Pension Fund Management: Implications For Sound Financial And Economic Management By M. K. Ahmad Director General National Pension Commission

2 Outline Characteristics of Pension Funds Pension Fund Management Impact on Financial and Economic Management Lessons from Nigeria

Characteristics of Pension Funds Sponsorship of Pension funds contribution by employers and/or employees wholly by employers Pension Funds as Institutional investors: collect, pool and invest funds for future pension entitlements of beneficiaries ensure sound financial and economic management through financial intermediation, which affect financial markets in particular and economic activity in general 3

Returns to members of pension plans may be purely dependent on the market or may be overlaid by a guarantee of the rate of return by the sponsor Portfolio diversification to mitigate against risk: spread of domestic securities international investment Pooling of risk for small investors Long term liabilities allowing holding of long-tenured and high yielding instruments 4 Characteristics of Pension Funds …Cont’d

Ability to absorb and efficiently process information on capital market operations Large size and thus economies of scale, which result in lower average cost for investors The countervailing power of pension funds that is often used to reduce transaction costs and custodial fees 5 Characteristics of Pension Funds …Cont’d

Pension Fund Management Pension Funds are managed by: Pension Fund Administrators – take investment decisions In some jurisdictions, pension fund management can be by asset management and insurance companies Some management decisions may be the responsibility of Boards of Trustees in some corporate organisations Pension Fund Custodians – keep custody of pension funds Custodial services may be provided by Central Banks in some jurisdictions In the UK, Pension Protection Fund provides compensation to contributors where employers become insolvent 6

Pension Fund Investment... Cont’d Regulations required to promote both the performance and the financial security of pension assets Regulations of pension funds require the appointment of a custodian, depository institution or trustee standards of conduct and minimum suitability of the operators of pension funds the rights of investors to withdraw funds the right of investors to full, timely and accurate information disclosure 7

The main goals of pension investment are to: Ensure adequate, affordable and sustainable benefits to contributors Secure safety & security of funds Ensure adequate liquidity to pay all pension benefits of contributors as and when due Achieve an optimal trade-off of risk and return through strategic asset allocation 8 Pension Fund Management … cont’d

Pension Fund Investment … cont’d Risk Management for pension assets established on Quantitative limits: maximum limits for individual, class or class of mix assets Principle of Prudent Man - the preservation of capital, while obtaining a reasonable income Benchmark: indicator of market, sub-market or a mix of assets commonly traded and used as a point of reference 9

Pension Fund Management... Cont’d In practice, 60% of pension funds invested in local markets Foreign investment might not overcome collective systemic risks to world capital markets Investment of pension funds in international market International diversification may reduce risk since shocks to equity markets tend to be country specific 10

Impact on Economic Management Pension funds can have positive impact on the economy through: generation of savings that leads to capital accumulation and hence promotes investment transfer of resources in favor of long-term assets would have significant impact on GDP growth Shift to long-term assets tend to reduce the cost of capital and increase the availability of equity and long-term debt financing to companies, and hence promotes growth 11

Impact on Economic Management... Cont’d Increase in capital investment and labour productivity Development of labour intensive, low productivity “informal sector” to a capital intensive, high productivity “formal sector” Availability of long-term financing will simplify government deficit financing through the issuance and purchase of government securities 12

Promotion of infrastructural development Development of other institutions Insurance  Annuity  Life insurance Rating Mortgage  REITs 13 Impact on Economic Management... Cont’d

Impact on Financial Management Development of the Capital Market Increased demand for new investment outlets would stimulate innovation and development of new long term instruments Increased market integrity/transparency and corporate governance Re-enforcement of Improved regulation and supervision of the market and its efficiency Creation of domestic institutional investors (PFAs/CPFAs), with long term focus, would moderate stock market and price volatility Trigger the modernisation of capital market infrastructure such as clearing and settlement 14

Impact on Financial Management... Cont’d International portfolio of investment risk reduction to pension funds reduction of volatility of returns Qualitative developments in the financial markets financial innovation development of corporate bonds market development of indexed instruments better accounting and auditing better information disclosure Efficient provision liquidity and price formation 15

Lessons from Nigeria Rationale for Pension Reform Defined benefit (DB) – Pay As You Go (PAYG) Largely dependent on budgetary provision for funding Unstainable pension liabilities Weak & inefficient administration Demographic shifts and ageing make DB schemes unstainable Low compliance ratio due to ineffective control & regulation Many workers in the private sector were not covered by any form of retirement benefits arrangement Existence of diversified arrangements which were largely unregulated in the private sector 16 Public Sector Private Sector

LESSONS FROM NIGERIA … Cont’d Characteristics of the Contributory Pension Scheme in Nigeria contributory: Contributions by both employer and employee fully Funded: Funds set aside for retirement individual Accounts: Nature of the account, portability and withdrawals (Lump sum, Annuity & Programmed withdrawal) privately managed: by PFAs, CPFAs and PFCs life Insurance Cover coverage and exemptions strictly regulated and supervised by PenCom 17

LESSONS FROM NIGERIA … Cont’d Pension Fund Investments managed by two institutional investors Pension Fund Administrators Closed Pension Fund Administrators Investment Instruments – subjected to both quantitative and qualitative regulations – all instruments must have rating grades as stipulated in the Regulations – rating carried out by Risk Rating Institutions – performance benchmark stipulated for each asset class 18

LESSONS FROM NIGERIA … Cont’d Securitization & Listing Pension fund investments assets must be securitized and listed for trading on the floor of the NSE or Electronic Platform of MMAN Pension Fund Assets: Generated pool of long term investible funds for the first time in Nigeria The industry has approximately N worth of assets as at 31 October, 2007 RSA assets – N billion CFPA assets – N billion AES assets – N billion 19

Quantitative limits and performance benchmarks stipulated Assets invested in various instruments - FGN and State Governments’ securities, equities, money market instruments, mutual funds, corporate debt instruments Offshore investments and derivatives are future developments 20 LESSONS FROM NIGERIA … Cont’d

Development of other institutional operators: Enhancement of the skills of rating agencies Development of mortgage industry Development of insurance industry  Provision of group life insurance policies  Developments of annuities market  Anticipated fall in premium rates Provision of statistics for national development National databank Pensioner verification exercise 21 LESSONS FROM NIGERIA … Cont’d

22 Thank You! National Pension Commission Plot 174, Adetokunbo Ademola Crescent Wuse II, Abuja 09 – – 40