Anne Maher Chief Executive London The Pensions Board 10 October 2006 EUROPEAN PENSIONS 2006 RISK AND RISK SHARING – REGULATORY PERSPECTIVE.

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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