anne maher chief executive london the pensions board 10 october 2006 european pensions 2006 risk and...
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Anne MaherChief Executive LondonThe Pensions Board 10 October 2006
EUROPEAN PENSIONS 2006EUROPEAN PENSIONS 2006
RISK AND RISK SHARING – RISK AND RISK SHARING – REGULATORY PERSPECTIVEREGULATORY PERSPECTIVE
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AgendaAgenda
What is risk? Influence of risk on regulation Should pension provision include risk? Current risk worries and how they might be
addressed
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What is risk?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
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What is risk?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
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Influence of risk on regulationInfluence 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
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Influence of risk on regulationInfluence of risk on regulationRegulators/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
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Should pension provision include risk?Should pension provision include risk?
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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
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Current risk worries – Current risk worries – How they might be addressedHow 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)
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Current risk worries – Current risk worries – How they might be addressedHow they might be addressed (continued)(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!
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ConclusionConclusion
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
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