Pension Funds and Insurance Companies: Challenges and Lessons

1
Pension Funds and Insurance CompaniesChallenges
and Lessons

• Dimitri Vittas
• Senior Adviser
• World Bank
• December 2003

2
Pension Funds and Insurance Companies

• NBFIs are a mixed bag of institutions.
• Pension funds and insurance companies are the
  most important
• in terms of mobilization of long-term resources
• potential impact on capital market development
• acting as countervailing force to commercial
  banks.
• They can help finance factoring and leasing
  companies and also promote housing finance and
  equity and debt market development.

3
Development and Regulatory Challenges

• They take a long time to develop.
• Magic of contractual saving and interest
  compounding.
• They start slow but they build large assets over
  time.
• Their success depends on stable macroeconomic
  policies, low inflation, fiscal balance.
• They require prudent management and the offer of
  affordable benefits.
• They require stable banking system, robust
  regulatory framework and effective supervision.

4
Private versus Public Management

• Public sector ownership has caused poor
  performance in many developing countries.
• Pervasive controls on insurance companies,
  covering premiums, investments, benefits, and
  reinsurance, have impeded the emergence of
  strong, efficient and well capitalized companies.
• Public management of the assets of pension and
  provident funds, including social security
  institutions, has produced highly negative real
  returns.
• Use of contractual savings as a captive source of
  funding large government deficits.

5
Reform Agenda in Africa

• Downsize public pillar.
• Improve assets management of public pension funds
  by building strong fund governance.
• Appoint executive board of trustees with clear
  mandate and safeguards against political
  interference.
• Create room for private pension funds and promote
  private sector presence in insurance sector.
• Eliminate captivity of contractual savings,
  encourage modern efficient assets management, and
  allow investment overseas.
• Build robust regulatory and supervisory capacity.

6
Build Efficient Institutions

• The key to the success of the reform agenda is
  the building of efficient institutions.
• Pension systems and insurance business are highly
  complex. They cover long-term contracts and are
  faced with considerable risk and uncertainty.
  They need to be based on public trust.
• Building efficient institutions that are able to
  adapt and respond to emerging new challenges is
  very important.
• Mauritius offers a very good example of the
  dynamic and durable benefits of building
  efficient institutions in both pensions and
  insurance.

7
Mauritius Pension System

• Multi-pillar structure. Both public and private.
• Basic Retirement Pensions.
• National Pension Funds.
• National Saving Funds.
• Occupational Pension Funds.
• Life Insurance Companies.
• Housing Assets.
• The system is generally well developed and
  managed.

8
Large Contractual Savings

• Large accumulation of financial assets.
• NPF 17 of GDP.
• NSF 2.
• Insurance companies 18.
• Occupational pension funds 11.
• Total 48 of GDP. However, double counting of
  7.
• Net assets 54 billion MUR or 41 of GDP.
• Large potential impact on financial sector
  development, economic growth and security of
  long-term benefits.

9
Basic Retirement Pension

• Offers 20 of average wage to all elderly (more
  to the very old).
• Current cost is low at 3 of GDP, but on
  unchanged policies likely to grow in the future
  and reach 6 in 2020 and 11 in 2050.
• Need to contain its future costs because of
  aging.
• Gradually raise retirement age.
• Offer means-tested benefits, either affluence
  test (exclude those above specified level) or
  subsistence test (include only those below) or a
  combination of tests with gradual claw backs.

10
National Pensions Fund

• Well run system high coverage (60) low
  contribution rate (9) low operating costs (39
  bp) high returns (11.72) in 2001.
• But based on opaque points system.
• And failure to attain promised replacement rate
  of 33.3.
• Possible move to NDC scheme.
• Appoint independent Board of Trustees and
  encourage professional assets management.

11
Occupational Pension Funds

• Several types and many schemes. Total coverage
  between 80,000 and 100,000 employees.
• Schemes for civil servants and employees of local
  government.
• Over 100 schemes for employees of statutory
  bodies.
• Over 1000 schemes for employees of private sector
  firms.
• Need to reform civil service schemes but private
  funds well managed.

12
Performance of Occupational Pension Funds

• Good overall performance with some exceptions.
• Generous benefits raising questions about
  long-term affordability.
• High assets diversification but underweight in
  government bonds and corporate debentures.
  Illiquid investments in equities and real
  estates. Large role in housing loans to members.
• Low costs and high returns.

13
Regulation and Supervision of OPFs

• Reasonable rules on vesting and portability.
• Compliance of sponsors with actuarial and
  accounting standards, especially MAS 25 (IAS 19).
• Though no requirement to hire qualified auditors
  and publish audited accounts.
• Fragmented regulatory framework.
• Lack of supervision and transparency.

14
Need for New Regulatory Framework

• Consolidate legal framework into new, modern act.
• Emphasize
• fund governance
• appropriate funding levels
• rules on vesting and portability
• assets segregation and safe custody
• assets diversification (with limits on
  self-investment)
• market valuations
• actuarial, accounting and auditing standards and
• whistle blowing duties.

15
Need for Effective Supervision

• Strengthen supervision under FSC.
• Improve transparency, require quarterly financial
  reporting in electronic form.
• Protect workers rights.
• Reform NPF. Bring under FSC.
• Provide choice to employers and employees.

16
Development of Insurance Sector

• Free from pervasive premiums, products ,
  investments reinsurance controls.
• Reliance on solvency monitoring.
• Use of international accounting actuarial
  standards.
• General insurance makes good use of reinsurance.
• Motor insurance largest branch in general
  business.
• Reasonable loss ratios and claims settlement.
• Life insurance is well developed, benefiting from
  tax incentives as well as pension funds and
  housing finance.

17
Investments of Insurance Companies

• Diversified portfolio.
• Underweight in government bonds but strong
  presence in housing loans and corporate bonds and
  equities.
• Strong demand for long duration assets to cope
  with reinvestment risk.
• Limited investments overseas despite high ceiling.

18
Insurance Regulation and Supervision

• Marked improvement in recent years.
• Need for greater emphasis on risk-based
  supervision and risk management.
• Most companies are well managed but some small
  companies appear weak with low earnings, high
  costs and slow claims processing.
• Need to develop early warning systems and
  regulatory ladders to take early action against
  weak companies.
• Growing reliance on actuaries and auditors to
  identify problems.

19
Main Lessons for Africa

• Development of strong contractual savings sector
  is feasible in a small economy.
• Need for economic and political stability.
• Respect of property rights.
• Good mix of public and private provisions.
• Robust regulatory framework and effective
  supervision.
• Focus on building efficient institutions that are
  able to respond to emerging challenges in a
  dynamic environment.

20
Implications for Capital Markets

• Develop long-term government bonds.
• Avoid roll over risk and offer long duration
  assets to institutional investors.
• Promote transparency of securities markets and
  efficient trading, clearing and settlement
  facilities.
• Support financing of housing through direct
  loans, mortgage bonds or mortgage securitization.
• Develop professional expertise in accounting and
  auditing, actuarial science, assets management
  and other areas.