Anne Maher Chief Executive London The Pensions Board 10 October 2006 EUROPEAN PENSIONS 2006 RISK AND RISK SHARING – REGULATORY PERSPECTIVE

2 Agenda  What is risk?  Influence of risk on regulation  Should pension provision include risk?  Current risk worries and how they might be addressed 2

3 What is risk?  The prospect of some event occurring which will cause disruption to the expected view of the future  Hazard, chance of bad consequences, loss etc, exposure to change or injury or loss 3

4 What is risk? For Pension Provision  Risk was always there but rarely mentioned until after 2000  Focus was on investment returns/benchmark risk  Scheme liabilities or investment return/liability risk became high focus when accounting standards required disclosure  Main risks Plan sponsor Investment/market Interest rate Inflation Longevity Fraud or failure  ‘Risk’ is now recognized as big issue 4

5 Influence of risk on regulation Main reasons for pension regulation are about risk i.e.  Control of commercial relationships between parties whose knowledge or power is unequal  Avoid risk of market failure of a financial institution 5

6 Influence of risk on regulation Regulators/Supervisors  Need to identify and prioritise risk areas  Supervision strategies should be based on risk assessment  Use risk assessment to focus regulatory activity in way which achieves good cost/member protection balance  Most regulators (and European Commission) aspiring/moving towards more risk-oriented regulatory framework  But need to avoid trying to regulate risk out of the market 6

7 Should pension provision include risk? 7   All business is about risk and opportunity   Cash or bond funds provide most risk-free investment for pensions but greatly increase the cost   Trustees (or scheme management board) should: Decide level of risk they can accept Develop risk management framework Managing risk should be priority for them

8 Current risk worries – How they might be addressed  Longevity Risk Huge impact and great uncertainty Longevity assumptions should be transparent Prudent to fund for further expected improvements  Defined Benefit Risk Funding standards and permitted recovery periods different in every country Poorly matched investment and membership profiles common – driven by investment return motive without trustee understanding of ‘risk’ Most funding standards include some acceptance of deficiencies and consequent risk Tightening of funding standards would help (but have other consequences) 8

9 Current risk worries – How they might be addressed (continued)  Move to Defined Contribution In DC individual bears salary, investment, inflation and longevity risk Individual cannot take risks at same level as large entity Individual will not have expertise/experience Clarity of options and good explanatory material essential Greater responsibility for employers/trustees to provide appropriate back-up for individuals faced with decisions would help Alternative DB/DC solutions help accommodate shared risk  New Trends in Investment Liability Driven Investment (LDI) being promoted as the great solution to controlling risk But LDI involves unregulated investment LDI could involve excessive concentration of risk in one issuer Trustees (or advisers) likely to have little experience and may not understand the trade-offs and their costs Handle with care! 9

10 Conclusion  Modern desire to avoid risk but Group pension provision should continue to accept risk and give high priority to managing it Individual pension provision should minimise risk  And regulators should monitor risk but not Try to regulate it out of the market or Frustrate pension operation or development by excessive risk regulation 10