A reality check on Funded Pensions This is the first step in a project approved by the WPPP at its last meeting in December Pablo Antolin Head of the Private Pension Unit Deputy Head OECD Financial Affairs Division

Structure presentation Challenges facing funded pensions and pension funds Their mandate (OECD Core Principles of Private Pension Regulation) The role of funded systems and pension funds in sustainable and ESG investment

Challenges facing funded pensions Population ageing Current economic environment of low interest rates, low returns, low growth and low wage growth

Population ageing Increase average age population, higher life expectancy (lower mortality rates), low fertility rates Differentiate between baby boom (temporary) and improvements in life expectancy (permanent?) Baby boom: costs incurred Life expectancy: account for it (proper mortality tables), problem with uncertainty about future improvements (longevity risk)

Population ageing Implications Solutions Higher dependency ratio (1) intense fiscal pressures on PAYG DB pensions: sustainability problems More years in retirement to be financed: (2) solvency problems for DB funded pensions; (3) adequacy problems for DC pensions Solutions Contribute more for longer Automatic adjustment mechanisms (actuarial adjustments, mortality tables, NDC, DCs)

Economic environment low growth, returns, interest rates Low internal rates of return in PAYG schemes, which increases the problem of fiscal sustainability Loss of confidence in funded (private) pensions, mistrust PAYG public pensions will deliver on their promises Low returns & interest rates in DB funded system increase problems of solvency, pension funds problems to deliver on promises, employers higher costs because of liabilities. Low financial returns generate retirement income adequacy concerns for DC (same savings lower accumulated assets, lower annuity payments, lower retirement income)

Economic environment low growth, returns, interest rates Solutions as before: contribute more and for longer, automatic adjustment mechanisms, appropriate and regularly updated mortality tables including future improvements (dynamic tables) Risks: Pension funds seek higher yields via higher risk investments to match the level of returns promised to beneficiaries Regulatory framework plays an important role here to prevent excessive risk taking in search for yield.

Pensions Funds The OECD Core Principles of Private Pension Regulation and the regulatory framework of OECD countries establishes that The main mandate of pension funds is to manage people’s retirement savings in their best interest Achieve higher retirement income possible, by balancing returns and risks: higher risk adjusted net of costs real returns Diversification Assess all investment opportunities by using appropriate risk assessment techniques and Have appropriate risk management

Pensions Funds, Sustainable Investment and ESG Sustainable investment opportunities and ESG investment opportunities are part of pension fund investment policy and risk management OECD work establishes that fiduciary duty does not prohibit ESG integration nor prevents it Regulation permits but (generally) does not encourage ESG investing, beyond the fiduciary of best interest of members (best real risk adjusted returns net of costs) Investors interpretation: prudent man, efficient market (everything is in the price), and lack of clarity on the rules by the regulator may discourage ESG integration

Pensions Funds, Sustainable Investment and ESG Practical barriers: Lack of standardised and homogenised data Lack of standardised and appropriate disclosure Lack of appropriate models, indicators, metrics, and approaches to assess ESG investment opportunities (future work of the OECD WPPP?) Availability of ESG investment opportunities that provide good risk adjusted net returns ESG no matter what (investment risk management)

Thank You!