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Solange Berstein– Chair IOPS Technical Committee Pensions Supervisor, Chile IOPS Regional Workshop Amman, Jordan February 2011. DC Supervision in Chile: Design elements to mitigate risks in a DC scheme. www.iopsweb.org. Contents. The need for supervision in a mandatory DC context. - PowerPoint PPT Presentation
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Solange Berstein– Chair IOPS Technical CommitteePensions Supervisor, Chile
IOPS Regional WorkshopAmman, JordanFebruary 2011
DC Supervision in Chile:Design elements to mitigate
risks in a DC scheme
www.iopsweb.org
Contents
1) The need for supervision in a mandatory DC context.
2) The Chilean approach: Design elements that mitigate risk
3) How to measure pension risk?
4) Lessons from Chile
Back to Basics: Concepts behind need for supervision
Asymmetric Information: Managers vs. Members
Moral hazard:Fiduciary responsibilityConflicts of interest
What is different about supervising Mandatory pensions? Massive membership implies:
Not active involvement Lack of information Poor financial education
Need to safeguard member’s interests (not just relying on market discipline)
Mandatory system = Social Security Public impact of system’s performance Close attention by policy makers, parliament,
government, etc. Potential impact on implicit and explicit fiscal liabilities
Need to safeguard state’s interests
4
What is different about supervising DC pensions?
Under DC arrangement individuals bear risks (investment, longevity)
May restrict/ control investment optionsMay need to provide information for members
Often competitive systems, so oversight of market discipline is key
May use strict licensing criteriaSupervision of the decumulation phase is also important
May prevent lump sum withdrawalsMay provide better transition between phases.
Risk management of the funds themselves importantMay provide guidance
Need careful oversight where individuals bear the risks, but don’t have enough information or education to make sensible decisions
5
Design elements to mitigate risks
35 or less 36 to 55 56 and older Retirees35 or less 33 to 50 51 and older Retirees
A Fund O O X XB Fund O Default O O XC Fund O O Default O OD Fund O O O Default O DefaultE Fund O O O O
X Not availableO Allowed to choose
O Default Assigned automatically
MenWomen
Investment Options
Default by age and restrictions for choosing riskier funds
This scheme have access restrictions for riskier funds and a default investment strategy for those members who do not select a fund type when enrolling to the system.
Design elements to mitigate risks
Fondo A
Fondo B
Fondo C
Fondo D
Fondo E
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
< 20 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 >= 70
Tramo Etáreo
% d
e A
fili
ad
os
po
r T
ipo
de
Fo
nd
o%
of
Aff
iliat
es b
y T
ype
of F
und
Age
Design elements to mitigate risks
Relax Investment Regulation: Only 5 limits by type of instrument remain by law Investment Regime in Secondary Regulation Investment Regulation can incorporate risk measurement norms Creation of Technical Investment Council that analyzes and
proposes investment regulation
Strengthen Corporate Governance of AFPs: AFPs must incorporate at least two autonomous directors into
their boards AFPs must create Investment and Conflict of Interests
Committees in their boards AFPs must have Investment Policies and Conflict of Interest
Resolution Policies that they must comply.
Design elements to mitigate risks
Financial Education Fund The Superintendence is part of the Committee that selects the
projects. The first Fund of US$ 2.7 millions has been already assigned on
May 28th to 34 projects. 2010: New call for projects. Estimated Fund: US$ 2.8 millions.
Adjudication: End of March 2010.
Pension Advisers Give a professional service 5 exam rounds have been taken to candidates. Number of rounds
for 2010: 2. There are already 476 pension advisers, some are individuals and
some are societies, registered in the Superintendence. These are validated jointly with the Securities and Insurances Supervisor (SVS).
Design elements to mitigate risks Create a wider 1st Solidarity Pillar
Basic Solidarity Pension for individuals who could not contribute
Solidarity Complement for individuals who financed small pensions (graph)
Bonus per child, equivalent to 18 months of contributions
Subsidy for contributions of young workers Mandatory participation for the self-employed
(improve enforcement) Provide equal conditions for men and women
Survivorship eligibility Insurance fees adjusted by risk Redistribution of pension savings in case of divorce
Design elements to mitigate risks
PBS
APS
TotalPension
Old age Solidarity Benefits
Self financedPension
TotalPension
APS
Disability Solidarity Benefits
PBS
Self FinancedPension
PBS
APS
TotalPension
Old age Solidarity Benefits
Self financedPension
TotalPension
APS
Disability Solidarity Benefits
PBS
Self FinancedPension
Design elements to mitigate risksIncome Profile
Contribution Profile
Expected Average IncomeLast 3 years
With APS
Without APS
13
Focus of regulation and supervision on risks (IOPS Principle 5: Risk orientation) Harder to quantify risk with DC funds (DB focus on funding) Focus on process not returns Focus on risk management and governance
The Superintendence has been working on the implementation of SBR over the last 5 years and it is now in a very advanced stage. Moving from compliance based supervision to RBS has been one of the main goals of the institution.
Design elements to mitigate risks
14
The focus should be on pension risk and not on short term volatility Relevant risk factors:
human capital risk investment risk Inflation annuitization risk.
Take heterogeneity of members into account Uncertainty in labor income Education Gender Risk aversion Qualify for other benefits: solidarity pillar, subsidies, guarantees
Life cycle strategies is a relevant mechanism to provide protection against market risk: Default options are very important
How to measure pension risk?
The default option provides protection. The riskier strategy available increases volatility of
replacement rates. Restrictions to the riskier strategy provides protection.
AB-C50
AB-C64
AB-C30
AB-C40
AB
CB-C64
CB-C40
CB-C50
CB-C30
CB
60%
70%
80%
90%
100%
110%
120%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Desviación Estándar
Pro
me
dio
LEYENDA
CB - Contrato BásicoAB - Fondo A - BCxx - Crisis a los xx años
How to measure pension risk?
CCCB: Default optionAB: riskier strategy availableCxx: Crisis at age xx
Ave
rag
e r
ep
lace
me
nt
rate
Standard deviation replacement rate
Crisis at age 30 Crisis at age 50
Crisis at age 40 Crisis at age 64
Probability Density Function
0
100
200
300
400
500
600
700
800
900
0% 10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
Tasa de Reemplazo
Fre
cu
en
cia
CB-C30 AB-C30
0
100
200
300
400
500
600
700
800
900
0% 10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
Tasa de Reemplazo
Fre
cu
en
cia
CB-C40 AB-C40
0
200
400
600
800
1000
1200
0% 10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
Tasa de Reemplazo
Fre
cu
en
cia
CB-C50 AB-C50
0
100
200
300
400
500
600
700
800
900
1000
0% 10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
Tasa de Reemplazo
Fre
cu
en
cia
CB-C64 AB-C64
17
Supervisory efforts are justified by market elements that are even more important in mandatory and DC context.
Design elements in the Chilean Pension systems mitigate market and financial risks.
As a mandatory DC system evolves, regulation becomes more flexible. Responsibility is transferred from the law to the pension fund managers.
This trend increases the need for better supervision. RBS allows to fulfil these needs. Pension risk in DC continues to be a challenge
Lessons from Chile
Solange Berstein– Chair IOPS Technical CommitteePensions Supervisor, Chile
IOPS Regional WorkshopAmman, JordanFebruary 2011
DC Supervision in Chile:Design elements to mitigate
risks in a DC scheme
www.iopsweb.org
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