Solange Berstein– Chair IOPS Technical CommitteePensions Supervisor, Chile

IOPS Regional WorkshopAmman, JordanFebruary 2011

DC Supervision in Chile:Design elements to mitigate

risks in a DC scheme

www.iopsweb.org

Contents

1) The need for supervision in a mandatory DC context.

2) The Chilean approach: Design elements that mitigate risk

3) How to measure pension risk?

4) Lessons from Chile

Back to Basics: Concepts behind need for supervision

Asymmetric Information: Managers vs. Members

Moral hazard:Fiduciary responsibilityConflicts of interest

What is different about supervising Mandatory pensions? Massive membership implies:

Not active involvement Lack of information Poor financial education

Need to safeguard member’s interests (not just relying on market discipline)

Mandatory system = Social Security Public impact of system’s performance Close attention by policy makers, parliament,

government, etc. Potential impact on implicit and explicit fiscal liabilities

Need to safeguard state’s interests

4

What is different about supervising DC pensions?

Under DC arrangement individuals bear risks (investment, longevity)

May restrict/ control investment optionsMay need to provide information for members

Often competitive systems, so oversight of market discipline is key

May use strict licensing criteriaSupervision of the decumulation phase is also important

May prevent lump sum withdrawalsMay provide better transition between phases.

Risk management of the funds themselves importantMay provide guidance

Need careful oversight where individuals bear the risks, but don’t have enough information or education to make sensible decisions

5

Design elements to mitigate risks

35 or less 36 to 55 56 and older Retirees35 or less 33 to 50 51 and older Retirees

A Fund O O X XB Fund O Default O O XC Fund O O Default O OD Fund O O O Default O DefaultE Fund O O O O

X Not availableO Allowed to choose

O Default Assigned automatically

MenWomen

Investment Options

Default by age and restrictions for choosing riskier funds

This scheme have access restrictions for riskier funds and a default investment strategy for those members who do not select a fund type when enrolling to the system.

Design elements to mitigate risks

Fondo A

Fondo B

Fondo C

Fondo D

Fondo E

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< 20 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 >= 70

Tramo Etáreo

% d

e A

fili

ad

os

po

r T

ipo

de

Fo

nd

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of

Aff

iliat

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of F

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Age

Design elements to mitigate risks

Relax Investment Regulation: Only 5 limits by type of instrument remain by law Investment Regime in Secondary Regulation Investment Regulation can incorporate risk measurement norms Creation of Technical Investment Council that analyzes and

proposes investment regulation

Strengthen Corporate Governance of AFPs: AFPs must incorporate at least two autonomous directors into

their boards AFPs must create Investment and Conflict of Interests

Committees in their boards AFPs must have Investment Policies and Conflict of Interest

Resolution Policies that they must comply.

Design elements to mitigate risks

Financial Education Fund The Superintendence is part of the Committee that selects the

projects. The first Fund of US$ 2.7 millions has been already assigned on

May 28th to 34 projects. 2010: New call for projects. Estimated Fund: US$ 2.8 millions.

Adjudication: End of March 2010.

Pension Advisers Give a professional service 5 exam rounds have been taken to candidates. Number of rounds

for 2010: 2. There are already 476 pension advisers, some are individuals and

some are societies, registered in the Superintendence. These are validated jointly with the Securities and Insurances Supervisor (SVS).

Design elements to mitigate risks Create a wider 1st Solidarity Pillar

Basic Solidarity Pension for individuals who could not contribute

Solidarity Complement for individuals who financed small pensions (graph)

Bonus per child, equivalent to 18 months of contributions

Subsidy for contributions of young workers Mandatory participation for the self-employed

(improve enforcement) Provide equal conditions for men and women

Survivorship eligibility Insurance fees adjusted by risk Redistribution of pension savings in case of divorce

Design elements to mitigate risks

PBS

APS

TotalPension

Old age Solidarity Benefits

Self financedPension

TotalPension

APS

Disability Solidarity Benefits

PBS

Self FinancedPension

PBS

APS

TotalPension

Old age Solidarity Benefits

Self financedPension

TotalPension

APS

Disability Solidarity Benefits

PBS

Self FinancedPension

Design elements to mitigate risksIncome Profile

Contribution Profile

Expected Average IncomeLast 3 years

With APS

Without APS

13

Focus of regulation and supervision on risks (IOPS Principle 5: Risk orientation) Harder to quantify risk with DC funds (DB focus on funding) Focus on process not returns Focus on risk management and governance

The Superintendence has been working on the implementation of SBR over the last 5 years and it is now in a very advanced stage. Moving from compliance based supervision to RBS has been one of the main goals of the institution.

Design elements to mitigate risks

14

The focus should be on pension risk and not on short term volatility Relevant risk factors:

human capital risk investment risk Inflation annuitization risk.

Take heterogeneity of members into account Uncertainty in labor income Education Gender Risk aversion Qualify for other benefits: solidarity pillar, subsidies, guarantees

Life cycle strategies is a relevant mechanism to provide protection against market risk: Default options are very important

How to measure pension risk?

The default option provides protection. The riskier strategy available increases volatility of

replacement rates. Restrictions to the riskier strategy provides protection.

AB-C50

AB-C64

AB-C30

AB-C40

AB

CB-C64

CB-C40

CB-C50

CB-C30

CB

60%

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0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Desviación Estándar

Pro

me

dio

LEYENDA

CB - Contrato BásicoAB - Fondo A - BCxx - Crisis a los xx años

How to measure pension risk?

CCCB: Default optionAB: riskier strategy availableCxx: Crisis at age xx

Ave

rag

e r

ep

lace

me

nt

rate

Standard deviation replacement rate

Crisis at age 30 Crisis at age 50

Crisis at age 40 Crisis at age 64

Probability Density Function

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Tasa de Reemplazo

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CB-C30 AB-C30

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CB-C50 AB-C50

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Tasa de Reemplazo

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CB-C64 AB-C64

17

Supervisory efforts are justified by market elements that are even more important in mandatory and DC context.

Design elements in the Chilean Pension systems mitigate market and financial risks.

As a mandatory DC system evolves, regulation becomes more flexible. Responsibility is transferred from the law to the pension fund managers.

This trend increases the need for better supervision. RBS allows to fulfil these needs. Pension risk in DC continues to be a challenge

Lessons from Chile

Solange Berstein– Chair IOPS Technical CommitteePensions Supervisor, Chile

IOPS Regional WorkshopAmman, JordanFebruary 2011

DC Supervision in Chile:Design elements to mitigate

risks in a DC scheme

www.iopsweb.org