot make the dissemination of information or its production at low cost mandatory. Private markets cannot manage the social risks associated with macroeconomic disturbances. While it is possible to distribute risk within generations, only government intervention can distribute transfers between generations. Financial transactions also imply incomplete contracts whose value is determined largely by the behaviour of the provider after the point of purchase. All this can lead to opportunistic behaviour.
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Regulation and effective collective monitoring can reduce transaction costs and raise welfare. e) Each intermediary has specialized information on its client base. At the extreme, each can monopolize a specific market. Consumers can delegate the task of monitoring to a regulatory agency. There are good reasons based on efficiency grounds to delegate monitoring and supervision to a regulatory agency. There are potential economies of scale to be achieved through authorization, supervision and collective monitoring of intermediaries. An additional role for regulation is to establish minimum standards and therefore to encourage poor quality intermediaries to leave the market. Regulation can provide a guarantee that market participants will observe certain minimum standards (Llewelyn, 1999). f) Many risks remain uninsured, resulting in incomplete financial risk markets. g) The financial education of retail consumers of financial services can be considered a merit good. Information asymmetries can be more harmful for the party that is least informed. In that regard, there are a number of reasons why it is rational for consumers to demand regulations: i) lower transaction costs where a regulator is used to collect and disseminate information, ii) provision of a reasonable degree of safety in financial transactions, iii) past experience of bad behaviour by financial firms, iv) high net-worth exposure because of the financial transaction, v) timely prevention of problems is cheaper than dealing with them subsequently through a new contract, and vi) they can take advantage of economies of scale in monitoring. Regulation can be of good or bad quality. If it is good quality, the costs of its implementation and the degree of distortion it introduces will be less than the damage caused by imperfections or failures in the system. In this respect, what matters is how institutions and markets operate in practice. Similarly, regulatory design should not lose sight of the structure of incentives facing firms; market discipline must be made to work. Regulation has the potential to improve the functioning of markets with failures, but this depends on the quality of the regulation5. Objectives, risks and generic forms of financial regulation Following Demaestri and Guerrero (2003), the correction of financial market failures is connected with achieving three essential objectives of financial regulation:
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a) Protection for consumers of financial services b) Systemic stability c) Efficiency of the financial system. The first objective refers to the combination of information asymmetries and long-term and often sporadic decisions by not very sophisticated consumers. Intermediaries can affect the wealth of their customers since firms can go bankrupt or can operate imprudently, negligently, incompetently or fraudulently. The goal of systemic stability is important because financial systems are unstable. They are subject to runs, bouts of panic, manias and bubbles. The instability of financial systems translates to the wider economy and financial crises have a high cost. The efficiency of the financial system impacts on the real economy through investment evaluations, risk management, and the provision of a payments system. If the sector works efficiently, it is to be expected that there will be better investment decisions, improved risk management and more effective mechanisms for payments. In Latin America, promoting the efficiency of the system has to do with the elimination of distortions, problems of scale and the inefficient use of financial intermediaries for purposes of redistribution. If the costs are excessive, a net burden is placed on the real economy which regulation can help alleviate. Regulation may prevent three types of risks (Srinivas, Whitehouse and Yermo, 2000): agency risk; systemic risk; and investment risk. Agency risk relates to incompetence, negligence or fraud, problems that may arise in any relationship that involves delegation (in this case, from consumers to intermediaries). Systemic risk is especially evident in banking, where a crisis can lead to contagion and possible disruption of the payments system. Although safety nets can help reduce systemic risk, they also create potential for moral hazard among consumers and financial firms. Securities firms, pension funds and insurance companies generally keep liquid assets, and the adjustment of positions is less complicated than for bank assets. Banks fund themselves short-term, whilst other financial institutions have long-term liabilities. As the assets of most nonbank financial institutions consist principally of publicly quoted securities, their market value and disposal value differ little. In banking, it is much more
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difficult to value assets, whilst the value of liabilities is exogenously determined (a deposit has a face value that has to be respected). Investment risk refers to the probability of capital loss. It has a component that can be reduced through diversification, taking advantage of the fact that there are assets whose risk is negatively correlated with others. However, there is also a risk component that cannot be reduced by diversification: macroeconomic risk. These risks can be dealt with through two generic types of regulation: x
Prudential (solvency, institutions).
x
Conduct of business (how firms conduct business with their customers).
safety
and
soundness
of
financial
Prudential regulation is required because of the imperfect information available to the consumer, problems of agency inherent to the nature of financial institutions, and because the behaviour of a financial firm after consumers have dealt with it could affect the value of the contract signed. The incompetence, negligence or dishonesty of an intermediary may reduce the value of contracts to the detriment of the consumer. There are arguments that justify prudential regulation of financial firms when the institution has a fiduciary role, when consumers are not in a position to judge the safety and solvency of institutions, when the post-contractual behaviour of an institution affects the value of contracts, and when the cost of risk-taking by a financial firm can be transferred to others. Regulation of conduct of business focuses on obligatory reporting requirements, the encouragement of honesty and integrity on the part of firms and their employees, the degree of competence expected, fair business practice, and the ways in which products are sold. General issues on pension fund regulation6 Private pension funds are a way of organizing the pension system, which in turn forms part of the social security system. Social security involves those actions that society undertakes to confront problems of need caused by the biological diminution of human capital as a consequence of old age, invalidity, death and the survival of dependents, accidents at work, sickness and unemployment. The pension system covers those ’claims’ related to old age, invalidity and the survival of dependents. There are four characteristics of a pension system in so far as it is adopted as a mandatory solution to such
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problems, thus replacing the more traditional system of voluntary arrangements (family support, charity, and voluntary savings). It is considered a merit good. In modern societies, resort to the family or charity is considered inappropriate or insufficient, and the argument is made that voluntary savings would not be sufficient to substitute for a general and compulsory scheme. Pensions-related savings may also constitute an important part of personal assets. The mandatory nature tends to avoid the risk of ’adverse selection’7 that occurs in a free access market with participants with different event risks. This risk would raise the cost of insurance because it would tend to make the system bear the worst risks. x
A mandatory system reduces moral hazard, by which individual pension savings would diminish if people think that the state will subsidize them in the future.
x
Individual behaviour (short-sightedness, incapacity to perceive personal risk or lack of information) can involve making pension savings mandatory.
Taxonomy of financial services Why should pension funds be considered alongside other financial intermediaries? Table IV.1 presents a taxonomy of different financial intermediaries, identifying the sort of business that each conducts, the specific type of contracts involved, the terms over which assets are realized and liabilities called in, and the types of risk involved. Notwithstanding the specificities of the business, contracts, terms and risks involved, financial services — pension funds included — have some similar characteristics: i) they have similar associated risks, although their degree depends on the sort of intermediation undertaken, ii) they have similar overall objectives although these differ in specifics, and iii) they are affected by similar sorts of market failure.
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Table IV.1. Taxonomy of Financial Services Intermediary Banking
Insurance
Securities
Pensions
Main business
Contracts
Loans and investments from deposits.
Fiduciary.
Management of investment portfolios. Liabilities determined actuarially.
Fiduciary
Capture of investment funds (primary market). Risk management (secondary market).
Fiduciary, through commissions (brokers).
Management of investment 1 portfolios.
Heterogeneous assets.
Protection with premiums.
Maturity
Risk involved
Long-term assets. Short-term liabilities.
Credit, term and market risks. Important systemic risk.
Short-term assets. Long-term liabilities.
Protection through the pooling of risk. Possibility of catastrophic risks.
Short and long-term.
Underwriting or best effort (primary market). Trading (secondary market).
On their own account, through spreads (dealers). Fiduciary through 2 commissions.
Medium systemic risk. Short-term assets. Long-term liabilities.
Agency risk. Significant 3 market risk. Medium systemic risk.
1. This contemplates two extreme varieties and combinations between them: a) obligations that are actuarially defined (under defined benefits); b) obligations that result from the manager’s best efforts (under defined contributions). 2. The fact that pensions are a merit good has led to differentiated tax treatments and the promotion of mandatory participation. 3. This risk can only be distributed between generations. Source: Authors’ own elaboration.
Integrated or specialized supervision? The main factors (evaluated in Demaestri and Guerrero, 2003) that have driven integrated financial supervision in various countries are: x
financial innovation (new products and greater complexity);
x
the rise of financial conglomerates;8
x
the quest for regulatory coherence;
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x
gray areas in the attributions and powers of specialized regulators; and
x
growing globalization in the provision of financial services.
In this section, the arguments are examined with reference to specialized versus integrated regulation, and, thereafter, there is a brief examination of the international experience of regulatory integration. Advantages and disadvantages of integrated and specialized regulation9 Although the need for coordination between regulators is clear, some institutional frameworks restrict information flows between them. At the very least, the institutional system should encourage regulators to share information and promote coordinated actions between the different agencies involved. At one extreme, there could be a single combined regulator, although integration may not be justified in all cases. It is important to recognize the differences between intermediaries, the nature of their business, the type of contracts they produce, the maturity of their debts, and the sorts of risk involved. Demaestri and Guerrero (2003) suggest a methodology and analyze the advantages and disadvantages of both approaches, linking these to the core objectives of financial regulation as well as the situation of countries in Latin America. Table IV.2 summarizes the expected strengths and weaknesses of an integrated approach.10 Having identified the factors that drive integration, the similarities and differences that persist among intermediaries and the pros and cons of integration, the main arguments in favour of integrating regulation in Latin America can be summarized as follows: a. economies of scale and scope; b. prevalence of financial conglomerates and the lack of clearly defined boundaries between products; c. competitive neutrality; d. transparency and accountability; and e. the coherence of the regulatory framework.
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Table IV.2. Pros and cons of integrated supervision Pros (of integration) 1) Financial products are increasingly difficult to distinguish. Specialized regulation can deal in a heterogeneous way with similar products, duplicating regulation and causing loopholes in consumer protection.
Cons (arguments for specialization) 1) Intermediaries differ in terms of their business, activities, and risks. 2) It may result in excessive risk taking among the public if the spectrum of risk between one sort of intermediary and another disappears.
2) Filling loopholes, correcting inconsistencies and eliminating overlapping regulation. It avoids regulatory arbitrage and use being made of ’gray areas’.
3) To avoid the ’Christmas tree effect’, (the number of heterogeneous and secondary objectives to be fulfilled by a regulatory 1 agency).
3) Segmented regulation can result in closed clusters where information is not shared (Bureaucratic Leviathans).
4) To avoid the Leviathan (danger that a mega-regulator turns into an omnipotent bureaucracy).
4) With segmented regulation, each regulator can monopolize certain activities. From the point of view of regulatory capture, it is no worse to have a unified regulator who concentrates regulatory activity.
5) Reduce the chances of regulatory capture. To capture a number of regulators may be more difficult (and expensive) than to capture just one, if there is competition between them. 6) Possible political economy reasons.
1. In Latin America, it is common for financial regulators to be involved in many heterogeneous activities with regard to financial regulation. Therefore, the objective of consumer protection may be ignored. Source: Own elaboration on the basis of Demaestri and Guerrero (2003).
a) Economies of scale There are economies of scope in regulation if the joint costs of regulating two or more financial activities simultaneously are less than the sum of the costs of regulating each financial activity separately. There are economies of scale if, for a single financial activity the average cost of regulation and supervision falls as the volume of that activity increases. Integration helps both types of economies to be achieved. For instance, a sole agency can be more efficient in eliminating overlaps in requests for and the processing of information. Integration also encourages the development of a single system of supervision based on risk. Regulatory resources can be directed towards those business areas that involve higher risks to the goals of financial regulation. The costs subject to savings that arise from regulation can be classified thus: (i) Institutional cost (the costs of running regulatory agencies); (ii)
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Compliance costs (the costs imposed on firms through regulation); (iii) Structural costs (such as excess burdens, stifling of innovation). The savings on institutional costs can be achieved by i) establishing a limited and clearly defined set of objectives; ii) budgeting the consolidated supervisory activities at an amount that is lower in real terms than the total of the costs of differentiated activities in previous years; iii) developing joint administrative, information and technology and other support functions; iv) recruiting and retaining qualified personnel; v) using specific know-how in special areas; and vi) achieving efficiencies in the deployment of staff with expert intellectual capital. Compliance costs can be reduced by means of i) introducing a single system for dealing with information requests for regulated firms; ii) having a single database for the registration, authorization and operation of firms; iii) establishing a consolidated set of rules; iv) introducing a centralized system for managing complaints and claims, and v) creating a single system for compensation. Structural costs are those arising from the design of each specific intervention. Minimizing them contributes to the quality of regulation. b) The importance of financial conglomerates and the blurred boundaries between products The growth in financial conglomerates requires that that the risk of the group be assessed on a consolidated basis and that its supervision is comprehensive. Supervision on an individual basis of the different institutions that make up a group is ineffectual. A centralized regulator is in a better position to achieve the aims of consumer protection and systemic stability. c) Competitive neutrality Specialized regulation means that firms with the most diverse range of products will have a more onerous supervisory burden. There are also more incentives for regulatory arbitrage. d) Transparency and accountability Unification provides an opportunity to strengthen control mechanisms in the legal and regulatory framework. A single system for dealing with complaints can be introduced, as can mechanisms for improving powers of investigation and discipline. Internal procedures can be established to ensure that enforcement is
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seen to be fair, including a separation of functions between the staff who investigate a case and those who make decisions related to enforcement actions. e) Coherence in the regulatory framework A single regulator with clear and consistent objectives facilitates coherent supervision that focuses on the relevant risks. Coherence also helps in the adoption and adapting of internationally accepted standards and codes of practice. International experience in integrated regulation11 This conceptual analysis is borne out in practice. In the ten countries with integrated supervision studied in Demaestri and Sourrouille (2003) — Australia, Canada, South Korea, Denmark, Iceland, Japan, Norway, the United Kingdom, Singapore and Sweden —all regulate banking and insurance. Except Australia and Canada, they also regulate securities. In Australia, Canada, Denmark, Iceland, Norway, the United Kingdom and Sweden, a variety of pension funds are also regulated. Responsibilities involved, albeit to varying degrees, are prudential policy and regulation, market performance, information dissemination, and payments systems. The United Kingdom, Sweden and Iceland cover the majority of these functions. Among the regulatory objectives are the building of confidence, the setting of standards for sound practice, the introduction of timely correctives, and the promotion of competition, equity and honesty. The powers that regulators have at their disposal include the licensing of financial entities, the establishment of norms and standards, the preparation and enactment of regulations, the removal of directors, the removal of auditors, the withdrawal of licenses, the suspension of operations, the imposition of penalties, and the transfer of engagements. The unified regulator in the United Kingdom encompasses all these regulatory powers, whilst the rest of the agencies studied have at least some of them. Most agencies cover their costs from contributions from the industry they regulate and have the right to set their own budgets, although some require government approval. This enhances their degree of autonomy from government upon which they depend functionally in many instances. The agencies mostly report to an executive board, although in some cases directly to government. In all cases where there is an executive board, this is appointed by government.
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There is no standard structure. Supervisory agencies may organize themselves so that their structure corresponds to an ’institutional’ model of integration in which they maintain divisions that relate to different types of institutions. On the other hand, they can adopt a ’functional’ organization whereby regulation is geared principally to correct specific market failures. The first of these is easier to implement, but tends to preserve the identities of their predecessors. Because of their importance, the following three issues require special attention. a) Conglomerates In most countries, conglomerates are limited exclusively to carrying out financial activities. In all the cases studied, capital adequacy requirements are set as well as limits to the excessive exposure to risk by the group as a whole. The integrated agencies in Australia, Canada and the United Kingdom have special divisions to supervise conglomerates, whilst elsewhere institutional units do so. b) Risk evaluation The objective of determining risk for banking and insurance is something that is common to most countries. Analysis for determining risk includes credit risk, market risk and operational risk. The aim of the agencies is to have a system that is applicable to all institutions. c) Crisis management All the supervisory agencies that were subject to analysis are able to intervene to resolve a crisis in an institution within their purview. In most of the countries looked at, the central bank or finance ministry also takes part in crisis management, in particular where systemic risk is present. Analysis of the advantages and disadvantages of consolidating pensions under an integrated regulator This section presents and applies the methodology proposed in Demaestri and Guerrero (2003) so as to evaluate whether it would be appropriate to integrate pensions under a unified financial regulator. The overall goals of regulation have been identified as consumer protection, systemic stability and promoting the efficiency of the financial system. Achievement of these goals is facilitated and strengthened by certain regulatory practices that can be considered sound in both contexts (integrated or
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specialized regulation) or that are particularly associated with the integration approach. The best practices that are applicable in both contexts include: x
With respect to the three goals: i) introduction of a group of limited and well-defined obligatory objectives, including the three core ones discussed here; and ii) depoliticization, financial autonomy, and the achievement of high technical capacity. The work of supervision is eminently technical and it is necessary to build up high-quality human capital and to provide it with training and continuity. Those in charge should have legitimacy (for example by means of legislative scrutiny of appointments and overlapping periods for political renewal) and a reasonable amount of autonomy (both political and financial). Political autonomy should bring stability, whilst giving the legislature the power to remove officials in instances of corruption through procedures that are simple, transparent and pre-determined. It should also involve rules and procedures to undertake investigations and disciplinary actions, maintaining the separation of these two functions.
x
With respect to consumer protection, i) the legislation should specify that the regulator has a mandate to educate the public with regard to the risks and benefits of different types of financial contract, and ii) the operational procedures for regulation and the method for dealing with complaints and claims should be published.
In turn, the integration of supervision is associated with the following sound practices: x
With respect to systemic stability: i) employ a mechanism for information dissemination that involves the central bank, so as to reduce the costs of separating out banking supervision from the monetary authority; and ii) devise systems for particularly rapid dissemination in times of crisis.
x
With respect to the goal of the efficiency of the system: i) budgeting of the savings arising from the fusion of regulatory roles; and ii) setting as an objective a single risk-based system of supervision in which regulatory resources go to those areas where risk is highest.
Overall objectives of financial regulation The goal of consumer protection is always relevant, both because of the meritorious nature of some financial contracts and the externalities derived from financial intermediation for the economy as a whole. It is especially relevant when the savings being administered are of a compulsory nature (as in the case
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of pensions), are of long-term maturity (as in the case of pensions and life insurance), or where the participants are small-scale consumers of financial services. Owing to the small scale of the latter, they are less likely to acquire the information and specific knowledge required or their participation may only be sporadic, which also is a disincentive to systematically acquiring the necessary information. The mandatory nature of participating in pension schemes is designed to avoid adverse selection, (participation in insurance for old age only of “bad risks”). Here there is a trade-off in which moral hazard is present. When participation is compulsory and there are few alternatives that involve any real choice, consumers of financial services may have little incentive to understand what they are doing and therefore levels of caution may be undermined. In such specific cases monitoring has a social value. The goal of systemic stability has specific applicability in certain sectors and regions. It is to be expected that it is more important in banking and securities, where the chances of systemic crisis is greater and where the potential for negative externalities on other intermediaries and the rest of the economy is also likely to be significant. It is also more important as a goal in countries like those of Latin America, where macroeconomic instability is a more distinctive feature than in more developed economies. In the case of pensions, a systemic crisis may affect those with savings, but more directly those cohorts caught up in the period of the crisis. The longer the terms, the easier it is to isolate the risk from those cohorts that are furthest away in terms of time from accessing the benefits.12 The goal of efficiency is particularly relevant for emerging economies like those of Latin America. Both the quality of intermediation and the economic and institutional context is better in developed countries. This is also the case of the level of competition in the financial industry, and there is a presumption (usually borne out by empirical evidence) that financial markets work more efficiently. In developing countries it is expected that the degree of efficiency will be less and that the objective of improving the efficiency of the system has greater importance. This is because more efficient financial intermediaries and markets allocate capital better, evaluate projects in a more efficacious manner, and therefore contribute more towards raising overall productivity in the economy. Additionally, there is a question of scale. In emerging countries, intermediaries work with lower transaction levels, which implies higher costs than, would be the case in developed countries. Efficient financial intermediaries nurture good practice and improve the workings of economic institutions. The example of pensions in Chile is well known. Initially, when accumulated capital was scarce, most funds were invested in government bonds. As the accumulated funds continued to expand, a better functioning capital market came into being with a greater diversity of vehicles for savings. 112
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Table IV.3. Efficiency and efficacy of the integrated and specialized approaches to supervision in meeting the core goals of financial regulation in Latin America Integrated vs. Specialized Approaches Issues
Goals
Efficacy Banking, Insurance and Securities
1. Less risk of Consumer moral hazard protection Systemic stability
+/-
Efficiency
Banking, Banking, Banking, Insurance, Insurance Insurance, Securities and Securities and Securities and Pension Pension Funds Funds +/-
+
+
+
+
+
+
+/-
Efficiency of the system 2. Less chance of regulatory capture
Consumer protection
+
+
-
+/-
-
+
+
+
+
Consumer protection
+
+
+
+
Systemic stability
+
+
+/-
+/-
Efficiency of the system
+
+
+
+
Systemic stability Efficiency of the system
3. Absence of Consumer ’Christmas protection Tree Effect’ Systemic stability Efficiency of the system 4. Less chance of bureaucratic Leviathan
Consumer protection Systemic stability Efficiency of the system
5. Achieving Consumer economies of protection scale and Systemic stability scope Efficiency of the system 6. Treatment of financial conglomerates
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Integrated vs. Specialized Approaches Issues
Goals
Efficacy Banking, Insurance and Securities
7. Greater competitive neutrality
Consumer protection Systemic stability Efficiency of the system
8. Greater Consumer transparency protection and Systemic stability accountability Efficiency of the system
+
Efficiency
Banking, Banking, Banking, Insurance, Insurance Insurance, Securities and Securities and Securities and Pension Pension Funds Funds + + +
+/-
+/-
+
+
+
+
+
+
+
+
+
+
Source: Columns ’Banking, Insurance and Securities’ from Demaestri and Guerrero (2003). The column “Banking, Insurance, Securities and Pension Funds” elaborated by the authors.
Analysis of the advantages and disadvantages of integrating pension supervision At this point we turn to presenting the main results from the analysis of integrating pension supervision into the framework of joint supervision of banking, insurance and securities. Using the methodology proposed and applied by Demaestri and Guerrero (2003), we start from the results identified by these authors (in relation to the relative efficacy and efficiency of reaching the main goals of financial regulation under an integrated system of supervision and a specialized one) and extend the analysis to considering the impact of adding pension supervision. Table 4 summarizes the main conclusions reached. In each case, the results are grouped in columns, following the criteria set down by Demaestri and Guerrero (2003) (for banking, insurance and securities) adding a new column that includes pension funds. A plus sign (+) indicates advantages of this approach in achieving a set objective, whilst a minus sign (-) indicates that the opposite approach would be better. A (+/-) sign indicates ambiguity where neither approach seems better. It is worthwhile making clear that these results are strictly qualitative in character and may not be free from a degree of subjectivity. Also, the Table IV.3 does not give a weighting as to the relative importance of each question or goal. This will depend on the institutional context and other features of the country under 114
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analysis. Nor does it bring together empirical evidence as to the relative weight that each one of these and the results presented may have in specific situations. 1) Less risk of moral hazard. Discussion on this refers to the goals of consumer protection and systemic stability. In the case of the former, there is ambiguity in terms of efficacy when pensions are excluded. There do not appear to be conclusive arguments that change this finding when pensions are included. For this reason, the ambiguity remains. With regard to systemic stability, it is clear that the integrated approach is better when pensions are excluded. This result is strengthened when pensions are added. This is because the overall contribution of the pension system depends on the stability of that system, as well as the stability of banking and securities markets. In the case of banking, this is the payments system and a safe monetary refuge in times of crisis. In the case of securities it is because investment portfolios are based on publicly quoted instruments. On the other hand, the smooth working of the pension system reduces the chances of parafiscal rescue operations. 2) Less likelihood of regulatory capture. This affects both the efficacy and efficiency with respect to consumer protection. An integrated approach (without considering pensions) gives better results in reducing the chances of regulatory capture, both with respect to efficacy and efficiency. If pensions are included in the analysis, the result does not change. A bigger and more powerful regulator is more difficult (expensive) to capture (corrupt) than various smaller ones (even though once captured and corrupted the danger could be greater)13. Similarly, it could be more efficient (cheaper) to try to control against eventual capture in the case of a unified regulator than would be the case of various specialized supervisory agencies. 3) Absence of the “Christmas Tree Effect”. The superiority of integration remains with regard to efficacy in the case of consumer protection when pension funds are included. For this, it is of key importance that the goals and activities of the regulator are properly attuned to these intermediaries. The consolidation of supervision provides the possibility of refining goals, avoiding secondary objectives and maintaining the focus on the core ones. 4) Less chance of building a bureaucratic Leviathan. This has to do with the efficiency of the system. The relative advantages of both systems are ambiguous, both with regard to efficacy and efficiency when pensions are excluded. The inclusion of pensions increases the doubts about integration. The risk of creating a bureaucratic Leviathan increases when the supervision of pension funds is included.
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5) Achievement of economies of scale and scope. When pensions are not included, there was a definite benefit in terms of efficacy and efficiency. Savings on resources increase, as do the chances of reducing the regulatory burden on the private sector. The superiority of integration is maintained or further enhanced by the incorporation of pensions. 6) Treatment of financial conglomerates. In this and the following two items all three goals of financial regulation are affected. Before including pensions, the integrated approach was more efficacious. In relation to efficiency, there were also advantages, although the result was ambiguous for systemic stability. When pensions are included, the results were the same. 7) Greater competitive neutrality. The results were similar to the preceding item since the problems are closely connected. The result was ambiguous for efficacy without pensions, but not for efficiency when systemic stability was considered. Adding pensions made no difference to the results. 8) Greater transparency and accountability. The advantages of the integrated approach were clear before pensions were added, as well as afterwards. In sum, the most conclusive results for the integrated approach are to be found with 5) achievement of economies of scale and scope; 6) treatment of financial conglomerates; 7) greater competitive neutrality; and 8) greater transparency and accountability. The only comparative advantage of the specialized approach refers to 4) the bureaucratic Leviathan. Ambiguous results remain on some points that were present before pensions were included in the analysis: 1) Less risk of moral hazard (consumer protection); 6) treatment of financial conglomerates (systemic stability); and 7) greater competitive neutrality (systemic stability). One way of evaluating the relative importance of these ambiguities about the integration of specific regulators is to assess the importance of each goal with respect to the activities that each of the intermediaries under its supervision carry out. A preliminary analysis suggests that consumer protection is particularly relevant for pensions, but is relatively less important for banks and insurance, and even less so for securities. Systemic stability is especially important in banking as well as in securities, and somewhat less so for insurance and pensions. The goal of the efficiency of the system is relevant in insurance and pensions, more relevant in banking, and less so in the case of securities. (Table IV.4).
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Table IV.4. Primacy of Core Goals in the Regulation of Different Intermediaries Core goals
Banking
Securities
Insurance
Pensions
Consumer protection (important in both developed and emerging economies).
Medium importance
Relatively low importance
Medium importance
Relatively high importance
Systemic stability (important in both developed and emerging economies).
Relatively high importance
Medium importance
Relatively low importance
Relatively low importance
Efficiency of the system (important in emerging economies).
Relatively high importance
Relatively low importance
Medium importance
Medium importance
Source: Authors’ own elaboration.
Consideration of the relative importance of each goal to each intermediary allows us to re-examine the ambiguities identified above. For instance, if we take into account the ambiguities found with respect to less incentive for moral hazard, the discussion should highlight consumer protection. From Table IV.4 we can see that this is something that is especially important for pensions, and of somewhat less importance for banking and insurance. With regard to the treatment of financial conglomerates and to competitive neutrality, ambiguities were to be found in systemic stability, a goal that has particular importance in banking. Specific aspects of pension regulation In the previous section, the integration of pension fund regulation was analyzed in the context of the discussion over regulatory integration of other financial services (banking, securities and insurance). So as to continue the study of this issue, taking into account explicitly the supervision of pension funds, this section now aims to analyze pension fund regulation. First, it explores the existing arrangements with respect to private pensions. Then it examines the objectives and instruments of pension regulation (owing to its importance a sub-section is dedicated to investment regulation). Finally, it considers the approaches followed for pension regulation. The private pension fund industry An explicit purpose of reforms to the state pay-as-you-go systems and the establishment of private pension funds have been to build financial security for
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those who have retired. This has involved making use of professional intermediaries to achieve higher rates of return consistent with prudent levels of risk. Supervision of pension funds involves multifaceted connections between the social security system and financial markets, especially that of insurance.14 This is because pensions are long-term contracts frequently based on tax incentives and subject to eligibility criteria set down in social security legislation. In accordance with the taxonomy of the OECD, pension funds can be public or private, mandatory or voluntary, with defined contributions or defined benefits, and occupational or personal. It is helpful to classify pension funds by their governance structure into four types, as does Rocha et al. (1999): x
Accounts in banks or insurance companies.
x
Participation in insurance company funds.
x
Accounts with pension fund administrators.
x
Foundations, trusts and mutual arrangements.
Most of the pension schemes that exist in Latin America come under one of these headings, particularly the last two. Accounts in banks and insurance companies are common in developed countries. A fund member has an insurance contract to provide for his pension. These funds have defined benefits and are treated more or less as a deposit, although many carry additional restrictions and performance conditions. In some cases, the only distinction between pension accounts and other types of deposit is the tax status of the account (income tax exemption up until the pension funds are withdrawn). The quality of corporate governance and administration depend basically on the quality of the institution and the regulatory framework in force for banks and insurance companies. There is no clear segregation of assets with respect to other products on offer. Participations in insurance company funds are allowed in some OECD countries. This type of fund is set up with a separate profit-making firm with shareholders and plan participants. There is a board of directors, but those buying into the fund are not represented on it unless they are also shareholders. The fund is constituted separately from other accounts. However, this type of fund also has the problem of the lack of any segregation of assets (between participants and shareholders). Pension fund administrators are the only form of pension provision allowed in the majority of Latin American countries that have private pension systems. Brazil is the most notable exception here. They operate basically as 118
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mutual funds without the right to vote. They have defined contributions, although the regulatory framework frequently imposes some performance conditions on the asset administrator. The quality of the governance and intermediaries depends basically on the legal and regulatory framework incumbent on the administrators. Transfers between funds are usually allowed, although restrictions and penalties may apply. In relation to the two previous categories, they tend to be more transparent and there is a clear segregation of assets since the assets of the funds have to be maintained separately from those of the administrator. A major problem that has arisen in most countries has been the high cost of administration, in part owing to the marketing techniques used, illegal sales practices and excessive transfers of those affiliated from one administrator to another. Regulation and supervision have tried to tackle these problems, but only to a limited degree of success. Foundations, trusts and mutual arrangements are very common in OECD countries. Normally they are occupational, but may also be open. They can be both with defined benefits and defined contributions. The problem of agency is normally mitigated by three factors. First, employer management is usually a member of the plan and has an interest in how it is managed because it includes its own retirement pensions. Secondly, employers habitually compete in the labour market offering a package of benefits and lose competitiveness if the value of the benefits on offer fall owing to poor fund administration. Third, the boards of directors of many occupational funds with defined contributions represent both employers and employees, encouraging the alignment of investment policies with the interests of the members of the plan. In the case of plans with defined benefits, the employer normally guarantees the defining of the benefit and also makes contributions into a guarantee fund. This provides an incentive for the employer to interest himself in the performance of the fund, since poor performance will increase his costs. Goals and features of pension regulation (what to regulate?) In general terms, the regulation of the pension industry is guided by the same regulatory objectives of other financial segments. However, the regulatory framework for pension funds involves consideration of their special features in covering social objectives, namely the provision of retirement income. They are considered as a merit good, and for this reason attract tax advantages. Participation tends to be mandatory so as to avoid moral hazard.15 Finally, pension schemes have a degree of regulation that, depending on the circumstances, is either more reactive or proactive. Insurance and pensions to some extent have a shared logic with respect to liabilities and coverage. In life insurance companies, the portfolio is made up of
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assets to cover obligations to policyholders plus the capital of the company. Debts depend basically on actuarial calculations based on mortality tables and assumptions about the return on assets. Errors in such assumptions and calculations are sources of risk. Sometimes, life insurance companies have faculties to issue their own debt in order to fund themselves. The risks they run concern their projections of mortality, the discontinuation of policies, their liquidity and investment (Davis, 2001). Pension funds with defined benefits are similar in their logic to insurance contracts. There exists a category of actuarial risk, even though if participation is mandatory there is no risk of the policy being discontinued. On top of the actuarial risks, there is the risk that increases in the real incomes of the participants may increase the replacement rate (income after retirement/income while in work) that is required. By contrast, funds with defined contributions have as an objective the maximization of returns subject to a given risk, reaching the highest possible replacement rate. Investment risks are present in both forms of pension fund, but only those with defined benefits can be transferred to the net worth of pension fund shareholders In this way, the schemes with defined benefits have similarities to life insurance companies, and those with defined contributions to mutual funds. Other differences are that pension funds do not necessarily have a capital base like an insurer, for whom excess returns on portfolios turn into profits for life insurance companies (Davis, 2001). Pension funds are subject to risks that are common to other financial intermediaries: investment risks, agency risks and systemic risks. The objectives of regulation have to do with how best to confront these risks. Investment risks have elements capable of being diversified and market elements (macroeconomic) that cannot be diversified. An appropriate degree of diversification of a portfolio will tend to eliminate the risk that is diversifiable, whilst maintaining market risk. One of the key aims of regulation is to encourage the diversification of portfolios. Funds are almost exclusively occupied in strategies to optimize their portfolios, focusing on diversification, selection and exploitation of premiums, rather than seeking profit from the spreads between rates or the administration of exposure to liquidity. Regulators have to ensure that the potential for diversification in a portfolio is exploited to the full extent. Non-diversifiable or market risk arises with pensions because the efficient allocation of risk between generations cannot take place (current generations cannot negotiate with those that have not yet been born). This can only be
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reduced by dividing up the risk and to share in the returns to investors over the long term. One of the ways of diluting non-diversifiable risk in pensions is through a “multipillar” or “multitier” system. Other ways to deal with it are to introduce the definition of benefits, to offer guarantees with respect to yields or minimum benefits, and to introduce variable annuities or a sequence fixed annuities. Agency risk appears when the interests of fund administrators and managers are not properly aligned with the interests of fund members. It may arise from incompetence, inefficiency, negligence or fraud. Agency risks appear because transactions take place between parties with different levels of information, leading to problems of moral hazard and adverse selection (hidden actions and characteristics). Interventions to limit agency risks take the form of prudential regulations and guarantees applied to financial markets and intermediaries. They include the following objectives: x
To avoid fraud arising from the manipulation of accountancy and auditing standards through the dissemination of information and rules against insider trading.
x
To reduce over-exposure to specific risks by requiring minimum levels of diversification with regard both to the issuer and the instrument.
x
To mitigate conflicts of interest by placing limits on self-investment.
x
To limit market powers by restricting concentration in the ownership of shares.
Finally, systemic risks arise out of the nexus between the pension industry and the rest of the financial system (and the economy as a whole). While pension funds are not subject to systemic runs and consequent bankruptcies, they can still suffer the effects of a financial crisis through other channels. In particular, they can experience rapid falls in the nominal and real value of their portfolios. The calming effect of having holdings over long periods can generally be taken for granted, although it should be recognized that fluctuations in asset prices can lead to differences in average returns and renewal rates among cohorts with the same level of income. Evasion or avoidance (elusion) of contributions is also a possible consequence. They can fall victim to negative externalities from other areas of the financial system and economy. Investment in capital markets depends crucially on possibilities of safe exit from liquid monetary markets. Following Demarco et al. (1998), the following are typical components of pension fund regulations:
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a) Criteria for licensing and authorization. b) Rules on governance. c) Rules concerning the segregation of assets and independent custody. d) External auditing and actuary. e) Requirements regarding dissemination of information. f) Regulations about investments. g) Guarantees, minimum capital and reserves. h) Regulations regarding costs and commissions. a) Licenses: those systems that use the trust/foundations impose more lax rules and rarely require minimum levels of capital or reserves. They seek to minimize costs and barriers to entry so as to attract participants. In Latin American the requirements are higher and minimum capital is required. In the United States, no specific license is required for occupational pension funds. These are built on the basis of contracts between private parties and do not have to receive approval from state authorities. The only action that resembles a license is the request to the tax authorities for preferential tax treatment. Although this is normally conceded, it is discretional. Many other OECD countries fit into this category (Demarco et al., 1998). b) Rules on governance: the same provisos apply as in point 1. c) Segregation of assets: the degree of segregation differs according to the typology of pension funds. In Latin America, it tends to be at its highest. d) External auditing: This is required in all countries, though its scope varies a great deal. Auditors should inform the regulators of problems that they find and are legally responsible if they fail to do so. External actuaries fulfil a similar role in schemes with defined benefits or defined contributions with guarantees. e) Requirements on information dissemination. OECD countries, with the occupational and closed systems, tend to be comparatively less demanding than new mandatory systems. f) Regulations about investments: there are two criteria: the ’rule of the prudent man’ (OECD), versus ’quantitative and draconian’ (Latin America). The first is minimally intrusive in the formation of a portfolio, whilst the second typically includes limits in the holdings of the issuer, types of instrument, risk,
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concentration of ownership and asset type. Owing to its importance, this point is dealt with below. g) Guarantees, minimum capital and reserves. It does not make a lot of sense to refer to the concept of capital in relation to funds constituted as trusts, foundations or those with defined contributions. If a fund has an explicit obligation to produce minimum returns, then it becomes essential to impose capital requirements commensurable with the obligation. Some countries have introduced schemes with guarantees, but these imply that thought is given to viability, costs and incentives. Relative guarantees are usually far from ambitious and do not appear to create financial problems of moral hazard. However, they are blamed for herding behaviour in those countries where they are adopted. Absolute guarantees raise more substantial problems about sustainability and incentives. h) Regulations regarding costs and commissions: these are a common feature in Latin America and the countries of Eastern Europe. Systems based on trusts generally do not explicitly regulate charges. The systems that typify the OECD have lesser marketing costs. In the new schemes in Latin America and Eastern Europe, competition for participants is left to a group of providers with incentives to win over participants from other operators. As investment regulation (as we shall see) leaves little scope for the differentiation of portfolios, the need of administrators to differentiate their products generates substantial costs in marketing, advertising, direct sales and commercial networking (Ferro, 2003). Investment regulations In the OECD countries, the criteria adopted for regulating investments are more lax than in the new private pension systems of Latin America. Although there are important variations between them, the OECD countries (of which the purest examples are the United States and United Kingdom) tend to rely on a form of asset regulation that has an important self-regulatory component (the rule of the prudent man). Portfolios are not subject to limitations; rather there is a general obligation for those administering investment portfolios to work with prudence, aptitude, probity and responsibility. Fund managers are expected to use fund resources with the same diligence that they would use their own money (the incentive so to do increases when fund managers, as employees, contribute to the same fund). There are those who operate their own portfolio selection, and those that subcontract to mutual funds. The ’rule of the prudent man’ is more common among pension funds than life insurance companies. Only the United States, United Kingdom and Holland use ’the rule of the prudent man’ for both institutions. Canada, Finland, Italy and Japan use it only
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for pension funds. In Germany and Switzerland neither follow the “prudent man”. (Davis, 2001). The other way of regulating assets involves quantitative controls, with ceilings for different types of asset and their distribution across a portfolio, floors for risk qualification, etc. It is common to employ differential treatments. These tend to be favourable in the case of public sector bonds, but less so in the case of foreign assets. Almost all the regulatory systems in Latin America include five types of limits on assets: x
Ceiling on asset types.
x
Ceiling on ownership concentration.
x
Ceiling by issuer.
x
Ceiling on the proportion of certain instruments within a portfolio.
x
Floor for risk qualification.
The limits on investments are established because of the existence of possible conflicts of interest. These limits are fixed by type of asset, by issuer, and by category of risk (established by the regulatory agency or private risk assessment agencies). With regard to asset type, some OECD countries (Australia, Belgium, France, Germany, Italy, Japan, Sweden and Switzerland) set portfolio limits of one sort or another. In others (Canada, Denmark, the United States, Ireland, Holland and the United Kingdom) there are no quantitative restrictions. However, funds are obliged to invest on the basis of prudence. The limits by issuer are designed to avoid investment concentration and the risk associated with it. Limits on risk are designed to avoid assets of poor credit quality. Finally, the fourth limitation prohibits investment in assets in companies with close ties to the administrator (Shah, 1997). With quantitative regulations, attention is focused on the investment itself. This is related to the continental legal tradition. The 'rule of the prudent man' focuses on the process by which an investment is made. The proof (of good performance) is the behaviour of the asset manager, the institutional investor and the process of decision-making. The rules governing decision-making tend to be accompanied by the presumption (explicit or implicit) that the diversification of investments is a key indicator of prudence (Davis, 2001). In regulatory contexts of 'the prudent man', it tends to be the case that the distribution of shares within a portfolio is relatively important (and pension
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funds hold a major proportion of total shares in the economy, a third in the case of the United Kingdom). Shares tend to have a higher return and more marked volatility than assets with a fixed yield. Consequently, these portfolios tend to perform better on average than those subject to quantitative regulations. Quantitative regulations include limits on building up portfolios with assets considered illiquid (like real estate) or relatively volatile (like shares). At the same time, the bias towards public sector bonds is connected with the introduction of a capitalization system to replace or complement a pay-as-yougo system. This means that resources from the latter will be quickly capitalized whereas the obligations contracted by the pay-as-you-go system will be maintained possibly for a generation. This involves a fiscal gap and the idea is that this can be filled through public debt acquired by the new private administrators. In fact, the regulatory suasion exerted by regulators on pension administrators to invest in public debt has no additional justification at all.16 With regard to foreign assets, the limits imposed on investing abroad provide domestic protection to those in need of funds by limiting the universe of options for local pension funds to domestic assets. Advantages and disadvantages of the two schemes The ’prudent man’ approach implies greater institutional development, selfregulation, good practice, and the ability to settle disputes in the courts. It is superior in as much as the ultimate goal of a system of capitalization is the management of portfolios that generate savings for use in old age. A portfolio with a higher yield results in a higher pension. Quantitative regulation in countries where capital markets, institutional practices and the court system are weaker imposes stricter controls, especially if the number of intermediaries involved is small. However, it has undesired effects since the optimization of risk/yield in portfolios will not square with what models for portfolio selection in the financial economy would recommend. Portfolios are chosen from a sub-optimal universe, with greater risk per unit of yield or lower yield per unit of risk. By eliminating or severely restricting certain asset classes from selection, it reduces the chances of finding assets with the opposite correlations that are needed to achieve adequate diversification17. At the same time, where there is quantitative asset regulation, the attempt to achieve greater uniformity while seeking greater regulatory control over the industry. In this sense, policy becomes "a contributor, an administrator, and a fund". This makes it harder to take advantage of differences in affiliates’ preferences that could otherwise have been the case if every administrator was allowed to offer, for example, an aggressive fund (better for young people and
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those less risk-averse) alongside a more conservative one (designed more for older and more risk-averse people). Is it possible to determine the net superiority of any one system? Both systems have strengths and weaknesses. There is a degree of consensus in the literature on the extent to which experience, institutional improvement and the passage of time lead to a shift from quantitative regulation towards ’prudent man’, easing the restrictions on assets, allowing more shares and foreign assets in portfolios, and offering a wider range of options to participants. It is extremely unlikely that regulators can systematically undertake the task of estimating the frontier of efficiency for portfolios any better than professional fund managers without restrictions. The regulation that seeks to encourage optimal portfolio performance implies very strict control being exercised over private investment administrators, with the state taking on a major responsibility for the results. A rather less ambitious objective than direct controls on investments might be simply to set a maximum limit to the risk of a fund portfolio.18 Even so, this is not an easy way to regulate the risk of a portfolio overall. Regulators in practice may try to restrict altogether investments in certain types of securities, or to limit them to a certain proportion of investments allowed. Under such restrictions, portfolios would be built up with interestbearing securities and which are highly correlated. By eliminating the possibility of combining less correlated assets, most of the opportunities for reducing risk and increasing returns would also be eliminated.19 If regulation prevents the selection of certain assets on the basis of their individual risk, the possibilities for reducing risk across a portfolio are eliminated. Additional restrictions that concentrate investment in even more highly correlated assets mean that the frontier is shifted further away from the region of maximum efficiency, the opposite of what is desired. Similar undesired effects arise by restricting assets such as stocks of companies where the capital is highly concentrated in few owners or that are affected by low rotation.20. Once again, such restrictions as they are tightened remove investments disproportionately from the frontier of efficiency, perhaps even making it impossible to build up an efficient portfolio.
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Why do regulators impose limits on investments? It is possible that the use of these sorts of restrictions arises from the extension of prudential regulation for banking or insurance (which correctly stressed the need for adequate solvency and liquidity to cover a predetermined level of liabilities) and extrapolating them to pension systems with determined contributions whose aim is to optimize the trade-off between risk and return. However, this sort of extrapolation is mistaken. Restrictions do not necessarily produce a ceiling on risk. On the contrary, they can cause a disproportionate loss of anticipated income, while it is by no means clear that the portfolios that result would be less risky. Problems of agency may require strong prudential regulation in less developed markets and may justify direct intervention in investments. If this is the case, a similar sort of regulation should be brought to bear on mutual funds and insurance (Shah, 1997). However, here the specificities of the pension industry come into play. The higher volumes involved, as well as the mandatory nature of pensions, may be factors that explain the setting of limits. However, the optimal choice between yield and risk is thus abandoned with quantitative portfolio regulations, because apparently it is more important to deal with agency risk arising from the mandatory nature of participation, the meritorious character of pension provision and the scale that the system acquires with the passage of time and the build-up of assets. Schemes for pension regulation (how to regulate?) Supervision of pension funds can, in general terms, be characterized by two basic models (Demarco, Rofman and Whitehouse, 1998): proactive or reactive. The basic difference between these two styles of supervision arises from the way the industry is organized. In developed countries, there are a greater number of funds, less intrusive practices in occupational pension systems, a higher level of development in both capital markets and legal systems, asset administration through other financial intermediaries that are already highly regulated (banks, insurance companies, securities firms), and well developed practices of independent auditing. This is not the situation in Latin America. The reactive approach, applied principally in developed countries, is based on self-regulation with much less detailed prescriptions from the regulators. The proactive model is associated with systems that are based on a small number of open funds like those that operate in the majority of Latin American countries. The regulators adopt a more interventionist stance. In general, the proactive
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approach involves detailed regulation of most of the activities of pension fund administrators. The reactive approach is associated chiefly with occupational systems organized as trusts and foundations. Typically, they are voluntary pension systems and ones based on employment. There are a large number of funds operating and higher levels of competition. They focus mainly on corrective measures. The regulator intervenes only when problems emerge, operating more in a remedial capacity. The system is based on trust that other participants will carry out monitoring and that will act upon it when the rules are broken. It presupposes a certain level of institutional development (audits, courts, etc) to help reinforce the exercise of market disciplines. Extending the analysis of advantages and disadvantages of integrated supervision, taking into account the peculiarities of pension funds As made clear above, the justification for regulating financial intermediaries stems from market failures or from the fact that certain products or sub-products of financial intermediation are merit goods. The more ’special’ or ’unique’ the intermediaries or their activities seem to be, the more reasons there appear to be to have specialized supervision. Similarly, the more similarities there appear to be between different sorts of business, contracts and financial intermediaries, the more the reasons to have an integrated system of supervision. What specific characteristics do pension funds have vis-à-vis other intermediaries that might justify the need for specific analysis of the advantages and disadvantages of integration over and above those for intermediaries dealt with above? Parting from the analysis in the previous section, some peculiarities can be identified on the basis of these four aspects:
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x
Importance of regulatory objectives (Need to protect a captive and not very sophisticated consumer of what is considered a merit good).
x
Legal status of pension funds. (Pension funds involve contracts that combine insurance with closed mutual funds or with high exit costs).
x
Taxonomy of the funds (Regulatory treatment of private funds, mandatory and with individual personal accounts).
x
Ways in which funds are regulated (Shift emphasis from conduct of business regulation towards reactive prudential regulation).
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In what follows, the methodology proposed in Demaestri and Guerrero (2003) is used to analyze these aspects with a view to the efficacy and efficiency of the integrated versus those of the specialized approaches in achieving the core objectives of pension supervision and that of other financial services. Table 6 summarizes the main findings. Once again, it is worth making it clear that the analysis is basically qualitative and that consequently it does not involve empirical measurement of the relative importance of the aspects under consideration or of the regulatory objectives involved.21 The first objective relates to market failures and the substantive regulatory goals relative to mandatory participation, pensions as a merit good and the fact that consumers of financial services are relatively unsophisticated. This is important for the core goal of consumer protection and relates to the efficacy and efficiency of regulation. An integrated agency with adequate legal powers and highly qualified staff would appear to be more efficacious than a specialized agency with less reach and more specialist staff. However, it could be argued that a specialized regulator could put more determination into protecting small-scale savers, who are captive and ill informed, than could a mega-regulator. The latter may have wider powers but has not only to concern himself with the protection of small-scale clients, but also has to protect savers, investors and consumers of financial services that are provided by more complex institutions that may eventually turn into conglomerates. Given these two arguments, the efficacy of the integrated approach is rated as ambiguous (+/-). However, with regard to efficiency, the correction of this ambiguity would be less costly under an integrated system. The costs arising from introducing changes in an integrated entity (including among key objectives the protection of pension fund contributors, the allocation of trained staff for supervisory functions) would be less than those arising from the need to analyze and control the chances of regulatory arbitrage and supervising appropriately how pension funds are managed within financial conglomerates. The second aspect relates to the legal profile of pension funds. Internationally, pension funds take a range of forms, from those that are not very specific, such as trusts, foundations and mutual arrangements, participation in insurance companies to those that are highly specific, such as individual accounts in fund administrators. If the veil of the legal formality is removed, we see that the funds are basically contracts that combine savings with insurance in mutual funds, where participation is either compulsory or voluntary but where the cost of withdrawal is high. Analysis of the advantages or disadvantages of integration rests on the efficacy with which the core goal of consumer protection can be achieved. An integrated agency that regulates securities, banking and insurance would be better placed to regulate mutual funds than a specialized one. For reasons of scale, then, to avoid regulatory arbitrage and to
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cope with the activities of multi-intermediary and multi-product conglomerates, it would be better to have an integrated regulator that takes charge of pension funds as well. The third aspect has to do with the taxonomy of the funds as to whether they are private, mandatory, and personal and have defined contributions. Here, the core goal of consumer protection is in play with regard to the efficacy of the approach adopted. This combination approximates to that of the pension fund administrators, the form most common in Latin America. The main exception to the rule is Brazil where occupational funds predominate. It was mentioned in the previous point that the juridical form a pension fund takes makes no difference to the need to have integrated or specialized supervision. But as before, it is more efficacious for consumer protection to have a powerful integrated agency with a purview over all financial intermediaries where highly qualified staff can be amassed. In the specific instance of plans with defined benefits, a point arises with respect to systemic stability. With defined benefits, there is a potential for a parafiscal rescue if private funds are hit by a crisis. Here there is an argument similar to that of having a lender of last resort for banking. With respect to systemic stability, the system gains in efficiency when there is integrated financial supervision. The way in which funds are regulated (prudential or conduct of business, proactive or reactive) is related to the efficiency of the financial system. Performance regulation is justified in situations where the institutional development is poor and the proactive approach suits those situations where the system is organized in pension fund administrators (few intermediaries). However, both performance regulation and the proactive approach (which are related to one another) can be seen as transitional towards the point at which institutions work better, experience of systems is built up and markets and instruments become more fully developed. At that point, it would be preferable to move towards forms of self-regulation, promoting the exercise of market discipline and supervising those areas where market failures persist. If supervision has to pass through a period of performance control and has to be proactive, it would seem more efficacious to have an integrated agency. However, since this is a transitional phase, it might be more efficient to pass through it with a specialized entity that would then disappear. Nevertheless, this type of regulation is costly. Taking into consideration both of these lines of argument, the efficiency of integration is ranked as ambiguous.
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Table III. 5. Efficacy and efficiency of the integrated approach to supervision in achieving specific goals of pension regulation in Latin America Issues
Goals
Efficacy
Efficiency
Integration of Banking, Insurance, Securities and Pension Funds
Integration of Banking, Insurance, Securities and Pension Funds
1) Regulatory objectives: Need to protect a captive unsophisticated consumer for a good considered meritorious
Consumer protection Systemic stability Efficiency of the system
+/-
2) Legal profile: Pension funds involve contracts that combine insurance with closed mutual funds or with high exit costs
Consumer protection Systemic stability Efficiency of the system
+
3) Taxonomy of the funds: Regulatory treatment of private funds, mandatory and with individual personal accounts
Consumer protection Systemic stability Efficiency of the system
+ (with defined contributions)
4) Forms of regulation: Shift emphasis from proactive performance regulation to reactive prudential regulation
Consumer protection Systemic stability Efficiency of the system
+
+ (with defined benefits)
+
+/-
Source: Authors’ own elaboration.
Table IV.5 summarizes the main results of the qualitative analysis undertaken on the advantages and disadvantages of integrating pension supervision regarding the four specific issues raised about: i) the importance of regulatory objectives, ii) the legal profile of pension funds, iii) the taxonomy of the funds, and iv) the way in which funds are regulated. They emphasize the greater efficacy of the integrated approach to supervising pension funds with respect to achieving the goal of consumer protection, the legal profile of the funds and their taxonomy (especially funds with defined contributions), and with respect to increasing the efficiency of the system, the ways in which funds
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are regulated. Table IV.5 also shows the greater efficiency of the integrated approach to supervision relative to consumer protection vis-à-vis regulatory objectives, and to systemic stability vis-à-vis questions associated with the taxonomy of funds. On the other hand, ambiguities are revealed with regard to the advantages and disadvantages of integration versus specialization. One of these relates to the efficacy of integration with respect to regulatory objectives. The other relates to the efficiency of integration with regard to the goal of systemic stability regarding the forms of private pension fund regulation. Once again, it is worth making it clear that this is basically a qualitative analysis and consequently it does not present an empirical evaluation of the relative importance of the issues selected nor the supervision goals under consideration. It is therefore not possible to reach a definitive conclusion about the predominance of positive evaluations (+) over ambiguous ones (+/-). Nevertheless, from the point of view of qualitative analysis of the matters summarized in Table IV.5, we can conclude that the integrated approach to financial supervision is superior when we look at aspects specific to pension supervision. Conclusion This study aimed to analyze the advantages and disadvantages of integrating pension supervision with other financial activities and services (banking, insurance and securities). We aimed to contribute conceptually to the implementation of reforms in financial supervision and in pension systems in Latin America. An analysis was undertaken of the advantages and disadvantages of integrated versus specialized supervision, with emphasis on the specific nature of private pension systems and the situation in Latin American countries. Taking into account a number of aspects related to financial supervision, we analyzed the relative efficacy and efficiency of integration in light of the quest for three core objectives: i) protection for the consumers of financial services; ii) systemic stability; and iii) development of the efficiency of the system. The analytical approach was basically qualitative, and consequently there was no quantification of the issues discussed, and no opinion given as to their empirical magnitude. It makes sense to regulate financial intermediaries in general, and pension funds in particular because of the need to deal with market failures (notably informational ones) and because certain products have the status as merit goods. Regulation has the potential to improve on markets with failures, but it was recognized that this is conditional on the quality of the regulation and that many practical problems may cost less than trying to correct them. 132
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The main factors that have encouraged the integration of financial supervision in many countries of the world have been financial innovation, the quest for economies of scale and scope, the rise of financial conglomerates, the search for consistency in regulation, the presence of ’gray areas’ between the attributions and faculties of specialized regulators and the increased globalization of banking. Differences and similarities were highlighted between pension funds and other financial intermediaries with regard to the nature of their business, the kind of contracts that they produce, the maturity of debts and credits, and the sort of risk management that they undertake. A taxonomy was developed. The main arguments in favour of integrated supervision are the achievement of economies of scale and scope; the growing dominance of financial conglomerates and the lack of clarity in the frontiers between products; the search for competitive neutrality; and the growing transparency, accountability and coherence of the regulatory framework. The most conclusive results of the analysis of advantages and disadvantages of integrating pensions into a single regulator along with other financial intermediaries was the superiority of the integrated approach in achieving economies of scale and scope, treatment of conglomerates, greater competitive neutrality, and greater transparency and accountability. The only comparative advantage for the specialized approach seemed to be the lower chances of creating a bureaucratic Leviathan. The results were ambiguous on some points, as they were before pensions were included in the analysis: the approach gives rise to less moral hazard (an aspect tied to the efficacy of promoting consumer protection); the relative treatment of financial conglomerates (with respect to the efficiency of encouraging systemic stability); and greater competitive neutrality (with respect to the efficacy of enhancing systemic stability). So as better to understand the significance of these ambiguous findings, we analyzed the importance of each objective vis-à-vis the respective intermediaries. Consumer protection is particularly relevant for pensions, but also for banking and insurance, whilst of lesser importance for securities. Systemic stability is especially important in banking, although also in securities while less so for insurance and pensions. The goal of financial efficiency in the system is particularly important for banking, less so for insurance and pensions, and is relatively less significant for securities. The last of these, highly dependent on the context, becomes increasingly important the lower the degree
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of development of markets and institutions, the lower the scale of operations, and the greater the pre-existing distortions. In order to detect those particular aspects of pension funds that might affect our conclusions, we deepened the analysis of the pension market and the special characteristics that the pension funds have as financial intermediaries. We examined the goals and instruments for regulating these intermediaries (what they regulate and how). A distinction was drawn between “reactive” types of supervision, common in OECD countries and which focus on prudential regulation and problem solving, and the 'proactive' schemes common among the new systems in Latin America and some countries in Eastern Europe. By studying the peculiarities of pension funds and their regulation, we were able to confirm the validity of conclusions reached earlier. And, despite encountering some ambiguous situations, we were able to underline a number of relative qualitative advantages of integrating the supervision of financial services, including those related to pensions in countries with characteristics similar to those of Latin America. In any case, it is worth reaffirming that the quality of the institutional context, as well as the introduction of sound regulatory practice which we described in the analysis of the advantages and disadvantages of consolidating pensions in an integrated regulator (Point 4), constitute preconditions for maximizing the full potential for integration and minimizing the downsides that may arise.
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NOTES
1.
It is estimated that pension funds in Latin America, North America and Europe accumulated more than USD 8 billion in 1998.
2.
A distinction can be drawn between regulation (the establishment of norms of behavior), monitoring (observation of compliance with those norms) and supervision (more general observation of the behavior of financial firms). In line with other authors, the terms are used interchangeably in this study.
3.
The methodology suggested is similar to that used by Demaestri and Guerrero (2003).
4.
Given the approach adopted here, the problems addressed are not quantified. Consequently, no opinion is given as to the empirically quantifiable magnitude of the issues discussed.
5.
It should also be appreciated that some problems may be of lesser importance than the potential costs of correcting them through intervention.
6. 7.
This section is based on Ferro (2003). Adverse selection implies that the participants with largest risks would be voluntarily over-insured and those of less risk under-insured. Juridical forms which carry out at least two of the principal financial activities.
8.
9.
This section is based on Demaestri and Guerrero (2003).
10.
Demaestri and Guerrero also discuss the merits of keeping banking supervision with central banks. They identify as “pros”: i) the lender of last resort has an interest in minimizing the costs of systemic crises through banking supervision; ii) the merging of activities reduces problems of coordination; iii) more information and tools at the disposal of the banking regulator; iv) concentration of high skilled human capital in one institution. As “cons”, they point out: i) in many Latin American countries, banking supervision is already divorced from the central bank; ii) conflicts of interest between monetary policy and supervisory roles; iii) a central bank with more duties increase the risk of political pressure (political pressure on monetary policy can be extended to banking supervision and vice-versa). This section is based on Demaestri and Sourrouille (2003).
11.
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12.
Davis (2001) suggests some responses to help protect those who are directly affected by a systemic crisis.
13.
Public scrutiny of a unified entity would be more searching than of various specialized ones.
14.
Pensions and insurance have various characteristics in common, as discussed below.
15.
He who does not contribute may claim assistance on retirement and charge the system for his lack of foresight. As pensions are considered a merit good, the way to obviate such opportunistic behavior is to make the system mandatory.
16.
In line with the objective set out at the beginning of IV.1
17.
The general idea is that the benefits from diversification are not fully realized. The core goal of investment policy consists in establishing an optimal trade-off between risk and return by means of an appropriate degree of diversification. This involves achieving the frontier of efficient portfolios in the area of risk/yield. Any other portfolio is less desirable (Davis, 2001).
18.
In the language of the world of two parameters, this involves placing a vertical bar in the quadrant for opportunities and avoiding all portfolios to the right of it.
19.
This is because the portfolio risk is not the sum of individual risks (standard deviation of the return of an asset examined over a period of time), but rather that each asset contributes to the overall risk in as much as it co-varies with the aggregate risk.
20;
The effects of creating ceilings for certain types of investments (for instance limiting the percentage of shares) can be represented graphically as vertical limits on investment possibilities.
21.
Qualitative judgements with a different level of subjectivity, as well as different weightings of the relative importance of different aspects analyzed in different contexts to those raised here, could lead to less conclusive results as regards the relative advantages of integrating pensions into a unified financial regulator.
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BIBLIOGRAPHY
Bebczuk, Ricardo (2000). Información Asimétrica en Mercados Financieros. Introducción y Aplicaciones. Madrid, Cambridge University Press. Davis, E. Phillip (2001). Portfolio Regulation of Life Insurance Companies and Pension Funds. OECD. Demaestri, Edgardo and Federico Guerrero (2003). The Rationale for Integrating Financial Supervision in Latin America and the Caribbean. Sustainable Development Department. Technical Papers Series. IFM-135. Inter-American Development Bank. July. Demaestri, Edgardo and Diego Sourrouille (2003). Integrated Financial Regulation and Supervision: Experiences in Selected Countries. Sustainable Development Department. Technical Papers Series. IFM-139. Inter-American Development Bank. December. Demarco, Gustavo, Rafael Rofman and Edward Whitehouse (1998). Supervising Mandatory Funded Pension Systems: Issues and Challenges. Unpublished Manuscript. The World Bank. Ferro, Gustavo (2003). Regulación y Costos Variables Endógenos en el Mercado de Fondos de Jubilaciones y Pensiones Argentino. Documento de Trabajo CEMA Nº 231. Universidad del CEMA. Buenos Aires, febrero. Financial Services Authority (2000). A New Regulator for the New Millennium. Financial Services Authority (2000). Building the New Regulator. Progress Report 1. Jordan, Cally and Giovanni Majnoni (2002). Financial Regulatory Harmonization and the Globalization of Finance. World Bank Policy Research Working Paper 2919, October. Llewellyn, David (1999). The Economic Rationale for Financial Regulation. Occasional Paper Series No. 1. Financial Services Authority, April. Rocha, Roberto, Richard Hinz and Joaquín Gutiérrez (1999). Improving the Regulation and Supervision of Pension Funds: Are There Lessons from the Banking Sector? Social Protection Discussion Paper Series No. 9929. The World Bank Shah, Hermant (1997). Towards Better Regulation of Private Pension Funds. Economic Development Institute. World Bank, April.
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Srinivas, P, Edward Whitehouse and Juan Yermo (2000). Regulating Private Pension Funds’ Structure, Performance and Investments: Cross-Country Evidence. Pension Primer Reform. July: World Bank. Stiglitz, Joseph (1994). The Role of the State in Financial Markets. Proceedings of the World Bank Annual Conference on Development Economics 1993. The World Bank. Working Party on Private Pensions (2002). Pension Fund Supervision Supervisory Structure. Directorate for Financial, Fiscal and Entreprise Affairs. Insurance Committee. Organization for Economic Co-Operation and Development (OECD), Paris. Working Party on Private Pensions (2003). Supervisory Structures for Private Pensions. Preliminary Survey Analysis. Organization for Economic Co-Operation and Development (OECD), Paris.
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V. THE EXPERIENCE OF CENTRAL AND EAST EUROPEAN COUNTRIES ON FINANCIAL SUPERVISION by Tibor A. Párniczky
The banking and insurance sectors in Central and East European countries operated under strict controls during the planned economy era. At the time, this sector consisted of a central bank, at least one dedicated state-owned commercial bank and one insurance company to meet the needs of its citizen and to carry out state functions, such as the issuing of subsidized loans and the collection of mandatory insurance premiums. Other forms of financial institutions included savings and insurance co-operatives. The banks fell under the supervision of the central bank and the Ministry of Finance, the latter also overseeing insurance enterprises. This financial structure underwent considerable changes in the 1990s. These changes included new regulations for the introduction of financial and capital markets, the privatisation of commercial banks and insurance companies, the creation of new financial intermediaries, as well as the development of investment and pension funds. A financial supervisory structure of these institutions was created. There were initial problems in some countries where several commercial banks went bankrupt and incidents of misconduct, such as misuse of investment funds and the occurrence of pyramid schemes, linked to financial markets occurred.. The financial “losses” incurred further eroded any trust in the financial institutions of these countries. A series of reforms were thus introduced. The establishment of private pension funds (PPF) – or privately managed, non-state pension funds – was part of this reform process, or in some cases the result of reforms in the public finance sector, i.e. social security.. It was strongly advocated at the time that it was necessary to establish a single independent PPF supervisor to implement structural pension reforms. Such a supervisor would enforce:: x
strict provisions to establish confidence in the pension system;
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x
pension specific, proactive regulations with a detailed set of rules, such as qualitative rules defined by quantitative measures; and
x
centralised solutions to the pension industry to reduce certain costs for members (collection, transparency measures, etc.)
The structure of the supervisory authority differs from one country to the next due to differences in the legal environment, the development of financial markets and financial institutions, the economic background, and past experience of pension arrangements. If we compare the pension reform experiences of two sets of countries, the Czech Republic and Slovenia on the one hand, and Kazakhstan and Russia on the other, we can highlight differences in the new systems. In the first set of countries, the introduction of voluntary private pension funds, combined with parametric pay-as-you-go reforms represents a cautious approach. In the latter set ofcountries, the introduction of mandatory non-state pension funds represents a change of paradigm of the pension system. The following study will summarise the development of pension reforms in Central and East European countries according to the answers provided to the OECD-INPRS questionnaire.1 The following countries responded to this questionnaire: Estonia, Bulgaria, Hungary, Kazakhstan, Latvia, Lithuania, Poland, Slovenia, Slovakia, Croatia and also Turkey and Ukraine. Changes of supervisory agencies The questionnaire was intended to collect information for the year 2001.It should be noted, however, that a number of changes have occurred or will be introduced to the pension supervisory structure in several countries. Some of these changes will become effective in 2004. These changes are outlined below. In Lithuania, the Securities Commission (LSC) and Insurance Supervisory Commission (LISC) will cooperate in the new regime. In the Czech Republic, the present Insurance and Pension Supervision Department of the Ministry of Finance will become an independent integrated supervisory organization. Similarly, in Kazakhstan, the Financial Supervision Department of the National Bank of Kazakhstan will become a consolidated financial supervisory organisation. In Slovakia, the Financial Market Agency (FMA) will take over supervision of pension plans. In Hungary, HFSA, the consolidated supervisory body, began operations in 2000, but is subject to change its governance structure. A controlling board will replace the single elected president, who was supported by an advisory council.
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The Financial and Capital Market Commission (FCMC) of Latvia began operating in 2001. The Polish integrated supervisory body, KNUiFE, and the Bulgarian consolidated financial market supervisory body, FMC, began operations in 2002 and 2003, respectively. In Estonia, Croatia and Ukraine, the new pension system and/or the supervisory regime began operations in 2002. Functions and responsibilities There is a dedicated private pension supervisory organization in most CEE countries. In most cases it is an integrated supervisory structure, the exceptions being in Bulgaria (SISA in 2001, and Croatia (Hagena). Pension supervision is regarded as part of the financial market in Estonia (Finantsinspektsioon, FI, 2002), Hungary (HFSA), Kazakhstan (Financial Supervision Department of the National Bank, FSD), Latvia (Financial and Capital Market Commission, FCMC, 2001), Turkey (Capital Markets Board, CMB, 2001; Undersecretariat of Treasury, UT), and Ukraine (State Commission for Financial Services Markets Regulation2, SCFSMR, 2003). In countries where supervision of banks is carried out by a separate organization, i.e. the central bank, pension funds can be supervised together with insurance and capital market institutions. This is the case in Bulgaria (FMS, 2003) and Slovakia (FMA, 2004). Pension supervision is partially integrated with capital market supervision in Lithuania (Securities Commission, LSC) and in Slovenia (Securities Market Authority, SMA). Another related market might be insurance. Several countries — Poland, Slovenia (ISA), Lithuania (2004, LISC), Czech Republic — have followed this logic. Pension supervision can also be divided between agencies. Historically, this is the case where ministries of labour and/or finance (i.e. Czech Republic, Slovakia, and Slovenia) have a role in pensions. From a functional perspective, the pension fund model might be regarded as being similar to either investment funds or insurance companies. This will affect the supervisory arrangement, as is the case in Slovenia and Lithuania where two agencies supervise the two types of pension funds. In Turkey the two elements of the pension entity are differentiated in the supervisory process: the pension fund management (company) is overseen by the Treasury, while the pension plan and fund by the CMB. In a similar way, SSMC is involved in supervising investment activities in Ukraine, but SCFSMR has primary role in the supervision and regulation of pension funds. The dedicated supervisor performs most of the supervisory functions.3 The Ministry of Finance or Tax Authority is involved in qualification for tax preferences a posteriori. Enforcement of collection of mandatory contributions
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is done by a separate agency in Croatia (called Regos, and which collects all state revenues) and in Hungary (Tax Authority). The social security administrator can also be involved in only certain aspects, as is the case in Croatia and Poland. Appointment of a custodian is mandatory in these systems. The Central bank or banking supervision oversees the custodian bank, which might be, in fully consolidated cases, within the same organization. Registration of members of mandatory funds is done by the supervision in Bulgaria and Hungary; in Croatia, Regos is controlled by the pension supervisory organisation Hagena. In Estonia, the registration is done by a separate organization, the Central Register of Securities. There is a Pension Guarantee Fund in Estonia and Hungary. In Poland, it is part of the KNUiFE. General public administration procedures regulate information exchange and secrecy rules in the jurisdictions of CEE countries. Where there are market specific rules, explicit co-operation exists in countries where the financial market supervision is not (fully) integrated (Poland, Croatia), or the pension supervision is divided between two agencies (Lithuania). Other forms of cooperation might be established with Tax Authority, Central Bank, or with the Office for Consumers Protection or Competition (e.g. Hungary, Ukraine) and the Social Security Administration. Information exchange can also be established through the governance structure: for example, board members in Estonia, Croatia, Poland and Turkey represent related market segments. A similar role can be delegated to advisory councils. Legal mandates of the supervisor All CEE supervisory bodies fall under public administration procedures, except the Estonian FI. As a consequence, all relevant resolutions are issued by the same body and can be appealed (Administrative Court in Croatia, Lithuania, Poland, and Turkey) for redress. Some of the supervisory bodies have regulatory power, as opposed to mere enforcement of a body of laws. It may be part of the general mandate of the parent organisation (central bank, ministry), as is the case in Kazakhstan and Turkey. Or it may be part of special provisions in the private pension or other legislation, as is the case in Croatia, Latvia, Poland and Ukraine. Other supervisors issue non-binding good practice notes and guidelines as part of their policy (Estonia, Hungary and Bulgaria).
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Political and institutional independence The supervisory agencies of the CEE countries in the survey are established as public administration offices by Parliament, in some cases with control by or reporting to the government (Croatia, Hungary, Latvia and Lithuania). In practical terms, this means that the head of supervision is appointed by the Parliament on the proposal of the Prime Minister. In Latvia, the Parliament appoints the Chairperson and Deputy Chairperson based on a joint proposal by the Minister of Finance and the Governor of the Bank of Latvia. The head of supervision reports to Parliament, but there can be a selected minister in the government related to the supervision, usually the Minister of Finance or Labour.4 In other jurisdictions, the supervision operates under the direct control of the Government as part of a ministry or as a separate organization. In Bulgaria (SISA), Poland, Slovenia, Turkey (CMB) and Ukraine it is mainly related to the Government or Council of Ministers. Pension and insurance supervision is the responsibility of a specific department of the Ministry of Finance in the Czech Republic, and of the Ministry of Ministry of Economic Affairs (UT) in Turkey.. In Kazakhstan, the Financial Supervision Department is part of the National Bank; deputy governors are appointed by the President and department directors are appointed by the Governor. In Estonia, the Minister of Finance and the President of the Bank of Estonia are office members of the governing body of the FI; other members are appointed by the Government. Two models in particular shape the governance structure and decision making procedures. In the first model, the highest decision making body is a committee/board of commissioners or governors with a chairperson. The second model is based on the principle of responsibility being held by one person. An example of the latter is the case where supervision is part of a large organization and the head of pension supervision is the head of a division of that organization.Another example is where an independent supervisory agency is headed by a president. In Latvia and Lithuania, the supervisory agency is overseen by a decisionmaking committee or board headed by a chairperson. This board is also the highest executive body comprising all section of the commission. In Poland and Turkey (CMB), leaders of the supervision and delegates of other agencies set up the committee; in Croatia, leaders and delegated experts, and in Slovenia solely delegated experts, comprise the committee. In Estonia, the FI has two boards: the governing body5 and the management board. The governing board consists of heads and delegates of the Ministry of Finance and the Bank of Estonia, and the management board of heads of sections of the EFI.
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The single responsible person model operates in Bulgaria (SISA) and in Hungary. There are consultative councils supporting decision-making in Hungary, Bulgaria, Latvia, Turkey and Ukraine. Market players delegate representatives to the advisory councils in Latvia, Turkey, Ukraine and Hungary in compliance with the relevant law. In some jurisdictions, there are separate rules for the appointment of the head of the supervisory agency as well as for the deputy head and the directors,6 or other board members. In Croatia, Hungary, Latvia, Lithuania, and Ukraine the head and deputy head of such agencies are appointed by the same body,. In Kazakhstan, all directors are appointed by the same body. Deputies and directors are appointed by the selected head of supervision in Bulgaria (SISA), Latvia (for the other members), Poland and Slovenia. In Poland, the deputy heads of the supervision are appointed jointly by the Minister of Finance and the Minister of Economy and Labour. In Estonia, the governing body appoints the management board. The competent person or body should allow for legal requirements for the post of the head of the supervision, with the exception of Kazakhstan. Conditions are similar in every country, that is the competent person should benefit from higher education (the only requirement in Bulgaria and Croatia), management experience and enjoy a good reputation. The term of appointment is fixed between five and six year,with the exception of Estonia (three or four years), Croatia and Ukraine (seven years), and Bulgaria (SISA) where there is no limit to the contractual appointment. The conditions of removal from office of the head of the supervision are also similar in most CEE countries: (i) end of the term, (ii) resignation, (iii) cases of recall as established in the law, such as conflict of interest, incompetence, violation of rights of the supervised, or other illegal infractions, or (iv) incompetence. The appointing body may initiate the removal in Bulgaria, Kazakhstan, and Latvia. In Croatia and Hungary the decision of Parliament is needed on the initiative of the Government. Financing There are two ways to finance the supervisory operations: self-financing using supervisory fees levied on the market or from general tax revenues. Where the organization is part of the government, the latter solution comes from the general setup, like in the Czech Republic and Slovakia (before 2004), Turkey (UT) and Ukraine. Bulgaria, Croatia, Latvia (which will change to full selffinancing as of 2007), and Lithuania have started tax financing to avoid placing additional burdens on a small market. Tax financing is/was also characteristic of countries which initially implemented only voluntary pension funds.
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Supervisory fees are prescribed in market-specific legislation in the case of integrated supervision. However, as the supervisory agency is a public administration office, its budget must be approved by Parliament. This is done as part of the state budget in Hungary, Poland, Slovenia and Turkey (CMB). In Estonia and Latvia, the governing board approves the annual budget of the supervision. The budget of the Financial Supervision Department of the National Bank of Kazakhstan comes from the budget of the National Bank of Kazakhstan, which has its own separate budget. There are no supervisory fees in Kazakhstan. The national auditing office of public spending oversees the financial management of the pension supervision in Estonia, Bulgaria, Croatia, Hungary, Latvia, Poland, Slovenia and Turkey. Table VI.1. Supervisory structures in EEC countries 2001/2002
Pension funds Funds Members Assets (10 00USD)
Entity/ -ies
Supervision Employees
Budget Comments* (10 00USD)
Bulgaria
9
591 558
112 057
separate
43
299
Croatia
6
1 038 827
751
separate
40
3 770
PF data September 2003; Budget of 2002
Czech Republic
14
24 730 2 793,744
integrated
20
N/A
Pension and insurance supervisors
Estonia
19
19 346
integrated
70
4 255
Hungary
110
3 407 000 4 193 123
integrated
541
33 918
All financial sector employees
Kazakhstan
16
5 000 000
N/A
integrated
165
2 212
Financial Supervisory Department 2003
Latvia
4
17 359
55 207
integrated
88
3 590
All financial sector employees
1 290
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Single supervisor in 2001 and without voluntary funds
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2001/2002
Pension funds Funds Members Assets (10 00USD)
Entity/ -ies
Supervision Employees
Budget Comments* (10 00USD)
Lithuania
N/A
-
0
integrated
41
954
From 2004 supervision shared by LSC and LISC
Poland
17
11 060 000 9 913 072
integrated
209
7 672
After merger, without voluntary funds; 2003
Slovenia
9
81 000
158 127
integrated
25
1 587
All funds; supervision ISA other entity: SMA
Turkey
72
24 842
4 419
integrated
450+21
N/A
31.12.2003; supervision shared by CMB and UT
Ukraine
47
31 000
3 080
integrated
170
640
31.12.2003
Transparency The objective of transparency and — in support of this objective — detailed reporting regulations were included in the pension reforms of the CEE countries. As a good practice, all supervisory bodies have a stated mission statement. To be consistent with the market, the supervisory body prepares quarterly and annual reports from pension fund data. These are based on statistics and research of the market, and published on the website, a common practice throughout the region. The supervisors prepare an annual report to the controlling body as well. In Estonia, pension fund data is part of the investment fund information contained in the government’s yearbook. Other examples of disclosure policies include the publishing of the resolutions of the supervisor on investigated cases (in Hungary), or the decisions of the governing body (Estonia, Latvia) in the official government paper and on the Internet. Regular press conferences are also a widespread practice (as in Bulgaria, Hungary, Slovenia, and Turkey)
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Table VI.2 Disclosure policies in the EEC supervisory agencies Bulgaria
FSC: http://www.fsc.bg
Croatia
HAGENA: http://www.hagena.hr
Czech Republic
http://www.mfcr.cz
Estonia
http://www.fi.ee/
Hungary
HFSA: http://www.pszaf.hu
Kazakhstan
http://www.nationalbank.kz
Latvia
FCMC: http://www.fktk.lv
Lithuania
LSC: http://www.vpk.lt - LISC: http://www.vdpt.lt
Poland
I&PFSC: http://www.knuife.gov.pl
Slovenia
SMA: http://www.a-tvp.si - ISA: http://www.a-zn.si
Turkey
Treasury: http://www.hazine.gov.tr CMB: http://www.spk.gov.tr
Slovakia
FMA: http://www.uft.sk
Ukraine
www.dfp.gov.ua
Human Resources Employees of the supervisory agencies have civil servant status in the countries studied, with the exception of Croatia and Estonia where labour laws are applied. Migration between public and private sector employment is not restricted, nor specially regulated for pension fund professionals. A general rule applies to civil servants in Lithuania; according to this rule, personnel leaving a supervisory agency must wait one year before accepting employment with a company they oversawI This is also the case in Croatia and Turkey (UT) which have similar market specific legislation. Other restrictions imposed try to prevent the misuse of insider information[Latvia and Turkey (CMB)]. Heads of supervision agencies enjoy independence in defining their remuneration policy and in establishing a corporate culture for the agency, with the exception of Croatia and Ukraine where government regulations place a certain number of constraints. In most cases, the salaries of supervisory employees are comparable with the market, with the exceptions of Bulgaria, Croatia, Turkey (UT) and Ukraine. Nevertheless, it should be noted that migration between the public and private sectors is rare because of the narrow income gap between the two sectors and/or the relatively short experience of new agencies.
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Pension supervisory staff come primarily from the public administration and its predecessor organizations, especially where integrated supervisory agencies are concerned. A second important source of recruitment is the education sector, both academics and graduates. Supervisors consider continued education as an important element in developing this new financial sector. There are internal training programs, but the most frequently mentioned form is participation in international conferences, seminars and study tours. Aid from the United States, both direct and via agent organizations, the World Bank and the European Commission have supported and implemented training programs linked to pension reform. Organisation Supervisory agencies are organised in such a way that the main departments — legal, supervisory, corporate services and administration — are separate. On-site and off-site supervision is differentiated mainly in cases of consolidated supervision, especially if the structure is defined according to functional (as opposed to institutional) lines. In cases of mandatory systems and systems linked to investment funds, off-site supervision send in daily asset reporting (on-line). Specialized pension supervisors [Bulgaria (SISA), Croatia, and Ukraine] are organised according to their functions. In the new Bulgarian FSC, the Social Insurance Supervision Division operates under a dedicated Deputy Chairman and the units follow risk management functions. Many consolidated supervisory agencies have functional divisions in Kazakhstan, Latvia, Lithuania, and Turkey (CMB). In Ukraine these division are sectoral. The organizational structure of the HFSA follows the matrix principle. The main structure is developed according to functions — supervisory and legal directorates — but the departments are organized according to the financial sectors. Moreover, the sectoral chief counsellors incorporate a horizontal flow of information according to the financial sectors. Until 2004, KNUiFE (Poland) was organized by function, except for the (voluntary) Employee Pension Programs Department. This has changed to a mixed sectoral/cross sectoral structure. Estonian FSA has sectoral divisions, but the legal services are cross-sectoral. Employees come from different fields and professions – particularly actuaries – with a large variance from one country to the next. The main differentiating factors are the level and way of integration, and the status of the insurance sector.
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Table VI.3. Employment in EEC supervisory entities Total Front-line Supervisory Corporate Number Number 3 Services Number of Superisory support of of 1 2 functions employees activities actuaries Lawyers Separated agencies Bulgaria – SISA
43
23
6
12
3
4
Croatia
40
15
3
7
0
8
Bulgaria - FSC
29
7
13
N/A
5
5
Estonia – FI
70
52
4
8
0
8
Hungary – HFSA
541
325
42
172
11
110
Kazakhstan
165
132
33
N/A
0
53
Latvia – FCMC
88
50
12
26
1
13
Lithuania – LSC
41
21
10
10
0
4
208
101
35
70
4
46
Slovenia - ISA
25
19
3
3
4
4
Turkey – CMB
450
180
45
225
0
25
74
7
21
N/A
3
1
170
94
39
31
0
29
Integrated agencies
Poland – KNUiFE
Turkey - UT Ukraine
1. For example, on-site and off-site supervision, licensing, enforcement, intervention and termination. 2. For example, statistics, studies, legal and economic analysis. 3. For example, administration, human resources, budget.
Conclusions The newly established agencies are based on integrated supervision and, recently, some stand-alone institutions have been merged into integrated supervisions. In their conclusions, respondent supervisors of integrated set-ups commend the synergies and other advantages of consolidated supervision.
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The CEE supervisors deem the pension supervision legislation adequate — save minor past and planned amendments, and the overly complex supervisory and regulatory framework in Slovenia. Similarly, they are responsible for their financial resources, except for central budget-financed entities in Croatia and Ukraine. As a whole, the questionnaire did not reveal serious deficiencies in the supervisory framework of the examined countries. However, it did make clear that there are several plans and actual developments of supervisory structures throughout the region. There are noticeable tendencies in the functional structure of the supervisory agencies to provide for risk-based supervision. This might be a result of the consolidated approach, but it does not solve certain problems related to the mandatory and defined contribution features of the private pension systems.
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NOTES
1.
See Annex II.2 of Chapter 2.
2.
In Ukraine, capital markets are overseen by the State Securities and Stock Market Commission (SSMC)
3.
Questionnaire 1.3: a) Licensing/registration, b) Qualification for tax benefits, c) Compliance to governance rules, d) Contributions and regularity of payment, e) Membership and portability (enrolment process, transfers and compliance), f) Benefits eligibility conditions and access to plans, g) Investments, asset allocation, performance, minimum capital and reserves, h) Custodian procedures, i) Financial, actuarial and accounting methods, j) Administrative cost, fees and marketing, k) Disclosure procedures referring to members and beneficiaries, potential members and accounts, l) Merger and liquidation process
4.
The exact composition and names of posts may change in each country. Other board members and parliamentary committees may also be involved.
5.
Also called supervisory board.
6.
Here, heads of sections.
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VI.
SUPERVISORY AGENCIES IN LATIN AMERICA by Ana Patricia Morera Martinelli
Introduction Benchmarking studies are usually used to set goals in accordance with external rules and objectives that are established on the basis of the behaviour of entities similar to the one under study (Morell, 1995). The subject, therefore, is to determine what are the best practices in an industry that help to make it successful. This study aims to determine a benchmark for the Superintendence of Pensions of Costa Rica in order to learn more about its levels of administrative efficiency and the cost of the supervision. This type of exercise will have validity provided the comparison is made with entities that are sufficiently similar to be comparable—which for our case means that their sphere of supervision should be similar and the quality of that supervision is equivalent and yet sufficiently different to establish the efficiency and learning curve,. For this study, information was needed directly from the Superintendences with desirable comparability characteristics. It was not possible to find entities with spheres of supervision identical to those of the Costa Rican institution. We did find, nevertheless, a significant symmetry in the responsibility of the regulatory bodies. In the case of Costa Rica there are responsibilities connected with supervision of the basic defined-benefit systems, plus certain insurance services such as work-related risks and private supplementary funds of all types. A common thread was finding the scope of supervision responsibilities to be limited to the reformed individual capitalization systems. On the other hand, the employment capitalization systems have been expanded in Latin America over the past decade. It was not possible to locate significant information elsewhere owing to the absence of any supervisory body established on a clear and permanent basis.
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This study used data from the Superintendencies of Argentina, Chile, El Salvador, Mexico and Uruguay. For the case of Costa Rica, the basic and special funds were included, together with their respective administrations, in order to properly quantify the work done by SUPEN. The National Directorate of Pensions and the Work-Related Risks System were not included. This study has clear limitations that must be taken into account when interpreting its findings. This fact lessens the possibility of making direct comparisons without bearing in mind the special features of the group of entities making up the sample. Among the main limitations the following should be noted: x
The scope of the supervisory responsibilities can vary greatly between the Costa Rican bodies and their foreign counterparts;
x
The degree of development of the markets supervised also varies considerably;
x
The sample included in the study is the product of the response received from the entities consulted within the framework of a controlled initial sample;
x
The absence of more detailed information makes it impossible to take the examination of the causes of certain global indicators any further.
This study begins with a brief description of the pension systems of Latin America and some descriptive variables of each system. This is followed by a discussion of the main efficacy and efficiency indicators for each Superintendence, after which the report concludes with a statement of the findings. General Comments on the Pension Systems Basic Features of the Individual Capitalization Systems
154
x
Defined contribution systems where the workers’ contributions are deposited into individual accounts in the name of each person. In this way, future consumption will depend on the amount saved over the individual’s working life and its yields.
x
Each worker’s savings are managed through the pension funds. These are administered by specialized companies in accordance with the parameters laid down by the supervisory authority.
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x
There has to be a separation of assets between the administering company and the pension fund in order to guarantee the contributors’ ownership of the fund.
x
The workers are free to choose the entity responsible for administering their pension fund. They can also switch to another administrator if they believe their resources are not being managed properly.
x
In some cases the workers are allowed to select the form of pension they wish to receive when they retire. In general, they can choose between a life annuity or programmed payments.
x
Additionally, some systems maintain an unfunded pension plan financed from the government budget (Jaikel and Morell, 2000).
Characteristics of the Pension Systems considered Argentina The legal foundation of Argentina’s pension system is found in Law 24,241 of 1993. It is based on an unfunded plan administered by the State through the Administradora Nacional de Seguridad Social in conjunction with an individual capitalization system for which the pension fund administration bodies established for the purpose are responsible. x
An allotment system, in which payment of the sums specified up to an amount set in the Budget Law is guaranteed. The payments are financed by the contributions of the wage and salary-earning workers (11% of their taxable income) and of their employers (16% of taxable income). Self-employed workers are required to contribute 27% of their base income by category. The funding of this system also includes 100% of the tax on personal property not incorporated into the production process; 10% of VAT collections and 20% of the revenue from the tax on earnings prior to co-participation; the annual amounts set in the Budget Law plus other resources specified in pertinent legislation.
x
An obligatory individual capitalization scheme in substitution of the foregoing. These systems include a 5% contribution by the workers and 16% from the respective employers. Ultimately the insured persons have available to them the cumulative balances in their individual accounts, less the commissions charged by the administration entities.1 In addition, the returns earned from the investments made with funds’ resources are also put in.
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155
x
The third pillar in the Argentina case is similar to the foregoing, with the difference that it includes voluntary individual contributions.
In Argentina, pension contributions are obligatory for both employed and self-employed workers, who can choose between the individual capitalization and the unfunded systems explained above. The Superintendency of Administrators of Retirement and Pension Funds is responsible for ensuring the stability of the individual capitalization system. Costa Rica The Costa Rican Pension System maintains a basic defined-benefit system administered by the State through the Costa Rican Social Security Fund (CCSS). There is also an individual capitalization system, which is obligatory and supplementary to the foregoing, administered by the Operators of Supplementary Pension Funds (OPCs). The reform dates from 2000 and was introduced by Law 7983. The Costa Rican system can be summarized as follows:
156
x
The basic system is made up of the Disability, Old Age and Death System of the CCSS, or the systems replacing it for the National Teaching Profession or the Judiciary, or ones funded by the National Budget. The CCSS system is funded by the contributions of the workers, the employers and the State. In addition, 15% of the profits of public enterprises is earmarked for this purpose. The other systems receive contributions from three sources.
x
The obligatory complementary system includes the individual accounts administered by OPCs through the pension funds. The amount of the pension remains in alignment with the amount saved plus the yields from the investments made by the fund less the commissions due to the respective administrators. The contribution payable is 4.25% of the wage or salary reported to the CCSS.
x
There is also a system of voluntary individual accounts based contributions paid in by individual workers or through collective membership agreements.
x
Finally, Costa Rican legislation makes universal a noncontributory pension for persons over 65 years of age who are living in poverty. This special system is financed by the Treasury and 95% of the net profits of the electronic lottery.
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x
The Superintendency of Pensions supervises the nine operators of supplementary pensions, the five basic systems and the ten funds established by special laws.
Chile The Chilean Pension System was established by Decree Law 3500 of 1980. It is the region’s oldest individual capitalization system. Despite being a pure capitalization system it currently includes an allotment component funded by the Treasury that is scheduled to disappear over time. There is also a Stateguaranteed minimum pension that kicks in if the savings built up over at least 20 years are insufficient to cover the amount payable. Membership is obligatory for wage and salary-earning workers and voluntary for the self-employed. The system operates with a contribution of 10% of the taxable income of the month and voluntary contributions not exceeding 60 development units are permitted.2 In this case, no employer contributions are involved; employers act solely as withholding agents. El Salvador The reform of the Salvadoran system came into force in 1997 by Decree 927. There is a system of individual capitalization, membership being compulsory for wage/salary-earning workers and voluntary for those who are self-employed. The contribution required is 12.98% of the worker’s wage/salary and these contributions are managed by the Pension Administrators supervised by the Superintendency of Pensions. Mexico Mexico also set up a pure capitalization system that is compulsory for wage/salary-earners and voluntary for the self-employed. The reform entered into effect in 1996 under the Law on the Saving for Retirement System (SAR). The administration of the resources is handled by private companies known as Administrators of Retirement Funds (AFOREs), who are permitted to take care of more than one pension fund at a time. The AFOREs are supervised by CONSAR. Uruguay A system of a mixed type similar to that of Costa Rica and consisting of a social security fund administered by the State through the Social Security Bank
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and the retirement pension system based on individual saving and administered by private entities known as Administrators of Retirement Funds (AFAPs). The legal reform entered into force with effect from 1995 under Law 16,173. The system resets on two pillars, namely: x
Retirement Fund based on Obligatory Individual Savings, financed in its entirety by the contributions of each worker and the yields obtained from the investments.
x
Retirement Fund based on Intergenerational Solidarity, which provides defined payments financed by the active workers, employers, some taxes established for the purpose and state assistance.
The workers who select a State-owned administrator can rely on the Government’s support to ensure a minimum return in the event that the administrators fail to do so. The Government also supports the payment of common retirement entitlements and assistance for those of advanced age, together with the survivors’ pensions deriving from them (Jaikel and Morell, 2000). In this case, supervision of the AFAPs is the responsibility of the Central Bank of Uruguay’s AFAP Supervision Division, which only regulates matters connected with the individual capitalization system. General indicators of each system Members and average wage/salary To establish differences of scale regarding the systems examined in the study, the number of members and the reference wages/salaries on which contributions are based must be considered. The cases of Mexico, Argentina and Chile stand out here, since they clearly surpass the possibilities of the Costa Rican system. Moreover, in June 2001 Argentina posted the highest average wage of the six countries. However, a significant drop is observed in the figure recorded 12 months later, due to the severe depreciation of the Argentine peso. With the exception of Mexico, the other countries also posted a drop in this variable.
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Table VI.1. Members and Average Wage per Country Members
Average wage (USD)
June 2001 Argentina Costa Rica Chile El Salvador Mexico Uruguay
June 2002
June 2001
June 2002
8 623 960
8 977 362
841
230
930 511
1 044 568
NA
250
6 331 239
6 480 819
482
456
898 725
956 583
316
312
25 555 664
28 044 152
448
487
586 219
606 118
587
463
Source: AIOS Statistical Bulletin of June 2002.
Scope of the systems This indicator is reported in order to measure the significance of the reformed system. The ratio of system membership to the economically active population (EAP) serves to point up the population covered by the system of employment capitalization pensions.3 In the first case Chile stands out, where the number of members exceeds the EAP. With El Salvador, on the other hand, the opposite applies with a low percentage coverage. Graph VI.1. Membership/EAP (percentages)
June 2001 June 2002
140 120 100 80 60 40 20 0 Argentina
Costa Rica
Chile E l Salvador
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Uruguay
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Funds supervised Chile has an individual capitalization system that administers the most funds in Latin America, the number of which has been built up over more than 20 years. It is followed in order of importance by Mexico and Argentina. However, in June 2002 the latter country only posted USD 9 billion due to the sharp depreciation of the peso and the economic crisis prevailing during the period covered by the study. Costa Rica is the country where the pension reform is of most recent date, a situation that would place it with the least amount of resources administered in the sample at only USD 137 million. However, it should be noted that in absolute terms the total sum administered increased five-fold in the space of one year. Moreover, SUPEN also supervises the special and basic funds, for which there are no counterparts in other countries. All in all, these items bring the total supervised in Costa Rica up to USD 2 503 million. Table VI.2. Funds supervised (USD millions) June 2001 Balance Argentina Costa Rica ROP Basic and special Chile El Salvador Mexico Uruguay
%GDP
June 2002 Balance
%GDP
22 166
8.2
9 734
11.1
2 271 23 2 248
10 0.1 9.9
2 503 137 2 266
14.6 0.8 13.8
33 777
50.2
35 838
55.2
657
4.7
896
6.1
22 293
3.6
28 033
4.6
926
5.1
861
7.3
Source: AIOS Statistical Bulletin of December 2001 and June 2002.
In line with the previous figures, in June 2002 the funds administered by Chile represented some 55% of that country’s GDP, a percentage considerably larger than those observed in the other systems. The atypical growth in the case of Argentina is explained by the deep recession affecting the country at that time.
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Fund administrators Table VI.3 shows that Costa Rica had the largest number of pension administrators in June 2001, followed by Uruguay with 18 in June 2001 and 17 in 2002. At the other end of the scale is El Salvador, where the pension funds are administered by just three operators. As regards the type of administrators supervised, SUPEN is responsible for 9 administrators of obligatory pension schemes and 17 special and basic funds. For its part, Uruguay supervises 4 administrators of social welfare funds and 13 covering voluntary funds. Table VI.3. Administrators and Pension Funds supervised by country Administrators December 2001
December 2002
Pension Funds December 2001
December 2002
Argentina
12
12
12
12
Costa Rica
26
26
71
74
Chile
7
8
14
36
El Salvador
3
3
3
3
Mexico
13
12
16
15
Uruguay
18
17
18
17
Source: Data compiled for this study.
In accordance with current legislation, the Argentine, Salvadoran and Uruguayan administrators are only permitted to manage one fund apiece. For its part, Costa Rica requires its supervisors to assume responsibility for a larger number of obligatory funds, in addition to the voluntary funds, maintaining an average of 6.3 funds. Moreover, 17 special and basic funds are also supervised. Special mention should also be made of the case of Chile, where 22 new funds were authorized during the study period, with the result that each administrator is managing 4.5 funds on average. Securities used in the pension funds Chart 2 shows the number of securities used by the pension funds in December 2002. It will be noted that the Costa Rican administrators are the ones who hold the largest number of securities in their portfolios, followed by Chile and Uruguay with two fewer in each case.
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The pension funds with the smallest number of securities in their portfolios - 16 - were those of El Salvador. Chart VI.2. Securities used in the pension funds December 2002
40 30
34
32
31
32
Mexico
Uruguay
25 16
20 10 0 Argentina Costa Rica
Chile
E l Salvador
Efficacy and efficiency of the Superintendencies of Pensions The supervision and regulation of the pension funds have been included as a critical element of the reform in the countries considered. To perform these functions, various entities have been created and strengthened with the aim of that the development of the pension systems be as transparent as possible. At the time this study was written, the provisional supervisory authorities lacked explicit supervision principles. This means that it was not possible to verify the information gathered by the sample entities as regards quality or depth. Neither is the supervision model in accordance with which the entities operate clear. Nevertheless, a brief institutional description is given here to explain the existing parameters, which parameters have to be in alignment with the explicit supervision models for each system. Annex VI.1 summarizes the mission and vision of the different Superintendencies. However, in the case of Argentina it was not possible to obtain this information, while in that of Uruguay supervision is performed by a specialized Central Bank unit, so clearly established mission and vision information is not available for either country.
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Structure of the superintendencies The basic structure of the Superintendencies comprises eight units: Control of Institutions, Financial Control, Benefits Control, Legal, Special Studies and Risk Assessment, Information and Institutional Management, Information Technology and the Medical Commissions. The Control of Institutions unit is the one responsible for authorizing new administrators and the pension funds; and also mergers and liquidations of them. It supervises the administrative and accounting work of the administrators and the recording of memberships and transfers. In addition, it reviews the internal control mechanisms. This unit performs its function by means of in-situ visits. According to KPMG (2001),4 this unit is independent in the case of Chile, Mexico and El Salvador, whose Superintendencies are the ones with the most highly developed functions. In Uruguay these tasks are performed jointly with the Financial Control unit and in Costa Rica they are grouped together with Benefits Control. Financial Control is tasked with supervising the price vector, financial operations, portfolio valuation, analysis of investment limits and determining the securities quota. The countries with an independent division are Costa Rica, Mexico and El Salvador. Chile combines these tasks with risk assessment. Benefits Control is responsible for verifying, checking, responding to queries and resolving complaints and claims regarding matters connected with payments and benefits. It only exists as an independent unit in Chile and El Salvador. In Mexico there is no unit to handle these matters, which are taken care of by the Mexican Social Security Institute, while in Uruguay this work is done by the Superintendency of Insurance. The Legal unit provides legal advice to the other departments of the entity. It also answers questions on legal points, acts in defence of the institution by representing it in actions or proceedings and is responsible for administrative actions undertaken by the Superintendency. In all the countries except Uruguay, which receives the advisory services in question from the Central Bank, it is an independent division. The job of Special Studies and Risk Assessment is to prepare studies on the behaviour of the economy and of the pension system, propose risk-based rules supervision and also financial and actuarial methodologies and criteria applicable to the system. It is also responsible for generating and monitoring early-warning indicators regarding the system’s principal risks. In Costa Rica, Mexico and Uruguay these functions are grouped in a single unit. El Salvador
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has a Studies Department and a Risk Assessment Department, while Chile has the Financial Division take care of these matters. The Information and Institutional Management unit administers the human and material resources of the institution. In general, it develops and controls the budget and also the contributions paid by members. In the majority of the countries it operates independently, but in Chile it works with information technology and in Uruguay it receives support from the Central Bank. Information Technology prepares the bases for the transmission, management and exchange of information between the Superintendency and the administrators. It is also responsible for ensuring the adequate availability of hardware and software in the institution. In Costa Rica, El Salvador, Mexico and Argentina it is an independent unit, while in Uruguay the necessary support services are provided by the Central Bank and in Chile said functions are carried out jointly with Information and Institutional Management. The Medical Commissions support the work of the medical staff whose task it is to ensure full compliance with the pertinent legislation as regards the procedure for qualifying as disabled, in order to guarantee objectivity in that process. There is a unit for this purpose in the Chilean and Salvadoran Superintendencies. In Mexico this work is done by the Social Security Institute and in Uruguay by the Superintendency of Insurance. Costa Rica does not have a unit for this purpose. Human Resources of the Superintendencies One of the simplest ways to measure the efficacy of an entity is to determine the number of employees it has and, in this particular case, the ratio of staff to entities supervised. These figures make it possible to ascertain workload levels but do not measure the quality or depth of the supervision. Total staff In December 2002 the Superintendencies of Pensions had 119 staff on average. Argentina and Mexico were the ones with the most personnel, 191 and 183 respectively. Chile’s number was also above the average, as the following figure shows.
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Figure VI.1. Total Staff Superintendency December 2001
Average 0
40
80 200
160 Uruguay
Costa Rica
120
El Salvador
Chile
Mexico
Argentina
The Superintendence operating with fewest staff is Uruguay’s; however, this figure only includes the employees of Control of Institutions and Special Studies and Risk Assessment, since it receives support from the staff of the Central Bank and the Superintendence of Insurance to perform the functions specific to a Financial Division. Costa Rica and El Salvador are the other two countries with below-average staff numbers. However, El Salvador has a payroll very close to the average and with 50% more staff than Costa Rica. Since the supervision work is performed for the most part at the administrator and pension fund level, the ratio of these two variables to the number of employees enables a rough estimate to be made of the efficacy of each entity. As regards employees per pension administrator, Uruguay and Costa Rica are the ones with a low indicator. However, it must be noted that in the case of Costa Rica all the staff connected with the supervisory work are included whereas in the case of Uruguay the count is only partial since only the employees of the Division of Control of the Administrators of Provisional Savings Funds are included. El Salvador reports the most staff per entity supervised, followed by Chile with 20, while Argentina and Mexico work with 15 employees per administrator. It must be emphasized that the ratio observed in Costa Rica is less than one fourth of those for the latter three entities, so it can be concluded that Costa Rica performs its functions with considerably fewer staff than the other countries.
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Chart VI.3. Staff per entity supervised December 2002
40
35
Staff/Fund
35
30 20
Staff/Administrator 20 16
16
13
10 1
3
16
4
2
2
0 Argentina
Costa Rica
Chile
E l Salvador
Mexico
Uruguay
As regards staff per pension fund, Costa Rica works with one staffer per each fund. The other countries employ larger numbers, with Uruguay being the next most efficient with two staffers per fund. Once again, El Salvador is seen to be the country with the largest number. Similarly, when comparing how efficient the Superintendencies are by looking at the previous indicator in relation to the first, it is again the Costa Rican institution that comes out best from this comparison because it is the country that has the most pension funds. In the case of Chile, when the staff/pension funds ratio is used an increase in efficiency is noted since the number drops from 20 employees to 4. In Mexico the difference is relatively small with the indicator dropping from 16 to 13. In the cases of Argentina, El Salvador and Uruguay an administrator is only permitted to manage one fund. Breakdown of staff The details gathered make it possible to draw some conclusions regarding the composition of the human resources involved. To develop this section three categories of staff critical to the supervision process were taken: inspectors, support staff and information technology officers. Inspectors: In December 2002 the Superintendencies had on average 18% of their personnel devoted to direct inspection work. Argentina and Costa Rica were above that percentage, while Chile reported a relatively small number of inspectors. El Salvador, Mexico and Uruguay were below the average.
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Chart VI.4. Inspectors as a percentage of total employees December 2002
35%
31%
30%
26%
25% 20%
16% 13%
15%
13%
10%
10% 5% 0% Argentina
Costa Rica
Chile
E l Salvador
Mexico
Uruguay
A more refined indicator results from finding the number of inspectors per pension administrator. This yields an average of three staffers for every administrator. In this instance, Argentina and El Salvador are the countries with the most inspectors per administrator, with a ratio of close to five inspectors. Mexico, Uruguay and Costa Rica are at the other end of the scale, and the latter two do not even have so much as one inspector for each entity supervised. Chart VI.5. Inspectors per administrator December 2002
6 5 4 3 2 1 0
5.0
4.7
2.0
2.0
0.7
Argentina
Costa Rica
0.3
Chile
El Salvador
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Mexico
Uruguay
167
x
Information technology officers: The different countries have set up highly automated information systems that make it possible to close the funds’ books on a daily basis. The functions of the computer departments accordingly constitute a critical support link in the supervision models. On average, computer specialists make up some 10% of the supervisory entities’ staff. However, Argentina posts a figure higher that that average, with computer specialists making up 18% of its personnel. Costa Rica ranks second in this respect, with 12% of its personnel employed in the IT field. The rest of the countries post numbers below the average, while no data are available for Uruguay because its IT people are on the Central Bank’s payroll. Chart VI.6. Computer specialists as percentage of total employees December 2002
20%
18%
15% 12% 9%
10%
7%
5%
4%
0% Argentina
Costa Rica
Chile
E l Salvador
Mexico
The indicator represented by computer specialists per administrator shows that Argentina and El Salvador rank highest under this head. Costa Rica and Mexico work with less than one IT person per entity supervised and the figure for Chile is in fact the average for the group.
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Chart VI.7. Computer per administrator December 2002
4.0 3.0
2.8 2.3 1.7
2.0 1.0
0.7
0.3
0.0 Argentina
x
Costa Rica
Chile
E l Salvador
Mexico
Support Staff: This category includes secretaries, messengers and miscellaneous. The Mexican Superintendency has the largest percentage of support staff on its payroll. Costa Rica is the country with the least support staff, at 12%. It should further be noted that Mexico, Uruguay and Argentina have above-average percentages, in excess of 20%. Chart VI.8. Support staff as percentage of total employees December 2002
50% 38%
40% 30% 20%
24%
22%
21%
18% 12%
10% 0% Argentina
Costa Rica
Chile
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El
Mexico
Uruguay
Salvador
169
Budget of the Superintendencies The efficiency of a superintendence can be determined from its budget performance, where the cost of each entity supervised and the average cost per institution staff member are significant factors. A breakdown of the budget headings also helps. These indicators provide a comparison of cost levels but given no indication as to the adequacy of the supervision. Total budget: In December 2002 the supervisory authorities had budgets ranging between USD 3 million for El Salvador to USD 17 million in Mexico. On average, each Superintendency manages about USD47 000 per staff. This indicator represents the intensity of expenditure on human resources but does not throw any light on the quality of those resources or of the investments made. The average expenditure per staffer in Mexico is practically double the average for the group. The Superintendency in Argentina has the lowest budget per staff member, followed by those in El Salvador and Chile. Costa Rica reports a figure above the average. It must be borne in mind that the Costa Rican system is the most recent of those included in the sample, which means that it was having to effect expenditures already made by its counterparts, a circumstance that might be causing a distortion in SUPEN’s budget. As regards the Superintendency’s total budget per administrator and for each pension fund, an average expenditure higher than that observed in the other markets was found. In this case, it was between USD 724 000 for each administrator and USD 533 00 for each fund. These figures are well exceeded by Mexico and El Salvador, which run at practically double the average for the group. The opposite applies for Costa Rica, which operates at one fourth of the average budget per administrator and one tenth of the average expenditure for each fund. Table VI.4. Total cost per Administrator and Pension Fund December 2002 (USD thousands) Administrator Argentina Costa Rica Chile El Salvador Mexico Uruguay
322 657 154 338 711 135 1 016 440 1 417 374 NA
Fund 322 657 54 227 138 276 1 016 440 1 133 899 NA
Source: Compiled for study.
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In the case of Uruguay, no figures are available because the Uruguayan system is financed through the Central Bank’s budget. Payroll expenditures: Review of the average expenditure on human resources reveals that the institution in El Salvador is the one that pays the lowest salaries. In Costa Rica,5 in December 2002 the average expenditures were higher than those in El Salvador and Chile. This datum could be influenced by the low number of support staff and by the type of social charges covered by the employer, since it was not possible to determine whether in the other countries the employers contributed to the social charges, so the respective adjustment could not be made. The Mexican supervisory authority is the one that spends the most, investing about USD 69 000 in each staff member, while Argentina only pays each employee USD 15 000 as a result of the country’s economic crisis. Chart VI.9. Average salary (USD thousands)
90 80 70 60 50 40 30 20 10 0
2002
68.7 71.8
2003 30.2 30.3 14.9
23.5 24.2
21.9 18.9
0.0 Argentina
Costa Rica
Chile
E l Salvador
Mexico
For 2003 the trends are maintained, putting Costa Rica in the position of having the Superintendency with the second-highest payroll expenditure per staffer. As regards the average increase in payroll expenditures, the fact is that no increase is posted for Costa Rica, unlike Chile and Mexico, where average salaries are USD 1 000 and USD 3 000 up, respectively. El Salvador, on the other hand, shows a reduction of USD 3 000 under this head. Expenditure on materials and supplies: Chart VI.10 shows the average expenditure per employee on materials and supplies, a heading that groups the allocations intended to cover purchases of required inputs (materials, equipment and instruments for use in the performance of administrative duties, foodstuffs, tools, etc.). It should be noted that Chile and Mexico have the
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Superintendencies with the highest expenditures under this head, namely USD 6 500 and USD 2 900 per staffer, respectively. For their part, Costa Rica and El Salvador posted the lowest expenditures in 2002 and did so again in 2003.
Chart VI.10. Average expenditure on materials and supplies (USD thousands)
2002
10 8
6.5
2003
6.6
6 4 2
2.9 0.9
1.0
0.5
3.0
0.5
0 Costa Rica
x
172
Chile
E l Salvador
Mexico
Expenditure on general services: General services included the cost of all types of services contracted for by the Superintendencies, such as: mail and telephone service, consultancies, training, studies and research. Chart VI.11 shows the average expenditure per employee under this head. In December 2002 Mexico reported the highest figure, followed by Costa Rica and El Salvador, who spent half the amount the Mexicans did. However, for 2003, Mexico posted a drastic reduction in the budget allocated to this expenditure with the result that it dropped to second place. In Costa Rica on the other hand the estimated average expenditure increased by USD 5 000, bringing the country up to top place for spending on general services.
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Chart VI.11. Average expenditure on general services (USD thousands)
20
15.6
2002
12.7
15
2003
7.7
10
5.5
7.0
5.0
5 0 Costa Rica
x
E l Salvador
Mexico
Capital outlays: Chart VI.12 shows the capital expenditure per employee for Argentina, El Salvador, Chile, Mexico and Costa Rica; however, for Argentina it was only possible to obtain the figure for 2002 while Mexico does not allocate funds under this head. The Mexican Superintendency is the one that made the greatest investment per employee since it renewed the infrastructure of its computer systems. In December 2002, SUPEN came out as the entity that invested the most per employee, on account of having purchased new computer equipment together with more software and other assets. El Salvador is seen to be the country that invested the least by way of capital expenditure, as USD 300 per staff member. Chart VI.12. Expenditure on movable property (USD thousands)
4 3.5 3 2.5 2 1.5 1 0.5 0
2002
3.5
2003 2.2 1.8 1.5 0.7 0.6 0.3 0.2
0.0 Argentina
Costa Rica
Chile
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E l Salvador
0.0 Mexico
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Main functions of the Superintendencies6 Inspections performed Two indicators were used to measure the work done by the Superintendencies in the way of inspections. The first is the inspections/inspector ratio to measure the output of the persons employed in one of the supervisory authority’s most important functions, and the second is the number of inspections performed of each administrator. Table 5 shows the figures obtained by calculating the inspections/inspector ratio. Only the data for Argentina, Chile and Mexico were available, beside Costa Rica, and the three first-named countries all posted higher figures than did Costa Rica. In particular, the figure for Chile stands out in that the number of inspections performed per inspector is so much higher than in the other countries. Table VI.5. Inspections performed per inspector December 2001
Argentina
3.06
Costa Rica
1.17
Chile El Salvador
27.46 NA
Mexico
3.63
Uruguay
NA
Source: Compiled for this study.
As regards number of inspections performed of each administrator, it was found that Chile far surpassed the other Superintendencies by visiting each administrator 94 times. On average, Costa Rica visited each operator twice.
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Chart VI.13. Inspections per administrator December 2001
94
100 80 60 40 13
20
7
2
0 Argentina
Costa Rica
Chile
Mexico
Penalties imposed In 2002 the Mexican Superintendency imposed a large number of penalties, in which respect it significantly surpassed its counterparts in this field. Costa Rica and Uruguay were the countries that imposed the
smallest number of penalties, with fewer than ten in each case. Table VI.6. Penalties per Pension Administrator December 2001 Penalties Argentina Costa Rica
NA 5
Chile
17
El Salvador
NA
Mexico
953
Uruguay
4
Source: Compiled for this study.
However, it must be emphasized that this work depends on the number of complaints submitted by system users, so that the findings must be interpreted with caution. It is recommended that they not be considered the sole parameter of efficiency.
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Conclusions Over the past 20 years, Latin American countries have been setting up pension systems based on the individual capitalization methodology. In these systems, each individual worker pays into an account in his/her name that is administered by a company formed especially for the purpose and supervised by a Superintendency of a governmental nature. This study sought to come close to the international standards for pension scheme supervision. However, the following limitations must be underscored: x
There are significant differences in the degree of development of the supervision systems put in place in the various countries, due to their experience and the time span over which they have been applying the particular systems.
x
It did not prove possible to obtain more detailed budgetary information that would have made it possible to establish more refined indicators.
x
SUPEN’s budget includes allocations for expenditures which are appropriate for a Superintendency still in process of strengthening its units and refining its supervision model. However, these expenditures have already been effected by its counterparts that have been in existence longer, which means that there is a measure of bias in the study’s findings which has to be borne in mind.
At the general level, the study found that Costa Rica is the country where the reform of the pension system is of most recent date. However, as of June 2002 its system had 1 044 568 members, which is a significant number in relation to the figures obtained for the other countries included in the study. The total amount of funds administered by Costa Rica’s individual capitalization system is the smallest in the region, a result of the short time during which contributions have been being paid in compared with other systems such as Chile’s, which has been working with its present scheme for 20 years. However, between June 2001 and June 2002 this amount increased fivefold. In addition, SUPEN supervises the special and basic pension funds, which together bring the total supervised up to USD 2.503 billion. As regards the ration of funds administered to GDP, Costa Rica ranks second at 14.6% of GDP. In this case Chile stands out with 55%. Administration of the money set aside for securing a pension is the responsibility of entities specially created for the purpose. In the region, Costa Rica
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has the Superintendency with the most administration companies under its supervision, namely 26. In addition, there are also nine operators of complementary pensions, who manage on average 6.3 funds each and 17 special funds, which makes SUPEN the regulatory entity with responsibility for the most funds. Various indicators were used to measure the efficacy and efficiency of the Superintendencies, including the number of staff of different categories and their numbers in relation to the entities supervised, in the first case, and budget performance in the second. In order to measure the efficacy of the work performed a comparison was first made of the average structure of the Superintendencies, at which time it was noted that Costa Rica does not have medical commissions for ensuring the transparency of the procedure for qualifying as disabled. It was further found that the Superintendencies operate with 119 staff members on average; Mexico is the one with the most employees (191). For its part, Costa Rica has 70 and, in terms of the ratio of employees to administration companies and pension funds supervised, SUPEN is the most efficient of the group. A breakdown of the payroll of each supervisory authority revealed that SUPEN works with 0.7 inspectors for each operator, whereas the average for the group is three. In the case of information technology specialists, Costa Rica works with less than one person per entity supervised while Argentina employs three and the group average is two. As regards support staff, Costa Rica operates with considerably fewer than the other countries. To assess the Superintendencies’ efficiency, the ratios of total budgets to staff and entities supervised were calculated and the main budget items were broken down. The former indicator worked out at an average of USD 47 000; here Costa Rica was above the average, as was Mexico, which spends USD 90 000 per staffer on average. As for cost per operator and per fund, Costa Rica was found to be the one with the lowest funding available. Upon breaking down the budget items it was found that in terms of salaries and general services only Mexico exceeded the figures for Costa Rica. As regards materials and supplies, Costa Rica’s spending was low in comparison with the other Superintendencies but for capital outlays we reported the highest level of expenditure owing to a high volume of computer equipment purchases and licenses renewals to be expected in the case of an entity only up and running for a short while compared with its counterparts.
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NOTES
1.
In Argentina these entities are known as Administrators of Retirement and Pension Funds (AFJPs).
2.
Development Units are an indexing mechanism used in the Chilean economy.
3.
Not all the countries have fully moved their pension systems to the individual capitalization model. In some cases, there are special systems, such as that for government employees in Mexico, or those for professionals, bank employees and notaries in Uruguay, among others. These were not included in the study because they are not supervised by the Superintendencies. As a result, some indicators could be higher than those presented here.
4.
The data contained in this report are used in the majority of the comments included in this section.
5.
Foe 2002, the payroll expenditures were adjusted in order to eliminate outgoings on vacation allowances paid to employees on the regular pay scale plus bonuses.
6.
The figures as of the close of 2002 are not available as of this writing from the majority of the Superintendencies.
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BIBLIOGRAPHY
AIOS. 2002. Boletin Estadistico. Buenos Aires, AIOS. AIOS Statistical Bulletin Nº7. Boxwell, R. 1995. Benchmarking para competir con ventaja. Madrid, Spain: McGraw Hill. CONSAR. 2001. Informe de Actividades. Mexico City, DF; Mexico FIAP. 2002. Boletin. Santiago, FIAP. Bulletin Nº12. Jaikel, R y Morell, C. 2000. Comentarios sobre los sistemas de pensiones en América Latina. San José, CONASSIF. Studies on Regulation and Supervision of the Financial System, Nº4. KPMG. 2001. Consultancy on Workloads in Costa Rica’s Superintendency of Pensions. San José, Costa Rica. SAFJP. 1999. Plan Estratégico de la SAFJP. Buenos Aires, Argentina. SAFP, 2000. Balance de Gestión Integral. Santiago, Chile Superintendencia de Pensions. 2001. Informe de Labores. San Salvador, El Salvador.
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Annex 1. Mission and Vision of the Superintendencies of Pensions December 2002
Country
Mission
Vision
Argentina
NA
NA
Chile
To provide security and service to the workers enrolled in the pension system, to the pensioners, to the Chilean State and to the institutions administering the pension funds, by promoting the development and perfecting of the system in the national sphere.
NA
Costa Rica
We are an institution responsible for regulating, supervising and inspecting effectively and efficiently the parties who make up the National Pension System and other Social Security systems, in order to ensure the proper administration of the members’ funds and the correct and timely granting of benefits. To this end we foster a regulatory framework that enables us to perform proactive supervision based in advanced technology.
SUPEN will be an agency of excellence in the supervision of the National Pension System and other social security systems, manager of regulatory, supervision and inspection actions designed to ensure its financial stability, with leadership in development of the pension sector, in accordance with international principles and standards, utilizing advanced technology and supported by highly qualified personnel of high human quality who promote a positive, dynamic and enthusiastic atmosphere. These
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Country
Mission
Vision factors will make it possible to foster transparency, confidence in and reliability of the functioning of the entities supervised, and to ensure timely and equitable access to benefits for the members.
El Salvador
We are institution governed by public law, made up of a specialized work team of high ethical standards, responsible for supervising, monitoring and controlling the pension system in a transparent fashion.
Mexico
To protect the interest of the workers and of their beneficiaries by ensuring efficient administration of their retirement savings.
Uruguay
NA
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To be a proactive institution with high credibility in the integral supervision of the pension system
NA
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VII.
PRIVATE PENSIONS SUPERVISORY METHODS IN AUSTRALIA by Greg Burner
Introduction In Australia, the term superannuation refers to savings specifically dedicated to the provision of financial support in the retirement period. The term is preferred to pension for historical reasons, largely because of the longstanding preference for retirement benefits to be paid as lump sums rather than income streams. Australia’s retirement income provision system has three ‘pillars’: x
The Age Pension, a means-tested pension for retired citizens distributed by the federal government.
x
Compulsory employer superannuation contributions (the Superannuation Guarantee). Since 1992, employers have been required to provide superannuation for their employees, with only a few exceptions. From 1 July 2002, the minimum contribution level is 9% of an employee’s earnings base (generally the person’s normal salary or wage but not including any overtime pay); and
x
Voluntary member superannuation contributions, contributions made, usually by members of superannuation funds, over and above the compulsory superannuation contributions or where a person is not eligible for superannuation guarantee contributions to be made on her or his behalf.
Together, the Superannuation Guarantee and voluntary superannuation form Australia’s private ‘pension’ system. The main information regarding number of funds, assets and account by type of fund is provided in Table VIII.1.
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Table VIII.1. Australia’s Superannuation Industry December Quarter 2002 Funds Type of fund Corporate Industry Public sector Retail Small Funds Subtotal Annuities, life office reserves etc Grand total
Number 2 045 109 78 240 2 251 756 254 228 NA
254 228
3
1
Market Share (%) 0.80% 0.04% 0.03% 0.09% 99.02% 100.00% NA
100%
Assets Accounts AUD Market Market Millions billion Share (%) Share($) 65 12.55% 1.4 5.58% 52 10.04% 7.6 30.28% 102 19.69% 2.9 11.55% 175 33.78% 12.7 50.60% 103 19.88% 0.4 1.59% 497 95.95% 25.1 100% 21 4.05% NA NA
518
100%
25.1
100%
1: 2:
Fund numbers are preliminary estimates only based upon 2001-02 trends. The number of small funds includes approximately 243 000 self managed superannuation funds regulated by the Australian Taxation Office. 3: APRA regulates approximately 11 000 funds in total, including approximately 8,000 small funds not regulated by the Australian Taxation Office (see Note 2) For the year ending December 2002, aggregate contributions into superannuation funds amounted to AUD 51.7 billion, while benefit payments amounted to AUD35.4 billion.
Types of superannuation entities Corporate funds are funds sponsored by a single employer or group of related employers. Membership is restricted to employees of the employer and, if the fund rules allow, contributions may also be accepted on behalf of the employee’s spouse or partner. Industry funds, often organised through industrial workplace arrangements, cater for members as a result of an agreement between the parties to an industrial award. An individual industry fund usually draws members from a large number of usually unrelated employers across a single industry. A public sector fund is one where the employer sponsor is a government agency or a business enterprise that is majority government owned. Retail funds are publicly offered superannuation funds that members join by purchasing investment units or policies that are sold through intermediaries such as life insurance agents or financial planners. Members of retail superannuation funds may include self employed people or people wishing to top-up their other employment based superannuation arrangements. Employers may use retail superannuation products to meet their superannuation obligations in respect of their employees, for example, by using a retail master trust.
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The number of Corporate, Industry, Public Sector and Retail Superannuation funds has been in decline in recent years, consistent with the trend to consolidation. This is contrasted by the steady growth in the numbers of small funds, that is, those with fewer than five members. As shown by Table VIII.1, the overwhelming majority of superannuation funds by number in Australia (approximately 99.0%), are small funds with fewer than five members. In late 1999, the Australian Tax Office (ATO) assumed responsibility for the regulation of the majority of small superannuation funds referred to as self managed superannuation funds (SMSFs). The 8 000 or so small funds that continue to be regulated by the Australian Prudential Regulation Authority (APRA) must have an APRA approved trustee and are referred to as small APRA funds or SAFs. Overall, despite small funds making up the majority of the superannuation funds in Australia, small funds represent a total of only 439 000 members, or less than 2% of individual Australians who have superannuation. The remaining 2 472 corporate, industry and retail funds represent over 98% of all member accounts. Supervisory framework Distribution of functions and responsibilities between regulators The regulation of the private pension (superannuation) industry is largely the responsibility of the Australian Prudential Regulation Authority (APRA), although the Australian Securities and Investment Commission (ASIC) and the Australian Tax Office (ATO) are also involved. Following the restructuring of the financial sector regulation in Australia in 1998, APRA was established as an integrated financial sector regulatory body and bears primary responsibility for the prudential regulation of superannuation, insurance and banking in Australia. APRA administers the prudential and retirement income provisions of the Superannuation Industry (Supervision) Act 1993 (SIS Act) and the associated Regulations, in respect of the superannuation entities for which it has regulatory responsibility. The SIS Act is the principal legislation relating to the prudent management of superannuation entities in Australia. ASIC is responsible for market integrity and consumer protection across the financial system including some areas of superannuation such as market conduct, disclosure and complaints systems.
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Aside from administering the entire Australian personal income, business and goods and services tax system, the ATO is also responsible for the regulation of self-managed superannuation funds under the SIS Act. APRA has Memoranda of Understanding (MOU) with ASIC and the ATO, which formalise the information-sharing activities of the bodies in relation to supervisory responsibilities. The MOU are aimed at reducing duplication and compliance costs for industry as well as achieving effective enforcement and compliance outcomes for industry and the agencies involved. In addition, regular liaison meetings are held between APRA and other financial supervisory and industry bodies. The Financial Sector (Collection of Data Act) 2001 provides for collection of data by APRA on behalf of other agencies, such as the Australian Bureau of Statistics, and data sharing arrangements between APRA and other regulatory agencies are codified under the Australian Prudential Authority Act 1998 (APRA Act). This study will focus primarily on APRA and APRA-regulated superannuation funds. APRA’s Supervisory approach The primary role of APRA is to enhance public confidence in Australia’s financial institutions through a framework of prudential regulation, which balances financial safety, efficiency, competition, contestability and competitive neutrality. Ultimately, APRA seeks to ensure that financial promises are met by regulated institutions. In relation to superannuation funds, this means that the trustees must operate in the best interest of their members, in order to maximise the member retirement savings outcome. APRA’s supervisory approach is forward-looking, primarily risk-based, consultative, consistent and in line with international best practice. This approach also recognises that management and boards of supervised institutions are primarily responsible for financial solutions. APRA supervision is both proactive and reactive, being a continuous process of risk assessment, supervision strategies and supervision activities. The risk assessment process involves supervisors forming an opinion on the risk profile of an institution, based on the likelihood of institutional failure and the impact of failure. The likelihood of failure is measured by the inherent risks of an institution, mitigated by the risk management, control features and capital support available to the institution. These risk ratings are not made public.
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The risk assessment rating determines the supervision strategy to be applied to an institution. The strategy includes the type of supervisory activity required to address key risk areas identified during the risk assessment process. The supervision strategy is implemented by coordinating and undertaking supervision activities. The main activities conducted are: on-site visits; prudential consultations; analysis of quarterly statistical returns lodged by funds with a minimum asset level of AUD 60 million; analysis of annual statistical data lodged by all funds; specific analysis; and external party liaisons Organisation and management of APRA Organisation structure APRA is a statutory authority with the legal status of a body corporate with perpetual succession. However, APRA is generally not entitled to any immunity or privilege of the Crown. As it is a statutory body and not a government department, APRA is relatively autonomous from the Commonwealth Government. APRA currently has a non-executive Board comprising nine members, with the majority of representatives from the private sector and representation from the Reserve Bank of Australia (Australia’s central bank) and ASIC. Post 30 June 2003, in place of the present board APRA will be headed by a commission-like body with a minimum of three full-time executive members (and up to five members in all). One member would be chairman - and effectively the CEO - and another would be the deputy chair. APRA is currently organised into four main divisions: x
Diversified Institutions Division (DID)
x
Specialised Institutions Division (SID)
x
Policy, Research and Consulting Division (PRC)
x
The Corporate groups: human resources, information technology, legal, public affairs, risk assessment, finance and secretariat.
Further information on APRA’s operating structure is found in Annex VIII.2. Staff levels and numbers APRA’s head office is located in Sydney, although there are regional offices in most states of Australia. There are 475 people currently employed at APRA, of whom 345 are engaged in supervision. During the 2003/04 year, 127 employees, equivalent to 37% of supervision staff, will be engaged in the
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supervision of superannuation operations. Thirty per cent of APRA’s current staff members were previously employed by its predecessor organisations including the Insurance and Superannuation Commission. The remainder of staff are drawn from within the finance sector (for example, banking, superannuation and insurance), accountants, graduates and other government agencies such as ASIC and the ATO. Accountability mechanisms APRA is ultimately accountable to the Australian Commonwealth Parliament and to that end APRA produces an Annual Report which is tabled in Parliament and is available to the public. APRA is audited by the Australian National Audit Office on a regular basis. APRA also has a responsibility to the regulated industries it levies to carry out its responsibilities as cost-effectively and efficiently as possible. In addition, the Commonwealth Treasurer (or his delegated Minister) may give APRA directions about the performance or exercise of its functions or powers under the SIS Act. As APRA is a statutory body under the Commonwealth Authorities and Companies Act 1997, the legislature has the power to change APRA’s procedures through amendments to relevant legislation and disallowance of associated regulations under which APRA operates, as well as those it administers. The Minister may also give APRA directions about the performance or exercise of its functions or powers. In addition, certain APRA decisions are defined as “reviewable decisions” under the SIS Act. A person affected by a reviewable decision may request APRA to reconsider the decision. If APRA confirms or varies the decision upon receipt of such a request, the affected person may seek to have the Administrative Appeals Tribunal1 review the decision. The Administrative Decisions (Judicial Review) Act 1977 also provides grounds for the Federal Court to review an administrative decision made by APRA. In addition to its annual report, there are a number of other avenues through which APRA maintains its ongoing accountability to the Parliament. These include: x industry consultations as part of the annual levy determination process; x the Treasurer’s involvement in determining levy rates each year; x regular appearances before Parliamentary Committees; and x audit by the Australian National Audit Office.
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Budget The overall budget for APRA is determined by its Board in consultation with the Commonwealth Treasurer. In finalising APRA’s budget the Board takes into account the resources required to conduct effective supervision for the forthcoming year for each industry under supervision. Of the AUD 69.8 million in levies collected from APRA regulated institutions in 2001/02, AUD 28.6 million was collected from superannuation funds (however the whole amount does not accrue to APRA, see next paragraph). APRA’s operating expenditure for that year was AUD 59.2 million spread over all the institutions regulated by APRA, including superannuation funds. Estimates for 2002/03 are total levy collection of AUD 75 million, of which AUD 31.9 million derived from superannuation funds. Forward estimates for 2003/04 are total levy collection AUD 68.6 million of which AUD 35.9 million is expected to derive from superannuation funds. The increase in superannuation levy revenue reflects a higher net asset basis rather than an increase in the number of entities levied. APRA collects levies on superannuation funds on behalf of the other regulators, ASIC and the ATO, as well as in respect of funding of its own activities. Of the estimated AUD 35.9 million superannuation levy revenue for 2003/04, AUD 8.1 million will fund ASIC’s consumer protection function and AUD 2.4 million will be paid to the ATO in respect of its administration of the unclaimed monies scheme. The balance of AUD 24.4 million will accrue to APRA. Strategic planning Objectives and outcomes APRA’s objectives are contained in the APRA Act, which sets out its constitution and its broad powers, and various other industry specific laws which it administers, such as the Banking Act 1959, the Life Insurance Act 1995, the General Insurance Act 1973 and the SIS Act. APRA’s mission is to establish and enforce prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions APRA supervises are met within a stable, efficient and competitive financial system. This is achieved by: x
formulation and promulgation of prudential policy and practice observed by regulated institutions;
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x
effective surveillance and compliance programs and, where relevant, remediation or enforcement measures, to give effect to the laws administered by APRA and to the standards issued under those laws; and
x
advice to Government on the development of regulation and legislation affecting regulated institutions and the financial markets in which they operate.
APRA’s business plan is organised into six Key Result Areas (KRAs). These are: x
supervision, enforcement and rehabilitation;
x
policies, standards and guidelines for prudential supervision;
x
prudential advice – relations with external stakeholders including government, parliament, media, industry, professional bodies, general community, international agencies and others;
x
staff numbers required and quality of people, now and into the future;
x
infrastructure to support operations; and
x
accountability framework.
The first three KRAs support the three APRA outputs of policy, surveillance and prudential advice. The KRAs relating to staff, infrastructure and accountability enable the first three KRAs to be performed within a sound administrative framework. Allocation of resources APRA is funded on a cost-recovery basis from the institutions it regulates. APRA is, accordingly, funded primarily from annual levies on financial institutions. A small proportion of funding comes from earnings on funds invested and charges for specific services provided, e.g. publications. The estimated percentage distribution of APRA’s operating expenditure across its main activities in 2001/02 is shown below.
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Table VIII.2. Distribution of APRA operating expenditure (2001/02) Main Activities
Supervision, rehabilitation and enforcement
Distribution of expenditure (%) 59
Development of prudential policies and standards
8
Prudential Advice
4
Administrative Support and corporate governance
29
Measurement of results APRA’s business plan sets out key performance indicators (KPIs) for each of the key result areas listed above. The table in Annex VIII.2 lists the KPIs. Supervisory Methods: entry requirements Legal requirements to licence or register a pension plan At present, there is no compulsory licensing system for all superannuation trustees or compulsory registration of superannuation entities [funds, approved deposit funds (ADFs) and pooled superannuation trusts (PSTs)]. The minimum requirement for entry to the concessionally taxed environment available to complying funds is that trustees must elect to have their funds regulated under the SIS Act. However, trustees of public offer funds, ADFs and PSTs are required to be approved by APRA (that is, to become an ‘approved trustee’). Trustees of funds that are not for public offer do not have to receive formal approval from APRA, but must still however comply with the trustee arrangements and requirements as provided in the legislation. APRA issues comprehensive guidance “Circulars” which elaborate on the provisions contained in the SIS legislation and indicate the way in which APRA will interpret and enforce trustee obligations under that legislative framework. This current system of approving only trustees of public offer entities however is set to change over the next two to three years, under the Federal Government’s policy to introduce universal licensing of all superannuation trustees.
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Trustee Approval The trustee of a public offer fund or entity must be an ‘approved trustee’ within the meaning of the SIS Act. A constitutional corporation may apply to APRA to be an approved trustee in the approved form which must be accompanied by the prescribed fee, currently AUD 2000. APRA will approve an applicant for approved trustee status if satisfied that the applicant can be relied on to properly perform the duties of an approved trustee. In addition, applicants must also have at least AUD 5 million of net tangible assets or that amount available under an approved guarantee, or combination of the two, or else have agreed to comply with any requirements imposed by APRA in relation to the custody of assets. Furthermore, APRA must remain satisfied with the competence of the trustee board and with the compliance and other systems of the trustee’s operation on an ongoing basis. Copies of the applicant’s business are plan are required to be provided to APRA as a part of the application process. The conditions under which an applicant is approved are set out in the Instrument of Approval. A copy of the relevant application forms and the conditions of the ‘Instrument of Approval’ for approved trustees can be found at the APRA website.2 Where there is no requirement for an ‘approved trustee’, the trustees must comply with the basic equal representation rules: x
in cases where funds have a group of two or more individual trustees, the number of employer and member representatives in the group must be equal; and
x
in cases where funds have a single corporate trustee, the number of employer and member representatives on the board of the corporate trustee must be equal.
There are also restrictions under the SIS legislation on who may be a trustee or a director of a corporate trustee of a regulated superannuation fund, ADF or PST. A disqualified person (including a body corporate) is prohibited from acting as a trustee or a responsible officer of a corporate trustee of a superannuation fund. An individual is a disqualified person if that person:
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x
at any time was convicted of an offence in respect of dishonest conduct or in relation to whom a civil penalty order was made; or
x
is an insolvent under administration; or
x
has been disqualified by APRA on the grounds of serious
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contravention of the SIS Act or the Collection of Data Act or APRA is otherwise satisfied the person is not a fit and proper person to be a trustee. A body corporate may be disqualified if: x
an official manager or administrator has been appointed; or
x
a provisional liquidator has been appointed; or
x
it has begun to be wound up; or
x
it knows, or has reasonable grounds to suspect, that a person who is a responsible officer is a disqualified individual.
In certain circumstances, a disqualified person (including a corporation) may apply to APRA for a declaration waiving their disqualified person status. APRA also has the power to suspend or remove a trustee on one or more of the following grounds: x
the trustee becomes a disqualified person;
x
it appears to APRA that the trustee’s conduct may result in the financial position of the fund becoming unsatisfactory; or
x
APRA revokes the approval of the trustee (in cases where approval is required).
Under reforms proposed to commence in 2004, all new superannuation fund trustees (other than trustees of self -managed superannuation funds and exempt public sector superannuation schemes) will require an APRA Superannuation Trustee Licence (STL). The conditions for obtaining a STL will include requirements for all trustees to meet minimum standards of fitness and propriety, have adequate resources, a risk management plan and adequate risk management systems (including a fraud control plan), systems to manage outsourcing, as well as any other conditions that APRA considers appropriate. These requirements will need to be met on an ongoing basis. Retail fund trustees will continue to be required to satisfy capital adequacy requirements. In addition, APRA must be satisfied that there is no reason to believe that the trustee licence applicant would not comply with the law or any conditions imposed if a licence was granted.
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Superannuation funds As noted above, superannuation funds currently do not have to be registered. However, all superannuation entities (other than Retirement Savings Accounts (RSAs) and some public sector superannuation schemes) must be established as trusts for the core purpose(s) of providing benefits to members upon retirement. The sole or primary purpose of the fund must be the provision of retirement benefits (or death benefits in the event of death before retirement). After a superannuation fund is established, the trustee(s) must notify the ATO of their election to have the fund regulated under the SIS Act. A decision to be a regulated superannuation fund is irrevocable. While supervision under the SIS Act is not compulsory, only regulated superannuation funds that comply with the relevant legislation are eligible to accept compulsory superannuation guarantee contributions and receive concessional tax treatment (complying superannuation funds). The governing rules of a regulated superannuation fund are deemed by legislation to contain the following trustee covenants which are codified in the SIS Act: x
to act honestly in all matters concerning the fund;
x
to exercise, in relation to all matters affecting the fund, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide;
x
to ensure that their duties and powers are performed and exercised in the best interests of the beneficiaries;
x
to keep the money and other assets of the fund separate from any money and assets that are held by the trustee or that are money or assets of a sponsoring employer or an associate of a sponsoring employer;
x
not to enter into any contract, or do anything else, that would prevent them from properly performing or exercising their functions or powers;
x
to allow a beneficiary access to any prescribed information or any prescribed documents.
Trustees may engage or authorise service providers (such as external fund administrators, actuaries, lawyers and investment managers) to act or do things on their behalf, however the trustee retains responsibility for the function. 194
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Banks, life insurance companies and investment managers may be appointed as service providers offering investment services, custodianship of assets, administration of records and other similar services. The reforms commencing in 2004 will require all licensed trustees to register with APRA the funds under their trusteeship. They must also register any new fund under their trusteeship before that fund may accept contributions. Similarly, any fund without a licensed trustee at the expiry of the two year transitional period will either be wound up, with members and assets transferred to a licensed trustee, or otherwise have a licensed trustee appointed. Tax concession requirements Tax concessions do not depend on the ‘approved’ status of a trustee. Rather, eligibility for tax benefits is linked to the status of a superannuation fund being a complying fund. Under Part IX of the Income Tax Assessment Act 1936, which operates concurrently with the Income Tax Assessment Act 1997, a superannuation fund is eligible for concessional tax treatment as a complying superannuation fund if it satisfies the following conditions: x
the entity is a superannuation fund;
x
the fund is a resident regulated superannuation fund;
x
the fund has met the prescribed requirements to be a complying superannuation fund for the purposes of the SIS Act; and
x
the trustee of the fund has received a notice from APRA stating that the fund is a complying superannuation fund, and has not subsequently received a notice stating that it is non-complying.
x
a fund that is, or is part of, an exempt public sector superannuation scheme is taken to be a complying superannuation fund for the purposes of entitling it to concessional tax treatment, without having to be a regulated superannuation entity or being subject to the SIS Act.
Number of applications in the last three years As only trustees operating public offer superannuation entities are currently required to be licensed by APRA, information on the establishment of new trustees is limited to those who apply for approved trustee status. Currently, there are 157 approved trustees; of these, 28 were approved in the last three years.
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Number of applications denied and reasons Applications are dealt with on a case by case basis by the responsible supervisor and over the last three years there have only been occasional instances where applications have been refused. A recent example was refusal on the grounds of a conflict of interest resulting from the Chief Executive Officer of the trustee having a 50% interest in the administration firm providing administration services to the fund. Monitoring changes In addition to notifying APRA of their election to have superannuation funds regulated by APRA, a trustee must also notify APRA if it elects to treat a fund as a public offer fund. If a small fund switches status to or from that of a self managed fund the trustee must disclose the change to the ATO. Such information is passed by the ATO to APRA Other changes to be notified: trustees are required to notify APRA of events having a significant adverse effect on the financial position of the superannuation fund. Significant events include those that may result in the trustee being unable to make payments to beneficiaries as and when the obligation to make those payments arises. There are civil and criminal consequences for failure to comply with these mandatory notification requirements. Other information requirements include any changes in the entity’s contact details, or decisions or resolutions to wind up the entity. In addition, the Regulator may by written notice require the fund or entity to provide information about the fund for a particular year of income. Superannuation fund actuaries and auditors are also required to notify APRA if they form the opinion that the financial position of the entity may be or become unsatisfactory. As discussed above, trustees wishing to become approved trustees must apply to APRA for approval. An approved trustee must notify APRA if a condition imposed by APRA is breached or there is a change in the conditions of eligibility with 30 days of the event. Failure to comply with this requirement is a strict liability offence. Relevant conditions include the provision of information regarding certain events to APRA, notification to APRA of a change in contact details, material change in the business estimates given upon application, any event which may affect the trustee's ability to perform in a proper manner the duties of a trustee of an entity, any changes to the office holders of the trustee and a notification if the trustee wishes to engage in any other business or commercial activity. Any material changes to the trustee’s capital position must also be notified.
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If a trustee has been appointed by APRA, the trustee may resign by writing to APRA. APRA may also revoke the approval of an approved trustee after first gaining the Minister’s consent. Trustees of funds that are not public offer funds are required to meet equal representation requirements. In the event of a failure to continue to meet these requirements, APRA may direct the trustee not to accept employer contributions. Approved trustees may apply to APRA for variation of approval, including changes to the conditions imposed on the trustee under its Instrument of Approval. Trustees may apply to have a fund declared not to be a public offer fund. Individuals may apply to APRA for a declaration waiving their status as disqualified persons. Supervisory methods: on-going supervision Compliance checks All three regulators – APRA, ASIC and ATO – are involved in assessing compliance of superannuation trustees and their funds with relevant legislative requirements and specific conditions. For its part, APRA focuses on monitoring compliance of trustees and superannuation funds with prudential operating requirements and retirement income standards such as those relating to contributions and the preservation of benefits within the superannuation system. As noted above, APRA supervision is a continuous process of risk assessment, supervision strategies and activities, and evaluation. In assessing the compliance of trustees, APRA conducts a two-year on-site review cycle as well as ongoing monitoring, data collection and analysis and risk assessment. In relation to approved trustees of retail funds, APRA looks to the trustee’s adherence with the requirements stipulated in its Instrument of Approval, data submitted annually by the trustee (including audited accounts) and the prudential management certificate submitted to APRA, in which the approved trustee attests to its compliance with requirements. Approved trustees that are not compliant risk having their approvals revoked. In monitoring the operations of superannuation funds, APRA uses information from a variety of sources including the trust deed; returns lodged with APRA; audited accounts that detail relevant financial and legislative compliance; PAIRS assessments;3 media comment and professional advice. Also examined are the effectiveness and competency of the trustees and their operating structures, outsourcing arrangements and investment management.
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With the introduction of the proposed licensing reforms, supervision of these trustees and funds will also become much more risk management focused. Compliance with governance rules Where the trustee entity is a corporate entity, the trustee must comply with the Corporations Law administered by ASIC. In relation to compliance with the governing rules of the fund and the relevant legislation, APRA relies to a large extent on the annual independent audit of both the financial statements and compliance of the trustee with specific provisions of SIS and the Collection of Data Act. In moving to the new licensing regime in 2004, APRA will focus on trustee decision making processes within the risk management framework. Contributions and regularity of payment The Superannuation Guarantee scheme, which requires employers to provide a prescribed minimum level of superannuation support in each financial year to their employees (equivalent to nine percent of the employee’s income), is administered by the ATO, and from 1 July 2003 these contributions must be paid at least quarterly. APRA has the power to direct the trustee of a regulated superannuation fund that has contravened a regulatory provision not to accept employer contributions4. It is a strict liability offence for an employer not to remit voluntary employee contributions to the fund within a specific timeframe. Part 7 of the SIS Regulations set out eligibility criteria in relation to persons in respect of whom contributions may be accepted. While these basically relate to age and employment status, contributions may also be accepted in relation to the spouse or partner, or eligible child, of a member. There are no legislative restrictions on the regularity of payment of voluntary contributions, with many self-employed members making only annual contributions. As with all retirement income policy measures that impact on fund operations (including in relation to membership and benefit payment requirements discussed below), APRA expects trustees to have robust processes and controls to ensure compliance with the law and to ensure beneficiary interests are safeguarded. APRA’s supervision approach places emphasis on operational risk issues (including compliance risk) and the identification and management of such risks. While APRA relies to a large extent on the annual independent compliance audit, where member complaints have been recorded in
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respect of operational issues, APRA’s supervisory processes will include examination of fund systems and processes. Membership and portability While ‘choice of fund’ has been a policy of the current federal Government since 1996, there is not yet a comprehensive choice or portability scheme in place for members of superannuation funds in Australia. The rules of some company funds still require that benefits remain preserved within that fund despite a member changing employment, while more commonly benefits must be taken out of the fund when a member changes employment. Due to changes in employment and the trend for many people to have several part time jobs at any one time, there is a trend for people to have several superannuation accounts. The Government has released draft ‘portability’ regulations that will, if agreed, permit members to roll over their benefits from one fund to another at specified times. There are also provisions for the “rolling over” of members’ benefits into “eligible rollover funds” that are also regulated by APRA.5 Benefits eligibility conditions and access to benefits The provisions covering these aspects are mainly located in Part 6 of the SIS Regulations and are the responsibility of APRA and the ATO (in respect of SMSFs). Part 5 of those Regulations also provide for the protection of members’ benefits, particularly minimum benefits. The ATO also oversees the access of members to their superannuation benefits to the extent to which it relates to income tax matters. A member’s benefits in a regulated superannuation fund may comprise preserved benefits, restricted non-preserved and unrestricted non-preserved benefits. On 1 July 1999 a new preservation regime commenced which deemed all contributions made by or on behalf of a member ‘preserved’ until the conditions of release are satisfied, including reaching a prescribed preservation age, retirement, death, permanent incapacity or temporary residents departing Australia permanently. Previously unpreserved amounts were ‘grandfathered’. Benefits are payable on permanent severance from the workforce, including on retirement, death before retirement, or permanent disability. Under certain circumstances, such as severe financial hardship or on specified compassionate grounds, limited amounts may be released to a member in advance of retirement, etc. However, requests for release of preserved benefits on grounds such as contributions made on the basis of bad or misleading advice, or lack of understanding of the law by the individual or other such reasons will not be acceded to by APRA.
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Investments, asset allocation, performance The SIS Act prescribes6 limits on in-house assets, prohibition on borrowing, sole purpose tests, and guidance on arms length investments. Trustees must formulate and give effect to an investment strategy that has regard to the whole of the entity’s circumstances including risks involved in the investments chosen, the composition of the investments as a whole and the liquidity of the investments undertaken. Non-compliance with this requirement may give rise to a civil liability action. In addition, trustees must comply with other prudential requirements relating to its investment function generally. These include requirements for the trustee to appoint an investment manager in writing and ensure that the investment manager is a body corporate and is not a disqualified person. Trustees must also ensure that agreements made with the investment manager allow the trustee to obtain sufficient information about the investments, termination of the agreement without liability, and maintenance of proper records and accounts for investments for at least five years. Penalties may be imposed for a breach of these prudential requirements. The legislation provides strict controls on the circumstances under which payments may be made out of a fund to an employer-sponsor. There are no quantitative requirements in the SIS legislation relating to investment returns, that is, investment results are not guaranteed by the Government. Members with an account balance of less than AUD 1 000 are treated as ‘protected members’, that is, the quantum of administrative fees and charges that can be imposed on the member’s balance must not exceed credited investment returns. This measure was designed to prevent erosion of small account balances at the start of the accumulation phase, and involves a degree of cross subsidisation by larger account holders. The provision is suspended during periods of poor investment returns. Risk management The risk management capability of an institution arises from the underlying governance, policies, practices, systems and controls established by the institution for the particular risks to which it may be exposed. Risk management is the process by which an institution identifies, measures, monitors and controls risk to ensure that:
200
x
risks are recognised and understood;
x
risks are within tolerances established by the board or senior management;
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x
risk-taking decisions are explicit, clear and consistent with strategic business objectives;
x
expected return has been assessed as compensating for the risk taken; and
x
capital allocation is consistent with risk exposures.
Currently, only approved trustees are required to produce a risk management plan for their fund operations however this is due to change over the next two years when the Federal Government introduces reforms that will require trustees to produce not only a risk management strategy for their trustee activities but also a risk management plan for each fund under trusteeship. Custodian procedures A custodian of a superannuation entity performs custodial functions in relation to the entity’s assets under a contract with the entity’s trustee or investment manager. A custodian under the SIS legislation must be a body corporate under SIS and meet capital requirements where relied on by an approved trustee that cannot, of itself, meet those capital requirements. APRA sets requirements for custodian agreements in its Instrument of Approval for approved trustees. However, the agreement itself is governed by contract law. If the trustee becomes aware of any problems with the custodian that jeopardise the safety of the assets of an entity or that indicate that the custodian can no longer be relied on to perform, in a proper manner, the duties of custodian of the assets of an entity, it must advise APRA in writing. The trustee must also notify APRA in writing at least 30 days prior to any change of custodian. Checks on the performance of outsourcers Trustees have ultimate fiduciary responsibility for the performance of the service providers they engage. Applicants for ‘approved trustee’ status are required in their application to provide information to APRA relating to the procedures that have been established to ensure that service providers to the relevant entities, delegates, and sub-contractors have appropriate qualifications, capacity and evidence of experience. They are also required to provide details regarding access to expert advice, and guidelines for determining the capacity, experience and qualifications of the expert. APRA will take this in to consideration as part of the applicant’s overall capacity to act as an approved trustee. APRA has published a prudential standard relating to outsourcing which will be reflected in requirements for licensing of all superannuation trustees.
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Financial, actuarial and accounting methods Professional bodies determine the actuarial and accounting principles followed by their members in discharging their duties. APRA has the power to “approve” auditors and actuaries to carry out duties under the SIS Act. Actuaries and auditors must meet specified criteria, namely actuaries must be a Fellow or Accredited Member of the Institute of Actuaries of Australia and auditors must be a member of one of a number of specified organisations, and in addition, be approved by APRA or otherwise be registered company auditors. Under Part 16 of the SIS Act, actuaries and auditors are also required to inform APRA when trustees breach their obligations under the SIS Act or are in an unsatisfactory financial position. APRA also has the power to refer an auditor/actuary for investigation by their respective professional bodies if it believes this individual has failed to adequately perform his/her duties under the superannuation legislation, or they are otherwise not a fit and proper person to be an approved auditor/actuary. For these same reasons, APRA can also disqualify a person from being an approved auditor/actuary. Administrative cost, fees and marketing ASIC supervises disclosure and market conduct as part of their oversight of reporting, disclosure and consumer protection under the Corporations Act 2001. In addition, member protection rules prohibit administration fees exceeding investment returns being charged on small accounts (accounts with a balance under AUD 1 000) except in periods of bad investment returns. In such periods member balances may be reduced if costs are apportioned in a fair and equitable manner. Disclosure requirements are set out in Annex VIII.4. Merger and liquidation processes APRA is responsible for oversight of winding-up of superannuation entities and transfer of members and assets to receiving funds. Successor fund provisions in the SIS Regulations provide for bulk transfer without individual member consent provided the successor fund offers equivalent rights and benefits. A wind-up return must be lodged with APRA when the transfer and wind-up process has been completed.
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Vested rights Compulsory employer contributions and member voluntary contributions vest immediately in the member. However, vesting scales still operate in some employer-sponsored funds in respect of employer contributions in excess of the 9% required under the Superannuation Guarantee regime. There are restrictions in SIS Regulation 13.16 on adverse alteration of accrued benefits. Exceptions relate to alteration may be made in compliance with tax laws or, in the case of marriage breakdown, with property settlements made in accordance with Family Law legislation. APRA may also agree to an adverse alteration of accrued benefits if two thirds of beneficiaries have agreed to an alteration that does not reduce minimum benefits, or if the alteration relates to rectification of an error that had permitted an advantageous alteration to a member’s benefit Supervisory examination Data collection instruments and techniques – annual returns The primary means by which the Regulators can review the management and operations of a superannuation entity is through analysis of the annual return and auditor’s report that are lodged with APRA by the entity, complement by on-site review. In particular, the returns can assist in the examination of whether the entity has complied with the SIS Act requirements and the entity’s overall investment strategy and performance. APRA regulated superannuation funds must send annual returns to APRA within four months after the end of each financial year. These returns are submitted electronically through APRA’s D2A (direct to APRA) system. APRA is currently setting requirements for more thorough and relevant reporting criteria. Table VIII.3 at Attachment E sets out the information to be contained in the returns for each type of fund, to apply in respect of the year ending 30 June 2004 onwards. Funds with a threshold asset value of AUD 60M also lodge quarterly, unaudited, statistical returns. Financial Risk Analysis Methodology APRA uses a risk based assessment approach in performing its supervision responsibilities. To support the risk assessment task, APRA has introduced PAIRS, or Probability and Impact Rating System (PAIRS). This is APRA’s central risk assessment model, and applies to roughly 3 000 regulated entities.
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In PAIRS, two estimates are created: the probability of failure, over a fiveyear time horizon, and the impact of entity failure should it occur. Failure impact is relatively straightforward, as it is based upon entity size. Failure probability is exceedingly difficult, and there is a major global industry centered on debt rating agencies trying to improve the state of the art. APRA’s PAIRS analysis starts with a structured risk assessment, and an assessment of an entity’s ability to manage risk. These two factors generate a net risk assessment, which is then compared to the entity capital position to determine an overall probability of failure. The major risk mitigants include a strong board and executive management supported by good corporate governance arrangements, internal compliance supported by independent audit, and good technical risk management particularly in determining liabilities and setting investment management guidelines. Once APRA has established a PAIRS grid position for an entity, the risk and likely impact of failure has been estimated. Then the appropriate supervisory stance to take with an entity is determined. APRA’s Supervisory Oversight and Response System (SOARS) is APRA’s core tool to determine its supervisory strategy with each regulated entity. There are four supervisory stances in SOARS. Normal entities are subject to routine information gathering from statistical returns and onsite visits. Oversight entities are not at material risk of failure, but some aspect of their risk position requires more extensive examination by APRA. Typical supervisory responses to oversight entities include more frequent and searching visits, more robust communication with the entity management and board, and possibly adjustments to minimum capital ratios. Some regulated entities follow business plans that mean that the best supervisory stance they can achieve is oversight. These entities have elected to accept more intensive APRA supervision, in order to pursue higher risk but hopefully higher return shareholder outcomes. Mandated improvement entities lie outside APRA’s tolerable risk range. Mandated improvement entities are unlikely to fail; typically, the split between medium and high risk, for example, is a 97% probability on expected five year performance. APRA intervenes vigorously in mandated improvement entities, particularly by issuing directions or accepting enforceable undertakings to improve some aspect of the entity’s risk position.
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Finally, come restructure entities. These entities have lost APRA’s confidence, and APRA looks to transfer the business to stronger hands while protecting beneficiaries from any potential losses. APRA’s supervisory strategy is based upon PAIRS and SOARS. Supervision starts with information flowing to supervisors. APRA’s data sources include statistical returns, on site visits, actuarial and audit reports, external ratings reports, and informal sources such as the media and whistle blowers. Out of this range of data APRA’s supervisors apply their professional judgment and experience to develop a PAIRS grid position. The PAIRS position is fed to SOARS. The SOARS supervisory stances are set by APRA senior management, and are the explicit embodiment of APRA’s institutional will to increase intervention as it observes worsening risk prospects for a regulated entity. The SOARS stance then feeds back to the supervisor, who crafts and executes a supervisory action plan. It is important to understand that there is a duality here for APRA’s supervisory cadre. Supervisors drive PAIRS, but are driven by SOARS. APRA follows this approach to achieve a good balance between supervisor independent judgment and the need for consistent and effective supervisory intervention across the regulated financial sector. PAIRS and SOARS were introduced in October 2002. Over 70% of the budget APRA supervises has been rated in the system, but it will require about two years to process all 3 000 regulated entities into the new setup. Diagrams in Annex VIII.5 illustrate the PAIRS/SOARS process. On site visits and inspections APRA’s risk-based supervision framework is a continuous cycle comprising four main components: analysis of risk exposure and risk management, assessment and supervision. Underpinning the framework is an assessment of the capability of an institution to manage the risks to which it is exposed. This overall assessment of an institution’s risk profile (risk assessment) will drive the development of an effective supervision strategy and appropriate supervisory actions. The framework promotes the concentration of resources more precisely on those institutions that exhibit greater risk and subsequently require more intensive supervision. As a result of undertaking such supervision actions APRA will be in a position to assess, on an on-going basis, the capability of an institution to manage the risks to which it is exposed.
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The supervision strategy for each institution is designed to project the frequency and intensity of supervision required to attend to the issues identified by our risk assessment processes and varies based on the institution’s overall risk profile. Under normal circumstances, APRA sets a program of on-site visits and inspections on a two yearly basis. Where the Supervisory Attention Index indicates other than normal, the frequency of visits will be increased. Allocation of time and resources As noted above, the determination of APRA’s supervisory stance and allocation of resources is based on the Probability Rating and Impact Rating for each rated institution. APRA has four supervisory stances: Normal, Oversight, Mandated Improvement and Restructure. A Normal mode means APRA collects and analyses data and makes routine on-site visits. Oversight' means a significant step-up in information collection and inspection intensity. APRA may increase minimum capital requirements for ‘Oversight’ institutions. Mandated Improvement means the institution is operating in an unsustainable way. APRA will direct these institutions to present and execute a remediation plan that addresses the area of identified weakness and restores financial stability. At this level, APRA allows the regulated institution to retain control of its destiny, but clearly signals that improvements must be made. APRA may issue directions and take other enforcement actions at this level. Restructure institutions are in serious danger of failure. Here, APRA applies its full enforcement powers, including issuing directions to replace persons and service providers and to restrict business activities. APRA's paramount concern in this situation is to quarantine the entity from further deterioration and minimise losses to depositors, policyholders and superannuation fund members. Number of on-site inspections in the last three years On-site visits and inspections to, and meetings and consultations in respect of, superannuation entities have increased over the past three years as set out below: 1999-2000 333
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2000-2001
622
2001-2002
1 073
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Whistle blowing If an auditor or actuary forms the opinion that there has been a breach of any SIS or regulatory provision, the legislation requires that the auditor or actuary must inform the trustee in writing of the matter. In addition, the auditor or actuary is required to notify the Regulatory in writing if the trustee fails to comply with the auditor or actuary’s request for a written report about how the trustee intends to rectify the matter or if the actuary or auditor is dissatisfied with the action taken by the trustee to rectify the matter. Member / beneficiary complaints Trustees must establish arrangements for dealing with inquiries or complaints that enable them to be considered and dealt with within 90 days after being made. Only after a complaint has been dealt with by the trustee can an unsatisfied complainant refer the matter to the independent Superannuation Complaints Tribunal. ASIC administers the complaints and inquiries processes; however APRA will take up with a trustee any indication that there are trustee processes that give rise to other than isolated complaints. Promotion of prudent management In addition to regulatory requirements, APRA publishes circulars and guidelines to promote prudent management of superannuation entities. These publications are available on the APRA website. Monitoring of provision of adequate information to members Member disclosure responsibilities are administered by the Corporations Act 2001 and fall under ASIC jurisdiction. Compliance enforcement and sanctioning Main irregularities observed during on-site and off-site supervision and what are the applicable fines, other penalties and enforcement procedures Main irregularities observed during on-site visits are operational risks and poor risk management practices. Examples of material operational risks usually found on-site include administration risk (risk of error or failure associated with the human administration aspects of the operation of the business); governance risk (risk associated with the board and / or senior management of an institution not effectively performing their respective roles); outsourcing and agency risk (risk arising from poorly drafted, executed and monitored arrangements with
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external service providers) and strategic risk (risk which arises from an institution’s inability to implement appropriate business plans and strategies, make decisions, allocate resources or adapt to changes in its business environment). Main irregularities observed off-site are usually increases in financial risks, and are determined by the types of products and services offered by an institution. Funds offering market linked investment products (such as accumulation superannuation) usually demonstrate irregularities linked to credit risk, asset concentration risk, pricing risk and liquidity risk. Those institutions offering assurance products (such as defined benefit superannuation funds and general insurers) usually exhibit irregularities related to liability concentration risk, liability valuation risk, liquidity risk and market risk. Fines, other penalties and enforcement procedures are dependent on the legislation under which an institution operates. In extreme cases in the superannuation industry, APRA has the power to revoke an approved trustee’s approval to operate retail superannuation funds, and may remove and replace a trustee. In less dire situations APRA may issue directions to a trustee to address the area of concern and monitor a rectification program. APRA also has a dedicated “Rehabilitation and Enforcement” function which oversees institutions which represent a ”high risk” and are classified as “mandated improvement” under the PAIRS process. Reasons justifying an intervention in a pension fund or a pension fund trustee company As noted above, APRA determines its supervisory stance based on the PAIRS rating for each institution. “Mandated Improvement” means the institution is operating in an unsustainable way and APRA will use its power to direct these institutions to present and execute a remediation plan that addresses the area of identified weakness and restores financial stability. Funds rated “Restructure” are regarded as in serious danger of failure. Here, APRA can apply its full enforcement powers, including issuing directions to replace persons and service providers and to restrict business activities, or even to direct the wind up of a fund. The procedures for interventions Internal procedures will vary depending on the type of intervention, however it is usual that a formal recommendation will be made by the responsible supervisor with the Executive General Manager and Senior Manager Legal
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(usually) approving such action, with input often sought from external legal sources as well. Action is always based on a PAIRS assessment and cost/benefit analysis of potential enforcement actions and impact on beneficiaries. APRA must obtain the Minister’s consent in advance in regard to actions such as revoking an approval to operate a retail fund or suspending or removing a trustee. It is also common for ASIC to be informed about such action due to requirements under the MOU. Table VIII.4. Sanction by type in the last three years
Enforcement Action
Application (administrative, court procedures, other public authorities)
When required
Number of sanctions in last three years
Show cause letter issues
Administrative
After trustee warnings & education have failed to produce a satisfactory result and before APRA takes action that may adversely affect trustees
22
Follow up delayed contributions
Administrative & other public bodies (ATO)
Delay of contributions
72
Disqualify auditor / refer to industry body
Administrative, other public authorities
When SIS obligations have been breached by auditor
4
Scope
Application (administrative, court procedures, other public authorities)
When required
Number of sanctions in last 3 years
Scope
Administrative remedies
Punitive / compensatory sanctions
Enforcement Action
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Enforcement Action
Scope
Replace trustees Intervention procedures
Investigator / liquidator / inspector appointed
Application (administrative, court procedures, other public authorities)
When required
Administrative, court procedures, other public authorities
Where appropriate; usually a last resort but may be immediate in cases of fraud
7
24
ATO
Matters involving self managed superannuation funds; Matters involving breaches of superannuation guarantee obligations by employers
18
Education, Issued notices, directions, enforceable undertakings obtained from institutions
Preliminary action to give trustees opportunity to rectify deficiencies and issues before resorting to more strict enforcement.
32
Administrative / other public authorities
Referrals to other bodies
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9
Breaches of sections of the SIS Act with criminal penalties
Police /ASIC / Director of Public Prosecutions
Other
Number of sanctions in last three years
Administrative, Court procedures if breached
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Conclusion The main issues for supervision of superannuation entities over the coming year that APRA intends to concentrate its focus and resources include: x
continuing refinement of the PAIRS risk assessment process;
x
introduction of the new annual reporting requirements for all superannuation entities regulated by APRA, and
x
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NOTES
1.
SIS Act section 344.
2.
http://www.apra.gov.au/Superannuation/Forms-for-SuperannuationEntities.cfm.
3.
The Probability and Impact Rating System (PAIRS) is APRA’s primary risk assessment tools for the institutions it regulates. A guide to APRA’s use of PAIRS can be found at http://www.apra.gov.au/PAIRS/home.cfm.
4.
Section 63 of the Superannuation Industry (Supervision) Act: http://scaleplus.law.gov.au/html/pasteact/0/443/top.htm.
5.
See Part 24 of the SIS Act: http://scaleplus.law.gov.au/html/pasteact/0/443/top.htm.
6.
See, for example, Part 8 of the SIS Act: http://scaleplus.law.gov.au/html/pasteact/0/443/top.htm.
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Annex VIII.1. Explanation of Some Terms Used to Describe Various Arrangements and Structures Regulated superannuation funds Regulated superannuation funds have a trustee that has elected to be regulated under the SIS Act. Trustees are either bodies corporate, or a group of individuals, or have the sole or primary purpose to provide old age pensions. A regulated superannuation fund cannot receive tax concessions unless it is a resident regulated fund. A regulated superannuation fund is established by governing rules in the form of a trust deed. The trust deed specifies who is allowed to make contributions to the fund and defines how those contributions are to be determined. The deed also specifies who is to receive benefits from the fund and the circumstances in which benefits are to be paid. Benefits may take the form of a lump sum, usually paid on or after retirement or termination of employment, or a pension usually payable from the time of retirement. Public-offer superannuation funds Public Offer funds are regulated superannuation funds that operate as retail funds which conduct their business by issuing interests to the public. They have at least one member who has joined the fund by his or her own choosing (i.e. the fund is not sponsored by an employer under an arrangement between the employer and the trustee). Other funds that do not have such members may elect to be public offer funds. Public offer funds include (but are not limited to) eligible rollover funds (ERFs – funds that must accept rolled over benefits from other funds) and master trusts (trusts that allow a large number of unconnected individuals and/or companies to operate under a single common trust deed). The trustee of a public offer fund must satisfy certain capital adequacy requirements and be approved by APRA. Small APRA funds (SAFs) SAFs are small regulated superannuation funds with an approved trustee and fewer than five members. SAFs are regulated by APRA and are exempted from certain SIS regulatory requirements.
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Standard Employer-Sponsored Superannuation Funds A standard employer-sponsored fund is a regulated superannuation fund that has at least one employer-sponsor who contributes to the fund either wholly or partly pursuant to an arrangement between itself and the trustee. Employers make contributions to the fund for the benefit of the employees who are eligible for membership of the fund. Employer-sponsored funds fall into two main groups, defined benefit funds and defined contribution or accumulation funds. Members of defined benefit funds are entitled on retirement or termination of employment to a benefit that is defined in relation to either a specified amount or the amount of the member’s salary at a given time. Members of an accumulation fund are entitled to the total contributions made by the employer (and any voluntary contributions made by the employee) which have accumulated in the fund in respect of the member. Approved Deposit Funds (ADFs) An ADF is an approved rollover fund that can accept superannuation rollover payments made to a fund member after leaving employment with an employer but before age 65, however there are usually minimum entry contribution requirements. ADFs are required to have approved trustees. The purpose of an ADF is to receive, hold and invest certain types of rollovers until such amounts are withdrawn, the beneficiary reaches age 65 or when he dies. Pooled Superannuation Trusts (PSTs) PSTs are investment management trusts regulated under the SIS Act in which assets of a number of superannuation funds, ADFs and/or other PSTs are combined, invested and managed by a professional manager. A PST is required to have an approved trustee. Public sector superannuation schemes These types of superannuation funds provide benefits for government employees. They are established by or under law or under the authority of the Commonwealth, a State or Territory and may elect to be regulated under the SIS Act. Some public sector superannuation schemes are not regulated under the SIS Act, but are instead subject to Commonwealth, State or Territory government supervision under their enabling Acts. These are referred to as exempt public superannuation schemes and are not regulated superannuation
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funds under the SIS Act; however, a Heads of Government Agreement (HOGA) requires these funds to comply with the spirit of the SIS Act. Retirement Savings Accounts (RSAs) RSAs are capital-guaranteed, non-trust based superannuation accounts that are offered directly off the balance sheets of either life companies or Approved Deposit-taking Institutions (banks, credit unions, building societies). RSAs are governed by separate legislation (the Retirement Savings Account Act 1997). Self-Managed Superannuation Funds (SMSFs) SMSFs are regulated superannuation funds that have fewer than five members where all the members are trustees (and there are no other trustees that are not members) and therefore actively participate in the fund’s management. SMSFs are supervised by the Australian Tax Office (not by the prudential regulator, APRA).
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Annex VIII.2. Divisional Structure of APRA The two divisions of APRA most directly involved with the supervision of superannuation funds are Specialised Institutions Division (SID) and Diversified Institutions Division (DID). Both these divisions are responsible for assessing applications for approved trustee status, conducting risk assessments of entities as well as ongoing monitoring of their performance and compliance with regulatory requirements. APRA’s Policy, Research and Consulting Division (PRC) provides support to the SID and DID frontline supervisors. SID Supervisors and analysts in this Division work in small teams with responsibility for a wide range of institutions including superannuation funds and approved trustees. In addition to ongoing review of institutions, SID analysts undertake on-site visits of every regulated superannuation fund on average once every two years, although depending on the risk status of a superannuation fund, visits can be as frequent as biannually or triennially. Located within SID is the Rehabilitation and Enforcement (R&E) branch of APRA. Institutions that are found to be in serious breach of their regulatory obligations or in a financially unsatisfactory condition are referred to R&E. It is the responsibility of R&E to assist troubled institutions to rectify their problems or to facilitate a smooth exit from the market. DID DID is responsible for the prudential supervision of more than 275 functionally diversified financial institutions, many with international connections. These include large financial conglomerates, banks, insurance companies and superannuation firms. Analysts conduct prudential and risk assessment duties on the institutions they are supervising. This involves off-site analysis of data and information, regular contact with senior people within the supervised institutions, as well as on-site reviews of those institutions. Research and analysis is also undertaken by analysts in the Technical Advice and Support (TAS) branch of DID. PRC Supporting SID and DID in their direct supervisory role is the PRC Division of APRA. PRC provides specialised risk management and consulting
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services to the other divisions of APRA. It is also responsible for the development of prudential policies relating to the full spectrum of institutions supervised by APRA and for financial sector statistics. Substantial research activities are also conducted in this division. PRC’s Risk Analysis and Research group provides policy staff and frontline supervisors with high-quality advice and recommendations on supervisory issues, particularly those with a quantitative aspect. PRC’s Capital and Risk Analysis is responsible for the analysis of issues associated with risk measurement and capital allocation. The group has a key role to play in the development of improved capital adequacy requirements for supervised institutions, including the gradual harmonisation of risk measurement and capital allocation techniques across traditional industry boundaries. The Actuarial Support Unit within PRC provides advice and guidance relating to actuarial issues which arise in the frontline supervision of insurers, friendly societies and superannuation funds e.g. analysing liabilities, providing commentary on financial reports. The unit also offers policy advice on actuarial matters relating to prudential standards. PRC’s Research Unit is responsible for a range of activities including publication of academic research papers and the development of APRA’s library facilities. The main priority of the unit is to undertake high quality research into topics of relevance to APRA, its regulated industries, and the financial system more generally. After internal review, research work is usually published internally as a working paper and is often followed by external review and publication in refereed journals. The Policy Development team within PRC develops policy proposals and advice, liaises with government agencies, other financial regulators (in Australia and overseas) and industry groups, and monitors regulatory and market developments in the financial sector. The Consulting Services area comprises five risk-based teams responsible for credit risk, operational risk, insurance risk, risk modelling, and balance sheet and market risk. These teams support the operational divisions of APRA by assessing the policies and practises of financial institutions, usually through onsite visits. The teams undertake detailed analysis of these risks within individual institutions and provide advice to the institutions and the operational divisions.
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Annex VIII.3. APRA Key Result Areas and Key Performance Indicators Key Result area
Prime objective
Prime Key Performance Indicators Performing entity ratio
Supervision
Minimise financial loss to depositors, policyholders and fund members through appropriate intervention
Money protection ratio Save ratio Number of institutional visits Number of institutions entering and leaving enforcement Supervision ratio Risk by institutional ranking
Policy
Develop prudential policies, standards and guidelines for minimising losses to depositors, policy holders and fund members
Statistical profile of institutions by number and value Policy development to plan Non-conformance to policy and legislation Policy development time to total time Public and media understanding of prudential issues
Prudential advice
Maintain open communication and constructive relationships with stakeholders
Expenditure on communication programs/plan Number of meetings with Minister and Treasury Number of meetings with industry, professional and consumer groups Call centre response times
Staff
Infrastructure
Sufficient staff with skills, experience and knowledge that meet prime objectives and strategy Cost-effective infrastructure that fully supports the prime objectives
Number of staff to plan Staff turnover ratio Training per employee Prudential supervision experience Activity by function and by industry Industry returns on time Levies collected to plan Operating and capital expenditure to
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Key Result area
Prime objective with professional support services
Prime Key Performance Indicators budget Cash flow to plan Occupancy per employee IT performance to targets Number of control risks rated as high Number of audit issues open
Account-ability
Assurance that objectives are met and risks are managed
Accumulated reserves / levies Level of compliance with Basel and IAIS Core Principles Full set of operational KPIs Quality metrics to be further developed
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Annex VIII.4. Disclosure Requirements Trustees of a regulated superannuation fund must disclose information to members, former members and other persons such as prospective members in accordance with the product disclosure requirements in the Corporations Act 2001 which is administered by ASIC. The disclosure regime covers such things as the point of sale disclosure requirements, the periodic statements for retail clients, the periodic disclosure of fund information, the ongoing disclosure of material changes and significant events, and information requirements about complaints. New members New members of a regulated superannuation fund must be informed of the following matters with regard to the fund within three months of joining: its main features; its management and financial condition; and its investment performance. Existing members Disclosure of information to existing members is usually sent out in a member benefit statement. This statement is distributed within six months of the completion of the fund’s accounting period, and must be sent at least once a year. The information provided must include: x The contact details of the fund. x Specific details of the withdrawal benefits and any eligible rollover fund details (an eligible rollover fund is a regulated superannuation fund which is eligible to receive lost or small benefits automatically rolled over from other funds). x If applicable, disclosure of contributions and rolled over benefits. x The fees, charges and expenses deducted. x The employer contributions and unpaid contributions. Members must also be informed of the occurrence of a "significant event", defined as any event in relation to the fund of which the trustees believe the member would reasonably expect to be informed. This information is generally required to be provided within three months, or within twelve months, if the event does not adversely affect the members. The members must in any case be
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informed, within specified timeframes, in the three following specific instances of significant events: x
Changes to the governing rules which adversely affect the members.
x
The transfer of members to a different category of membership or to a different fund.
x
The receipt by the fund of a notice of non-compliance from APRA.
Members must upon request be provided with the following information within one month: x
The governing rules;
x
The audited accounts.
x
The latest actuarial report (where relevant) and the latest annual report of the fund.
ASIC is the government body responsible for all consumer protection matters in the financial services sector, particularly concerning product disclosure. ASIC thus plays the leading role in ensuring that consumers receive adequate information to make informed decisions about financial products. All regulated superannuation funds (except for self managed superannuation funds) must appoint a contact person to receive enquiries and complaints from fund members. Relevant details for the contact person must be provided regularly to members by the trustee. Complaints should be dealt with in writing within 90 days of receipt, and when the fund advises complainants about the outcome of a complaint they must also be advised of the existence and function of the external Superannuation Complaints Tribunal (SCT). The SCT is a statutory body established to deal with complaints about decisions of superannuation fund trustees that affect the rights and benefits of individual beneficiaries. Complaints may only be made on the grounds that the decision concerned is "unfair or unreasonable". The SCT tries to resolve complaints by conciliation or voluntary arbitration. A SCT decision may only be overturned on a question of law, by appeal to the Federal Court. The SCT cannot hear a complaint unless it has already been made to the trustees under the funds’ internal complaints arrangements.
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Departing members Members who leave a regulated superannuation fund must be provided with the following information within one month of leaving: x
The contact details of the fund.
x
Details of withdrawal benefits, death benefits and insurance continuation options.
x
Details of the funds’ internal complaints arrangements.
x
Details of the functions of the Superannuation Complaints Tribunal.
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Annex VIII.5. Annual Reporting Requirements to Commence from 1 July 2003 Statistical and Compliance Fund Type Annual Report Information
Public Offer Funds
Eligible Rollover Funds
Small APRA Funds
Multimember Approved Deposit Funds
Single member Approved Deposit Funds
Pooled Superannuation Trusts
Other
General Fund/Trust and Trustee details
External administrator details
External investment manager details
9
Custodian details
Other service providers’ details (actuaries, lawyers, accountants, other advisers)
Auditor details
Duration of the year for which the fund was a public offer fund
222
9
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Fund Type Annual Report Information
Public Offer Funds
Eligible Rollover Funds
Small APRA Funds
Multimember Approved Deposit Funds
Single member Approved Deposit Funds
Pooled Superannuation Trusts
Other
Retirement benefits details
9
Reserve details
9
Functional description of the fund
9
Membership details
9
9
9
9
Fund/Trust income
9
9
9
9
9
9
9
Fund/Trust expenditure
9
9
9
9
9
9
9
Fund/Trust balance
9
9
9
9
9
9
9
Fund/Trust assets
9
9
9
9
9
9
9
In-house assets
9
Derivatives
9
Liabilities
9
Compliance details (SIS requirements satisfied?)
9
9
9
9
9
9 9
9 9
9
9
9
9
9
9 9
9
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9
9
9
223
Fund Type Annual Report Information
Public Offer Funds
Eligible Rollover Funds
Whether all investments are in individual policies of life insurance
Small APRA Funds
Multimember Approved Deposit Funds
Single member Approved Deposit Funds
Pooled Superannuation Trusts
Other
9
9
Prudential Details
Details on beneficiary choice
9
9
External review details
9
9
Significant events1
9
9
Change in computer systems
9
Status of solvency certificate (defined benefit funds only)
9
Financial and compliance audit report
9
9
9
9
9
9
9
9
9
1. A significant adverse effect is legally defined as one that endangers the ability to make scheduled payments to beneficiaries.
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LOW
1
10
50
250
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Low
M e d iu m
H ig h
E x tre m e
IM P A C T R A T IN G
15
150
750
3750
M E D IU M
H IG H
75
750
3750
18750
P R O B A B IL IT Y R A T IN G
3 U R E D E L O L W \ D Q G , P S D F W 5 D WLQ J 6 \ V WH P 3 $ , 5 6
ANNEX VIII.6. PAIRS/SOARS
5 225
2250
11250
56250
EXTREM E
VIII.
PRIVATE PENSIONS SUPERVISORY METHODS IN HUNGARY by Erdos Mihály
Institutional framework, market structure and general approach to supervision The Hungarian pension system is composed of the following three pillars. a) First Pillar: a state managed, pay-as-you-go system. Participation in this system is mandatory for all insured people. The retirement age is 62 for men (by 2003) and will be 62 for women by 2009. The social security contribution is 8.5% for non–private pension fund members, 1.5% for private pension fund members, and 18% for employers. While employees contribute no more than twice the amount of their average wage, there is no upper limit to employer contributions. b) Second Pillar: a privately managed, fully funded, defined contribution (DC) system without minimum benefit guarantees. Participation is mandatory for new employees (new entrants to the labour force). Institutions operating in this area are private pension funds. Fund members pay 7% of their gross salary, with an upper limit imposed by law. An individual may join only one fund. c) Third Pillar is also a privately managed, fully funded, DC system without minimum benefit guarantees. Participation is voluntary for members. Pension funds have the same institutional framework as the second pillar. Members pay a minimum fee, set by fund regulations, taken from their own personal savings. However, employers are encouraged to support their employees’ fund through generous tax and social security allowances; this implies that employers may pay the pension fund fee on behalf of their employees. Individuals have the legal right to join as many pension funds as they wish. Although the objective of the regulation is to ensure that officials benefit from this fund only when they officially retire, it is nevertheless possible to have access to the fund after ten years membership. Given that this fund was created in 1994, third pillar funds will become operational in so far as disbursements are concerned as of 2004. However, no major structural changes are anticipated once this process begins.
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Features of the system which strongly influence the supervisory framework Institutional form of private funds: The owners of the funds are also its members. They make strategic decisions at general assemblies (election of the board and supervisory committees, etc.). The efficiency of this type of direct democracy is limited to certain funds (i.e. those funds with more than 100 000 members) and to certain financial groups, generally those operating personal plans. Employer-supported funds (occupational type) operate under strict member control. Outsourcing of different functions: Pension funds may choose between in-house asset management and out-sourcing, the latter being more frequent. To a certain extent, this choice is based on administrative reasons in that pension benefits can be bought from insurance companies in the second pillar, but not under the third pillar. One fund in two pillars: Pension funds are allowed to act in both the second and thirds pillars, but with separate accounts in the administration. Decentralized collection system (Second Pillar): Each pension fund is responsible for the collection of contributions. This work dominates the administration work, since the largest funds collect fees from approximately 100 000 employers, respectively. Mixed systems (occupational and personal) with same basic requirements: The pension system is based on personal and professional private funds, with only minor differences in their institutional framework. through Essentially, these differences pertain to relations between the board of directors and the supervisory committee. Limited employer rights: Employers have the right to nominate one person to the supervisory committee if their financial support towards the payment of members’ fees exceeds half of the fund’s income. Although, employers often support the funds, they have only limited legal rights to influence its operation (indirect influence). . Common investment risk bearing strategies: A fund has a single investment strategy. This is true for second pillar funds, and although third pillar funds can by law invest in more than one strategy, in general they limit themselves to one. In practice, members join a fund in order to ensure they will have a pension, but they do not base their choice according to the investment strategy of a particular fund.
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The market From the start, there has been rapid and continuous growth of membership and assets of pension fund markets, although this growth has in general been characterized by a continuous process of consolidationand mergers. By the end of 2003, 18 pension funds operated under the second pillar (as opposed to 38 pension funds in 1998), representing 2.2 million people (55% of the working population). Market concentration is very high, with the six largest funds (all sponsored by financial institutions) representing 87% of the membership and 83% of assets. Total assets exceeded HUF 410 billion (¼ billion) by the end of 2003. Market concentration is slightly lower in the third pillar, even though consolidation of funds was very high (190 pension funds in 1998, and 82 in 2002). The market share of the fifteen largest funds is 83% of the total market membership and 80% of the total market assets. Employer-sponsored pension funds play a more significant role in that they represent 29% of the market’s membership and 34% of the total assets. The market consists of 1.1 million people (about 15% are non paying members) and HUF 358 billion (¼ billion) asset. Total assets collected by pension funds (both types) amount to approximately 5% of the GDP. Supervision The introduction of a third pillar also saw the introduction of a single supervisor in 1993. The State Supervision of Private Funds controlled only pension funds, health care funds and self-support funds. In April 2000, three different supervisory agencies (the State Supervision of Private Funds, the State Supervision of Insurance Companies, and the Money and Capital Market Supervision) were merged to form a single institution, the Hungarian Financial Supervisory Authority (HFSA)s. The HFSA is an integrated supervisory agency for all financial sectors and financial institutions in Hungary. At present, 541 persons are employed by the HFSA, which is financed exclusively by market participants. The most important income sources are the licensing and supervisory fees (the latter is currently set at 0.5%), which are regulated by law. Payment received from fines cannot be used for operational purposes, and must therefore be channelled back into the market (education, associations, etc.). The supervisory budget was 7.6 billion HUF (¼ PLOOLRQ) in 2001. Financing is cross-sectorial, although the supervision of funds is not divided into cost-centers (neither on functions, nor on institutions).
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The HFSA is based on directorates and departments, which represent the different functions of the supervisory body.There are four directorates operating in the organization: 1) on-site and off-site financial supervision, 2) licensing and legal enforcement, 3) analytical and methodology, and 4) the IT. The first two directorates are the largest, with 182 employees (including: 24 for healthcare funds, pension funds, and self supported funds) and 84 co-workers (9 for healthcare funds, pension funds, and self supported funds), respectively. There are several departments dealing with pension fund issues in the above mentioned directorates; however, not all directorates have departments dealing with pension fund issues. The research, strategy planning, customer service, and actuarial tasks are integrated under one directorateIn order to express the institutional specialties, there are four senior advisors overseeing the following sectors: money market, capital market, insurance and pension funds, and working directly under the president. The advisors coordinate the work of the same institutional departments from different directorates, and lead different projects. However, they do not have wide-range powers (i.e. establishing salaries or deciding on staff employment). The supervisory approach is a pro-active one. The HFSA produces daily, quarterly and annual reports on the objectives and results of the pension funds. The Supervision Department of Pension Funds is composed of inspectors and supervisors, the latter lawyers from the Licensing Department for Pension Funds, the Monitoring Department, and the Actuarial Department. While inspectors are responsible for on-site examinations, the role of the supervisor is to maintain contact with the supervised entities and carry out off-site supervision.. All mandatory pension funds — mixed (mandatory and voluntary together), voluntary and problematic — are supervised. (). In view of the financial efficiency of a high number of pension funds, the HFSA is trying to institute a greater number of off-site supervision as opposed to on-site ones. HFSA organizes preventive and prudential meetings with fund managers. Preventive meetings offers the opportunity to obtain non-quantifiable information, such as changes in management, in service providers and in strategic plans. In many cases, these meetings are required by fund regulations. Our experience shows that these meetings are more effective in attaining supervisory objectives than they are in collecting financial fines. Prudential meetings are necessary when the on-site or off-site controls reveal business activities which although legal, remain doubtful. All activities are integrated so as to allow the control and compliance functions of the supervisory body to be fully operational. Current research calls attention to the risks associated with the top-down approach of the different institutions in the financial sector. (The Monitoring Department is responsible 230
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for the bottom up approach.) In addition, the HFSA publishes its recommendations for the supervised entities, which aim to communicate good practices for the various sectors. Market participants closely follow these recommendations. Entry requirements Legal requirements to licence or register a pension fund The fund should ensure the smooth functioning of general assembly meetings, and accept business plan strategies and the election of the executive management staff. The HFSA provides the operational license if the fund is registered by the competent court and is registered with the Tax Authority. In the case of mandatory private pension funds, there is an additional requirement which is to obtain a social security registration number. An HFSA license is necessary to: a) establish a fund; b) start the fund’s operation; c) implement the benefit regulations and to start the provision of fund services. The organizations concerned shall certify the existence of the requirements specified. The HFSA may grant a three-year exemption from the actuarial degree or the required experience. All funds require an HFSA license in order to be established. Voluntary pension funds must obtain an operational license from the HFSA if they intend to provide fund services, in which case the requirements for granting the operational license is identical with the provisions governing the foundation license. The HFSA shall grant the foundation license and the operational license if the applicant fulfills the requirements listed in the law. The application for the foundation license and the operational license (hereinafter referred to as the "foundation license") shall contain: x
the draft deed of foundation,
x
realistic estimates as to the planned membership,
x
a presentation of how the founder intends to ensure the personnel, material and financial resources necessary to establish the fund, and
x
the deed of foundation.
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Based on the foundation license, the founder shall establish a deed of foundation, and, pursuant to the provisions, convene the first delegates meeting and commence to organize operation of the fund. Documents requested in the case of mandatory private pension funds The deed of foundation shall contain: x
the founder’s name and registered office,
x
the name of the fund,
x
the date of establishing the fund,
x
the scope of activity and the fund’s registered office,
x
the membership scope,
x
the starting date of operation,
x
the name and particulars of the person acting on behalf of the founder,
x
the budget,
x
the date of issuance of the deed of foundation, and
x
the official signature of the founding organization.
The fund shall submit the following documents when applying for an operational license:
232
x
the foundation’s deed,
x
the fund regulations,
x
evidence that the application for registration has been submitted to the court, or the final legal decision on registration,
x
document verifying that the fund has a tax number, a bank account and a social security registration number,
x
documents verifying the number of members specified in the law
x
the business plan,
x
the regulations governing asset management, benefit provision, and, if the fund's assets valuation regulations is more detailed than required by the legal regulation, the assets valuation regulations,
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x
the particulars of the members of the Board of Directors, the Board of Supervisors and the auditor,
x
documents verifying fulfillment of the personnel and material conditions necessary for conducting fund activities in accordance with the law,
x
a declaration on the intended starting date of operation,
x
a declaration certifying that the fund is prepared for the data reporting obligation in accordance with the law,
x
the regulations referring to the fund’s internal control and auditing system,
x
any contracts concluded by the fund commissioning other organizations to conduct operational and administrative activities,
x
the contract concluded with the custodian, and
x
a declaration certifying that the fund shall disclose to an independent assessor registered by the HFSA information as is indispensable for evaluation of the fund’s performance. Such information, however, shall not include trade secrets.
Documents requested in the case of mandatory in case of voluntary private pension funds The deed of foundation shall contain: x The founder’s name and registered office, x The name of the fund. x the date of establishing the fund, x the scope of activity and the fund’s registered office, x the membership scope, x the starting date of operation, x the name and particulars of the person acting on behalf of the founder, the budget made available, x the date of issuance of the deed of foundation, and x the official signature of the founding organization.
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The fund shall attach to the application for the operational license: x the minutes and the registration sheet of the General Assembly x the deed of foundation, x the Fund Regulations, x evidence that the application for registration has been submitted to the court, or the final legal decision on registration, x tax number, a bank account number and a social security registration number, x the financial plan, x employer contract (if any), x the regulations governing asset management, and benefit provision, and x the contract concluded with the custodian (service providers if there are outsourced activities). Procedures for analysis of the documents All documents are verified by the Licensing Department of Pension Funds, by the Fund Controlling and Enforcement Department, the Department of Actuaries, and the Department of Policy and Methodology. The licensing department examines the completeness of the foundation request, the documents of the foundation General Assembly (GA) meeting, and its constitution. They also examine the necessary declarations, tax number, and court registration. The Supervision Department for Pension Funds examines the business plan. The Actuarial Department examines the preliminary business plan as a whole, including the services, the calculating methods and its accuracy, the detailed plans and working ability of these plans. The Department of Policy and Methodology examines the whole of the documentation and the correlation between all the documents submitted. The Licensing Department of Pension Funds summarizes its professional opinion (and if necessary, consults with other involved colleagues and fund members). The fund’s application for the operational license shall be rejected by the HFSA if the application and the attached appendices fail to meet the 234
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requirements established by law. It is also rejected if the fund fails to fulfill any request for remedy of deficiencies by a given deadline. The HFSA may call for the modification of the submitted documents if, based on such documents, it can be assumed that the fund’s operation is not safe, or if the submitted documents contain professionally inappropriate provisions. Evaluation of the business plan A business plan is required for the licensing of a fund. The HFSA analyses the licensing, and its on-site control of the current plan, which has certain requirements laid down in the law. (Until the end of 2003, pension funds had to report their plans to the supervisory agency on an annual basis.) Actuaries, economists and lawyers examine whether: x membership and asset development is realistic, x fixed and variable costs are covered by income and operational reserves, x all costs are included in the plan concerning the activities, x all fund functions are taken into account, in comparisons with the contracts, x outcomes (including benefits) are planned in timely fashion, x
rate of returns are in conjunctions with the expected capital market developments, and
x
the plan is consistent with capital and pension fund market developments, and the plan own regulation.
Applying for tax benefits As mentioned above, the pension fund – following its foundation but awaiting its operational license – is registered with the Tax Authority and given a tax registration number. With this number, the fund is able / authorized to issue tax certificates and at the end of each year issues a certificate on membership contributions to each member. That person will then indicate the amount in his/her personal income tax avowal, enabling him thus to receive a tax allowance or reduction. If the employer deducts the member’s fund contribution, then the tax allowance is deducted from that member’s salary along with other monthly tax deductions.
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Provisory and permanent licenses The HFSA issues only permanent licenses. However, when the new pension system began operation, there were cases when the HFSA gave out licenses for clearly defined periods of time. In the case of mandatory private pension funds, licensing is a two-step process. The pension fund can start its operation — organize its activities, recruit members, and collect membership contributions — when the fund receives its foundation license. Providing services, however, can only be started when the fund receives its operational license. There are 180 days between these two steps, during which time all necessary documents must be assembled and up to 2000 members recruited. Should these requirements not be fulfilled, the fund loses its foundation license. It must then decide whether to apply again or withdraw / liquidate its application / assets. Revocation of licenses The number of voluntary private pension funds is decreasing because of market concentration (due to mergers, liquidation, etc.) Although all three types of funds have developed dynamic strategies, the results are such that the funds seem to be precarious. Operational licenses can be revoked for the following reasons: not adhering to legal obligations and establishing rules which are contrary to the law. It can also be revoked if the fund is not properly registered. The funds existing prior to the institution of the new rules have in most cases been liquidated. Table IX.1. HSFA — Registration of pension funds 1999
2000
2001
Mandatory private pension funds
3
—
—
Voluntary private pension funds
2
2
1
Table IX.2. HFSA — Applications for pension funds registration denied 1999
2000
2001
Mandatory private pension funds
—
—
—
Voluntary private pension funds
—
2
1
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Reporting and approving posterior changes in the initial status of the pension fund structure In the case of voluntary private pension funds, it is generally not necessary to seek approval for changes made a posteriore. Amendments to the foundation’s licenses and to contracts with service providers must be sent to the HFSA. In certain cases, the HFSA can require further amendments to these documents. The voluntary private pension funds have the opportunity to run / operate supplementary business activities; however, they need special authorization / approval from HFSA for this. In the case where the fund wishes to operate an optional portfolio system (different portfolios with the same fund), it needs to receive special approval of the HFSA for this. In the case of mandatory private pension funds, the HFSA should approve the rule of services and all of amendments related to it. For other rules and contracts, the same regulation is in practice as for voluntary private pension funds. On going supervision Information and the documents required, the frequency and the procedures for off-site supervision Compliance with governance rules: Funds must invite representatives from the supervisory agency to their general assembly (GA) meetings and report the minutes. Supervisors attend these meetings and are often queried about legislation by fund delegates. In so far as off-site supervision is concerned, lawyers examine the GA minutes, the election of new board members, and the fulfilment of their legal requirements. This task is comprehensive at the time of licensing. Member complaints often initiate investigations. Contribution rules: The rules of contribution (amount, timing, collection) are regulated by law in the second pillar, and by the fund constitution in the third pillar. The latter are less restrictive and take into account that fund members join these fund on a voluntary basis and cannot be forced to pay. In the mandatory pension fund rules, compliance is strictly imposed. Special processes regulate the task of pension funds if contributions are not paid correctly and on a timely basis. If the employer does not solve the problems on fund request, this must be reported to the tax authorities and to fund members. During on-site inspections, the supervisory agent examines whether or not the
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fund adhered to regulations.,. Quarterly reports present the development of the “not clear” contributions paid to the fund (off-site), and where this figure is increasing, HFSA requires clarification and measurements to deal with it. It is intended that there will be a central supervisory administration which manages personal and payment data on every fund member in the second pillar. This project has not yet been completed. Many recommendations are published for the funds about the collection of contributions, the reconciliation with employers, and the processes with tax authorities. Membership and portability (enrolment process, transfers and compliance): Members in the second pillar must adhere for a period of least for six months. Switching funds is not limited to voluntary funds. Members who wish to change funds must submit a written request with either the new or the former fund. The amount of the personal account is transferred to the new fund on a quarterly basis, which in turn is based on its market value. Between the last day of the quarter and the time of the transfer (legally regulated) funds must yield the required amount. The law limits the costs, which are deducted at the time of transfer. Inspectors verify that transfers are done properly. Such verification includes compliance with the transfer schedule, the correct calculation of the transferred amount, and the pricing and cost of deductions resulting from that transfer. Investments, asset allocation, performance measurement and attribution, risk management: Mandatory pension funds and large voluntary pension funds must submit to the supervision the asset allocation of their portfolio (securities, prices) through their custodian on a daily basis. Quarterly reports and annual reports contain more data on membership, contributions and outcomes (costs, benefits). Although the reporting of the achieved rate of return is part of the quarterly report, HFSA focuses more on the annual data. The supervision emphasizes and examines not only fund compliance with legal investment limits, but also the investment policy of that fund. Daily reporting, which also presents this information (off-site and on-site controlling combined), can verify asset pricing. Within the framework of on-site investigations, inspectors examine the correct performance calculation and cost deduction (asset management and custodian fee). Attribution analysis is not a supervisory task (it is done by rating agencies), although HFSA has issued a research paper on the different performances, fee structures and amounts of different institutions of the same financial group. This “fine tuning” measurement has achieved its market impact. The lack of historical data over the long-term renders difficult the use of risk management tools. However, HFSA analyses the differences between fund
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and benchmark performances (alpha), relative to the market average. More sophisticated models (VaR) are in the preparation phase. Minimum capital and reserves: There is no requested minimum capital for the operation set by law. However, HFSA examines the income-outcome balances in comparison with the invested capital, verifies that there are reserves for operation and, where it is applicable, the actuarial fair calculation of the benefit reserves. Custodian procedure: The custodian is the most important market partner of a supervisor to control pension funds. Every transaction (securities and payments) must flow through the custodian. He is responsible not only for technical functions (settlement, safekeeping, etc.), but must also verify the work of asset managers (if the limit is exceeded, this must be reported to the fund and the HFSA) and is responsible for the pricing of securities. The Delivery Versus Payment (DVP) system enables pension funds to avoid partner risks. Asset managers may not hold securities and money from the bank (with few exceptions). HFSA, as an integrated supervisory agency; is able to check any transaction at the different stages of the deal, etc., at the custodian level, at the pension fund level, and at the asset manager level. All can be fined after an investigation, which is not always the case under the separate supervisory agencies. Checks on the performance of outsourcers: One of the main tasks of the Supervision is to make sure that the supervised institutions adhere to the law. Checking of bad or good performances of the supervised institutions is not a supervisory task. The violation of law, however, could play a role in cases of good or bad returns. Therefore, the main responsibility is verification of compliance with the regulations. HFSA examines the control mechanisms of the outsourcers by the fund management; whether payments and services correspond to the contract, and that these are documented. The supervision also investigates the functioning of internal control mechanisms. Financial, actuarial and accounting methods: The financial plans of the funds serve as a starting point for the financial control. Increasing the number of members is crucial for the fixed and variable costs, which are backed by contracts. Taking into account the actuarial forecasts, the timing of the outflow from the funds, and the financing of the operation can be evaluated. There are different ratios, which indicate the expected working life of the fund without new members, and without new income. Applied financial ratios belong to EAR (earnings), CAPOZ (capital), LQ (liquidity) and APO (asset and portfolio) groupings, and used for the ongoing monitoring. In order to strengthen the consolidated function of the HFSA, these ratios are set up in a unified function
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matrix for each supervised sector. For instance, the same activities at pension funds, insurance companies, banks and capital market institutions are measured by the same or similar ratios. The verification of accounting methods starts with the examination of the accounting and controlling systems. The payment and transfer processes are also investigated. The correctness of the bookkeeping is checked by sample tests. Transactions are controlled randomly, taking into account the amount, season, timing and the contracted partners. Information to potential members and other distribution issues: In the framework of the on-site controlling consulting offices and their documents are checked. It is very difficult to investigate the work quality of the agents; the supervision focuses on payments to them and services rendered. However, the integrated characteristics of the HFSA offer an excellent opportunity to control the agents’ registration and history. Administrative cost, fees and marketing: The supervisory task is to check the title and reason of the costs, compliance with the law (limited amounts), contracts and with the fund’s own regulation (entry, switching, withdrawal, retirement), the cost control (internal controlling) mechanism, and the adequate level of operational reserves. Marketing documents can be used as a reason for investigation if they contain unrealistic promises and their content is against the law (annualized monthly performances, false performances, etc.). Disclosure to members: The copy of the announcement proves the fulfilment of the disclosure requirements. HFSA controls the sending of the annual individual account and its content (on-site). Funds’ websites: Checking of the funds’ websites is not part of supervisory investigations. However, based on client complaints it can initiate an on-site examination. Nevertheless, internet does not yet play a major role in the development and functioning of financial institutions (including pension funds). General organization, IT procedures, internal controls of on going supervision Investigations will occur if:
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x
the operation of the supervised institutions, or the whole financial sector (its segment) indicate immediate intervention;
x
there is a suspicion of illegal activities, or
x
other state or private entities, responsible professionals, or clients report acts which are not in conformity with the law.
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Pension funds are informed at least 45 days in advance of any comprehensive investigation. The deadline is three days for planned, targeted and follow-up investigations. In emergency cases or when the information could limit the effectiveness of the investigation, these deadlines may be changed. According to annual plans, the Monitoring Department prepares ratios for the investigation in order to support its effectiveness. Because of this, the supervisor of the affected fund sets up a conceptual summary about the most important features and information of that fund, and he/she gives it to the head of the on-site inspection with the suggested control points. Based on this information, the head of the on-site inspection prepares the actual, concrete control plan derived from the general control plan and discusses it with the supervisors. According to the emphasis and the type of investigation, the head of the supervision department responsible for the on-site inspection designates the members of the team. The assignment of the off-site supervisors is the right of their heads of departments (for instance, actuarial, legal, IT) on the recommendation of the supervision departments. People working on off-site and on-site inspections are responsible for different parts of the control plan, but all results of their activities are submitted to the head of the team. During this period, they must follow the instructions of the team leader. If there is an urgent reason to extend the time of the investigations, the team leader is allowed to decide it alone, up to 20%. Monitoring the risk level of pension fund portfolios The supervision applies different ratios to monitor the risk level and effectiveness of the portfolio. Simple ones represent the asset allocation by asset type, by issuer, liquidity, and their changes. Liquidity is also measured by the connection to the expected outflow. Relative measurement aims the comparison with the targeted benchmarks: differences with the investment policy and with the benchmark performance (D). Advanced methodologies are in the preparation phase. The use of Value at Risk model is the most likely methodology to be used for risk monitoring. ALM models are not relevant because of the DC characteristics of the system, and the market is still in the accumulation phase. Planning on-site inspections The president of the HFSA regulates the processes and responsibilities in a Presidential Direction. The different types of investigations are: (i) comprehensive, (ii) targeted and (iii) follow-up. Investigations can be
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targeted towards one entity (alone) or towards a group of entities with the same leadership or belonging to the same financial group. Investigations can be conducted by the HFSA itself or by external firms, and can be carried out either immediately or after advance warning of the dates that this investigation will occur. Departments must submit all investigations they would like undertaken, along with the reasons for those investigations, by a specified date. A list is the compiled and submitted to the general management meeting for approval. The president makes the decision by the end of the third quarter. Based on the final version of the plan, the department of coordination informs the directorates in order that they may plan the staff necessary for each investigation. The supervision departments inform the supervised institutions about the expected time of the investigation. On-site inspections take place every two years at mandatory pension funds (determined by law) and every 2-3 years for voluntary funds (by practice). The length of the inspections lasts 3 to 15 working days depending on the asset size and the number of members of the fund. Current changes aim to shorten the time and frequency necessary for effective on-site inspections, and to turn to off-site inspections on a more frequent basis. Targeted investigations, rather than comprehensive investigations, must play a more important role. As of 2002 the outsourcing of administration activity has been under HFSA control. However, there is no legal obligation for the frequency of their inspections, the supervision having examined all independent companies. The aim of these investigations is to ensure that the pension funds’ administration can be checked through these service providers. Documents required and the procedures for inspection The most important documents are:
242
x
Regulation about benefits.
x
Regulation about the return allocation.
x
Regulation about the payments to members (switching).
x
Regulation about the reserves.
x
Regulation about the handle of the client complaints.
x
Regulation about the client services.
x
Regulation about the protection of personal data, and business secret.
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x
Prospects, documents, letters about annual accounts sent to the members.
x
Contracts about the rent or the ownership of the offices.
x
Announcements about the general assembly.
x
Minutes about the board and supervisory committee meetings.
x
Accounting policy
x
Copies about the disclosers.
x
Regulation about the cash and payment processes.
Frequency and intensity of the inspections Depending on the size of the fund, two to eight people can conduct the investigation. The team leader is always an economist from the supervision department. In the case of inspections of smaller funds, the investigative team is composed of staff from the supervision department only. In the case of inspections of bigger funds, other experts, such as jurists, actuaries, and IT experts take part. These professionals have long supervisory (5-10 years) experiences. In 2001, 160 on-site investigations took place. Apart from on-site inspections, there are six meetings with funds’ directors and managers per month. Depository institutions and rating companies are also supervised. Compliance, enforcement and sanctioning Main irregularities observed during on-site and off-site supervision and the applicable fines, other penalties and enforcement procedures Typical or frequent problems are: x
Deadlines for payments (switching) to members are not respected.
x
Costs deducted from members are against the law.
x
Returns are allocated to members in the wrong way.
x
Fund regulations are not updated to reflect current legislation.
x
Control and self-regulation of the IT systems is not sufficient.
x
Board meetings are not properly documented at smaller funds.
x
The controlling of the asset manager (outsourcing) by the pension fund is not effective.
x
Auditors do not carry out their duties.
x
The calculation of the achieved rate of return is not proper.
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Reasons justifying an intervention in a pension fund or a pension fund managing company In the case of both pension fund types, independency and self-supporting is a basic principle. Therefore, the HFSA can intervene in the operation of the fund only in justified cases. The HFSA intervenes in the interest of the fund members, and that the fund respects legal requirements. The reasons for intervention are similar to those disclosed during the controls The HFSA can also intervene if the financial condition of the fund is not adequate. However, there was no example of this. In certain cases, the HFSA intervenes if the management of the fund is not prudent or violates the prudential rules. Until now, there has been only one case of this. Therefore, general conclusions cannot be withdrawn. Procedures for interventions Legal assertion has basically three forms, which are the following: a letter from the HFSA management; an imperative letter and public administration resolution. Legal assertion is the task of the Fund Licensing Department, which basically complies with the memos of involved departments, as well as the observation of the licensing department. The most important documents are the closing resolutions of the inspections (minutes-reports; observations of the fund, evaluation of the observations, executive summary, minutes recorded during the inspection). According to inspection documents, the licensing department prepares a draft resolution in consultation with the supervision department. Following this, the resolution is signed by the appropriate manager, and sent to the fund. The HFSA closes all its inspections with a resolution. Their observations, which concern actions not necessarily against any law or regulation but which are nevertheless criticized by the HFSA, are notified by letter to the management level of the staff by the head of supervision department . In the case where the data arrives late or is suppressed, the data control department sends an imperative letter to the fund to fulfill its duty. If this is still not sufficient, then DC department prepares a memo to the licensing department to impose a resolution. All facts are detailed in this resolution and the DC department proposes a fine/penalty. Following this, the licensing department issues the resolution.
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In the case of mandatory private pension funds, the Central Registration of Pension Funds Department acts in accordance to the data provided. If necessary, the Central Registration of Pension Funds Department sends an imperative letter to request the missing data. The CRPF Department notifies the supervision department and, if necessary, notifies the legal department if they require a resolution or proposal for fining the fund. The documents of the General Assembly (GA) meetings arrive at the supervision department, who forwards the documents with an accompanying letter to the licensing and the actuarial departments. The supervision department summarizes the observations of the memos and if necessary sends an imperative letter to the fund. On the basis of the documents received from the fund, the supervision department comes up with a proposal for arrangements and sends it to the licensing department. The licensing department issues either an imperative letter or a resolution which makes the necessary arrangements. Table IX.3. Number of sanctions in pension funds by type 1999
2000
2001
350
225
279
Suspension of member recruitments
2
1
4
Calling for Extraordinary GA meeting
20
1
3
Ban of payments*
0
3
2
Suspension of the operation*
0
3
2
Withdrawal of operational license
18
10
16
Launch for liquidation
6
18
14
Penalty
39
26
44
Resolutions
* Same cases Notes: - Withdrawal of the operational license can happen as sanction or in cases when the fund winds up without a legal successor, - launch for liquidation can happen when the fund is not able to close its operation (few members and do not attend on GAs), and is connected to the withdrawal of operational license in many cases.
Conclusions Supervising pension funds is a challenging task. The legal framework is always changing; and supervisory methods must follow. The most important features of the current Hungarian experiences indicate the following:
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x
A shift from on-site towards off-site supervision in order to use the supervisory resources more effectively, although on-site cannot be negligible.
x
Supervisory goals and compliance with the regulation can be achieved in many ways, such as through preventive meetings with fund management, supervisory recommendations (guidelines), and fines (“last solution”). These must be implemented on an individual case-bycase basis (no general ranking of their effectiveness).
x
Although publication of the resolutions is an HFSA basic rule, it also acts as a strong supervisory power for market participants. It is a difficult task to separate objective and subjective measurements because they are interdependent, and many of the subjective characteristics cannot be measured objectively.
x
The focus of investigations must comply with the development of the market (life cycle). At the start, it is the administration which assumes the main risks, followed by the market (investment risk), and finally the actuarial sector (liquidity risk). In addition to the risk characteristics of the market, the other influential factors are the size of the market, the maturity of the market, market concentration and role of other professionals (custodians, actuaries, auditors).
x
There is no general rule. Every country must find its own way, for instance it is not the structure of the supervision (integrated, separated) that is essential, but rather how the supervisory goals can be achieved more effectively. Development and changes of supervisory tools is a continuous task: HFSA analyzes its own monitoring system with the objective of making changes whenever necessary.
The following are suggestions for further work.
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x
Watching for trends in the supervisory approaches.
x
Selected topics for more in-depth analysis include risk-based monitoring, effectiveness of different supervisory tools (fines, sanctions, guidelines), and the advantages-disadvantages of different approaches (on-site, off-site),
x
Benchmarking of the supervisory structures (employments) is also a tempting topic, but it can be misleading because of differences in supervisory activities.
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IX.
PENSION FUND SUPERVISORY METHODS IN IRELAND by Mary Hutch
Introduction Occupational pension schemes in Ireland are invariably established under trust. The trustees’ legal obligations in respect of the sound management of the scheme are established in the jurisprudence of the national superior courts and codified in legislation such as the Trustee Act, 1893, as reinforced by the Pensions Acts, 1990-2002. The legal duty, which the trustee owes to the members and / or beneficiaries of an occupational pension scheme may be summarised as a duty to act in the best interests of the member / beneficiaries. Where a trustee breaches the fiduciary duty owed to members / beneficiaries, recourse may be had by aggrieved parties to the national courts to enforce all the duties and obligations owed by the trustee. At the end of 2002, overall assets of Irish private pension funds were ¼ELOOLRQDQGWKHODVWQDWLRQDOVXUYH\RQ pension’s coverage (2002) shows total private pensions coverage in Ireland of 50.7% of those in employment age 20 – 69. Central to the sound management of Irish occupational pension schemes is the legal requirement that the assets of schemes are held in trust for the members and beneficiaries. Irish law requires that trust assets are kept separate from the employer’s business. The law requires that the scheme assets cannot be used for any purpose other than those set out in the trust documents. The trust documents generally consist of the formal Trust Deed and Rules governing the scheme. Irish pension funds are supervised having regard to qualitative investment criteria in accordance with the “prudent person” principle where the trustees, subject to prescriptive legal requirements, have primary responsibility for the investment and sound administration of the scheme assets which may culminate in personal liability of the trustees where they breach their duty of care.
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Since the implementation of the Pensions Act, 1990 all “private” occupational pension schemes approved by the Revenue Commissioners must be funded. In this context “private” includes occupational pension schemes for the private sector and some occupational pension schemes for commercial State bodies. Other occupational pension schemes for the public sector including the Civil Service and non-commercial State bodies are operated on a pay-as-you-go basis. Retirement Annuity Contracts (RACs), which provide personal pensions, must be established with a life assurance company and are supported by an underlying insurance policy. The new Personal Retirement Savings Accounts (PRSAs) for, which the framework is included in the Pensions (Amendment) Act, 2002 must also be supported by underlying funds. The first pillar pension arrangement operates on a pay-as-you-go basis and a National Pensions Reserve Fund, was established for the purpose of partially pre-funding the cost of First Pillar old age pensions and public sector pensions. Among recent reforms, there was a National Pensions Policy Initiative from 1996 – 1998 involving research and consultation on pensions. This culminated in a Pensions Board Report to Government in May 1998. This recommended: x
raising Social Welfare pensions to 34% average industrial earnings in order to avoid poverty and provide replacement income for 30% lower paid people in society;
x
continuation of voluntary private pension provision and various changes to the system including the introduction of Personal Retirement Savings Accounts (PRSAs) in order to increase private pension coverage from approximately 50% of the workforce to 70% of the workforce over 5 – 10 years;
x
partial funding of Social Welfare pensions (i.e. National Pensions Reserve Fund).
Supervisory Framework The supervisory framework, which specifies the legislative requirements to guarantee the key objectives of security, portability and accountability for occupational pension schemes, was established in Ireland under the Pensions Act, 1990. This legislation has been regularly updated over the years, most recently with the passing of the Pensions (Amendment) Act, 2002. The Acts provide a regulatory framework for defined benefit and defined contribution schemes and the new Personal Retirement Savings Accounts (PRSAs). For the purposes of regulatory supervision, a statutory body, the Pensions Board was
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established which comprises representatives of the social partners, the pensions industry, trustees, pensioners, consumers and Government. The primary function of the Pensions Board is to monitor and to promote the security and protection of members of occupational pension schemes and contributors to Personal Retirement Savings Accounts, as required under the Pensions (Amendment) Act, 2002 and where necessary to enforce compliance through the Courts. As part of this function, it issues guidelines on the duties of trustees and codes of practice of specific aspects of their responsibilities. The Board also encourages and monitors the provision of appropriate training for trustees. In addition, the Board has a statutory function to advise the Minister for Social and Family Affairs on all matters in relation to pensions, both operational and policy. The Irish Financial Services Regulatory Authority (IFSRA) established on 1 May 2003, is responsible for the regulation of all financial services firms including, inter alia, life and general insurance and related consumer issues. There are over 65 000 Retirement Annuity Contracts (i.e. personal / selfemployed pensions). The providers of these arrangements are prudentially regulated by IFSRA. These arrangements do not come under the jurisdiction or supervision of the Pensions Board. The remainder of this section therefore will deal with occupational pension schemes and will also include some commentary on the new pensions product, Personal Retirement Savings Accounts, (PRSAs) where the product is also regulated by the Board. The Pensions Board The Pensions Board was established under the terms of the Pensions Act, 1990. Its main functions as set out in that Act and amending legislation, most recently the Pensions (Amendment) Act, 2002 are: x
to monitor and supervise the operation of the Pensions Act and pensions developments generally, including the activities of PRSA (Personal Retirement Savings Account) providers, the provision of PRSA products and the operation of PRSAs;
x
to issue guidelines or guidance notes on the duties and responsibilities of trustees of schemes and codes of practice on specific aspects of their responsibilities;
x
to issue guidelines or guidance notes on the duties and responsibilities of PRSA providers in relation to PRSA products;
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x
to encourage the provision of appropriate training for trustees of schemes, and to advise the Minister on standards for trustees;
x
to advise the Minister on all matters in relation to the Pensions Act and on pension matters generally.
Occupational pension schemes must register with the Board and most schemes must pay an annual fee to meet the Board’s administrative costs. The Board can act on behalf of pension scheme members who are concerned about their scheme; it can investigate the operation of pension schemes; it has the power to prosecute for breaches of the Pensions Act and to take court action against trustees for the protection of members and their rights. In relation to PRSAs, the Board and the Revenue Commissioners are jointly responsible for the approval of PRSA products in order to provide for the protection of PRSA contributors and the need for effective supervision of the production, marketing and sale of such products. The Board can collect fees on an annual basis from PRSA providers to defray the costs of the supervision of this function; it can act on behalf of PRSA contributors who have concerns about their PRSAs; it can investigate the state of the PRSA product, the PRSA Provider in respect of its PRSA activities and employers in relation to statutory requirements of the Pensions Act; it has the power to initiate prosecutions for breaches of the Pensions Act. The prudential supervision of PRSA providers remains within the jurisdiction of IFSRA. The Pensions Board includes representatives of Trade Unions, employers, Government, pension scheme trustees, the pensions industry, consumer interests, pensioner interests and various professional groups involved with occupational pension schemes and PRSAs. The staff of the board consists of a Chief Executive, management team and support staff. Staff is divided into five units, namely Investigations and Compliance, Information and Training, Corporate Services, PRSAs and Technical Services and Research. The approved staff complement at the end of 2002 stood at 38.5 posts with 32 posts filled and the remaining 6.5 posts to be filled as required in the context of activity level. The Board’s approved staff complement was increased to meet those functions which flow inter alia from its additional role as supervisor of PRSAs as provided for in the Pensions (Amendment) Act, 2002. The Board as a statutory body is an agency of the Department of Social and Family Affairs. The Minister for Social and Family Affairs is represented on the Pensions Board as is the Minister for Finance.
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The Board’s normal running costs are met by pension schemes, and most schemes have to pay a fee to the Board every year. The fee may vary according to the size and nature of the scheme. As regards the financing of the supervision of PRSAs, the Pensions (Amendment) Act, 2002, provides for a separate fee income streamed to cover the cost of regulating the PRSAs. The Board has a committee system and much of its detailed work (such as reports to the Minister for Social and Family Affairs), are considered in the first instance by a committee. The committees may include people who are not members of the Board, usually appointed because they have expertise in a particular matter being examined. The Board has a mission statement for the purpose of defining its activities. It also develops a strategy for its term of office, which is five years. The Boards’ Strategy 2002-2005 is published on its website www.pensionsboard.ie . The Board’s Annual Report and accounts for 2002 are also accessible on the website. Entry requirements Occupational pension schemes must be set up as trusts to qualify for tax relief. Schemes must first be approved by the Revenue Commissioners or comply with restrictions imposed by legislation. Therefore each occupational pension scheme must normally be first approved by the Revenue Commissioners, who will supply a Revenue reference number for the scheme, before it can start. In order to gain Revenue approval, the scheme must comply with restrictions on: x
The level and type of benefits the scheme can provide. Sometimes these benefit restrictions are referred to as ”Revenue maximum benefits”.
x
Who can be admitted to the scheme.
x
When and how benefits can be taken.
Scheme Registration Each occupational pension scheme must also be registered with the Pensions Board. An annual registration fee is payable by an occupational pension scheme to the Pensions Board. The annual fee varies according to the number of members in the scheme. The Pensions Act specifies that trustees of an occupational pension scheme must ensure that their scheme is registered with the Pensions Board. Registration involves completing a specially designed registration form and sending it to the Pensions Board. A reference number (PB
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number) is then allocated to the scheme by the Board and a letter issued by the Board confirming registration of the scheme and the PB number allocated. Changes to the information provided for the purposes of registration have to be notified to the Board. A special form is also available for that purpose. It is essential that accurate and up-to-date information is held in respect of schemes on the Board’s register. This information is required by the staff of the Board for x
monitoring compliance with the Pensions Act requirements
x
carrying out investigations into the state and conduct of schemes
x
arranging for payment of fees to the Pensions Board
x
providing a tracing facility for early leavers with an entitlement to preserved benefits.
In the years 1999 – 2002 the following number of new schemes were registered with the Board; x
15 066 in 1999
x
17 465 in 2000
x
13 550 in 2001
x
12 145 in 2002.
At the end of 2002, the Pensions Board register of schemes showed that there were 107 764 schemes with an active membership of 709 332 (Table X.1). This figure compares with an overall total of 97 931 with an active membership of 670 498 at end 2001. The overall membership increase for the period was 38 834 (or 5.5%). The Board’s register shows that the number of current Defined Benefit at the end 2002 has decreased compared to the previous year’s figures. While 52 new Defined Benefit schemes were registered during 2002, in total there was a net decrease of 55 in the number of registered Defined Benefit schemes at end 2002; however, there was an overall increase of 16 214 in the number of members. Only 14.26% of the membership increase is attributed to new registrations, the balance was due to increases in membership of existing schemes. The following table shows the current number of schemes on the Board’s register of schemes:
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Table X.1 Current Schemes – Defined Benefit and Defined Contribution Number of schemes Scheme Size
31 Dec 02
31 Dec 01
Number of members 31 Dec 02
31 Dec 01
Non Group
87 776
79 792
87 776
79 992
1-50
19 014
17 189
98 883
92 541
51-99
429
421
30 530
29 693
100-500
422
407
89 716
85 630
501-100
62
64
41 666
42 758
1001 +
61
58
360 761
340 084
107 764
97 931
709 332
670 498
Total
Scheme Approval / Registration Process As indicated above, occupational pension schemes must be approved by the Revenue Commissioners in order to qualify for tax reliefs and must be registered with the Pensions Board. There are no licensing requirements. The approval / registration process involves the completion of one form which is submitted both to the Revenue Commissioners and to the Pensions Board. As it is the scheme trustees who are responsible under the Pensions Act, 1990 for ensuring their scheme is registered with the Pensions Board, the form must therefore be signed either by them or a person authorised to do so on their behalf. The form seeks the following scheme details: x
scheme name.
x
commencement date.
x
renewal date.
x
number of members at commencement.
x
scheme type, e.g. whether defined benefit, defined contribution, current, frozen, AVC only, death benefit only, etc.
x
administration details, e.g. whether it is insured, selfadministered, small self-administered or unfunded.
x
life office details – which are to be completed in respect of insured schemes only.
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x
name and address of contact person.
x
name and address of employer.
x
consultant / broker details.
x
contact details, i.e. registration contact to whom the Pensions Board’s Registrar may direct registration enquiries.
x
fee contact, i.e. the person to whom the Registrar may direct enquiries relating to the payment of Pensions Board fees.
x
the Revenue reference number assigned to the scheme.
x
the Pensions Board reference number assigned to the scheme.
In addition, the appropriate sections of the Scheme Trust Deed, showing all employer and trustee details, must be copied and attached to the form for Pensions Board registration. Pensions Board fees are not remitted with the application form but fees will be levied upon registration and an invoice issued with the Board’s acknowledgement of registration. Effectively, the Revenue operates a self-assessment type of procedure in relation to approving schemes under the Taxes Consolidation Act, 1997. The Revenue have discretion under their legislation to withdraw approval if, in their opinion, the facts concerning any scheme or its administration cease to warrant the continuance of its approval. All Trust Deeds and Rules governing occupational pension schemes contain a clause to the effect that the employer and the trustees may at any time by deed amend, extend, modify, alter or add to the provisions of the Trust Deed and Rules provided that no such alteration, amendment, extension, modification or addition would be made which would prejudice Revenue approval of the scheme. It is therefore most unlikely that any action would be taken that would so prejudice the scheme’s approval and it is very rare that approval would be withdrawn in relation to a scheme. On going supervision Irish pensions regulation is underpinned by the Pensions Act 1990. As indicated earlier, it is supervised by the Pensions Board which was established under the terms of the Pensions Act. The principal ways in which the Board carries out its regulatory role are by:x
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Scheme Registration – this involves ensuring that all schemes required to register with the Board are so registered.
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x
Funding Standard – this involves ensuring that all schemes which are required to do so submit an Actuarial Funding Certificate to the Board every three and a half years.
x
Random Examination – this involves carrying out random examinations of schemes in order to check their compliance with Disclosure of Information requirements.
x
Response to enquires/complaints – this involves responding to problems reported by scheme members in relation to the administration of their scheme, their own personal pension entitlements and/or difficulties in obtaining information requested from their scheme.
x
Investigations – this involves carrying out scheme investigations in relation to non-compliance with the Pensions Act.
x
Whistle-blowing – this involves perusing reports received under the reporting requirements in Part VIII of the Pensions Act.
x
Prosecutions / Legal Proceedings – the Board has a prosecution policy and will initiate proceedings where this is appropriate under the Pensions Act.
x
Indirect Regulation – this involves the provision of authoritative guidance to trustees, scheme administrators and their professional advisers.
As well as its monitoring and supervisory role as described above, the Board’s promotion of the security of occupational pensions is also implemented by guidance and information activity. These include provision of a Legislation Service, Guidance Notes, a Trustee Handbook and Codes of Practice, information booklets, approval and evaluation of trustee training courses, surveys of trustees in relation to their training requirements, and the operation of enquiry services. Another important feature of Irish pension regulation is the emphasis on disclosure of information. This is intended to enable pension scheme members, their trade unions and other advisors, to monitor the health of their own pension arrangements.
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Monitoring of Funding Standard Under the Funding Standard provisions of the Pensions Act, defined benefit schemes are required to submit to the Board Actuarial Funding Certificates (AFCs) at 3½ yearly intervals. The purpose of the actuarial funding certificate is that the scheme actuary can certify that, if the scheme had would up at the effective date of the certificate, its assets would have been sufficient to meet its liabilities. A certificate must be submitted to the Pensions Board not later than nine months after its effective date. If the scheme could not have met its liabilities a funding proposal must be submitted which is designed to put the scheme in the position that it could meet its liabilities no later that the effective date of the next actuarial funding certificate. The Board takes a proactive stance in ensuring that certificates are submitted in accordance with the statutory requirements. This is particularly important in view of the difficulties schemes may be experiencing in meeting the funding standard due to the falls in the investment markets over the last three years. The Board received a total of 548 Actuarial Funding Certificates in 2002. All but 17 of these satisfied the funding standard. Of the 17, 11 schemes have submitted funding proposals and the other six are in the process of having proposals agreed. As the table below illustrates, the position at year end was that funding certificates were in place for 1 634 defined benefit schemes. This represents 91.4% of the schemes that are required to have funding certificates in place and 98.5% of the members of such schemes. New measures have been introduced in relation to the minimum funding standard under the Pensions (Amendment) Act, 2002. As indicated earlier, the Pensions Act, 1990 already provides for the submission of an AFC to the Board at least every 3½ years. Now, the 2002 Act also provides that during the 3½ year interval, actuarial reviews must be undertaken to establish whether a scheme continues to satisfy the minimum funding standard and that corrective measures be taken where negative assessment arises, including the preparation of a full AFC (and if relevant a funding proposal). The Social Welfare (Miscellaneous Provisions) Act, 2003 amended the Pensions Acts to give additional flexibility to the Pensions Board in its administration of the funding standard. The Board can extend the 3½ year period for correcting a shortfall to as much as ten years, subject to certain conditions been met.
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257 44 34 1 788
501-1000
1000 +
Total
231 992
112 656
29 846
57 318
13 747
18 338
87
No. of Members
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190
51-100
101-500
1 176
87
No. of Schemes
1-50
Non Group
Scheme Size
DB Schemes Subject to the Funding standard
1 634
33
44
255
185
1,063
54
No. of Schemes
228 576
110 855
29 846
57 089
13 380
17 352
54
No. of Members
Funding Certificates Received
6
0
0
0
0
6
0
No. of Schemes
61
0
0
0
0
61
0
No. of Members
Funding Certificates Outstanding
TableX.2 Compliance with the Funding Standard as at 31 Dec 2002
148
1
0
2
5
107
33
No. of schemes
3 355
1 801
0
229
367
925
33
No. of Members
Other
Random examination – disclosure compliance strategy Since 1997, the Pensions Board has been carrying out random compliance monitoring of the disclosure of information requirements under the Pensions Act. This is an audit process which involves the Board requesting, from the trustees of the scheme, copies of the documentation that must be provided or made available for scheme members. The Board then audits the documentation received against the detailed requirements of the legislation to ensure it is compliant. Results of the initial audits produced clear evidence that pension scheme administration was not up to date. In early 1999, the Board made the various pension and industry representative organisations aware that it had identified substantial pensions administration arrears and that this was not acceptable. The Board reiterated its policy of achieving compliance as far as possible through co-operation and in this spirit requested trustees and their advisers to approach the Board if they had a problem, so that a way forward could be agreed without, of course, jeopardising member protection in any way. During 1999 a number of the largest practitioners approached, or were approached by, the Board in relation to the pension schemes which they were administering on behalf of trustees. Almost all of the practitioners involved were willing to co-operate with the Board and subsequent monitoring activity showed that a substantial amount of work was done to update pensions administration during 1999 and 2000. This has resulted in a large number of non-compliant schemes becoming compliant. It has also resulted in a substantial number of schemes which were not previously registered with the Pensions Board, being registered. The Board will, of course, have recourse to legal proceedings where it believes it is necessary in particular circumstances. The Board successfully took proceedings against the trustees of 5 pension schemes in 1999 and prosecuted the trustees of three further schemes in November 2002 in relation to their failure to provide the Board with information requested by the Board under Disclosure of Information provisions. A total of 202 schemes were selected for audit in 2002 and 165 were actually audited. While the number of non-compliant documents was relatively small, the Board deems it unacceptable that so few documents were fully compliant. A document is deemed satisfactory where the Board would view the non-compliance of being of a minor nature and would ask the trustees to ensure that the issue is corrected in future documents. Non-compliance implies that the documents should be corrected immediately.
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The Board views disclosure of information as a crucial element of allowing the scheme members the ability to become aware of and monitor their own schemes. Enquiries/Complaints It is the Boards policy to promote good practice in the running of pension schemes and to encourage scheme trustees to comply with their responsibilities. Where members have problems, the Board will advise them of their rights and will direct them to a contact person in their pension scheme, in the first instance. The aim is that as many queries and complaints as possible will be directed to pension schemes and resolved, without the direct involvement of the Board. If the member reports to the Board that he/she has received no response or an inadequate response, the matter is generally then pursued by the Boards staff through direct contact with the trustees, scheme administrator or professional advisers. Investigations Investigations of schemes are generally initiated following enquiries or complaints from scheme members, trustees, trade unions, through compulsory or voluntary reporting or as a result of random audits carried out by the Pensions Board. The biggest issue in relation to the Pensions Board’s investigations continues to be non-payment of either or both employer and employee contributions to a scheme. From 1 January 2003 the Remittance of Contributions provisions of the Pensions (Amendment) Act, 2002 came into effect. These provisions place specific requirements on employers and trustees in relation to payment of contributions by employers to trustees and the investment of those contributions by the trustees. The Board gives guidance on the Remittance of Contribution requirements in the form of Frequently Asked Questions (FAQs) on its website. The Board’s primary objective in any investigation is to protect the interests of the scheme member or members. Section 18 of the Pensions Act provides the Board with specific powers of investigation and provides specific penalties for failing to co-operate with the Boards investigations. Where it is felt that the use of those specific powers is necessary to expedite an investigation a Section 18 investigation is authorised.
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The Board has not carried out any on-site investigations as yet. If necessary, however, the Board has extensive power to inspect schemes books and records, to enter premises and to require people to give explanations. The Board initiated 74 new investigations into issues concerning occupational pension schemes during 2002. This was one less than in the previous years. The Board closed 113 investigations during the year, an increase of 36 on 2001. At end 2002, there were 69 open investigations compared to 108 at the end of 2001. A revised Occupational Pensions Scheme Compliance Strategy document was agreed by the Board in December, 2002. Compulsory and voluntary reporting to the board There are statutory provisions, known as “whistleblowing” which place a mandatory requirement on a range of specified persons involved in the operation of occupational pension schemes and PRSAs to report actual or suspected fraud or material misappropriation to the Board. There is also provision for the making of a voluntary report on any matter concerning the state and conduct of a scheme or the state of a PRSA. Specified persons for the purpose of a scheme include actuaries, auditors, trustees, insurance intermediaries, investment business firms and any other person who has been involved in assisting the trustees of a scheme. Specified persons for the purposes of a PRSA include administrators, investment managers, custodians of the PRSA, investment business firms, PRSA providers, PRSA actuaries, auditors of the business of a PRSA provider, and employees of employers who do not operate an occupational pension scheme or who operate schemes with eligibility restrictions. A total of 15 new reports were received by the Board in the year 2002, compared to 12 in 2001. At end 2002, there were 16 cases remaining open, one less than at the end of 2001. Prosecutions / legal proceedings The Board tries to achieve compliance with the Pensions Act as far as possible through co-operation with the trustees and their advisers in the first instance rather than by recourse to legal proceedings. The Board will, have recourse to legal proceedings where it believes it is necessary in particular circumstances. To date prosecutions initiated by the Board against trustees of schemes related to non-compliance with disclosure of information requirements. The penalties on conviction are considerable – on summary conviction a fine,
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not exceeding ¼ RU LPSULVRQPHQW IRU D WHUP QRW H[FHHGLQJ RQH \HDU RU both) and, on conviction on indictment, a fine not exceeding ¼ 500 or imprisonment for a term not exceeding two years (or both). The Pensions Act also imposes continuing fines in the case of continuing offences. Indirect regulation Another way in which the Board implements its regulatory role is through providing guidance and information for trustees and pension scheme practitioners. As the Pensions Act and its regulations override the Trust Deed and Rules of schemes, it is important that scheme trustees, administrators, and other professional advisers ensure that the legislation and the Pensions Board guidance to which they refer are fully up to date. The Board provides a Legislation Service which is available by subscription. Subscribers to this service receive the consolidated text of the Pensions Act and the Regulations, including all amendments made to date. The text of the legislation is made available in loose leaf format which facilitates regular updating. The Board also makes available, by subscription, detailed Guidance Notes on all of the main parts of the Pensions Act. In addition the Board publishes a Trustee Handbook which contains the legislative requirements and also codes of practice in relation to the discharge of the trusteeship role, including investment responsibilities. A key objective of the Board in promoting the security of occupational pensions is to provide authoritative guidance on how to achieve voluntary compliance with the Pensions Act and other relevant legislation and good practice generally in relation to scheme administration. The Trustee Handbook is regarded as making a major contribution towards achieving this objective. In relation to trustees’ investment responsibilities the Pensions Act specifies that trustees of pension schemes should provide for the proper investment of the resources of the scheme in accordance with the rules of the scheme. Irish pension funds are supervised on the basis of qualitative components for investment and operated in accordance with the “prudent person” principle. The “prudent person” principle is supervised through supervision of the trustees in accordance with the Pensions Act and general trust law and ensuring that they comply with the Trust Deed and Rules governing their activities. Pension schemes do not have an obligation to submit internal information regarding their adherence to the “prudent person” principle, but any information in this regard required by the Pensions Board must be supplied on request.
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There are no specific statutory requirements in relation to managing the investments and risks other than the general rules in relation to “proper investment” of the resources of the scheme. There is no requirement to report on a regular basis to the supervisory authorities on future investment policies. Investment rules of the scheme do not have to be reported to the supervisory authorities unless so requested. As part of its overall functions the Board is responsible for the regulation, supervision of providers in respect of their activities supporting approved PRSA products and compliance with the PRSA provisions of the Acts. To assist in the task of developing effective processes and procedures to carry out this function, the Board engaged consultants to identify and produce the necessary processes and procedures to allow the Board to properly adjudicate on applications for product approval and the ongoing monitoring role of the Board for PRSAs. Included in this is the receipt of regular reports and returns from each provider in relation to its approved products. Upon completion of the project, the Board had in place suitable processes and procedures to give proper effect to it’s regulatory role in PRSAs. Compliance enforcement and sanctioning The Pensions Board has strong powers of investigation under the Act. It also has powers to prosecute proceedings for offences in the court and the penalties for these and fines and / or imprisonment. The Board also has the power to make formal decisions on parts of the Act which may conflict with the rules of a particular pension scheme. Where there is conflict, the Act overrides scheme rules. In making these decisions the Board can, if it wishes, hold an oral hearing. It is the Board’s policy that, as far as possible, investigations and hearings will be conducted informally. The Board can apply to the High Court to have pension scheme trustees suspended or replaced if it considers such action is necessary in order to protect the interests of members. In addition, there are severe penalties if a person is found by the Courts not to have carried out his / her duties under the Act properly – he / she can be fined up to ¼ 500 or imprisoned for up to two years, or both. As stated earlier the Board carries out audits in relation to schemes to ascertain whether or not they are in compliance with statutory requirements. Schemes are asked to submit certain documentation to the Board for audit purposes, failure to supply documents to the Board can result in prosecution.
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The Board also has powers of direct intervention in the administration of a scheme, this is warranted, in order to safeguard the pension rights of members. In particular, the Board may apply to the High Court to: x
order an employer to pay arrears of contributions;
x
order restoration of scheme resources to be paid or transferred to any person;
x
order a disposal of an investment where its retention is likely to jeopardise the rights and interests of the members under the scheme;
x
grant an injunction to prohibit any action by any person which would result in a misuse or misappropriation of any resources of the scheme;
x
order the replacement or suspension of the trustees of a scheme.
Failure to submit an actuarial finding certificate to the Board can constitute an offence under the Act. Without an AFC the Board is unaware of the funding position of a scheme. If the Board were not to receive any AFC it has the option to prosecute the trustees for failure to submit or issue what is known as a Section 50 Direction whereby the Board can direct the trustees to reduce the benefits which would be payable to members in order for the scheme to meet the minimum funding standard. Much of the Pensions Act regulation imposes duties on trustees, however this emphasis is now shifted slightly and employers are now under a direct duty under Section 58A of the Pensions Act to remit contributions within their 21day limit. In addition, the list of persons against which the Board can initiate prosecution proceedings has expanded and now includes: x
trustees
x
employers
x
PRSA providers
x
an actuary or auditor of a scheme or a PRSA in his capacity as such actuary or auditor
x
a person who is required under regulations made under Section 5A (external schemes) to carry out trustee duties
x
any other person.
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In the event of fraud, the Board can also involve the relevant fraud office, which in turn, can refer the case to the Director of Public Prosecutions. The Pensions Act does not contain provision in relation to civil sanctions nor does it allow the Board to be a giver of redress. However, the Pensions (Amendment) Act, 2002 provides for the establishment of the office of Pensions Ombudsman. The Ombudsman has recently been appointed and his office opened for business in September 2003. The Ombudsman is legally independent and has powers to investigate and determine complaints in relation to PRSAs and occupational pension schemes. The complaints that can be referred to the Ombudsman will be those of maladministration leading to financial loss and disputes of fact or law in relation to an act done by a person managing a scheme or PRSA. The Ombudsman has power to give such directions as he considers necessary or expedient for the satisfaction of the complaint / resolution of the dispute. However, any financial redress cannot exceed the actual loss of benefit under the occupational pension scheme or PRSA. Conclusions As can be seen from the forgoing, the Board operates on the basis of comparatively detailed regulation and light supervision. The rationale underlying this regulatory stance takes account of the large number of schemes to be regulated and the level of resources available to the Board. It also takes into account the voluntary nature of schemes and the need for a system of regulation which does not discourage the continuation of existing schemes or the establishment of new schemes. The fact that the primary responsibility for the good conduct of schemes rests with trustees is also a major factor in the formation of Irish pension regulation. The Board has two statutory roles: regulatory and policy. It recognises its regulatory role as its primary one but also believes that the representative nature of the Pensions Board makes its policy role an important one. It sees the two roles as being complementary to each other. In its regulatory role, which is the focus of this study, the Board sees the desired level of supervisory activity for occupational pension schemes as being some increase in supervisory activity over and above the level currently operated but only in selected ways / areas in which the compliance gains are likely to be significant. It believes that this role would be supported by selective prosecutions and increased public education. The Board recognises and is
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concerned about the dangers of over-regulation and excessive complexity and in this context sees a need to consider the question of “simplification”. In this regard, the Board set-up an Expert Working Party on simplification in summer 2002. This led to a Report of its Interim Recommendations on Simplification which was sent to the Department of Social and Family Affairs and the Department of Finance. Some of the issues raised were responded to in the Finance Act, 2003 and discussions on implementation of the other issues are ongoing. The Board is planning to continue its work on longer term simplification issues later in 2003. The Board is also currently examining the appropriateness and effectiveness of the funding standard as set out in Part IV of the Pensions Act. The objective of this is to ensure that we have a funding standard going forward which will most effectively protect the interests of pension scheme members. The outcome of this examination is expected to be a consultation document to be circulated later this year. Any initiatives by the Board in relation to pensions simplification or the funding standard will be considered in the context of the EU Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision (IORPS), in order to ensure consistency with its requirements. In the meantime, the Board has taken measures to deal with funding of schemes in response to the exceptional fall in global equity markets. For defined benefit schemes this has occurred at a time when the liabilities of those schemes have, for a number of reasons been increasing. The result of this is that a number of schemes might not satisfy the funding standard if they had to produce an actuarial funding certificate at this point in time. This situation arises notwithstanding the fact that the scheme may have a satisfactory long term funding position. The funding standard is effectively a wind-up standard. Employers are concerned that they may be required to pay additional contributions in order that the scheme will be able to meet its liabilities if it were to wind-up, when there is no intention or likelihood of the scheme winding-up. On the other hand scheme members will be anxious that the scheme’s funding position is such that their benefits are secure. Having discussed the issue with various interested parties the Board recommended an amendment to the legislation that will give the potential for some flexibility in the time period over which a scheme that fails to meet the funding standard must take steps to ensure it does meet the standard. The
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amendments to the legislation were effected in the Social Welfare (Miscellaneous Provisions) Act, 2003 with effect from 3 April 2003 (paragraph 3.2.6). The amendment gives the Board the power to consider granting a longer period over which the failure to meet the funding standing has to be rectified in response to an application for an extension from the trustees of the scheme. This power is subject to certain conditions such as the actuary having to certify that the failure is a result wholly or primarily of the fall in the investment markets. The Board must also be satisfied that agreeing to a longer period is in the interests of the members. Some of these requirements are set out in the legislation and some of the terms and circumstances can be specified by the Board. In the case of PRSAs, regulation / supervision involves implementation of new practices and procedures based on the PRSA framework, as set out in the Pensions (Amendment) Act, 2002 and underlying regulations. The overall aim would be to achieve a balance of regulation / supervision as between occupational pension schemes and PRSAs so that the extent of their relative provision and take-up is not dictated by their regulatory / supervisory environment. Overall, the Board operates its regulatory role under certain principles. The main principles are:
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x
All regulation should “add value” from the point of view of member protection.
x
It should take into account the voluntary nature of schemes and the need for a system of regulation which does not discourage the continuation of existing pension provision or the establishment of new pension provision.
x
Consistency is important between different types of pension arrangements.
x
The trust system and the role of trustees is a major component for occupational pension schemes. The primary responsibility for the good conduct of occupational pension schemes is vested in the trustees.
x
There is a strong emphasis on disclosure of information. This is intended to enable individuals, their trade unions and other advisers, to monitor the health of their own pension arrangements.
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x
The policy is to try to secure compliance with regulatory requirements without recourse to legal action, but that such action is taken if necessary. A primary determinant here is the best interests of scheme members.
x
There is a need to increase the level of pension coverage in particular by means of the transparent and cost efficient method being introduced through PRSAs.
The Board accepts its involvement in information provision, pension awareness and development of pension coverage and its ongoing strategy incorporates this. In this regard the Board provides information and where appropriate support, on pension related matters to a wide range of parties including scheme members, pensioners, trustees, the media and the general public. The Board has been asked by Government to carry out a National Pensions Awareness Campaign the objective of which is to heighten pensions awareness with the view to increasing pension coverage in Ireland. At this point Ireland believes that it has a reasonable balance of pensions regulation. Pension schemes have continued to develop and there have not been any major pension problems since the passing of the Pensions Act, 1990. The Board recognises the need to constantly evolve regulation in order to respond to internal and external developments. This requires an educated, effective and flexible regulatory body. In the Irish experience, a good regulatory system is an essential ingredient in the development of private pensions.
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X.
PENSION FUNDS SUPERVISORY METHODS IN MEXICO by Isaac Voulin
Introduction Overview of the Mexican Private Pensions System The genesis of the new Pension System for the private sector dates back to 1992 with the introduction of individual accounts as a complementary defined contribution program to the Pay-Go system. This program was known as the Retirement Savings System (SAR 92). Each individual account consisted of two sub-accounts — retirement and housing — and the contributions to these accounts were 2% and 5% of the worker’s salary respectively, which were paid by the employer on behalf of the worker. The retirement sub-account savings were invested in Federal Government credits through deposits in the Central Bank, and the rate of return was set by the Ministry of Finance at prevailing market levels, whereas the housing subaccount resources were transferred to the Housing Institutes. Whenever a worker is granted a pension, he/she receives the total amount of his retirement sub-account as a lump sum. As for the housing sub-account savings, they are used to amortize the mortgage loan that the worker may have acquired with the Housing Institute. Otherwise, the worker is entitled to withdraw them in a lump sum payment at the same time as the retirement subaccount. On 1 July 1997, the SAR 92 program was transformed into a full fledged mandatory defined-contribution pension system for the private sector workers affiliated to the Mexican Social Security Institute (IMSS). This replaced the old Pay-Go scheme.
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This new scheme relies on individual capitalization accounts and a minimum pension guarantee by the Mexican Social Security Institute (Federal Government). Consequently, the pension of a worker depends on the savings accumulated in his individual account and the returns generated by them. If the worker does not meet the requirements to get a pension, he/she will withdraw the accumulated savings at the retirement age (65 years). It is worth mentioning that the 5% contribution for the housing sub-account remains administrated by the Housing Institute for the private sector workers (Infonavit). The individual accounts are then managed by the Pension Funds Managers, called Administradoras de Fondos para el Retir,(AFORES), that compete in a free market for the workers’ preferences. The AFORES are specialized financial entities responsible for administrating the individual accounts and the investment of the savings through an SPV called Sociedades de Inversión Especializadas en Fondos para el Retiro (SIEFORE)s. The AFORES and SIEFORES are two legally separate entities with their own paid-in capital. Both need the approval of the National Retirement Savings System Commission (CONSAR) to begin operations. CONSAR is the entity in charge of the regulation and supervision of this new pension system. Its core activities include: regulate and supervise the system, grant, modify and revoke authorizations to operate AFORES and SIEFORES, impose fines and sanctions when the regulation is breached, inform Congress about the system status, and disseminate relevant information to the public. CONSAR is part of the Ministry of Finance, although it has technical and executive autonomy. It is financed partially by the supervision quotas, which are collected from all the supervised entities. Additional funding is requested to the Federal Government by means of the Ministry of Finance. CONSAR has two governing bodies: the Board and the Surveillance Committee. Both bodies have representatives of the government, the employees and the employers. This tripartite representation gives equal voice to all stakeholders of the pension system and legitimizes all structural decisions taken at CONSAR. The Board is the top governing entity, and it is presided by the Minister of Finance. The other 15 members of the Board include two representatives of the workers, one representative of the employers, and representatives of several governmental agencies, especially those related to social security and financial themes. The President of CONSAR is directly appointed or removed by the Minister of Finance.
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The Surveillance Committee is the other governing body integrated with equal representation by federal government officials, unions leaders, and employers. This Committee is in charge of the surveillance and development of the Retirement Savings System. One distinguishing feature of this pension system is its collection model: it is a centralized, hub and spokes model. The key player in this model is the National SAR Database Operator Company (Procesar). The owners of PROCESAR are the AFORES and the banks that managed the SAR 92 recordkeeping. The collection process consists of three main parts: first, the employers deposit the contributions in the authorized banks, which in turn transfer the information to PROCESAR and the money to the Central Bank. Second, PROCESAR cross-checks the information received, reconciles it with the deposits and generates files with the details of the contributions that will be distributed to each SIEFORE from the concentration account at the Central Bank. Finally, the AFORE cross-checks the information with the money that the SIEFORE has received, determines the contributions to each individual account and the fees on those contributions. To complete the cycle, the SIEFORE then buys securities with the savings received. As for the housing sub-account, AFORES act only as record-keepers for each individual account. However, the savings are transferred to the Housing Institute (Infonavit) and used for granting mortgage loans to contributing workers. Contributions not used by workers to repay a loan are withdrawn at retirement age together with the retirement sub-account to pay for an annuity or by means of programmed withdrawals. As of December 2003, 13 AFORES operated in the system. Summary of the supervision scheme The framework for supervisory activities of CONSAR is defined by the Retirement Savings System Law (LSAR). In particular, Article 89 states that participants must be evaluated in terms of the risks that they are subject to, their internal control systems and the quality of their management. CONSAR’S main objective is to protect the interests of the workers and their beneficiaries. CONSAR has technical autonomy and executive powers to make any decision regarding the participants of the pension system, including
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the managerial intervention of an AFORE, and the revocation of its license. These decisions are submitted to the Board for ratification. Regarding supervision procedures, CONSAR has established mechanisms to prevent risks in the AFORES and SIEFORES, instead of acting after the regulation has been breached. The pension system development and the existence of cheap and powerful information technology have enabled CONSAR to update its supervisory models: from the basic surveillance adequate accounting registries, to a surveillance of the processes that ensure that workers rights (savings and freedom of choice) are always respected. All the objectives and results of the inspection and surveillance processes of CONSAR are set forth in the respective Annual Programs. CONSAR has a labour force of 150 persons of whom 31% are involved in front-line supervision activities, 31% are involved in supervisory support functions, and 38% are involved in corporate services. CONSAR’S annual budget for 2001 was USD 161.0 million pesos (USD 14.7 million dollars). CONSAR informs Congress twice a year about its main activities and results. It also publishes and distributes an annual activities report. Supervision scheme Entry requirements Requested documents According to the Retirement Savings System Law (LSAR), anyone who wishes to apply to operate an Afore must fulfil the following requirements:
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x
Application to operate an AFORE and draft of the company’s bylaws.
x
Programs of: operations, information disclosure, self-regulation and capitalization.
x
Five-year balance sheets of each of the AFORE’s shareholders.
x
Study that justifies the establishment of the AFORE and one or more SIEFORES.
x
Background of the founding partners, Board members, and main staff.
x
Organizational handbook.
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After the application has been approved, applicants have 90 days to prove to CONSAR that they comply with the following requirements: x
Certified copy of the company’s deed.
x
Draft contracts of administrative services with its SIEFORE.
x
Draft contract with an institution for securities deposit and custody.
x
Registration of the company at the Ministry of Finance.
x
Draft contract with one or more financial institutions or brokerage houses.
x
Draft contract with PROCESAR.
x
Information on the location of its main office and branch offices.
x
On-site certification of the IT installations with the corresponding contracts to operate these systems.
x
On-site certification of the correct functioning of the Risk Management and Portfolio Management units.
To evaluate all the documents and information presented by the applicants, CONSAR has created “Compliance Matrixes”. With these matrixes, every single requirement is checked and given a grade. The beginning of operations is then contingent to the full and correct presentation of all the requirements and an acceptable number of points from the “Compliance Matrixes”. Capitalization The minimum paid-in capital that every AFORE must have is MXN 25 million (USD 2.3 million). The first SIEFORE must have a minimum capital of MXN 4 million (USD 366 000) and each additional SIEFORE MXN 1 million pesos (USD 91 000). Moreover, the AFOREs must have a “special reserve” of the greater between MXN 25 million pesos (USD 2.3 million) and 1.65 times the VaR limit. The “special reserve” is design for two purposes: to cover any losses the SIEFORE may incur when the investment regime has been breached, and to align the incentives of the administrators with workers savings. Board of Directors and Staff Regarding corporate governance issues, the Board of Directors must have at least five members, and at least two of them must be independent counsellors.
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The Surveillance Committee must approve the appointment of the independent counsellors and the comptroller. On-going supervision The supervision of the retirement savings system participants is one of the main tasks of CONSAR. Our ultimate goal is to protect the workers’ interests through the supervision of the system’s processes and the correct management of the individual accounts. CONSAR’S initial supervision model emphasized on the timely flow of information and money across the parties involved in the process. However, as the system has proven its effectiveness in that matter, improvement in other key areas has become the goal. Modernization guidelines for supervision are the following: x x
x
Emphasis on prevention. CONSAR has established mechanisms to prevent risks in the operation of the AFOREs and SIEFORES instead of acting when the regulation has been breached. Focus on processes that involve the worker. The pension system development and the technological modernization has enabled CONSAR to redirect its supervisory model towards an integral surveillance that analyzes the processes in which workers interact with the AFOREs. This is important to ensure that workers’ rights are preserved. Deregulate and promote self-regulation. At the beginning of the system, CONSAR issued the rules that dictated the way the participants had to operate, the controls and the timing of each process. Currently, CONSAR is modifying this policy to set only the main goals and some operating guidelines. With this shift in policy, CONSAR seeks to encourage AFOREs to prevent irregular situations through self-regulation programs.
CONSAR’s supervision model rests on four pillars: self-regulation, surveillance, inspection and sanctioning. Self-regulation practices Self-regulation practices constitute an important complement in the traditional supervision because they allow for the development of surveillance activities that involve a wider range of issues than those the authority can supervise. The Law requires that the AFOREs must have a comptroller that must report only to the Board. The comptroller verifies the compliance of the
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AFOREs’ staff with the internal and external regulations and supervises the degree of fulfillment of the authorized self-regulation processes. The comptrollers must correct any anomaly detected in the operating, accounting and financial processes through the self-correction programs, and inform CONSAR about any operative inconsistency identified and the preventive steps that will be taken to avoid any further inconsistencies. It is worth mentioning that the AFORES may only submit to CONSAR for approval the self-correction programs in those areas that are not covered by the current regulations, and when the violation of those programs does not affect affiliates’ rights. In the coming years, CONSAR’s main challenge will be to reinforce the comptroller’s independence and support the industry in the definition of its own regulation program. Surveillance Among CONSAR’s supervisory activities, the surveillance of the system’s operative transactions, the compliance with the Investment Regime and the calculation of a daily fair net asset value of the SIEFORE, play a central role. b.1) Operative surveillance Operative surveillance focuses on two themes, the contributions’ collection process and workers’ interaction with the system: b.1.1) Contributions’ collection process. This surveillance focuses on making sure that flows of information and money among all parties involved are consistent and properly reconciled. That is, the money and information that flows among the banks receiving the payments from employers, the Central Bank that concentrates and then disseminates the money, PROCESAR that receives information from the bank and transfers it to AFORE and to individual accounts, must coincide across all stages and players. In order to perform this surveillance, CONSAR receives electronic files from all parties involved and cross-checks them on a daily basis with IT systems. CONSAR also checks routinely that commissions, contributions and returns are correctly registered in each individual account.
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Workers’ interaction with the system Workers must interact with the AFORES in several instances. The most relevant interactions are the following: x
registry with the initial Afore
x
transfer to a different Afore
x
withdrawal of savings at retirement
x
deposit and withdrawal of voluntary savings
CONSAR’s duty is twofold: i) provide a regulation that allows processes to be carried out in the most cost and timely efficient fashion for workers, and ii) make sure that workers’ rights are respected in every process they are involved in. This surveillance, especially the registry with and transfer to a different AFORE, is performed by mining large and complex databases. The goal is to detect trends by AFORE, salesman, type of worker, etc., that may signal unhealthy practices in the industry. Violations to workers’ rights and to the regulations may end up in large fines to the AFORES. However, it is CONDUSEF, a Federal Government agency which performs the role of Ombudsman for the financial services industry. Surveillance of the Investment Regime. As in other Latin American countries with a defined-contribution scheme, investments of retirement savings are subject to certain quantitative limits known as “Investment Regime” (IR). The main objective of an IR is to avoid excessive risk-taking by the portfolio managers given that the Prudent Person Rule is not applicable in the region. This is due to the lack of an adequate judicial system for that purpose. CONSAR supervises on a daily basis that SIEFORES portfolios comply with all applicable limits and to avoid that a non-permitted transaction occurs. The surveillance begins with a cross check of the portfolio. This process is automated and it compares the portfolio provided by two different and independent sources of information: the AFORE and its securities custodian. The specific goal at this stage is to avoid misrepresentations of the true assets composition.
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In the next step, the structure of the portfolio is compared to the various quantitative limits of the IR. An early warning system flags when a parameter is close to the limits. If any limit is exceeded, a fine is imposed to the AFORE. Moreover, if the IR is breached and the portfolio has a negative return in that day, the AFORE must cover the loss with its capital. Surveillance of SIEFORES’ daily fair net asset value In the Mexican system, workers can switch AFORE at any given day once a 12-month period has elapsed. Thus, keeping a fair net asset value is paramount to avoid wealth transfers among workers entering or leaving an AFORE. To that end, CONSAR reviews on a daily basis the SIEFORES net asset value (NAV) and their share price. In order to do that, AFORES must report every day their balance sheet, a NAV and a share price. An independent price vendor provides a valuation of every security of the portfolios and a NAV. CONSAR cross checks the information and performs its own calculations. Discrepancies are identified, reviewed, reconciled and corrected. On-site inspections On-site inspections are carried out according to the “Annual On-Site Inspections Program”, which contains the number of inspections to be performed, entities to be supervised, and processes that will be audited. This program defines the way and terms the inspection will be performed, as well as the activities calendar. It establishes at least one visit per year to each participant of the system. The scope of the inspection varies according to the goals, which in turn are a function of new regulatory requirements, potential problematic areas detected at previous inspections, surveillance reports or problems detected by the comptroller. CONSAR may perform, at any time, additional on-site inspections to those considered in the inspections program. Lately, inspections have emphasized AFOREs’ compliance with risk management regulation, investment best practices and operational requirements for derivatives. Compliance enforcement and sanctioning CONSAR imposes fines when it detects that an AFORE does not comply with the regulation. Fines imposed will never exceed the equivalent of 5% of
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the paid-in capital and reserves of the company. It is worth mentioning that sanctions do not relieve the AFORE of its duties and responsibility to fix the situations that generated the sanction. The President of CONSAR is empowered to dictate the necessary steps to fix the anomalies and impose deadlines. If the problem is not fixed before the deadline, the President must inform the Board, who can dictate the intervention of the AFORE or even the revocation of its license. Conclusions CONSAR is in charge of the coordination, regulation, supervision and surveillance of the Retirement Savings System and its main objective is to protect the interests of the workers and their beneficiaries. It has technical autonomy and executive faculties to make any decision and take action regarding the participants of the pension system. CONSAR has two governing bodies: the Board and the Surveillance Committee. Both bodies have representatives of the government, the employees and the employers. This tripartite representation gives equal voice to all stakeholders of the pension system and basically legitimizes all structural decisions taken at CONSAR As for supervision procedures, CONSAR has established mechanisms to prevent operating risks in the AFOREs and SIEFORES, instead of acting after the violation is committed. It has updated its supervision models from surveillance on adequate accounting registries to an integral surveillance, which analyzes the processes that ensure that workers’ rights are preserved. The supervision of the retirement savings system participants is one of the main tasks of CONSAR. Our ultimate goal is to protect the workers’ interests through the supervision of the system’s processes and the correct management of the individual accounts. In upcoming years, CONSAR’s main challenge will be to reinforce the comptroller’s independence and support the industry in the definition of its own regulation program. This constitutes an important complement in the traditional supervision model because it allows for the development of surveillance activities that involve a wider range of issues than those the authority can manage.
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XI.
SUPERVISION OF PRIVATE PENSION PLANS IN THE UNITED STATES by Morton Klevan, Carol Hamilton and David Ganz
Introduction The United States system of pension supervision is best understood in the context of the role of private pensions in providing retirement income for retirees and the historical development of the employment based system in the United States. The United States’ system of government is federal, with much of the governmental services provided by the fifty state governments and the innumerable local governments, all of whom have local taxing authority. Many government functions which are the responsibility of centralized governments in other countries, such as education and criminal law, are primarily the responsibility of the various state governments. Also, the dominant ethos of the country’s citizens is one of individualism, something which was noted by DeToqueville in the 1830’s. Given this background, it is not surprising that until the Great Depression of the 1930’s there was no provision for pensions provided by the national government. In the 1930’s a national pension program (called “Social Security”) was created for workers, financed by a payroll tax on wages. The concept of providing retirement security for the elderly envisages a “three legged stool” of income support – Social Security to provide for subsistence income to keep the elderly out of poverty, with private pensions and personal savings providing the additional income to enable a comfortable retirement. Reflecting the individualistic nature of American society, there are no mandates that private employers provide pensions or that individuals save for retirement. Indeed, until World War II, there were relatively few private pension plans. During World War II, the United States government severely limited wage increases so as to prevent inflation, but allowed unions to bargain with
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employers to provide pension plans and health plans. Given the scarcity of labor, employers whose workers were represented by unions adopted pension plans and many non-union companies did the same, for competitive reasons. The government encourages employers to create pension plans by giving favorable tax treatment to the employers who establish the plans and to the plans themselves. Reflecting the size and diversity of the country and the voluntary nature of the private pension system, there are a variety of private pension plan arrangements. Those established by a single employer are known as single employer plans, while plans which cover workers at a number of businesses in a common industry, pursuant to a collective bargaining agreement with a union representing workers in the industry, are known as multiemployer plans. Of the approximately 6 million private firms in the United States, about 1.8 million provide some pension coverage to their employees. A large proportion of these are small and medium size employers, many of whom provide pension coverage through slightly more than 3,100 multiemployer plans, which provide about 15% of private sector workers with pension coverage. Single employer plans are the most common type of pension plan, accounting for the remainder of the 730,000 private pension plans. There are a wide variety of private pension plans, which are crafted to meet the particular needs of the employer adopting the plan, taking into account the nature and needs of its workforce. However, while there is great variety in the particulars of each individual pension plan, private pension plans fall into two different general categories — defined benefit (DB) plans, in which a benefit is computed from a formula specified in the plan and is typically paid as a lifetime annuity payable on retirement, and defined contribution (DC) plans, in which an individual account is created for each participant and the benefit at retirement is a lump sum resulting from the value of the assets contributed to the account plus any investment gains less any investment loss and any administrative expenses charged to the account. There are two essential differences between DB and DC plans. In a DB plan, investment and mortality risk is underwritten by the employer sponsoring the plan, who is responsible for any funding shortfall and for payment of the annuity as long as the retiree lives. If the employer goes bankrupt and there aren’t sufficient assets in the plan to pay benefits, a government agency, the Pension Benefit Guaranty Corporation (PBGC), assumes control of the plan and will pay annual pension benefits up to a maximum amount, which was USD 43 997.24 per year in 2003 for workers who retire at age 65. This amount suffices to cover the entire annual pension annuity for the average worker. In contrast, in a DC plan, the individual worker bears the investment risk of his account and risks outliving his accumulated funds.
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When the national law governing private pension plans (the Employee Retirement Income Security Act, known as ERISA) was passed in 1974, the bulk of the pension covered workforce was in DB plans. In 1975, 87% of the pension covered workforce was in DB plans, compared to only 50% in 1996. The major reason for the shift was the desire of employers to reduce and make more certain their pension costs and the fact that workers found DC plans easier to understand and valued them more. Currently, there are about 60 000 DB plans and 670 000 DC plans, with combined assets of USD 4.4 trillion in 1998, compared to USD 260 billion in 1975. Pension plans play a major role in capital markets, holding about 20% of all outstanding equities and 17% of all corporate bonds. ERISA was passed in 1974 as a result of rising complaints of workers that the private pension plans that covered them often had unreasonable requirements for their right to a pension to become nonforfeitable (vesting rights), that the plans were not required to be funded in a separate entity, so that if the employer went bankrupt, employees would receive no pension, and that the plans often required a lengthy period of employment before an employee was eligible to participate in the plan, while containing provisions stating that a relatively short break in service (for instance, a period of unemployment) would wipe out all service credited prior to the break in service. These factors combined to make the pension promise illusory for a large portion of workers covered under private pension plans. ERISA provided for minimum standards for vesting, funding, participation and breaks in service to protect workers, and gave the Department of the Treasury the primary responsibility for enforcing those rules. Prior to the passage of ERISA, with the exception of some weak reporting requirements that were within the purview of the Department of Labor, jurisdiction over pension plans was totally within the purview of the Department of the Treasury, within the Internal Revenue Service (IRS), through the tax qualification process. At the same time, there was evidence that many employers did not clearly reveal to their workers the many conditions they had to meet to receive a pension, thus deceiving them as to their eligibility for a pension. There was also evidence of cases in which pension plan fiduciaries mismanaged pension plans, making imprudent investments or engaging in self-dealing. To rectify these problems, ERISA contained provisions governing fiduciary conduct and contained provisions for reporting of certain information to the government and disclosure of information to plan participants, along with provisions for enforcement of the fiduciary responsibility and reporting and disclosure requirements by the government (primarily by the Department of Labor) and by plan participants. A major concern of employers was also addressed. In reaction to worker complaints, several states had passed laws regulating private pension
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plans, and more were considering enacting such laws. Because many plans covered participants in more than one state and some covered participants in every state, it would be quite expensive to comply with different and sometimes conflicting laws. The drafters of ERISA provided a broad provision stating that ERISA preempted all state laws with certain relatively minor exceptions. Because of the division of responsibility for the administration of ERISA between the Department of Labor and the IRS, and the provision of insurance of DB plans by the PBGC, this paper will separately discuss structures of the IRS and the PBGC and the Department of Labor. It should be noted that there is regular coordination between the Department of Labor and the IRS and coordination between the agencies and the PBGC as the need arises. Department of labour supervisory, compliance and enforcement structure The unit within the Department of Labor charged with administering ERISA is the Employee Benefits Security Administration (EBSA). Another unit within the Department of Labor, the Plan Benefits Security Division of the Office of the Solicitor, provides legal advice to EBSA and brings lawsuits, along with regional offices of the Office of the Solicitor, based on EBSA’s investigations. The fiduciary responsibility, reporting and disclosure and enforcement provisions of ERISA were adopted against the backdrop of the voluntary nature of our private pension system, the large number of plans, their diversity in terms of size and type of plan, and the limited resources of the government to police such a large number of plans (730 000 private pension plans in 1998, as well as 6 000 000 health and welfare plans covered by ERISA.) Recognizing the voluntary nature of private pension plans and their great diversity, ERISA’s fiduciary responsibility provisions, in establishing requirements for the administration of pension funds and the investment and disposition of fund assets, sets forth general principles and generally focuses on process rather than on specifying particular directives for fiduciaries to follow. For example, unlike the pension laws in many countries, there are no maximum or minimum percentage requirements for investment of assets and no prohibition of any category of investments. ERISA requires plan assets to be held in trust (unless it is held by an insurance company) so as to assure that plan assets are safe in the event of an employer’s bankruptcy. The trustees are responsible for the administration of the plan and the investment of its assets, unless such responsibility is allocated or delegated to others. Whoever has responsibility for the management of the
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plan or for exercising discretion in the investment or disposition of its assets or who provides investment advice for a fee is considered a fiduciary of the plan under ERISA and is subject to ERISA’s fiduciary responsibility requirements. These requirements, in brief, are that the administration of the plan and the investment of its assets be done in a prudent manner. This requires that the fiduciaries have expertise appropriate for the matters for which they are responsible, and exercise skill and diligence in undertaking their actions. The fiduciaries’ actions must be for the exclusive benefit of the plan’s participants and defraying the reasonable expenses of the plan. This duty of loyalty prevents fiduciaries from making investments whose primary purpose is to further an interest external to the plan, such as regional development or even enhancing the job security of the plan sponsor’s employees. Pension plan investments are required to be diversified to minimize the risk of large losses. DC plans, if they so provide, can override this provision. If they do so, they are still subject to the underlying requirement that their investments be prudent. ERISA also contains provisions which prohibit certain transactions that have a high potential for conflicts of interest and self-dealing. These are generally transactions between the plan and its fiduciaries, plan sponsors, employees of the employer, service providers to plans, their relatives, and unions representing the employees, and certain related entities. Because these prohibitions cover many potentially advantageous transactions for plans, ERISA provides statutory exemptions for certain categories of transactions and has a process for securing administrative exemptions from the Department of Labor. The reporting and disclosure provisions are meant to enable plan participants to know the details of their pension plan and to enforce their rights and for plan participants and the government to detect fiduciary violations. Plans are required to furnish their participants summary plan descriptions shortly after they become participants in the plan and updates whenever there is a material modification to the plan, along with a summary annual report, which provides an abbreviated description of the plan’s financial status. Plans are required to file an annual report with the government, which contains extensive financial information, and to make that report available to participants on request. If the plan has 100 or more participants, the plan must obtain a financial audit by an independent auditor and submit the opinion of the auditor on the completeness and accuracy of the financial statement contained in the annual report. If the plan is a DB plan, an actuary has to certify as to the reasonableness of the actuarial assumptions used in funding the plan. The reporting and disclosure provisions provide regulators and participants with essential information to assess compliance with the law and also serve as a substantial deterrent to irresponsible or illegal behavior. Willfully violating the reporting and disclosure provisions of ERISA is a criminal offense.
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ERISA provides for enforcement of its fiduciary provisions both by plan participants and the Department of Labor. Given that there are 730 000 pension plans and 6 000 000 health and welfare plans, and 900 employees in EBSA, a major emphasis of EBSA is on securing voluntary compliance with ERISA. This is done in the first instance by issuing regulations, advisory opinions and field assistance bulletins to clarify areas of the law which are ambiguous or which apply settled areas of the law to new financial products which were not contemplated when ERISA was passed. EBSA also has a vigorous outreach program to plan sponsors and plan participants, publishing many booklets and maintaining a website explaining aspects of ERISA, as well as participating in many conferences. When violations are found during the course of an investigation, the first course of action is to secure voluntary compliance, which is generally successful. ERISA provides a strong incentive for persons in violation of the law to voluntarily comply with the law when the government finds a violation, by providing for a 20% civil penalty measured by the amount of loss to the plan payable to the government if a court finds a fiduciary breach. This is over and above the requirement that the fiduciary restore the plan’s losses. There are general criminal law penalties for fraud or embezzlement, and provisions in ERISA requiring bonds in certain maximum amounts to protect plans from losses due to criminal activity. In addition, though not required by ERISA, many plan fiduciaries secure insurance to cover losses resulting from fiduciary misconduct. Private pension plan participants play a key role in policing possible fiduciary misconduct in making pension plan investments, particularly in DC plans, where any plan losses show up in their investment accounts. Where a fiduciary breach does not cause a loss to the plan, but rather a loss to a particular plan participant, usually an improper denial of a benefit, ERISA only provides for a lawsuit to secure the denied benefit. ERISA does not provide for consequential or punitive damages in any cases. Because claims for improper denial of benefits typically are for relatively small amounts and the award of attorney’s fees are discretionary to the court, it is difficult for participants to find attorneys to pursue these cases. As a result, EBSA has allocated 105 of its 900 positions to the Office of Participant Assistance and to employee benefits advisors in its field offices to help participants voluntarily resolve their claims against their plans. EBSA benefits advisors handled 82 792 inquiries from plan participants in the first half of fiscal year 2003, of which 26 147 related to pension plan issues. This activity brought USD 33.58 million in benefits to pension participants in the first six months of fiscal year 2003. During the first half of fiscal year 2003, EBSA also participated in 1004 outreach efforts.
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Organization of Department of Labor Compliance Components EBSA is headed by the Assistant Secretary of Labor for Employee Benefits Security who is appointed by, and serves at the discretion of, the President. This agency head is therefore a political appointee who provides overall policy leadership for the agency and generally serves only for the administration of a single President. The day to day operations of the agency are the responsibility of a senior civil servant, the Deputy Assistant Secretary (DAS) for Program Operations, who provides advice to the agency head on policy matters and is responsible for managing the operations of the agency. Within EBSA, there are four components which carry out the pension compliance program: x
The Office of Enforcement (OE) (15 employees) located in the National Office (headquarters) which sets policy, priorities and procedures, provides support (such as training), and conducts evaluation for enforcement activities.
x
The Office of Participant Assistance (OPA) (40 employees) located in the National Office which sets policy, priorities and procedures, provides support (such as training), and conducts evaluation for participant assistance activities.
x
The Office of Chief Accountant (39 employees) located in the National Office charged with enforcing ERISA’s reporting and disclosure requirements. In a typical year it rejects approximately 2500 annual report filings for material deficiencies and requires the filings to be corrected.
x
Ten regional offices with assigned geographic jurisdictions that divide up the United States, which carry out the enforcement and participant assistance activities.
OE, OPA, OCA and each of the ten regional offices report directly to the DAS for Program Operations, which means that OE and OPA are staff offices without direct line authority over the field offices. The direction from OE and OPA to regional offices ensures that the regional offices carry out overall agency priorities and apply uniform policies and procedures, and that there is a sufficient centralized review to assure quality control across the regions. Within this overall direction, regional offices have considerable latitude to carry out their activities in a manner that best suits the universe of plans and the types of problems encountered in their geographic jurisdiction. Thus, the field offices exercise broad discretion in determining the focus and nature of their supervisory and compliance activities to suit the requirements of their specific area of jurisdiction, but function within the overall national policy framework and guidance.
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Strategic planning, operational planning, and evaluation EBSA’s compliance program is primarily carried out through civil examinations (which are called investigations), which seek to identify and correct violations. The agency also conducts criminal examinations where theft or fraud is suspected. About 85% of the agency’s resources are directed toward civil issues and 15% toward criminal. In addition, EBSA carries out a public information program to advise participants of their rights and to advise employers, service providers and plan officials of their obligations. In summary, EBSA’s current strategy for enforcing ERISA’s pension plan provisions is a multi-faceted approach of investigations supplemented with a strategically focused outreach/public education effort. Outreach efforts use the internet, brochures on specific topics and appearances at events. They are aimed both at plan participants and plan sponsors, as well as a new voluntary correction program that is carried out by the field offices. To direct these activities, EBSA sets out an overall strategic plan, develops annual operational plans at the National and regional levels, and establishes evaluation criteria. Strategic planning The size and diversity of the pension plan universe coupled with scarce enforcement resources dictate EBSA’s compliance strategy. The agency has limited resources, about 400 investigators, to supervise a vast plan universe, which consists of 730 000 pension plans with about USD 4.4 trillion in assets, and about 6 million health and other employer-based benefit plans. As a result, EBSA must carefully decide how it will use its scarce resources to gain the greatest levels of compliance. For the first ten years of its existence, EBSA did not formally set out an overall compliance strategy. Regional offices had almost unfettered latitude to determine their priorities and direct their enforcement efforts to the areas within their geographic jurisdiction where they perceived the greatest needs. However, EBSA was criticized for trying to do a little bit of everything and for not having an organized and coherent enforcement strategy that set overall priorities and direction. In response, in 1986 EBSA issued its first strategic plan for compliance activities. This plan identified two “significant issues” and required that regional offices spend 50% of their resources on activities related to these issues. For pension plans, the “significant issue” concerned abuses by financial institutions which provide services to these plans.
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EBSA’s current strategic plan for enforcement activities is set out in a document, issued in 2000, and entitled the “ERISA Strategic Enforcement Plan (StEP),” which describes the current goals, priorities and methods. The primary purpose of the StEP is to establish a general framework through which enforcement resources may be efficiently and effectively focused to achieve the agency’s policy and operational objectives. To most effectively use scarce resources to safeguard the interests of plan participants and beneficiaries, the StEP establishes the following broad policy priorities. x
Effective targeting. The term “targeting” refers to the process whereby specific individuals or entities are identified for examination because of some indication that an ERISA violation may have or may be about to occur. The goal in targeting is to identify factors that can be used to identify specific plans, individuals, and other entities that are violating the pension law, so that examinations will be most likely to find and correct violations. Thus, EBSA does not conduct random audits, but instead seeks to effectively target investigations to where they will have the greatest positive impact in safeguarding pension plan assets and benefits.
x
Protecting at-risk populations. At-risk populations are those plan participants and beneficiaries whose retirement security is in the greatest danger of being harmed as a result of ERISA violations. An example of this group would be participants in defined contribution plans, such as 401(k) plans (these are plans funded by employee contributions, often matched in whole or part by their employer, where participants direct their investments among several options provided by the employer). By contrast, the risk to participant’s retirement security from fiduciary misconduct in defined benefit plans is substantially lower, as the employer is responsible for making up plan losses to fund promised benefits, and if the employer fails to do so, benefits are guaranteed up to a certain level by a governmental corporation, the PBGC.
x
Deterring violations. EBSA seeks to deter illegal conduct through the continuing effectiveness and impact of its examination efforts, and by publicizing violations and corrections. While EBSA seeks to recover losses, it also seeks to maintain the financial and operational integrity of the private pension system, by conducting examinations that address potentially abusive practices, where losses may not have yet occurred. Examinations of firms providing services to plans, such as administration, accounting or legal firms offer the opportunity to address abusive practices that affect many plans.
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Operational planning National Plans. For each fiscal year (FY), EBSA’s National Office issues guidance on the specific compliance priorities for that year (which reflect the overall policy priorities set out in the StEP), and on the level of activity to be carried out. The specific compliance priorities are called National Projects, and are intended to ensure that enforcement activities focus on the areas which are most critical to the well being of pension plans. For FY 2003, the National Projects include plans with employee contributions (mainly 401(k) plans) to ensure that employee contributions are forwarded to the plans; plans that are abandoned by the individuals responsible for them to assure that plan assets are properly distributed to plan participants; and plans whose sponsors have filed for bankruptcy, to assure that the plan’s interests are protected in the bankruptcy proceedings. Regional Plans. Based on the National Office Guidance, each of the ten regional offices submit plans for approval by the National Office, which set out the regional office’s participation in National Projects, their conduct of Regional Projects and the number of examinations and public information activities to be carried out in the fiscal year. Regional Projects are compliance initiatives developed by a regional office to address areas that are unique or particularly problematic in their geographic jurisdiction. Each region has a lot of flexibility in selecting projects. This is because different regions have different characteristics. For example, the New York region has many large plans, multiemployer plans, and large service providers to plans, while the Kansas City region has many small plans. Because of the diversity between regions, each region has the unique opportunity to observe industry practices within the region first hand and select issues for development as regional projects, which may ultimately be appropriate for adoption as national projects. Because some national projects may originate as an expansion of a successful regional project or arise in connection with field office investigations, communication between the national office and field offices is key to a successful enforcement program. Evaluation As required for all Federal agencies, EBSA has selected measurable goals against which performance can be evaluated. These goals highlight the most important activities of the enforcement program and challenge the agency to improve its efficiency and effectiveness. For FY 2002, the goals include increasing by 5% per year (to 1993 in FY 2002) the number of examinations with violations corrected and to increase by 1% per year (to 35% in FY 2002) the ratio of examinations with violations corrected to all the examinations conducted. From these National goals, detailed goals are set for each regional 288
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office, whose performance is measured by the number of civil and criminal examinations conducted and the results from these examinations, including the number with violations corrected, the amount of funds secured and the number of criminal convictions. These evaluation criteria reflect the policy priorities described earlier: effective targeting, protecting at-risk populations and deterring violations. Conduct of Department of Labor investigations Targeting cases Targeting is an effective method for case selection in the ten regional offices. A good source of targeting is the information received from participant complaints. Our participant assistance activities provide field offices with many sources for opening investigations, including participant complaints and congressional inquiries stemming from complaints from constituents. The best source for cases has come from customer service leads. In order to increase the number of leads received by EBSA’s employee benefits advisors, EBSA continues to work on informing the general public of their rights with regards to their pension and welfare employee benefit plans. Since this targeting method is key to our enforcement program, we continue to expand our outreach programs in order to advise the general public of our existence and mandate. Another fertile targeting method involves opening cases based on a review of the Annual Report Form 5500 filed by employee benefit plans subject to ERISA. These forms are filed by the plan administrators or plan sponsors and include basic plan information, plan type, sponsor’s name, benefits provided, funding arrangements, covered participants, asset information, service provider information, and accountant’s opinion when required. This form is extremely useful for targeting purposes due to the amount of financial information being provided about the employee benefit plan. In addition to the above-mentioned methods, regional offices target cases through the following arenas: the news media, trade journals, bankruptcy court records, real estate records, and information received from other regulatory agencies such as the IRS, federal banking regulatory agencies, State Insurance Commissions, the Securities and Exchange Commission, U.S. Attorney’s Offices, the Federal Bureau of Investigation, U.S. Postal Inspection Service, and other federal and state agencies. EBSA has memorandums of understanding governing the exchange of information with respect to ERISA covered plans with the IRS, federal banking regulatory agencies, and the Securities and Exchange Commission.
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Many regional offices coordinate on a regular basis with other federal and state agencies who are conducting investigations of employers who may have employee benefit plans and who may receive complaints regarding ERISA covered plans. Regional offices are known to utilize the Internet to target potential cases and to develop and research leads. Monitoring the media in outlying areas of regional jurisdictions can be a valuable source for targeting potential cases. By reading newspapers published on the Internet, investigators are able to develop potential leads from articles. In addition, by monitoring enforcement actions by other agencies and regulatory groups on the Internet can lead to cases. Targeting of criminal investigations happens in various ways, including computer data analysis, information obtained through a civil investigation, leads from individuals such as plan participants, plan officials, service providers to plans, informants, news media sources, or information obtained from other federal and state agencies. Once such leads have been identified and unlawful conduct is indicated or suspected, the field office managers are responsible for determining whether an investigation should be opened and then whether the investigation should proceed criminally, civilly or both simultaneously. Case opening After the targeting methods are applied, the field office then needs to make a determination whether to formally open an investigation on the subjects found from the particular targeting method. Investigations may be opened on plans, plan sponsors, service providers, or for criminal investigations, on individuals. Regional offices are generally responsible for opening investigations and each office needs to analyze the factors such as the possible conduct in question, the amount of money or property potentially at risk, the number of participants potentially effected and the resources available to conduct such investigations. The field offices, at the direction of each regional director, must apply its investigative resources in a manner that will result in prompt and effective enforcement actions, and timely results. Once cases are selected either through a national office project, regional office project or through some targeting method, the particular entity selected for review needs to be identified and entered into the computer system for tracking purposes. Entering the information into the computer system allows the investigator to review the regional office’s indices in order to ensure that a case is not already opened on the subject. In addition, every case opened must have a narrative detailing the reason for selecting a particular subject (employee benefit plan, service provider, or financial institution) for investigation. Therefore, the
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pre-investigative steps include selecting or assigning a case, reviewing the regional office’s indices, obtaining and reviewing the Annual Report 5500 for prior years through a national ERISA data system, identifying potential issues, and then officially opening the case. Case conduct Once the case is opened the investigator can proceed with obtaining information on the employee benefit plan and addressing any possible issues that have been identified. ERISA assigns to EBSA and its regional offices the power to conduct investigations, and in connection therewith to require the submission of reports, books, and records and to enter such places, inspect such books and records and question such persons as they may deem necessary to determine the facts relative to the investigation. Normally, the investigator will send an opening letter detailing our investigative authority and advising the subject that an official investigation is being conducted. This letter initiates contact with the subject under investigation in order to begin the process of obtaining evidence through both written documentation and oral testimony. If EBSA encounters resistance and the subject refuses to voluntarily provide documents, EBSA has subpoena authority to compel testimony and/or the production of documents. There are procedures to follow in serving a subpoena and limitations on the extent of the amount and type of information being required under that subpoena. Once documents are received (either voluntarily or through the subpoena process), the investigative process begins with drafting an investigative plan on how to proceed with the review and to address the predicate issue on why the case was opened. An investigative plan for a subject case includes an analysis and scope of the investigation by setting forth the issue and/or issues being investigated and which sections of ERISA, if known, which may have been violated. After laying out each allegation within the context of the applicable sections of the statute, interpretations and regulations, the investigator can move onto the planned investigative activities. Normally, an investigative plan will include what records will be reviewed and/or what interviews will be conducted in order to fully investigate each issue. Interviews of employee benefit plan fiduciaries may be conducted in order to understand the plan and how the plan is administered. The objective of an interview of a fiduciary or of a service provider to an employee benefit plan is to develop credible information that is relevant and material to the investigation and to ascertain the interviewee’s version of the facts. Once an interview is completed, the investigator will timely record the interview in a formal written report. This report of interview will become part of the exhibit file. Regional
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Directors have the authority to permit investigators the right to discuss their findings (depending on the situation) with plan officials during an investigation, provided that the officials are advised that the matters discussed represent only the views of the investigator and the findings are always subject to review by higher authority. It is understood that it may be useful in certain circumstances during an investigation to discuss with the plan officials their position and intentions regarding any possible action they may take voluntarily to correct a violation. Once the investigation is complete, the investigator will draft a report of investigation with the facts of the case and organize all of the exhibits. The report of investigation contains facts of the investigation only and will not contain opinions of the investigator. Subsequent to this draft, the investigator will prepare the final report of investigation and submit this report with the exhibit file to their supervisor. The investigator will also make recommendations on the disposition of the matter. Case disposition After the completion of the investigation, the field office makes a determination on the disposition of the case. A case is closed with no action taken when no violations are identified. In addition, while violations may be identified, a decision may be reached that the matter will not be pursued because it is not worth the governmental resources that would be required or the parties responsible for the violation are unable to make the correction. Where violations are found and are pursued, remedies and sanctions are imposed, as appropriate. In fiscal year 2002, 3 762 pension cases were opened, 3 370 civil cases were closed, with 1 985 cases finding a violation. USD 691 million was restored to pension plans. Also, 203 criminal cases were opened, 154 criminal cases were closed, with 134 indictments and USD 4.6 restored to pension and health and welfare plans. Remedies and sanctions under the labor provisions of ERISA There are a variety of remedies and sanctions designed to address the many types of violations and financial transactions encountered in EBSA’s investigations. EBSA’s priorities are to protect plan assets, to recover losses, to assure future compliance, and in some cases, to punish the parties responsible for violations.
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Civil remedies ERISA provides for “make whole relief” to the plan, which means placing the pension plan back in the position it would have been in if the violation(s) had not occurred, and holds the parties responsible for the violations to be personally liable to the plan for the losses. In addition, any illegal gains must be “disgorged,” which means returned to the plan. The law allows for the removal from positions affecting plans of parties responsible for violations and for barring them in the future from serving in such positions. ERISA also provides for civil penalties in certain situations, which are monetary fines. x
Voluntary compliance. Most violations are corrected by a process called “voluntary compliance,” through which EBSA sends a letter to the responsible parties citing the violations and requesting correction, generally in the form of make whole relief and disgorgement. The letter states that if the parties cited do not make the correction voluntarily, the matter will be referred to the legal department to bring suit in Federal court. Only the Federal courts have the authority to compel the correction. Nevertheless, most violations are corrected voluntarily, based on the expectation that, if correction were not made, the Department of Labor would bring suit and prevail, and a civil penalty would have to be paid to the government in addition to making good any losses to the plan. Regional offices have the authority to settle cases through voluntary compliance. EBSA also has two self-correction programs, one for certain straight-forward civil violations and the second for reporting violations. For the former, where parties that have engaged in certain types of civil violations, such as failing to forward employee contributions to 401(k) plans, the program allows the violators to correct the violations, notify EBSA, and in return, receive a letter from EBSA accepting the correction. For reporting violations, the parties file the correct report and pay a reduced fine from the amount that would otherwise have been due.
x
Litigation. Where parties do not voluntarily correct violations cited by EBSA, or where the violations are especially egregious, EBSA refers the examination to the Office of the Solicitor of the Department of Labor to bring suit in Federal court. These suits seek make whole relief for the plan, the disgorgement of ill-gotten gains and, in egregious cases, the barring of responsible parties from serving as fiduciaries to ERISA plans. In addition to legal action by the Department of Labor, ERISA provides participants and beneficiaries with the standing to sue in Federal court to correct violations of ERISA and to obtain benefits illegally denied to them.
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x
Penalties. ERISA provides civil penalties for failing to report required information to EBSA when due (up to USD 1 000 per day, payable to the government) and for failing to disclose information to participants when requested (up to USD 100 per day payable to the participant, if approved by a Federal court). In addition, ERISA provides for a 20% penalty payable to the government of the amounts recoverable from a responsible party as a result of a settlement agreement or a court order to correct violations of this law. This penalty is rarely assessed for violations corrected by voluntary compliance.
Criminal sanctions Criminal sanctions include imprisonment, fines and the restitution of illegal gains. EBSA refers its criminal violations which it finds to the federal Department of Justice or to the appropriate state prosecutor, depending on the severity of the criminal violation. If the criminal defendants are found guilty after trial or enter a plea of guilty, they may be fined or imprisoned or both and are required to reimburse the pension plan for any losses suffered as a result of their criminal acts. IRS supervisory, compliance and enforcement structure Determination letters An employee retirement plan that meets certain requirements under the Internal Revenue Code (the “Code”) is referred to as a “qualified plan” and is entitled to favorable tax treatment. For example, contributions made in accordance with the plan document are generally currently deductible expenses for the employer. Earnings on plan assets are not taxable and participants will not include the employer contributions to the plan in income until the time they receive a distribution from the plan. In some cases, taxation may be further deferred by rollover to another qualified plan or individual retirement arrangement. Finally, plan earnings may accumulate free of tax. Employee retirement plans that fail to satisfy the requirements under the Code are not entitled to favorable tax treatment. There are no legal requirements to initially register a pension plan with the Department of Labor, the IRS, or the PBGC. Given the significant adverse tax consequences of failing to satisfy the qualification requirements of the Code, however, most employers desire advance assurance that the terms of their plans satisfy the qualification requirements.
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The IRS provides such advance assurance by means of the determination letter program. A favorable determination letter indicates that, in the opinion of the IRS, the terms of the plan conform to the applicable requirements of the Code. To be a qualified plan, however, a plan must satisfy, in both form and operation, the applicable requirements of the Code, including requirements that the plan not discriminate against low wage workers and cover a certain percentage of the workforce. The application process for determination letters differs based on the type of plan that has been adopted. Sometimes prototype plans are sponsored by financial institutions, accounting firms, or other plan service providers. These prototype plans are submitted to the IRS for an opinion letter that the plan’s design satisfies the requirements of the Code. The adopting employer completes an adoption agreement under which various design options available under the plan are selected. In the simplest case, the adopting employer relies on the opinion letter and does not file for an individual determination letter. In the more complex cases, the employer files the adoption agreement with the IRS for an individual determination letter. Individually designed plans are submitted for individual determination letters. A determination letter application is accomplished by filing with the IRS an application form (Form 5300 for individually designed plans or Form 5307 for certain adopters of prototype plans), the plan document, and a fee (as much as $1,250 for individually designed plans and as little as USD 125 for prototype plans). The level of the user fee is generally dependent on whether the plan is seeking comfort on the methodology of certain non-discrimination testing under the plan. The plan document and documents are reviewed by the IRS to determine if all of the elements of a properly executed plan document are present as dictated by the Code. An investment policy for the plan is not required by the IRS, but is strongly encouraged by the Department of Labor, and many plan fiduciaries adopt a policy for the plan. Such investment policies are not subject to initial review or evaluation by any government agency. There is a lively debate as to the prudence of using an investment policy. Many plan sponsors believe that they offer protection in the event of the loss of value of plan assets. If the investment policy was prudent and was followed, then a loss of asset value could be defended. Other plan sponsors argue that a formal investment policy only provides more opportunities to fail to follow the terms of the plan.
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Determination letters apply only to the plan as submitted. If the plan is subsequently amended, often due to a change in the qualification rules, the plan will need to be re-submitted for a determination letter. Because of the regular changes in recent years to the qualification rules, plan sponsors have been submitting their plans for a favorable determination letters every 10 years or so. During 2003 (to date) and for the four prior years, the numbers of determination letter applications filed with the IRS were as follows: 1999 2000 2001 2002 2003
37 177 27 005 30 492 71 368 44 134
If a determination letter application is timely filed, the applicant is permitted to make retroactive amendments to the plan to remedy any issues discovered as part of the determination letter application. Because of the dire consequences of failing to satisfy the qualification requirements, virtually all plans take advantage of that opportunity. Because of this ability to make amendments and the desire to do so, virtually no plans are denied a favorable determination letter. During 2003 and the four prior years, only nine plans were denied favorable determination letters. Generally, changes in the plan’s structure are not required to be approved or reported. However, a favorable determination letter applies only to the document as submitted. Thus, when a plan is amended, the plan’s sponsor generally files for a new IRS determination that the plan’s terms do not violate the qualification rules of the Code. Examinations The office of Employee Plans (EP) under the Tax Exempt and Government Entities (TE/GE) operating division of the IRS helps retirement plan sponsors, plan participants, and practitioners working in the retirement benefits arena understand and comply with the pension law. The goal of EP Examinations is to promote voluntary compliance by analyzing operational features of retirement plans. Activities include developing processes to identify areas of noncompliance, developing corrective strategies, and assisting other functions, such as EP’s Customer Education and Outreach and ruling and Agreements in implementing those strategies. EP uses a centralized examination case selection and review process to enhance consistency of enforcement activities and to
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focus resources on the areas of highest noncompliance. During fiscal year 2002, 7 558 examination cases were closed by EP Examinations. In inventorying and classifying returns for examination, EP has used an informal doctrine called "LUQ" — that is, returns are scrutinized to determine if an item is Large, Unusual or Questionable. The IRS is now moving towards using more sampling and analyzing sampling variants to identify the items that may lead to a mix of issues that lead to compliance problems. The IRS uses this analysis not only to pick the returns with the highest potential for noncompliance but also to identify the issues that are relevant to a particular market or customer segment. In some market segments, because of the low number of trained agents, statistical sampling is not appropriate at this point. One area for a high potential for statistical sampling is 401(k) plans. The IRS will be identifying a significant number of these cases and will have a good opportunity for statistical sampling. The IRS will be developing the appropriate baseline criteria for its customer segments. The IRS is moving to special audits and away from general audits and developing audit technique guidelines. The IRS is developing limited scope audits that will be limited to those issues that are relevant to a particular market segment. The IRS has received significant feedback that its current audit strategy is too burdensome and that irrelevant and extraneous items where there is no history of noncompliance are being audited. With a limited scope audit approach, more plans can be covered. Four initiatives are underway related to examinations in EP’s current work plan in various stages of development and evolution: x
multiemployer plans — cases are being selected based on number of participants and amount of assets; program findings will be used to create baseline data, which, in turn, will be used to develop long-term compliance strategies;
x
403(b) and 457 plans — new selections are being made taking into consideration the changes made in recent legislation; audit guidelines are being developed; the pilot project for ineligible employers is continuing;
x
401(k) plans — the IRS recently increased its examination units to 600 because of increased Congressional interest; and
x
a more in-depth look at plans of larger corporations with a team audit approach including subject matter experts, computer audit specialists, etc
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There are three other projects that EP is contemplating seriously for next year: x
Non-Filers. These are either people who filed for a while and stopped, or never filed, or filed incomplete returns to minimize their exposure to an EP examination thinking that they have satisfied their filing requirements;
x
Simplified Employee Plan adopters, and
x
Service Providers.
Compliance assistance programs The Employee Plans Compliance Resolution System (EPCRS) is a comprehensive system of correction programs for sponsors of retirement plans that are intended to satisfy the requirements of sections 401(a), 403(a) or 403(b) of the Code, but which have not met these requirements for a period of time. EPCRS is based on the following general principles:
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x
Sponsors and other administrators of eligible plans should be encouraged to establish administrative practices and procedures that ensure that plans are operated properly in accordance with the applicable requirements of the Code.
x
Sponsors and other administrators of eligible plans should satisfy the applicable plan document requirements of the Code.
x
Plan sponsors and other administrators should make voluntary and timely correction of any plan failures, whether involving discrimination in favor of highly compensated employees, plan operations, the terms of the plan document, or adoption of a plan by an ineligible employer. Timely and efficient correction protects participating employees by providing them with their expected retirement benefits, including favorable tax treatment.
x
Voluntary compliance is promoted by providing for limited fees for voluntary corrections approved by the Service, thereby reducing employers’ uncertainty regarding their potential tax liability and participants’ potential tax liability.
x
Fees and sanctions should be graduated in a series of steps so that there is always an incentive to correct promptly.
x
Sanctions for plan failures identified on audit should be reasonable in light of the nature, extent, and severity of the violation.
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Administration of EPCRS should be consistent and uniform.
x
Plan Sponsors should be able to rely on the availability of EPCRS in taking corrective actions to maintain the tax-favored status of their plans.
EPCRS includes the following basic elements: x
Self-correction (SCP). A plan sponsor that has established compliance practices and procedures may, at any time, correct insignificant Operational Failures without paying any fee or sanction. In addition, in the case of a Qualified Plan that is the subject of a favorable determination letter from the Service or in the case of a 403(b) Plan, the plan sponsor generally may correct even significant Operational Failures without payment of any fee or sanction.
x
Voluntary correction with Service approval (VCP). A plan sponsor, at any time before audit, may pay a limited fee and receive the Service’s approval for correction. Under VCP, there are special procedures for certain submissions involving only Operational Failures (Voluntary Correction of Operational Failures ("VCO")), and for certain submissions in which limited Operational Failures are being corrected using standardized corrections (Voluntary Correction of Operational Failures Standardized ("VCS")). VCP also includes a special procedure that applies to 403(b) Plans (Voluntary Correction of Tax-sheltered Annuity Failures ("VCT")), a special procedure for anonymous submissions ("Anonymous Submission Procedure"), a special procedure for group submissions (Voluntary Correction of Group Failures ("VCGroup")), and a special procedure that applies to SEPs (Voluntary Correction of SEP Failures ("VCSEPs")). During fiscal year 2002, 780 voluntary compliance cases were closed.
x
Correction on audit (Audit CAP). If a failure (other than a failure corrected through SCP or VCP) is identified on audit, the plan sponsor may correct the failure and pay a sanction. The sanction imposed will bear a reasonable relationship to the nature, extent and severity of the failure, taking into account the extent to which correction occurred before audit.
Taxpayer communication and education EP’s Customer Education and Outreach (CE&O) helps plan practitioners, plan sponsors, plan participants and plan vendors understand their tax responsibilities. Activities relating to CE&O include both direct contacts
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(through IRS delivery at EP Benefit Conferences, speeches, workshops, panels and exhibits) and indirect contacts (through newsletters, publications, educational videos and interactive CDs, and websites). During fiscal year 2002, the IRS participated in 265 outreach efforts reaching 51 778 customers directly and 432 customers indirectly. Technical guidance EP provides guidance that explains how the tax law may apply to individuals or plans. In addition to guidance items of general applicability that are published weekly in the Internal Revenue Bulletin and accessible on the IRS website, individuals may request a letter ruling that applies to their specific situation. The supervisory role of the Pension Benefit Guaranty Corporation (PBGC) The Pension Benefit Guaranty Corporation (PBGC) was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation and maintenance of defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum. The PBGC is not funded by general tax revenues. The PBGC collects insurance premiums from employers that sponsor insured pension plans, earns money from investments and receives funds from pension plans it takes over. The PBGC pays monthly retirement benefits, up to a guaranteed maximum, to about 345 000 retirees in 3 132 pension plans that ended. Including those who have not yet retired, the PBGC is responsible for the current and future pensions of about 783 000 people. Under its Early Warning Program, the PBGC monitors certain companies with underfunded pension plans. Through this effort, PBGC identifies corporate transactions that could jeopardize pensions and works with companies sponsoring underfunded pension plans to arrange suitable protections for those pensions and the pension insurance program. One important source of information about underfunded plans is the report that must be filed annually with the PBGC under ERISA by companies that sponsor plans with significant amounts of underfunding, although the PBGC does not confine its analyses simply to the information submitted under this provision. While the PBGC focuses on companies in bankruptcy proceedings, it also negotiates non-bankruptcy-related agreements. During 2002, such agreements were valued at about USD 454 million and provided contributions, security, and other protections for the pensions of about 57 000 workers and retirees.
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Conclusion Due to the large number of pension plans in the United States, the voluntary nature of the pension plan system, the great variety of plans, and the limited amount of resources allocated to the governmental agencies charged with supervising pension plans, a significant emphasis on the part of government has been on voluntary compliance, through educational outreach programs and voluntary compliance programs for plan sponsors and plan fiduciaries who have discovered violations and want to correct them. Both the Department of Labor and the IRS have sophisticated programs for identifying likely areas of non-compliance with the law and targeting examinations at those areas. Through these programs, the agencies have made significant recoveries of money for plans and have imposed plans to correct deficiencies in their operations.
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XII. THE STRUCTURE AND FUNCTIONS OF THE SUPERVISORY REGIME OF RETIREMENT INCOME PROVISION IN THE REPUBLIC OF BULGARIA by Bozhidar Parvanov
1.
Overview of the Bulgarian pension Framework and Market Structure
system:
Institutional
The old pay-as-you-go (PAYG) system based on the use of social insurance contributions of the workforce to finance the pension payments for pensioners proved to be unsustainable and has been replaced by a new system whose main objective is to insure a sustainable social insurance for people born after 1959. These reforms were needed in a country where approximately 1/3 of the total population is pensioners. The reform of the system has been introduced by the Law on Supplementary Voluntary Pension Insurance (LSPI) and the Mandatory Social Insurance Code (MSIC) adopted in December 1999. The objective of this law is to protect pension scheme members by minimizing the risk of insolvency. The new legislation improves the old PAYG system and introduces supplementary mandatory and voluntary systems. The law provides for the following three elements or “pillars” of social insurance: Pillar I: Public Scheme for Mandatory Pension Insurance Pension insurance under this pillar is universal. That means the conditions and the formula for defining pensions are the same for all participants and there are no privileged groups of people. Only under this first pillar the state still keeps its priority role. Pensions received under the first pillar cover the basic needs of pensioners. Its amount is average 40% of the size of the income received from the employees before retirement. (replacement rate) Public social insurance provides assistance, benefits, and pensions in the event of the following social risks – temporary working capacity, temporary
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reduced working capacity, disability, maternity, old age, death, and unemployment. The insured persons are all economically active individuals, including employees, self-employed, single entrepreneurs, farmers, regardless of whether they are working under labor contract or without labor relation. The insurer is any individual or legal entity as well as organization, which according to the law has to pay insurance contribution on behalf of other persons. What is new in the public social insurance is that the benefits are set in correspondence to the contribution of the insured, which motivates active participation by the insured in the system. The funds for pensions are segregated from the funds for all other insurance risks in separate funds: (i) Pension Fund; (ii) Work Injury and Occupational Sickness Fund; (iv) General Sickness and Maternity Fund; and (v) Unemployment Fund. The amount of insurance contribution as well as their distribution between insurer and insured is determined on an annual basis by the State Social Security Budget Act. For the year 2002 the contribution rate is 36,70% for all insurance events and the contributions are distributed in a ratio of 75 to 25 between insurer and insured. The contribution of 36.7% for all insurance events includes: 29% for Pension Fund for persons, born before January 1st, 1960 27% for Pension Fund for persons, born after January 1st, 1960 0,7% for Work Injury and Occupational Sickness and Maternity Fund 4% for Unemployment Fund As a result of their participation in the mandatory social insurance the insured can receive: cash benefits for temporary incapacity or reduced working capacity due to general sickness, work injury or occupational sickness, pregnancy and birth and child care; assistance benefits for disability and occupational rehabilitation; old age pensions, disability and survivor pensions.
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Entitlement conditions: Old age pensions: reaching a certain minimum age, which increases with 6 month every year up to 2009, when the minimum retirement age for men will be 63 years and for women 60 years, for 2002 the age for men is 61,6 years and for women 56,6 years; the sum of the age and the length of participation should equal or exceed a certain points. Not less than 98 points for men and 88 points for women, as of December 31, 2000, the sum of the years of participation and age shall be increased by one until 100 points is reached for men and 94 for women. Disability pensions: a person becomes entitled to disability pension in case of loss of working capacity – entirely or partly, forever or for a long period. Entitlement is granted upon verification by a territorial advisory medical board. Survivor pensions: old age and disability pensions can be transformed into survivor pensions. The children and the survived spouse as well as the parents of the deceased person are entitled to survivor’s pension, if they do not receive individual pension. Pillar II: Mandatory supplementary pension insurance The mandatory supplementary pension insurance is fully funded. A leading principle is that contributions done by individuals are defined and the amount of the pension depends on the accumulated sum of the contributions, together with the investment income (or additional gains from investment). The legal separation of assets of the pension fund and the pension insurance company managing the pension savings of the individuals secures them against bankruptcy. There are two kinds of mandatory pension insurance funds – universal and occupational. Universal fund covers all working persons, born after January, 1st 1960 and Occupational fund covers those, working under labor category I and II – people, working under hazardous condition. Insurance at occupational pension funds started from January, 1st 2000, and at universal funds – from January 1st, 2002. The replacement rate, from the second pillar, is expected to be 20 to 30% of the salary prior to retirement. The contributions for universal pension funds are determined on an annual basis by the Public Social Security Budged Law and are at the expense of the
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employer. For 2002 the contributions for occupational pension funds are 12% for those, working under labor category I and 7% for those, working under labor category II. The contributions are made additionally and separately from the contributions for the first pillar. Entitlement to early retirement pension benefits from an occupational pension fund can be received by every person who has: Not less than 10 years of service under labor category I and age lower by 8 years compared to the age for old age pension under I pillar; Not less than 15 years of service under labor category II and age 3 years lower than the age for old age pension under I pillar. The early retirement pension is a limited-period and it is received up to the date of eligibility for the old age pension from the first pillar. The amount of the early retirement occupational pension benefit is determined by the period of its receipt and the funds collected in the individual account of the insured - a sum of the contributions and the investment return minus the management expenses of the fund. In case the insured does not use the right of early retirement, there is an opportunity to transfer the collected funds in the universal pension fund, thus increasing the supplementary individual pension. Additional rights – the insurance in occupational pension fund gives the right to lump sum or limited period payment of the amount accrued in the individual account upon decision of the territorial board of health experts for reduced working capacity; lump sum or limited period payment of the amount accrued in the individual account to the inheritors of a deceased member fund or pensioner. Everyone born after 1960 that is insured in a universal pension fund may receive individual supplementary pension. This pension is for life and is received together with the old age pension, granted under the first pillar. The amount of the benefit is determined on the basis of the accrued funds in the individual account and the income from their investment reduced by the legal fees and deductions, as well as on anticipated life expectancy after retirement, determined in the mortality tables.
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The contributions for universal pension funds are determined on an annual basis by the Public Social Security Budged Law and are at the expense of the employer. For 2002 the contributions for universal pension funds is 2%. Additional rights –the insurance in universal pension fund gives the right for: pension for life for age after acquiring right to pension for insured practice and age; one time payment of up to 50 percent of the resources accumulated in the individual account for disability for life over 70,99 percent; one time or deferred payment of sums to the heirs of a deceased insured person and of a pensioner under the conditions of this division. Pillar III: Supplementary voluntary pension insurance The target of the introduction of the third pillar is the creation of more opportunities for a better standard of living in retirement age. It will provide supplementary income to retirees in addition to the first and second pillar. The objective for the three pillars is to secure for the Bulgarian employees a cumulative replacement rate of approximately 60% of their last salary. Employees can make voluntary contributions in private pension funds. Pension insurance companies will manage the funds accumulated in the individual accounts. Pension savings are going to be invested according to the investment limits and the instruments authorized by law. The goal is to obtain the maximum investment income with the minimum risk. All persons who are 18 years can insure themselves voluntarily under the third pillar. In addition to the contribution of the employees, insurance contributions can be made by their employers or others The type of pension benefits available to the insured under the third pillar are: an individual benefit for old age and disability, and a survivor benefit in case of death of the insured person. The individual old age pension can be for life or for a limited period of time. The insured person makes the choice between the two Entitlements to this benefit occurs upon reaching the age required for the old age pension from the first pillar. Early entitlement is possible up to five years earlier that the standard retirement age.
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The amount of the pension benefit is determined on the basis of the accrued funds in the individual account and the income from their investment, reduced by the legal fees and deductions. Not less than 90% of the investment return of the voluntary pension fund for insurance through cash contributions is allocated among the individual accounts. The insured person has the right to transfer the accrued individual contributions or a part of them to a spouse, to relatives in direct line on condition that their purpose is kept the same. The insured person has the right to transfer the amount in its individual account to other voluntary pension fund once a year. The amount accumulated from employer contributions can be withdrawn by the insured only at the occurrence of an insurance event. The insured person can withdraw the accumulated sum in the individual account from individual contributions, at any moment. An important change introduced in the reform of the pay-as-you go system concerns the gradual redistribution of the proportion of contributions employers and employees in the. In 2001 the employer and the employee pay the contributions for the Mandatory State Social Security in an 80:20 proportion respectively. As of 2002, the proportion will be modified, in yearly steps of 5 annual percentage points, until the contribution of both parties reaches 50:50 in 2007. Payments to the universal pension fund of the second pillar are also divided between the employer and the employee in the same ratio as contributions for the mandatory scheme. Pension funds belonging to the second and third pillar are administered by the private pension insurance companies licensed by the State, and operate on a capital accumulation principle. The size of the supplementary voluntary pensions included in the second and third pillars is a function of the contributions made by the insured person. The size of the pension income from the three pillars is expected to reach between 65% and 80% of the net salary prior to retirement. The pension system has undergone significant structural changes brought about by the entry into force of the Law on Supplementary Voluntary Pension Insurance (LSPI) of 1 January 2000. Before then, the voluntary pension funds that appeared in Bulgaria since the economic reforms of 1991 were operating without any specific legal basis as legislation on supplementary insurance had not as yet been enacted. By the end of 1998 there were 30 such registered pension funds (all private) in Bulgaria, but only 12 were in operation.
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Following the implementation of the pension reforms and the establishment of the State Insurance Supervision Agency (SISA) that started operations in March 2000, government licenses were granted to the following 9 companies, 7 of which were already operating in the country: Allianz-Bulgaria, Berlinische Leben, Bulgarian Pension Insurance company, Doverie, Lukoil Garant-Bulgaria, Newton-Sila, Rodina, Saglasie and Solidarnost. Currently the number of companies is 8 following the voluntary liquidation of Berlinische Leben, merger between the Bulgarian Pension Insurance Company and Doverie – May 2003 and licenses of DZI Company – November 2003. Each of the 8 licensed pension funds listed above has registered one voluntary (Pillar III) pension fund, and one universal and one professional (Pillar II) fund. Foreign participation in pension funds is very strong. At end of December 2002 it accounted for 54.8% of the equity capital of such companies. The total number of persons with transferred contributions as of 19th March 2003 is 1,222,633 or 78.58% of the number of accepted applications. In comparison with the previous years, the number of contributors has increased significantly. From January 2003 the increase was 2.6%.1 The total number of applications accepted for occupational pension funds is 167,796. The total number of contributors for 2000 is 120,812 or 72% of the total number of accepted applications, and for 2001 it is 130,596 or 77.83% of the total number of accepted applications and for 2002 – 116,963 contributors or 69.71%.2 The insurance contributions of the insured are deducted from the taxable income and those of the employer, amounting up to 40 leva, per month, per employee, are recognized as deductible expense. The investment income of the funds of the pension fund allocated among individual account is non-taxable. Taxes are imposed upon exit of the system (benefits are taxable upon withdrawal). The pension benefits received or lump sums are subject to taxation. Early withdrawals from individual accounts in the third pillar are punished with additional 20% tax. There is a guaranty concerning results from pension assets investments. The legislation requires a minimum rate of return that pension plans in pillar two should achieve as a result of pension assets management. Results from this type of guaranty are debated, especially the bench marks that should be used for measurement.
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2.
The organization and scope of authority of the Supervisory Agency
The two main instruments for the implementation of the reforms of the Pension Fund System are the Law on Supplementary Voluntary Pension Insurance (LSPI), in force since 1 January 2000 and the Mandatory Social Insurance Code (MSIC), approved by the Bulgarian National Assembly in December 1999. The law aims at protecting pension scheme members by minimizing the risk of insolvency. State Insurance Supervision Agency (SISA), independent government body that started operations in March 2000. Chairman
General Secretary
Licensing Regime Directorate
Legal and Economic Department
Acturial and Financial Analysis Department
General Administration
General and Financial Supervision Directorate
Methodological Department
General Supervision Department
As of March 1st, 2003 the Law on the Financial Supervision Commission came into force. This Law establishes the Financial Supervision Commission (FSC) and terminates the activities of SISA and transforms it into a specialized division of FSC. The FSC is a specialized state body for regulation and supervision over the activities of: the regulated securities markets, the Central Depositary, investment intermediaries, investment and management companies, natural persons who directly execute transactions in securities and provide investment advice, public companies and other securities issuers pursuant to the Law on Public Offering of Securities; the operation of the insurers, insurance brokers and insurance agents under the Law on Insurance;
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the operation of the companies carrying out activities concerning the supplementary social insurance, including the pension, and for unemployment and professional qualification, as well as of the managed by them funds under the Mandatory Social Insurance Code, the Supplementary Voluntary Pension Insurance Act, the Health Assurance Act and the Unemployment Protection and Employment Promotion Act. The FSC, in the fulfillment of its powers, is independent of the executive power and reports on its activities under this Law to the Parliament. Three main departments have been set up in the FSC – “Investment Supervision”, “Insurance Supervision” and “Social Insurance Supervision”, each being directly led by a deputy chairman of the Commission. The Commission in the execution of the functions and powers entrusted to it under this Law is guided by the following goals: Protection of the interests of investors, the insured and socially insured persons; Securing integrity, transparency and confidence in the financial markets. These goals are achieved though the control exercised by the FSC over all participants in the non-banking financial sector, as well as by providing information about their operation to the general public. It is not very clear why one of the commission’s goals is not to maximize the total surplus on the market. The FSC’s powers are described in Chapter three of the FSC Act: “The Commission, in exercising its powers, shall be independent from the executive power, and shall report its activities under this Act to the National Assembly” art.2. The Commission consists of seven members: a chairman, three deputychairmen (in charge of the three main divisions in the Commission) and another three members. They are elected by the National Assembly, and the other officials are appointed by the Chairman. The members of the Commission may be only persons with higher education, having the appropriate professional qualification and experience in economy and finance. Each member of the Commission is appointed for a term of six years. The first members of the Commission have been elected with a term of respectively six, five and four years. The appointment member of the Commission is terminated by the National Assembly where the preconditions explicitly stated in the Financial Supervision Commission Act exist. The other directors are discharged from
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office by the Commission’s Chairman. The Commission may sit if more than half of its members are present. The decisions of the Commission are adopted by majority of not less than four votes. No abstention is allowed in voting. The FSC exercises all supervisory powers in relation to the pension insurance companies, managing funds for supplementary pension insurance, independently. The decisions of the Commission are not subject to approval by a superior authority. The commission is a very powerful regulator, it is a budget-supported legal entity that has a mandate to adopt rules and practices. Most importantly, some of the commission’s decisions “shall not be subject to appeal through court” as follows:
Refusals to issue a permit (license) for engaging in the activities of an insurer, health insurance company, investment company, management company, investment intermediary, or a supplementary social insurance company;
Decisions to withdraw a permit (license);
Refusals to issue permission for the transformation.
The individual administrative decisions of the Commission should be justified and subject to appeal before the Supreme Administrative Court, with the exception of the above decisions. On the basis of the above-mentioned we can conclude that the rules for entering and operating on the pension insurance market are very strict, but some subjective factors exist. FSC is a budget supported legal person, reports its activities to the National Assembly, and on its budget spending – to the National Audit Office. The National Assembly adopts the Commission’s budget, which is an independent part of the Republican Budget of the Republic of Bulgaria. FSC charges fees for the issuing of licenses, permits, exercising of overall financial supervision and for other activities, explicitly laid down in the Financial Supervision Commission Act, that are received as revenues of the Commission’s budget. The total number of the Commission’s staff on the pay-roll is 197, allocated in divisions.
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Structure of department “Public insurance supervision” of the Commission for financial supervision”
The total number of employees in the Social Insurance Supervision Department is 29.
On-site Supervision Department – 7;
Off-site Supervision Department – 7;
Regulatory Regimes and Risk Evaluation Directorate – 6;
Actuaries – 5;
and Lawyers – 5.
The establishment of a unified regulatory authority has facilitated the exchange of information with the other government bodies and the communication among the individual sectors of the financial market. In relation to the effective performance of its functions, the FSC works in close cooperation with the Ministry of Finance, Ministry of Economy, Ministry of Labor and Social Policy, the Bulgarian National Bank, Bulgarian Stock Exchange-Sofia, The Central Depository, Ministry of the Internal Affairs, the judiciary authorities, etc. The FSC is a member of the Advisory Council for Financial Stability together with the Minister of Finance and the Bulgarian National Bank. The Advisory Council aims at contributing to the safety, integrity and development of the financial markets in Bulgaria. The FSC performs the regulation of the funds for supplementary pension insurance mainly by issuing licenses and approvals, as mandated by law. One of the FSC’s powers is to adopt sub-statutory acts (ordinances and instructions),
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where that has been envisaged by law, gives written guidelines with regard to the application and interpretation of the laws, as well as of the sub-statutory acts. The FSC gathers financial information and other types of information, on quarterly and annul basis. The FSC publishes a bulletin about the conditions for the supplementary pension insurance in Bulgaria. The FSC does not produce any research but some statistics can be found on the FSC website www.fsc.bg. 3.
Entry requirements
The pension insurance companies are a joint-stock company licensed by the order of CSI3 and registered according to the Commercial Law. In order to obtain registration as a joint-stock company, the pension company is required to have as main activity only additional pension insurance. The minimum required capital for a pension insurance company is 5 million lv. at the moment when the license is issued. This capital requirement comprises the composite and structure of the equity capital (capital base) of the pension insurance company and to the minimum liquid funds of the company and the supplementary pension funds under its administration4. CSI establishes specific requirements for the members of the managing and control bodies and the actuary (Issued termless license from FSC5), Art.121e. These requirements apply to their education and professional background. In accordance to IMF’s country report (No. 02/188, august 2002)6 concerning Pension Funds “The legislation does not establish an adequate fit and proper test for shareholders, members of the board of directors or investment managers.”. Part of the problems has been solved by new Code of Social Insurance (2003) art.121e “Requirements to Members of Managing and Controlling Bodies”. The problem is that there is not Professional Standards according to work of: actuaries, financial managers, and pension management in general. With regards to auditing and actuarial practices and the suitable entities carrying out these operations, Bulgaria still has not developed NGOs that can establish good practices in financial governance. In order to carry out its activity on additional pension insurance, the jointstock company must obtain a pension licence from the Commission. The pension licence shall give the right to carry out activity on additional pension insurance upon obtaining a permit for managing a fund for additional pension insurance by the deputy chairman of the Commission. The permit shall be issued for each fund individually.7 The issued pension licence shall be termless. Art. 122f of CSI sets the circumstances when an issued pension licence issued to a pension insurance company8 can be withdrawn, which are the following:
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Does not begin the activity for which it has been licensed within 6 months from obtaining the licence;
Carries out another trade activity, except the one directly related to the additional pension insurance;
Is transformed through separation, incorporation or merger with another pension insurance company;
Is dissolved by a decision of the general assembly of the stockholders;
Is insolvent;
Has withdrawn permits for management of all funds established by it for additional pension insurance;
Has presented documents which have served as grounds for issuance of the licence, containing untrue data.
In addition to the cases mentioned above, the deputy chairman of the commission may extend a proposal for withdrawal of the issued pension licence when the pension insurance company9:
Violates the requirements for the members of the managing and control bodies and requirements for the stock-holders;
obstructs the supervision and/or does not fulfil the imposed compulsory administrative measures;
Does not fulfil its obligations to the insured persons in the funds managed by it and commits systematic violations of not submitting required information;
Does not observe the voluntary principle in choosing a fund for additional pension insurance;
Concludes transactions affecting the financial stability of the managed funds for additional pension insurance, thus threatening the interests of the insured persons;
Systematically violates the provisions of this code and the acts for its implementation.
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4.
On-going Supervision
Information sources and monitoring The “Reporting to supervisors and off-site monitoring” is governed by Chapter fifteen “Accounting and Reporting” of CSI. The reports, required from FSC, are standardized and submitted regularly - every month, information about pension companies and funds activities. The Bulgarian Supervision Commission with the assistance of the USAID-Labour Market Project developed a methodology for off-site control10 (October 2000) and regulatory ratios that should be observed on a regular basis. There are two types of indicators: control indicators – required quantity by law, and pointer indicators – that characterize financial condition and possible future situation of companies. “Pension Insurance Companies and Pension Funds Supervisory Ratios and Tests on Quantitative Risks” is a ratio based methodology. Information is gathered monthly, quarterly and on a yearly basis both electronically, and on paper. The Pension department prepares reports to the members of the commission for each fund and company. Concerning investment risk and rules for using derivatives to hedge the risk, the regulations are very simple. Pension funds can use derivatives of securities, like for example put options of indexes and bonds, traded on regulated security markets only for the purposes of reducing the investment risk. Currently the Bulgarian capital market doesn’t trade derivatives, and pension funds do not use them in theirs portfolios. The Investment portfolio structure is defined by law and there are strong requirements relating to investment limits, CSI art. 251. By law CSI, art 120b, the supervisory authority has wide-ranging powers for conducting on-site inspections and gathering information deemed necessary for the performance of its duties. Also, according to section five of CSI “Transformation, Termination and Bankruptcy of Supplementary Social Insurance Companies and Funds”, the Commission has available, and makes use of adequate instruments to enable timely preventive and corrective measures. There are special rules about Procedures of Issuance of Permit for Transformation. Part of FSC’s functions is preventive. New lines of business, licensing of products, and all corrections in contract and policy should be pre approved by the Commission. The Commission has the power to take the following actions, should any serious problems arise with the entities it supervises:
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to adopt the Rules guidelines for its activities, regulations and instructions, give written guidelines, to issue or refuse issuance of the respective permits (licenses), permit or refuse permission, for a merger, take-over, spin-off, or split;
to initiate bankruptcy proceedings for the supervised person; appoint conservators;
to issue written orders for the dismissal of one or more persons authorised to manage and represent the supervised person; make decisions on concluding co-operation and information exchange agreements with the Bulgarian National Bank or other domestic and overseas authorities exercising supervisory functions over financial market operations.
An important part of the FSC’s information policy is the regular meetings and discussions with the managers of the funds on key business issues. One of the FSC’s priorities is the enhancement of the financial awareness of the general public. In this relation the Commission has initiated various events, targeted at deepening the interest and the knowledge of different public groups in respect to the financial markets. Intervention – On-site Inspections Examination is a basic form of current control using by FSC, there are two types of examinations:
Depending on scope – full, regular, and partial; and
Depending on frequency – planned and extraordinary.
Investigation and findings, data analysis, assessment and compliance with the laws are major ways for company’s observation. Periodic financial and accounting reports are used for defining the controlled level indexes and some main ratios and tests for the pension companies and funds. Pension companies have to report the following information: compliance with capital adequacy requirements, general reserves and liquidity; investment of company’s own assets; calculated investment returns; fees and deductions; pension reserves for each pension fund; profitability of capital; income/expenses per insured person; income/expenses for company operation; PIC operation expenses/pension fund assets.
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Pension funds have to report: controlled level indexes, ratios and test, structure and return of the investment portfolio; liquidity of voluntary pension fund assets; obligations of the pension fund; distribution of return; prompt investment of contributions; investment expenses. For each on-site inspection, the division chairman appoints an inspection group. On the base of available information, the group prepares an action plan that includes: examination of available information; reasons for selection and additional information; an examination plan and issues an examination orders. During the examination process, the group: reviews documentation; discusses with the PIC; reports on the results of the examination by drafting a protocol of findings; imposes administrative and penal proceedings as mandated by FSC. In the period March – June, 2003 the FSC’s supervisory activity in the field of the social insurance supervision, over the operation of the pension insurance companies and the pension funds managed by them, supplementary pension insurance, is fulfilled through an off-site control and on-site inspections. The non-licensed commercial companies are also object of the control activity - voluntary pension insurance, subject to termination by liquidation under the procedure of § 5 of the Transitional and Final Provisions of the Supplementary Voluntary Pension Insurance Act (SVPIA). During the reviewed period, 3 inspections were conducted and a fourth full inspection that started simultaneously in two companies will be completed next quarter. Three coercive administrative measures were imposed by which 12 mandatory instructions, 15 acts of administrative violations have been drawn up and 10 penal warrants have been issued. With reference to the complaints, claims and signals received in the FSC, inspections against documents have been carried out. In some cases, additional information has been required from the complainants or written explanations by the pension insurance companies. In other cases, the supervisor carried out on-site inspections in the companies targeted by the complaints. The custodian bank, at the end of each working day, sends to the deputy Chairperson of the Commission information concerning the cash received, the transactions conducted, and the value of the assets of the supplementary pension fund. The custodian bank informs, in due time, the deputy Chairperson of the Commission of any established violation of the CSI by of the pension company11. 5.
Compliance enforcement and sanctions
As mentioned above, the Commission is a very powerful12 regulator and some of the commission’s decisions are not subject to appeal through court. The 318
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Commission has the authority to apply unmilitary sanctions without negotiation with pension companies with corrective, remedial, punitive goals. The deputy chairman, supervision”, has the right to13:
managing
department
“Public
insurance
give, refuse, or withdraw permits for managing a fund for additional social insurance;
issue permissions in the cases, provided in the normative acts for additional social insurance;
approve changes and supplements in the regulations of the funds for additional social insurance and issue other documents;
approve methodical guides, contracts, lists, models and other documents, related to the activity for additional social insurance;
determine the kind, the form and the content of the accounts, which are presented to the commission by the companies for additional social insurance; exchange information;
organize the operational control for lawful exercising of the activity for additional social insurance;
order together with the Bulgarian National Bank the implementing of checks of the banks about their activity as bank-trustees;
determine the officials, who are to be present at the sessions of the management bodies of the companies for additional social insurance in the cases, provided in the normative acts for additional social insurance;
determine the officials, who have the right to compile acts for established breaches of the normative acts for additional social insurance;
apply the compulsory administrative measures, stipulated by the Code of social insurance;
issue punitive decrees for imposing of fines and proprietary sanctions in the cases, provided in the normative acts for additional social insurance;
exercise supervision over the companies for additional social insurance in a proceedings on transformation, liquidation or insolvency;
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6.
notify the prosecutor’s office at the existence of grounded doubt about implemented crime;
organise and manage the activity of department “Public insurance supervision”;
Take decisions on other issues, connected with the activity for additional social insurance, which are not within the explicit competence of the commission. Conclusions
There is not yet a fully functioning information system for conducting effective off-site monitoring that can identify potential problems. Generally speaking more efforts should be put into developing a good methodology and information system likes Insurance Regulatory Information System (IRIS) and Financial Analysis Solvency Tools (FAST) used by National Association of Insurance Commissioners (NAIC) as a system for testing, early detection and prompting corrective action to pension insurance companies. The Bulgarian legislation, concerning pension funds, still does not have very clear rules about risk management of pension funds. There are lots of rules regarding investment limits, reserves, internal control etc. (see CSI) but, generally speaking, the risk management monitors and control system are not clearly recognized as an aggregate system. FSC doesn’t require using stress testing methods for recognizing eventual risks in company’s activities. Concerning derivatives, legislation is still inexistent, probably because Bulgarian capital market doesn’t trade derivatives, and pension funds do not use them in their portfolios.
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NOTES 1
Bulgarian National Social Security Institute
2
Bulgarian National Social Security Institute.
3
Code of Social Insurance (title amend., sg 67/29 Jull 2003)
4
5(*8/$7,21 RI1RYHPEHUWK
5
REGULATION for issuing license to actuary of pension insurance company
6
International Monetary Fund http://www.imf.org/external/pubs/ft/scr/2002/cr02188.pdf
7
Art. 122., Pension licence (amend., SG 67/03)
8
Art. 122f. (new, SG 67/03) (1)
9
Art. 122f. (new, SG 67/03) (2)
10
Bulgaria - Examination Manual.doc
11
Custodian Bank Art.123a. (new – SG 67/2003)
12
Authorities of the commission LKFN Art. 13. (1)
13
Authorities of the deputy chairman, managing department “Public insurance supervision” LKFN, Art. 17.
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REFERENCES:
Republic of Bulgaria, title amends. SG/67 of 2003, Social Insurance Code, http://www.fsc.bg/. International Association of Insurance Supervisors, October 2003, Insurance core principles and methodology, http://www.iaisweb.org. International Monetary Fund, August 2002, Financial System Stability Paper on Bulgaria, http://www.imf.org/external/pubs/ft/scr/2002/cr02188.pdf Swiss Re, 2001, Sigma #1, http://www.swissre.com USAID Labor Market Project – Bulgaria, March 2004, Manual for on-site examination of pension insurance companies and pension funds, http://pension.bg/pension1/en. European Commission, Combating money laundering, BG/IB/2001-JH-03, http://europa.eu.int/comm/enlargement/pas/phare/programmes/national/b ulgaria/2001/bg0103-07-money%20laundering.pdf Republic of Bulgaria, Law on Measures against Money Laundering (LMML) (State Gazette issue 85 of 24 July 1998, amended State Gazette issue 1 of 2 January 2001).
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XIII. SUPERVISION OF PRIVATELY MANAGED, DEFINED CONTRIBUTION PENSION SCHEMES IN HONG KONG by Hong Kong Mandatory Provident Fund Authority (MPFA)
Overview of the private pension system System, scheme organization and history Funded pension provision in Hong Kong is done through two main venues: a voluntary system of privately managed funds and a mandatory system comprised of privately managed, provident funds – the Mandatory Provident Fund System (MPF). Hong Kong has a long history of private arrangements for retirement savings. Such schemes date back to 1919 when the first scheme was established. Gadbury et all note that these schemes have functioned virtually unregulated until 1993, when the Occupational Retirement Schemes Ordinance (ORSO) came into force. The only restriction present in the system was a ceiling of 15% on the contribution levels and taxation of benefits that exceeded a certain amount. The Occupational Retirement Scheme Ordinance defined and regulated retirement funds, requiring such entities to be established either under trust or in an approved insurance policy. According to this law, every employer that provides a retirement scheme must register with the government and undergo professional certification, including annual audits. In 1999 there were 19,000 ORSO schemes covering more than 900,000 employees. In 1995, the Mandatory Provident Fund Schemes Ordinance was approved and in 2000, the Mandatory Provident Fund (MPF) system was introduced. Mandatory provident fund schemes are defined contribution savings schemes that provide a lump sum at retirement. In this system, employers must enroll eligible employees in, and self-employed persons must join, a mandatory
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provident fund scheme. Employers may choose among three types of schemes and make arrangements for employees to become a member of the scheme chosen, whereas the self-employed may join a master trust scheme or, if eligible, an industry scheme. Both employers and employees can contribute 5% of the employee’s salary up to the limit of HKD 20,000 per month. In addition, employees, employers and self-employed persons may make additional voluntary contributions to the mandatory provident fund scheme. As mentioned before, there are three types of schemes that employers can choose to provide a framework for retirement savings. Employer-sponsored schemes: Occupational mandatory provident fund scheme sponsored by a single employer and its associated companies. Membership this type of fund is restricted to the employees of this employer and of its associate companies. Industry Schemes: Industry-wide mandatory provident fund scheme established for employees in industries with high labor mobility. At present, industry schemes exist for the catering and construction industries. These schemes are only open to employers and self-employed persons active in the respective industries. Accrued pension rights are fully portable within the industry. Employers in the respective industries may choose to enroll their employees in the industry scheme, but are not obliged to do so. Master trust schemes: membership to master trust schemes is open to employees of more than one employer, self-employed persons and persons with accrued benefits transferred from other schemes. By pooling the contributions of small employer units together for administration and investment, such master trust schemes may have a high degree of efficiency resulting from economies of scale and are thus especially suitable for small and medium sized companies. A central organizational feature of the MPF’a in Hong Kong is the fact that all schemes operate with an approved trustee. A very similar structure can be observed in the Australian system of retirement income provision. The legislation and regulation as a whole hinges on the role and the involvement of trustees in the operation of the pension funds. Many of the responsibilities of compliance; prudential management and monitoring are the responsibility of the trustees.
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General information about the financial system and culture Hong Kong has a well developed financial system, with a large number of specialized participants and a comprehensive monetary and financial regulatory systems. As Jeremy Gadbury et all note, the these systems started to be implemented in the 1960’s, providing support for the rapid economic growth that occurred in the past four decades. The entire organization of the financial system relies very heavily on the institution of the trustee and many transactions are conducted in the absence of strict regulation, by virtue of the market forces. The role of the government in supervising financial markets is relatively small, limited to a basic legal framework that provides the basis for prudent conduct. Gadbury et all note that legal authority for regulating and supervising the financial and monetary sector in Hong Kong comes form three main sources: laws and ordinances enacted by the legislature; rules and guidelines formulated by financial institutions themselves; and rules, codes of conduct and detailed regulations issued by the regulatory bodies. In Hong Kong, social security is provided mainly through market-based instruments, supplemented by basic “safety net” arrangements that are financed through general tax revenue. Like in many other developed countries, Hong Kong has a population that is aging rapidly, putting all the instruments of social security provision under stress, but especially those that are non-contributory and financed from the general state budget. Until 2000 though, coverage of the market-based retirement income provision instruments was fairly limited. The introduction of the Mandatory Provident Fund scheme has been an important step towards addressing the challenge of the population ageing phenomena and putting social security on financially sound and sustainable basis. The functional organization of the funded component of the retirement system in Hong Kong follows very closely the Australian approach. More specifically, there is a great deal of emphasis put on governance mechanisms and reliance on the institution of the trustee for ensuring adequate prudential behavior. Market Size and Concentration At present, there is no accurate account of the market share of MPF providers. The general view though is that there are many market participants
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and that, as the schemes mature, this number will go down significantly following a process of consolidation that will lead to higher concentration levels in the market. From the market share estimates made by Watson Wyatt Hong Kong Limited, we can infer that almost 60% of the MPF market share is shared among three sponsors that offer all together 10 pension schemes.
Figure 1: Basic Statistics on the Mandatory Provident Retirement System in Hong Kong MPF COMPLIANCE RATE Employers Employees Self-employed Persons
97% 96% 80.3%
APPROVED TRUSTEES
19
MPF SCHEMES Master Trust Schemes Industry Schemes Employee Sponsored Schemes
48 44 2 2
APPROVED CONSTITUTENT FUNDS
321
By Fund Type Balanced Fund Equity Fund Capital Preservation Fund Guaranteed Fund Bond Fund Money Market Fund
134 73 48 37 19 10
By Sponsoring Scheme Master Trust Schemes Industry Schemes Employer Sponsored Schemes
299 12 10
APPROVED POOLED INVESTMENT FUNDS
253
REGISTERED MPF INTERMEDIARIES Corporate Individual
24,663 253 24,231
Source: MPFA at: http://www.mpfahk.org/main.asp?nodeID=66&langNo=1
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Apart from the sponsors themselves, there is al large number of intermediaries, who are certified professionals registered with the MPFA. The role fulfilled by intermediaries is to sell MPF schemes and to advise the participants or the scheme managers. The number of registered MPF intermediaries, as disclosed by the MPFA was 24,663, out of which 25,765 are individual intermediaries and 253 corporate intermediaries1. The number of intermediaries providing services for the MPF is quite large, considering the fact that the number of schemes is close to 49. Their activity is supervised jointly by the Securities and Futures Commission; the Insurance Authority and the Hong Kong Monetary Authority, as a result of an official understanding with the MPFA. The MPF intermediaries are not only subject to registration requirements and compliance with rules set forth by the four institutions that are responsible for supervision, they are also required to go through specialized training in their area of expertise. Coverage With the implementation of MPF on 1 December 2000, complemented by personal savings and the Comprehensive Social Security Assistance (CSSA) Scheme operated by the Government, Hong Kong now has in place all the three pillars for old-age protection. Before the implementation of the MPF System, only about one-third of the workforce of 3.4 million people had some form of retirement protection. Now, 85 per cent of the working population are under retirement protection, regardless weather it is mandatory or voluntary. The chart below shows coverage distribution among the different types of retirement schemes, for eligible working population. Tax Treatment The different types of recognized occupational retirement schemes and MPF schemes are collectively treated in the tax legislation as “ recognized retirement schemes”.
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Figure 2: Coverage of Employed Population by Type of Retirement Scheme Estimated Population by Type of Retirement Scheme (as of 31 Dec.2003)
Joined MPF Scheme 63%
11%
4%
Joined Other Retirement Scheme 22% Not required to join any Local Retirement Scheme 11%
22% 63%
Should join but have not yet joined any MPF Scheme 4%
Source: The Mandatory Provident Fund Authority – www.mpfahk.org
Contributions: made by the employer to a recognized retirement scheme are deductible expenses, as long as they do not exceed 15% of an employee’s emoluments for the period for which they are made. The contributions paid by the employees used to benefit from no tax relief, prior to the introduction of the MPF in 2000. All contributions were made out of after-tax income. The mandatory contribution of an employee to the MPF are deductible against salary tax up to a yearly amount of HK$12,000. This cap is used for aggregated employee contributions to MPF and the voluntary retirement schemes. Gadbury et all note that, since contributions are deductible against salary taxes and there are relatively few people who pay these taxes, the value of the tax deduction for retirement savings is very small. Benefits: Pension benefits are generally tax-free when they are received upon termination of employment, at retirement age or at termination in the following circumstances: termination occurs after 10 years of service or more; the employee has reached the specified retirement age in the scheme, which must be at least 45; termination occurs by reason of death or incapacity.
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If pension benefits are accessed while the contributor/beneficiary is still employed, they are subject to the general salary tax. This rule does not apply after the employee turns 60. After this age pension benefits received by employees are no longer subject to tax, under the current regulations. When the employee reaches the age of 60, he or she is deemed to have retired from employment for tax purposes, although he or she may still actually be in employment with the same employer. In such a situation, the benefits received will be tax free. There are no public guarantees for either the MPF or the voluntary pension schemes. The table below summarizes the tax regime of the different types of schemes, for each potential participant and/or beneficiary. Figure 3 Taxation of ORSO and MPF schemes summarized Employee Mandatory Contributions
Allowable deduction up to HK$12000 a year
Voluntary Contributions
Not allowable
Scheme Level
Free of Honk Kong taxes
Benefits from mandatory MPF contributions Benefits from ORSO and voluntary MPF contributions if received on termination of employment
Free of Tax
Employer’s balances: taxable on less than ten years of service, unless received on retirement, death or incapacity, in which case will be tax free. Own balances: free of tax
Self-Employed
Employer
Allowable deduction up to HK$12,000 a year Not Allowable
Allowable deduction up to 15% of emoluments
Free of Tax
Not applicable
Repayments subject to profits tax Free of tax
Source: Jeremy Gadbury, Alan Taylor, Jonathan Watkin, Pensions and retirement funds in Hong Kong, 2003
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Member Protection There are no explicit public guarantees for either the MPF or the voluntary pension schemes. Members are protected against losses in accrued benefits due to misconduct or fraud of fund administrators and trustees by the MPF compensation fund. This fund was basically established by the government with an initial subsidy of HK$600 million and is maintained with a levy of .03% of the value of assets of the schemes. Summary of Supervisory Practices in Hong Kong Hong Kong has a three pillar pension system: a publicly managed, taxfinanced social safety net; a mandatory, privately managed, fully funded provident scheme (MPF) and a voluntary personal savings and insurance pillar. Within the mandatory provident scheme, plans can be set up as a master-trust2, governing multiple companies, an industry scheme for an entire sector or as an employer-sponsored scheme. The supervisory authority in Hong Kong is the Mandatory Provident Fund Authority (MPFA), established in 1998. All schemes are funded in individual accounts and must be set up under trust, with trustees approved by the Mandatory Provident Fund Authority. The number of privately managed schemes in Hong Kong is much smaller than in other countries with pension regulation based on Trust Law and the number of mandatory reporting requirements and adequacy criteria is higher, but the market can still be described as an open one. There are no formal licensing procedures apart form the approval of trustees and financial intermediaries, but the MPFA monitors and validates compliance with capital adequacy requirements that are in place. MPFA monitoring function is moderately intense3. Although the volume of information reported to the supervisor is fairly high, the trustees and auditors serve as an intermediary layer for monitoring this information. Master trusts, industry schemes and employer-sponsored schemes have to submit annually: trustee returns containing mainly financial information; a statement with policy information and a report on internal controls that includes assessments from independent auditors regarding general performance as well as compliance with capital requirements regulations. Trustees must also publish annually a consolidated report that is submitted to the MPFA and is accessible to any member upon request. Communication to members is generally the responsibility
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of the trustees. The supervisor ensures transparency by making available daily information about trustees and correction activities on its web-site. Apart form these traditional sources of information MPFA also relies on whistle-blowers that are usually auditors that must report to the supervisor whenever they come across an event of non-compliance. With regard to measurement and analysis, it is only very little that is done by the supervisor. This activity falls under the responsibility of the trustees and auditors. Investigations and other types on intervention occur whenever the supervisor believes there has been non-compliance. MPFA suspends or withdraws approval for trustees when the assessed non-compliance exceeds a certain limit. The supervisor can also initiate and supervise the procedure of scheme wind-up whenever a pension scheme has been unable to fulfil its responsibilities towards members. These facts describing intervention and supervision, combined with their frequency suggests a re-active approach that appears to be typical for systems where pension funds are established under trust. The activities of the Mandatory Provident Fund Authority in Hong Kong resemble very much those carried out by Australian Prudential and Regulatory Authority in Australia, with the exception of the monitoring activity. The MPFA monitors more information in a more pro-active way than its Australian counterpart. Organization and scope of authority of the Supervisory Agency: The Institution in charge of private pension supervision in Hong Kong is the Mandatory Provident Fund Schemes Authority (MPFA). The MPFA is a specialized institution that was established in 1998. The mission of the Mandatory Provident Fund Schemes Authority (MPFA) is to ensure the provision of retirement protection for Hong Kong’s workforce through an effective and efficient system of prudential regulation and supervision of privately managed provident fund schemes under the MPF system. Some of the most important responsibilities of the MPFA as a supervisor and regulator are: to ensure compliance with relevant legislation; register the MPF schemes; approve qualified persons as trustees, regulate the affairs and activities of approved trustees and ensure that they administer the registered schemes in a prudent manner.
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The MPFA fulfills its mandate by operating in close collaboration and interaction with other financial market supervisors and regulators that are in charge of maintaining compliance in adjacent sectors of the financial market. The Mandatory Provident Fund Schemes Authority is an independent agency. The MPFA is the lead regulator in this field, although it shares regulatory responsibilities with the other regulatory institutions in the financial market. In the exercise of supervision and regulation of provident schemes and their adjacent intermediaries, the MPFA collaborates closely with The Office of the Commissioner of Insurance; The Hong Kong Monetary Authority; and the Hong Kong Securities and Futures Commission. Office of the Commissioner of Insurance – Ensures that the insurance companies involved in the MPF business comply with the capital requirements and that they are properly operated. Approves and regulates the activities of financial intermediaries who conduct their primary business in the insurance field. The Hong Kong Monetary Authority (HKMA)– established in 1993performs the functions of a central bank and banking sector supervisor. It regulates all the banks that are involved in the MPF process as custodians, trustees or intermediaries. Hong Kong Securities and Futures Commission(CFC) – oversees the futures and securities market as an independent organization, separated form the governmental apparatus. The role of the SFC in the context of the mandatory provident funds is to: authorize certain MPF schemes; license certain service providers, like investment managers and custodians who engage in securities lending. The role of this institution is significant, given that the size Hong Kong securities and futures market is the second in Asia, after Japan. In terms of organizational structure, the MPFA is overseen by a board of directors and receives advice from a committee of scheme representatives and other various groups for the regulatory work it undertakes. Entry requirements and administration: In the MPF system there are several types of trustees, but the most common ones are the local corporate trustees and the individual trustees. Individual trustees operate in this capacity only for the employer-sponsored MPF schemes.
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The MPFA has the responsibility to approve both the individual and the corporate trustees. Since the trustees have such a crucial role in the governance of the retirement income provision system, the criteria they have to meet in order to obtain approval from MPFA are stringent, with specific limits and rules for capital adequacy, financial soundness, and internal control mechanisms. Capital adequacy requirements for individual trustees are paid-up share capital and net assets of at least HK$1501 mil or HK$30 million contingent on continuous financial support from a well-established financial institution. The equivalent capital adequacy requirement for the individual trustees is to have an insurance policy or a bank guarantee against potential losses caused by improper conduct, that covers approximately 10% of the value of the assets in the scheme. This requirement, together with the multiple sanctions that could affect trustees if they fail to meet their responsibilities are very powerful deterrents to conduct that could jeopardize the interests of the scheme members. In addition to prudent behavior, trustees have to submit regular returns, financial statements and internal control reports to the MPFA and they are required to act as “whistleblowers” and report instances of non-compliance of auditors, funds managers, etc. The main responsibilities of the trustees are: comply with the governing rules; exercise the care, skill, diligence and prudence to be reasonably expected of a person who is administering provident fund schemes; act in the interests of schemes members and not in the trustees’ interests; ensure that the funds of the scheme members are invested in different investments so as to minimize the risk of losses of those funds. manage the contribution and benefit administration themselves; appoint a custodian to hold the scheme assets (an approved trustee may be custodian under specific circumstances); establish a separate individual account for each scheme member;
1
Source: Gadbury et all
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ensure that each member’s account is kept in such a manner that the market value of the accrued benefits of a member can be ascertained at least once a month. Trustees can obtain approval to operate form MPFA contingent upon their permanent residence in Hong Kong and proof of good conduct without incidents involving fraud or dishonesty. A registered trust company incorporated in Hong Kong which applies for approval as trustee must: comply with the prescribed capital adequacy requirements; have at least five directors of which all must be individuals; have sufficient presence and control in Hong Kong; satisfy the MPFA that it is capable of carrying out the business of administering registered schemes for which purpose the MPFA may enter and inspect premises intended to be used by the company carrying out the business of administering registered schemes; not do any other business than trust business; satisfy the MPFA that all of the controllers of the company are persons of good reputation and character and, in particular, .. satisfy the MPFA that the chief executive officer and a majority of directors of the company have the skill, knowledge and experience that are necessary for the successful administration of provident fund schemes. The licensing and approval procedure for trustees, financial intermediaries and other relevant entities is done jointly with the other three regulatory and supervisory agencies: The Hong Kong Monetary Authority; The Office of the Commissioner of Insurance and The Securities an Futures Commission. On-going Supervision: Monitoring The MPFA works toward the goal of protecting member’s interests and securing their welfare in retirement by setting up mechanisms of monitoring the activity of the relevant parties that are efficient, given the functional structure of the schemes.
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The stringent criteria on capital adequacy, financial soundness, fitness and propriety as well as the internal control standards required for trustees are the first mechanisms used by MPFA in the monitoring activity. Since trustees play such an important role in the system of private pension provision in Hong Kong, they are the primary target for the regular monitoring activity undertaken by the supervisor. Fund Managers and other service providers fall under the responsibility of the trustees. Trustees monitor their compliance with the requirements, standards and guidelines of MPF. Trustees are required to submit returns, financial statements and internal control reports on a regular basis. The MPFA also conducts field inspections to ensure trustees comply with requirements and enable early detection of deficiencies. In cases where there is suspected non-compliance with the requirements, the MPFA conducts detailed investigations to establish the caused and restore compliance. In instances of minor non-compliance, MPFA can issue warnings, order the trustee to take remedial action or even impose financial penalties. In serious cases, the MPFA can ask the trustee to conduct a special audit and investigation. The MPFA has the power to suspend the trustee form administration of a MPF scheme, or even revoke its approval or take prosecution action in a court of law for serious non-compliance.
Application of Sanctions and Compliance Enforcement Depending on the circumstances of each case, the MPFA takes different enforcement measures in the handling of complaints. Factors to be considered include whether the interests of scheme members have been protected, and whether the enforcement measures have an adequate deterrent effect.
Since trustees play such an important role in the administration of the pension schemes in Hong Kong, most of the sanctions and penalties that the MPFA applies are directed towards them. Sanctions that can be imposed on trustees for minor penalties include reminders, written warnings to take remedial actions, surcharge notices, pursuance of claims on behalf of the members or fines. The penalties for more serious problems include revocation of approval; mandatory audits; substantial fines, or even prosecution in a court of law. The MPFA conducts investigations into all complaints received. Complainants’ identities and information provided are kept confidential. The MPFA notifies complainants of the results upon completion of the investigations. Employees are encouraged to report to the MPFA as early as practicable when suspecting that their MPF rights are infringed upon. Apart
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from acting on complaints, the MPFA also conducts proactive on-site inspections. Legal actions will be taken against those non-compliant employers to protect the interests of scheme members. From this perspective, MPFA assumes an active role in protecting the interests of members. The scope of the authority of MPFA of applying sanctions is primarily remedial, with instruments of correction applied when rights or interests of members have were affected.
NOTES
1
Data source: Jeremy Gadbury, Alan Taylor, Jonathan Watkin, Pensions and Retirement Funds in Hong Kong, 2003
2
In Hong Kong there are 299 schemes approved as Master Trust Schemes, 12 Industry Schemes and 10 employer sponsored schemes in the Mandatory Provident Fund pillar out of 48 existing in 2004.
3
Trustees have to submit annual balance sheets, profit and loss accounts, auditor’s reports and director’s report. They also have to submit an annual statement of any changes of significance in the performance of service providers or changes in the investment policy.
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