Principles and Guidelines for Good Pension Fund Regulation AIOS Seminar 11 – 12 November 2003 Guillermo Arthur Errázuriz President International Federation of Pension Fund Administrators

CONTENTS I.Introduction II.Principles and guidelines for regulating pension funds III.Challenges

I. INTRODUCTION Mandatory saving requires regulation. Influence on the development of the industry: Accumulated experience makes it possible to distinguish between good and bad regulatory practices Proposals for changing regulations may have negative consequences on the pension system Continued

Regulation objectives: To ensure that the aim of the system is achieved as efficiently as possible To protect members’ interests To reduce the cost of state guarantees In order to fulfil these objectives, regulations must conform to certain basic Principles and Guidelines These “Principles and Guidelines” are relevant for systems that are mandatory; based on individual capitalization; non occupational; and with defined contributions

1.Aims of the pension system 2.Freedom 3.Competition 4.Control of conflicts of interest 5.Diversification of investments 6.Neutralization of political risk 7.Subsididiary role of the State 8.Common rules for members 9.Relation between the effort of saving and the benefits 10.Information and social security culture II. PRINCIPLES AND GUIDELINES FOR PENSION FUNDS REGULATION

To finance pensions (old-age, disability and survivorship) when the worker retires. In order to protect this aim, regulations must ensure:  That the funds cannot be used for other purposes  Separation of net worth  Ownership of the funds  Single corporate purpose  Immunity of the funds from seizure 1.- AIMS OF THE PENSION SYSTEM

2.- FREEDOM To achieve a balance between controls and freedom. Freedom for the worker: Choice of AFP (and freedom to transfer) To choose the time to retire To choose a pension mode To save over and above the mandatory amount To select the type of fund in which he/she wants to invest his/her resources (Multifunds) Freedom for the Administrators: - To decide on their investment policies, within a general framework - To fix commissions - To choose their target market

3.- COMPETITION Competition encourages higher yield, lower costs, lower commissions and a better quality of service. In order to promote competition, regulatory practices must :  Ensure that there are no legal barriers to entering the industry  Stimulate yield comparison on an appropriate time axis  Provide information about commissions: their value, their modifications and their level, compared with those of other administrators  Allow the transfer of members between administrators  Allow a variety of marketing channels

4.- CONTROL OF POTENTIAL CONFLICTS OF INTEREST To ensure that the funds are not invested with aims other than that of obtaining adequate yield with security. Regulations must ensure that investments are made exclusively in the interests of the members:  Net worth separation  Revelation and use of inside information  Trading of financial securities in regulated and supervised markets  Development of Corporate Governance institutions  Establishing of systems for valuing instruments on the basis of market prices  Physical custody of securities by specialized bodies  Regular information regarding transactions to be sent to the supervisory body  Risk rating

5.- INVESTMENT DIVERSIFICATION Investment criterion: security and yield In order to achieve this objective, regulations must:  Authorize investment in a wide variety of different financial instruments and issuers  Set investment limits that give the administrators a certain slack  Avoid the pension funds being forced to invest in a particular instrument  Authorize plenty of investment abroad  Allow the administrators to offer multifunds

6. NEUTRALIZATION OF POLITICAL RISK It is necessary to avoid specific political and economic situations, which have nothing to do with pensions, leading to undesirable changes in regulation. In order to neutralize political risk it is important to:  Set up pension systems on the basis of specific laws which cannot be altered by political decisions  Avoid long-term competition between the new capitalization system and the old systems  Set up technical, independent supervision, to safeguard the interests of members and of the system  Have well-informed members who are committed to their pensions  Give priority to private management (separation of supervision and management)

7. SUBSIDIARY ROLE OF THE STATE Protection for the worker through regulation and supervision of the pension system; subsidies in the case of the most unprotected workers. Regulation should consider Government participation in:  Providing a basic pension for those who fulfil certain requirements  Recognizing in a fair and timely way the savings of those who transfer to the capitalization systems  Guaranteeing the payment of pensions in the case of the possible bankruptcy of a Life Insurance Company responsible for paying Life Annuities  Ensuring that a minimum yield is obtained for the workers’ savings, as a last resort.

8. COMMON RULES FOR MEMBERS All members must receive the same treatment as far as benefits are concerned. Nevertheless, there can be flexibility in matters that have to be weighed up on the basis of public policies:  Pension requirements varying between men and women  Jobs described as “heavy”  Employed and self-employed workers  The unemployed and those in work

9. RELATION BETWEEN THE EFFORT OF SAVING AND THE BENEFITS There should be equivalence between the effort of saving and the pension received. This creates incentives for the worker to act responsibly in paying his/her contributions. The regulations of benefits should:  Authorize alternative modes of pension payment  Protect the pensions from risk of inflation  Restrict early pensions where these would be very much lower than the worker’s income during his/her active period  Provide complete, relevant information to members when they retire  Avoid funds being cashed and diverted to other uses

10. INFORMATION AND SOCIAL SECURITY CULTURE The efficiency with which the system operates depends to a large extent of the quality of the decisions taken by members. “The actors of the system” must: Provide relevant, systematic and comprehensible information Act with transparency Encourage greater proximity with their clients The Government must: Implement public policies that encourage knowledge of social security

III. CHALLENGES The regulations of the individual capitalization systems must inevitably be adapted to the social and economic conditions of each country and the political decisions regarding the type of social security system desired. However, this should not prevent the regulators/supervisors and the industry from identifying those principles and more specific types of regulation that are necessary to ensure the success of the new capitalization systems. Pension reforms cannot be allowed to fail. This is the time to work on consolidating and developing them. We have to respond to the expectations and hopes that millions of workers have placed in us.