1. Pension Funds and Insurance Companies: Challenges and Lessons Dimitri Vittas Senior Adviser World Bank December 2003

2. Pension Funds and Insurance Companies  NBFIs are a mixed bag of institutions.  Pension funds and insurance companies are the most important: – in terms of mobilization of long-term resources –potential impact on capital market development –acting as countervailing force to commercial banks.  They can help finance factoring and leasing companies and also promote housing finance and equity and debt market development.

3. Development and Regulatory Challenges  They take a long time to develop.  Magic of contractual saving and interest compounding.  They start slow but they build large assets over time.  Their success depends on stable macroeconomic policies, low inflation, fiscal balance.  They require prudent management and the offer of affordable benefits.  They require stable banking system, robust regulatory framework and effective supervision.

4. Private versus Public Management  Public sector ownership has caused poor performance in many developing countries.  Pervasive controls on insurance companies, covering premiums, investments, benefits, and reinsurance, have impeded the emergence of strong, efficient and well capitalized companies.  Public management of the assets of pension and provident funds, including social security institutions, has produced highly negative real returns.  Use of contractual savings as a captive source of funding large government deficits.

5. Reform Agenda in Africa  Downsize public pillar.  Improve assets management of public pension funds by building strong fund governance.  Appoint executive board of trustees with clear mandate and safeguards against political interference.  Create room for private pension funds and promote private sector presence in insurance sector.  Eliminate captivity of contractual savings, encourage modern efficient assets management, and allow investment overseas.  Build robust regulatory and supervisory capacity.

6. Build Efficient Institutions  The key to the success of the reform agenda is the building of efficient institutions.  Pension systems and insurance business are highly complex. They cover long-term contracts and are faced with considerable risk and uncertainty. They need to be based on public trust.  Building efficient institutions that are able to adapt and respond to emerging new challenges is very important.  Mauritius offers a very good example of the dynamic and durable benefits of building efficient institutions in both pensions and insurance.

7. Mauritius Pension System  Multi-pillar structure. Both public and private.  Basic Retirement Pensions.  National Pension Funds.  National Saving Funds.  Occupational Pension Funds.  Life Insurance Companies.  Housing Assets.  The system is generally well developed and managed.

8. Large Contractual Savings  Large accumulation of financial assets.  NPF 17% of GDP.  NSF 2%.  Insurance companies 18%.  Occupational pension funds 11%.  Total 48% of GDP. However, double counting of 7%.  Net assets: 54 billion MUR or 41% of GDP.  Large potential impact on financial sector development, economic growth and security of long-term benefits.

9. Basic Retirement Pension  Offers 20% of average wage to all elderly (more to the very old).  Current cost is low at 3% of GDP, but on unchanged policies likely to grow in the future and reach 6% in 2020 and 11% in 2050.  Need to contain its future costs because of aging.  Gradually raise retirement age.  Offer means-tested benefits, either affluence test (exclude those above specified level) or subsistence test (include only those below) or a combination of tests with gradual claw backs.

10. National Pensions Fund  Well run system: high coverage (60%); low contribution rate (9%); low operating costs (39 bp); high returns (11.72%) in 2001.  But based on opaque points system.  And failure to attain promised replacement rate of 33.3%.  Possible move to NDC scheme.  Appoint independent Board of Trustees and encourage professional assets management.

11. Occupational Pension Funds  Several types and many schemes. Total coverage between 80,000 and 100,000 employees.  Schemes for civil servants and employees of local government.  Over 100 schemes for employees of statutory bodies.  Over 1000 schemes for employees of private sector firms.  Need to reform civil service schemes but private funds well managed.

12. Performance of Occupational Pension Funds  Good overall performance with some exceptions.  Generous benefits raising questions about long-term affordability.  High assets diversification but underweight in government bonds and corporate debentures. Illiquid investments in equities and real estates. Large role in housing loans to members.  Low costs and high returns.

13. Regulation and Supervision of OPFs  Reasonable rules on vesting and portability.  Compliance of sponsors with actuarial and accounting standards, especially MAS 25 (IAS 19).  Though no requirement to hire qualified auditors and publish audited accounts.  Fragmented regulatory framework.  Lack of supervision and transparency.

14. Need for New Regulatory Framework  Consolidate legal framework into new, modern act.  Emphasize: –fund governance; –appropriate funding levels; –rules on vesting and portability; –assets segregation and safe custody; –assets diversification (with limits on self-investment); –market valuations; –actuarial, accounting and auditing standards; and –“whistle blowing” duties.

15. Need for Effective Supervision  Strengthen supervision under FSC.  Improve transparency, require quarterly financial reporting in electronic form.  Protect workers’ rights.  Reform NPF. Bring under FSC.  Provide choice to employers and employees.

16. Development of Insurance Sector  Free from pervasive premiums, products, investments & reinsurance controls.  Reliance on solvency monitoring.  Use of international accounting & actuarial standards.  General insurance makes good use of reinsurance.  Motor insurance largest branch in general business.  Reasonable loss ratios and claims settlement.  Life insurance is well developed, benefiting from tax incentives as well as pension funds and housing finance.

17. Investments of Insurance Companies  Diversified portfolio.  Underweight in government bonds but strong presence in housing loans and corporate bonds and equities.  Strong demand for long duration assets to cope with reinvestment risk.  Limited investments overseas despite high ceiling.

18. Insurance Regulation and Supervision  Marked improvement in recent years.  Need for greater emphasis on risk-based supervision and risk management.  Most companies are well managed but some small companies appear weak with low earnings, high costs and slow claims processing.  Need to develop early warning systems and regulatory ladders to take early action against weak companies.  Growing reliance on actuaries and auditors to identify problems.

19. Main Lessons for Africa  Development of strong contractual savings sector is feasible in a small economy.  Need for economic and political stability.  Respect of property rights.  Good mix of public and private provisions.  Robust regulatory framework and effective supervision.  Focus on building efficient institutions that are able to respond to emerging challenges in a dynamic environment.

20. Implications for Capital Markets  Develop long-term government bonds.  Avoid roll over risk and offer long duration assets to institutional investors.  Promote transparency of securities markets and efficient trading, clearing and settlement facilities.  Support financing of housing through direct loans, mortgage bonds or mortgage securitization.  Develop professional expertise in accounting and auditing, actuarial science, assets management and other areas.