Reform Pension Fund Regulations

Improved governance and reform of pension fund regulations are crucial to the long-term sustainability of the industry and the development of the broad financial sector in Jamaica and the rest of the Caribbean region, according to Dr Gene Leon, resident representative in Jamaica for the International Monetary Fund (IMF).

"Improving governance is by no means an easy task for pension funds or their regulators," he said.

"However, the business of pensions is too important to the security of a nation for it not to be a priority."

Reform is important because the investment strategies of pension funds are relevant not only from the perspective of retirement income, but also because of their impact on the development of capital markets and the supply of capital for innovative enterprises, Leon said.

"There is, in essence, a symbiotic relationship between pension-fund investment and capital-market development," he told participants at a seminar on pension regulation in the Caribbean, organised by the Caribbean Association of Pension Supervisors (CAPS), last Thursday.

Noting that transformation of the regional pension fund landscape must address internal governance, regulation, and sustainability, Leon said the establishment of CAPS, which has a multi-jurisdictional reach in pension supervision, was a positive step towards reforming the industry.

He explained that public pension governance is a complex area where structures and processes depend upon country and scheme characteristics. "In the current environment, there may be the temptation, even the necessity, to take on higher risk in an attempt to increase returns," Leon said.

Higher risk, added responsibility

He added, however, that it must be understood that with higher risk comes added responsibility, bringing a need for best-practice governance, which is increasingly being seen as an important aspect of an efficient pension system.

Leon noted that empirical evidence links good governance among funds to enhanced performance and returns, while maintaining stability, greater control over the management of the plan, and potential decrease in administration costs.

In managing the risks of the fund, he said, the governing body should carry out such important functions as assessing the performance of persons involved in the functioning of the fund. This includes persons in operation, those in oversight and strategic decision making, as well as outside service providers such as consultants, actuaries, and asset managers.

The governing body should also conduct regular reviews of the compensation mechanism to ensure that incentives are aligned correctly.

Compensation should be designed to motivate trustees to act in the best interests of beneficiaries, and, importantly, to focus on long-term sustainability of the fund as long as it is a going concern.

In the case of investment managers, Leon said, this may be accomplished by partially basing compensation on risk-adjusted returns.

The body should also identify, monitor, and correct conflicts of interest, which can be achieved by appointing independent board members.

Leon said there is a growing body of research that shows a direct link between good governance and superior performance of pension funds.

"In fact, a recent study estimates that the good versus bad governance differential can account for one to two per cent of additional return per annum," he said.

The IMF representative said that similar to developments for deposit-taking institutions, the current economic climate has seen a need for increased regulation and legislation in the insurance and pension-fund market.

"Reform of pension fund regulations to make them more counter-cyclical can engender long-term viability, stability, and security of member benefits," he said.

"At the same time, these reforms help broaden the regulatory perimeter of the financial sector."

Leon said an improvement in the sustainability of the region's pension funds can be achieved through changes to the contribution rate, the accrual rate, or the minimum retirement age.

He suggested that reform in the three criteria - governance, regulation and sustainability - should be done by each country under the watchful eye of CAPS to ensure a harmonious correction across jurisdictions.

Legislation and regulation aside, the role of ethics, training, and leadership for the managers and staff of the industry are also important, Leon suggested.

"At this juncture, pension funds have the opportunity to be an active intermediary in the financing of growth, and in aiding the development of the capital market in the region. Let the reforms happen, and reshape the impact of pension funds on the region," he concluded