Managing Public Pension Reserves

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Managing Public Pension Reserves

• Robert Palacios
• World Bank Conference on
• Public Pension Fund Management
• Washington D.C.
• September 24, 2001

2
Structure of presentation

• Managing public pension reserves why is it
  important?
• The failure of public management
• Policy options for reform

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Managing public pension reserves why is it
important?
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Reserves exist in 60 DCs
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Socio-economic impact can be large

• Social welfare and labor market policy
• Sustainability of pension benefit promises
• Need to raise taxes on labor
• Fiscal policy
• Short run increase in public consumption
• Long run intertemporal constraint
• Financial sector development
• Positive vs distortionary impact or nil?

6
Social policy impact - pension levels
7
Fiscal policy impact pension debt
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Financial sector development impact
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The failure of public management
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Abundant indirect evidence

• Deteriorating funding ratios there are no fully
  funded public DB schemes
• Low balances in provident fund accounts
• Likely increase in government consumption due to
  captive credit
• No evidence of positive capital market impact,
  some distortions likely
• Stories of corruption and waste

11
Some direct evidence returns
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Some direct evidence returns(vs bank deposit
rates)
13
Some direct evidence returns(vs income per
capita growth)
14
What lies behind this failure?

• Mandates and restrictions
• Deficit financing by forced purchase government
  debt
• social investments (e.g., housing)
• development projects and ETIs
• support for particular firms or whole market
• prohibition on foreign investments
• Governance
• Tripartite boards have been ineffective
• Political appointees have conflicting objectives
• Lack of accountability and monopoly power
• Lack of transparency

15
Result is poor asset allocation
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Policy options for reform
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Three key areas must be addressed

• Institutional arrangement
• Investment policy
• Governance system
• Country-specific conditions

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Institutional arrangement - options

• Centralized, public managers
• Centralized with private managers chosen by
  independent authority
• Centralized with private managers chosen by
  individual members
• Decentralized with private managers chosen by
  individuals or employers

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Institutional arrangement - options

• Centralized, public management
• Tripartite boards with executive control exerted
  through political appointments
• Monopoly in-house public management
• Bureaucrats with little incentive to take risks
  and no competition
• This traditional approach has widely failed

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Institutional arrangement - options

• Centralized with private managers chosen by
  independent authority with private sector
  expertise
• Relevant country examples include
• The CPP Investment Board
• Irish Reserve Fund
• Norwegian Petroleum Fund
• Untested but promising under the right conditions

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Institutional arrangement - options

• Centralized with some individual choice of
  provider or portfolio or both
• Choice of provider
• Bolivias AFP concession
• Indias recent OASIS proposal
• Choice of portfolio, not provider
• Hong Kongs industry funds
• US Thrift Savings Plan

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Institutional arrangement - options

• Decentralized with private managers chosen by
  individuals or employers
• The most popular structure for new funded pension
  schemes minimizes political risk although not
  eliminated
• Examples include
• Chile and other Latin America
• Hungary, Poland, Sweden and the UK
• Australia and Hong Kong
• Singapores individual opt out

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Investment policy

• Clear statement of objective invest for the
  best interest of the plan, explicitly prohibit
  other criteria
• Some strategies to avoid conflicts of interest
  discretion
• Passive management
• Dont set minimum for government bonds
• Prohibit illiquid investments
• Allow significant foreign investment
• Avoid active corporate governance

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Investment policy

• Transparent rules for evaluating performance of
  asset managers
• Set clear monitoring targets for risk and returns
• Benchmarks Contracts with external managers can
  specify deviation allowed from indices

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Governance

• Trustees with clear competence in related fields,
  no public officials
• Adequate remuneration
• Minimize conflicts of interest
• Transparent selection process with appropriate
  checks and balances
• Appropriate assignment of liability
• Clear mandates and limited discretion

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Governance

• Unless subject to scrutiny, this wont have the
  desired effect
• Reporting and disclosure of decisions made by
  Board and results needed
• Ultimately, public awareness and understanding is
  the best discipline
• If not, then governance problem may be too
  endemic to overcome

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Country specific conditions

• Size of fund relative to markets
• Size of fund relative to other institutional
  investors
• Absolute size and multiple fund case
• Depth and quality of capital markets
• Capacity to regulate, standards of accounting,
  trust law etc.
• Human resources available
• General governance quality

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Summary

• More than 60 low and middle income countries have
  significant public pension reserves with dozens
  more considering establishing them
• Good management can have important impact on the
  social, fiscal and financial sector conditions
• To date, traditional public management practices
  have produced poor results in each area
• Improvement will depend on institutional design,
  investment policy, governance and how well these
  are adapted for country specific circumstances

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End