A REALITY CHECK ON FUNDED PENSIONS Pablo Antolin

A REALITY CHECK ON FUNDED PENSIONS Pablo Antolin Head of the Private Pension Unit Deputy Head OECD Financial Affairs Division

Structure presentation Ø Challenges facing funded pensions and pension funds Ø Their mandate (OECD Core Principles of Private Pension Regulation) Ø The role of funded systems and pension funds in sustainable and ESG investment 2

ØChallenges facing funded pensions Ø Population ageing Ø Current economic environment of low interest rates, low returns, low growth and low wage growth 3

Population ageing Ø Increase average population, higher life expectancy (lower mortality rates), low fertility rates Ø Differentiate between baby boom (temporary) and improvements in life expectancy (permanent? ) Ø Baby boom: costs incurred Ø Life expectancy: account for it (proper mortality tables), problem with uncertainty about future improvements (longevity risk) 4

Population ageing Ø Implications Ø Higher dependency ratio Ø (1) intense fiscal pressures on PAYG DB pensions: sustainability problems Ø More years in retirement to be financed: Ø (2) solvency problems for DB funded pensions; Ø (3) adequacy problems for DC pensions Ø Solutions Ø Contribute more for longer Ø Automatic adjustment mechanisms (actuarial adjustments, mortality tables, NDC, DCs) 5

Economic environment low growth, returns, interest rates Ø Low internal rates of return in PAYG schemes, which increases the problem of fiscal sustainability Ø Loss of confidence in funded (private) pensions, mistrust PAYG public pensions will deliver on their promises Ø 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. Ø Low financial returns generate retirement income adequacy concerns for DC (same savings lower accumulated assets, lower annuity payments, lower retirement income) 6

Economic environment low growth, returns, interest rates Ø Solutions as before: contribute more and for longer, automatic adjustment mechanisms, appropriate and regularly updated mortality tables including future improvements (dynamic tables) Ø Risks: Ø Pension funds seek higher yields via higher risk investments to match the level of returns promised to beneficiaries Ø Regulatory framework plays an important role here to prevent excessive risk taking in search for yield. 7

Pensions Funds Ø The OECD Core Principles of Private Pension Regulation and the regulatory framework of OECD countries establishes that Ø The main mandate of pension funds is to manage people’s retirement savings in their best interest Ø Achieve higher retirement income possible, by balancing returns and risks: Ø higher risk adjusted net of costs real returns Ø Diversification Ø Assess all investment opportunities by using appropriate risk assessment techniques and Ø Have appropriate risk management 8

Pensions Funds, Sustainable Investment and ESG Ø Sustainable investment opportunities and ESG investment opportunities are part of pension fund investment policy and risk management Ø OECD work establishes that fiduciary duty does not prohibit ESG integration nor prevents it Ø 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) Ø 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 9

Pensions Funds, Sustainable Investment and ESG Ø Practical barriers: Ø Lack of standardised and homogenised data Ø Lack of standardised and appropriate disclosure Ø Lack of appropriate models, indicators, metrics, and approaches to assess ESG investment opportunities (future work of the OECD WPPP? ) Ø Availability of ESG investment opportunities that provide good risk adjusted net returns Ø ESG no matter what (investment risk management) 10

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