Regulation and Supervision of Public and Government Pension Funds: Risks and Regulatory Responses5
Public pension plans are schemes, social security or similar, whereby the government administers the payment of pension benefits. The basic goal is to provide benefits for the population at large. Traditionally, public plans have been PAYG, although some countries have prefunded pension liabilities or private plans.
Oversight of government-run plans is required for numerous reasons, particularly the fiscal implications of mismanagement. The risks associated with DC schemes managed by the public sector arise namely from the government’s control over a large pool of funds. Such control can be problematic because those funds are frequently subject to political manipulation and pressures to, among other things, increase benefits, lower contributions, and hide problems. Moreover, government officials can be tempted to direct the investment of such funds either into government securities to help fund the budget or into politically attractive projects, disregarding the interests of pension investors. Risks also arise when fund management is outsourced to the private sector, including the possibility that the funds will not be optimally managed.
Under-funded pension systems can impose a heavy fiscal burden. Recent Financial Sector Assessment Programs have found that many government plans are under-funded and sometimes insolvent. The main culprit is the mismatch of funds, whereby often generous benefits are not matched by adequate contributions. Short working years and early
Table H.1. The Core Principles of Occupational Pension Regulation (OECD 2004)
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Source: OECD (2004).
retirements, which are common and sometimes encouraged, contribute to the mismatch problem.
A range of appropriate regulations can be established to oversee public pensions:
• Profitability rules (or minimum return requirements) can be imposed on private suppliers to reduce the risk that the funds will under-perform the industry average. This regulation also reflects the moral obligation imposed on a government to ensure an adequate pension income for individuals with no control over their investments.
• Restrictions on portfolio composition of pension funds can ensure a high probability that their performance will fall within a narrow range.
• A guarantee fund can be established to supplement shortfalls.
• A strong government commitment is needed to the disclosure of both the composition and performance of the portfolio.
• A strong and publicly disclosed set of internal governance standards should be required.
• Public pension schemes must show a commitment to regular audit for compliance and efficiency by an independent audit agency.
• Public pension schemes must report against publicly agreed benchmarks for performance.
Strong regulatory standards are also necessary for DB schemes to ensure that the promise of a specific payout is honored, especially when management is privatized or contracted to the private sector. Regulation usually takes the form of periodic actuarial reviews of the funds to assess the capacity of the fund to meet its payment obligations.
