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Ralph C. LewarsFinancial Sector Supervision AdviserCARTAC
The views expressed in this presentation are entirely my own and do not necessarily reflect the opinion nor the policy of either the IMF or CARTAC.
Discussion Topics An overview of the work of CARTAC in the region.
…how CARTAC links into the IMF Funding and operation
The Pension Landscape in the Caribbean Social Security Schemes, and Private Pension Plans Systemic Risk and Financial Stability Status of Legislation in the Caribbean Issues and Challenges Reform Options
Measuring Risk and Vulnerabilities Stress Testing Financial Stability Indicators
About CARTAC The Caribbean Regional Technical Assistance Centre
(CARTAC) is one of ten IMF Regional Technical Assistance Centers (RTACs) located around the world in the Pacific, the Caribbean, in Africa, the Middle East, India and Central America.
These Centers were created to: help countries strengthen human and institutional capacity design and implement sound macroeconomic, and financial
sector policies that promote growth and reduce poverty. Became operational in 2001
CARTAC Provides Technical Assistance in Six core areas Macroeconomic Programming and Advice Public Financial Management Tax and Customs Administration Financial Sector Supervision Financial Stability and Crisis Management Real Sector and External Statistics
NB: Since its inception, CARTAC has provided TA to several countries in the region on updating their respective Pension legislation and enhancing supervisory oversight, and developing risk and vulnerability indicators for the sector.
Who Funds CARTAC International donors
The government of Canada through it’s aid office Global Affairs Canada (GAC);
International Monetary Fund (IMF); United Kingdom (DFID); and European Union (EU)
The Government of Barbados finances the costs of office facilities, while the other 20 beneficiary countries make annual contributions to the Centre’s operating expenses.
Other contributors since the inception of CARTAC include Australia (AUSAID), Caribbean Development Bank (CDB), the Inter-American Development Bank (IADB), the United Nations Development Programme (UNDP), Ireland, the United States (USAID), and the World Bank (WB).
How CARTAC operates Regional resource center of the International Monetary
Fund headed by a Centre Coordinator appointed by the IMF
The priorities of CARTAC are approved by a Steering Committee (SC) consisting of representatives of recipient countries, donors and the IMF.
CARTAC, combines on-the-ground capacity building with strategic advice and support from the IMF
All technical assistance (TA) is integrated with the IMF’s lending and surveillance operations, and coordinated with other IMF TA, as well as that of other providers.
All TA is backstopped by IMF, ensuring quality and consistency of policy advice.
The Pension Landscape in the Caribbean
Characteristics of the Pension Systems in the Caribbean (1) _ Source: IMF Working Paper - National Insurance Scheme Reforms in the Caribbean; By Koffie Nassar, Joel Okwuokei, Mike Li, Timothy Robinson and Saji Thomas
All Caribbean countries have social security schemes which are broadly similar in design Provide a wide range of benefits -invalidity and survivor’s pensions, as well
as benefits for sickness, maternity, and employment injury. Some countries have added unemployment benefits (Barbados and The Bahamas), and partial health benefits (Belize, Jamaica, and The Bahamas).
Coverage may be mandatory for employees and the self-employed (except for Trinidad and Tobago), although the enforcement of contribution provisions is much looser for the latter than for salaried workers.
Basic structure - traditional defined-benefit The most significant benefit provided by the NIS is old age pension, which
accounts for about two-thirds of total benefits. Public sector employees in some countries receive government pensions, which are non-contributory.
Examples of key differences among the schemes in the region: Barbados has three separate NIS funds (old age, unemployment and
severance) and Jamaica has a scheme that offers both flat-rate and wage-related pension
Characteristics of the Pension Systems in the Caribbean (2) _ Source: IMF Working Paper - National Insurance Scheme Reforms in the Caribbean; By Koffie
Nassar, Joel Okwuokei, Mike Li, Timothy Robinson and Saji Thomas
The schemes are the main component of public social security and are financed by payroll taxes paid by both employees and employers. Contribution rates vary significantly across countries, with the employer
paying a larger share in most cases Total pension contributions for old age pension, survivor and disability, as
a share of pensionable wage average 10 percent in the Caribbean, which is lower than comparators in Latin America, Europe, and Asia and the Pacific (see Table on next slide).
Contribution rates are very low in Jamaica, but are above the regional average in Barbados, Dominica, Guyana and Trinidad and Tobago. These rates apply to wages up to a statutory limit (wage ceiling), which are increased by legislation from time to time.
In all countries, private pension funds exist and are organized along occupational lines. Some countries also have private annuities, and a variety of retirement savings vehicles, such as individual retirement accounts
Contribution Rates for Social Security SystemsSource: IMF Working Paper - National Insurance Scheme Reforms in the Caribbean; By Koffie Nassar, Joel Okwuokei, Mike Li, Timothy Robinson and Saji Thomas
Social Security Schemes(NIS) – Reform Options (1)Source: IMF Working Paper - National Insurance Scheme Reforms in the Caribbean; By Koffie Nassar, Joel Okwuokei,
Mike Li, Timothy Robinson and Saji Thomas
Long-term projections point to continuing unfavorable demographic trends and large increases in pension spending
The actuarial deficits calculated as the Present Discount Values (PDVs) of future benefit expenditure minus income over the period 2016-60 at a discount rate of 5 percent, range from 0.7 percent of GDP in Barbados to 92 percent of GDP in Jamaica.
In the absence of reforms, contingent liabilities of several percentage points of GDP could materialize in few countries, putting substantial pressure on public finances
Risks can be mitigated by taking timely reform measures - raising the retirement age; freezing old-age pension benefits; and increasing the contribution rate.
However, the above would not be sufficient to effectively contain actuarial deficits in some countries
Consider measures to improve coverage, with a view to reducing the old age dependency ratio. Improve public information and disclosure Independent oversight and evaluation of social security schemes, and public
sector pension plans, including the publication of actuarial reports (periodically –every 3/5 year?)
Pension Funds – Systemic Risk and Financial Stability (1) There are over 900 private pension plans operating in Trinidad & Tobago,
Barbados and Jamaica with assets of over USD800 Million. Pension assets account for a significant share of total financial assets in some
countries Pension Investments are mainly concentrated in two major asset classes
(government bonds, equities) in the Caribbean Concentration of investment in individual countries (Often the result also
of investment portfolio limits) elevate risk, due to country-specific riskfactors, illiquidity of markets, short maturity of government debt
Though it brings benefit to local capital markets, benefits fromdiversification not fully realized
Can pension funds contribute to systemic risk and financial instability? Pension Plans are one of the largest groups of institutional investors and
can therefore have a significant impact on financial markets Sizeable re-allocations of assets (between fixed income and equities) in
pension plans can also significantly impact financial stability
Pension Funds – Systemic Risk and Financial Stability (2); Source: E Philip Davis, 2016 Pension funds may not pose systemic risks in the sense of “a
combination of events that threatens the functioning of the financial system in its entirety” (Beetsma and Vos 2016) Pension funds are typically not leveraged so no multiplier effects in their
profits and losses Average duration of pension fund liabilities 15-20 years so natural long
term investors DB pension funds can be technically insolvent but in many countries
cannot go bankrupt (change parameters such as contributions, indexation, entitlements, to return to solvency gradually). For DC funds assets are the same as liabilities so issue of insolvency usually does not arise, unless there are guarantees
Pension funds are commonly restricted from using derivatives except for hedging
EIOPA stress tests show generally stabilizing influence for financial markets by portfolio rebalancing following sharp price change of a given asset
Pension Funds: Transmission Channels – Sources of Feedback Effects on the Macroeconomy
Source: Adopted from S. Nicholls; 2016
Jamaica: Private Pension Plan Investments - March 2017 (J$Bn)
Private Pension Plans – Regulatory and Supervisory Implications (1); Source: Flavio Marcilio Rabelo Objectives of pension supervision:
Protection of benefits; ensuring adequacy of coverage; and financial stability (Kiel and Bacchas, 2016)
In all countries with private pension systems, the main elements/features of the legislative and regulatory architecture are:
licensing (authorization/registration) criteria; Accounting for pension liabilities governance rules; asset segregation rules; independent custodian; external audit/actuarial review; disclosure requirements; investment limits (“prudent person approach” and the “use of quantitative restrictions”); guarantees; minimum capital and reserves; and regulations on costs and fees.
The relative emphasis given to each of these components depends on the nature of the plan and benefits and also on the development of domestic capital and money markets
Private Pension Plans – Regulatory and Supervisory Implications (2); Source: Flavio Marcilio Rabelo
The type of benefit structure of pension plans (defined benefit or defined contribution) and form of provision (occupational or personal pension plans) influences the scope of regulation and supervisory oversight:
Defined benefit (DB) plans use a benefit formula based on years or service and salary averages – benefit is guaranteed by the assets allocated in the pension fund.
Key concern – adequacy of funding to finance accrued liabilities (pension promises).
A key objective of regulation and supervisory oversight is to mitigate the insolvency risk of these plans.
In defined contribution (DC) plans, the final benefit depends on the value of the participant’s accumulated account balance. There is no guaranteed benefits. These plans are by definition always fully
funded and the investment risk is entirely borne by the participant. However, due to irregular or small contribution or poor investment returns the
participant may not accumulate a sufficient amount of money to provide for an adequate replacement rate in retirement.
Private Pension Plans – Regulatory and Supervisory Implications (3) DB plans are more difficult to administer than pure DC plans
DB plans need to keep funding levels and solvency at sufficient levels in order to be provide promised benefits at or after retirement
Actuarial calculations/projections required Good ALM expertise required to select the types of investment and the
maturity of the assets to match the projected pension benefits liabilities
In a pure DC plan, it is the individual or plan participants that ultimately ends up bearing both the risk of longevity and the investment risk prior to and after retirement.
In pure DB plans, these risks are generally borne by the employer, the pension fund, or the state (as guarantor). Individuals are theoretically protected against any kind of fluctuation in terms of the underlying returns earned on the pension asset and changes in life expectancy
Private Pension Plans – Regulatory and Supervisory Implications (4); Source: Flavio Marcilio Rabelo
Occupational pension plans (defined benefit or defined contribution) are part of a company’s total remuneration package Not a commercial product and are not accessible to the general
public Regulation and supervisory oversight are designed to ensure
that the rules of these plans are clearly stated and that the employer complies abide by the established rules
Personal pension plans are savings vehicle offered mainly by insurance companies to the general publicMostly defined contribution, although some may offer minimum
return guarantee Supervisory oversight is needed to ensure and/or monitor
maintenance of required solvency margins by the sellers of these products
Accounting for Pension Liabilities (1) Accounting for pension liabilities incurred by the public sector -
promised future pension payments under a public PAYG pension system may not/do not completely appear in official government statistics
the reason for this absence of accounting is attributed to: these are promised payments, and may not necessarily be legally enforceable claim on future resources - because they are implicit by nature and they are often easier to renege on
Accounting for private pension plans: the accounting standard known as IAS 19 deals with pension liabilities of companies
Under IAS 19, companies are required to provision for future benefit liabilities. If the plan is based on final salaries, companies have to project the liabilities on the basis of projected wages instead of current wages. Further, assets valuation has to be based on market values and benefit obligations have to be discounted using current market rates for a similar duration as the pension promises, which could lead to volatility in the balance sheet.
Status of Pension Legislation in the Caribbean – Overview
All countries are committed to the reform of their respective pension system but are at different stages of evolution due to several factors, including other domestic priorities
The absence of legislation (or updated legislation) in some jurisdictions has constrained the authority of the pension regulators/supervisors, and their ability to take corrective actions. For example, pension regulators may not have the power to request that contributions are paid over within a certain time or that plans should fund deficits
Inadequate and/or timely prudential reporting Gaps in registration of pension plans makes it difficult to develop
comprehensive knowledge of the industry
Pension Legislation in the Caribbean (1)
Pension Legislation in the Caribbean (2)
Registration, Monitoring and Supervision of Pension Plans in the Caribbean Registration:
Jamaica has registered pension plans, trustees and their agents Barbados, Bermuda, Cayman, Suriname and Trinidad and Tobago have carried out registration of
pension plans The Eastern Caribbean countries of Grenada, St. Vincent & the Grenadines, St. Lucia and Antigua
and Barbuda are in the process of registering pension plans. The other countries either have not commenced registration, despite having the authority to do so
or have no power to register pension plans.
Monitoring and Supervision: Jamaica has adopted the risk based approach to supervision and is using an Early Warning Risk
tool (looks at the frequency and severity of risks, provides an overall score to categorize plans into risk categories) to identify plans at risks in order to take proactive action before those risks crystalize.
Barbados has in place a system to identify plans at risks. Most of the other countries have either not started active supervision of the pension industry or
are using a compliance based approach. Only a few countries conduct onsite examinations of the industry; namely Barbados, Bermuda,
Jamaica, Trinidad & Tobago (limited to Corporate Trustees (banks) and insurance companies) and Suriname.
Key Challenges Funding is a major constraint in advancing the pace of
reform, and objectives/mandate of the pension supervisors in the region
Impacts staff capacity, capabilities Limit ability to develop necessary processes, including prudential
reporting regime required to effectively monitor and supervise In some of the smaller jurisdictions where there is no separate pension
legislation, oversight is provided by supervisors with insurance expertise – continued specialized pension training is required
For those regulators that are at a more advanced stage of pension supervision, a key challenge going forward is to provide the tools and/or training necessary to educate trustees and agents on proper pension management/governance, including managing risks
Key Challenges - E Philip Davis, 2016
The pension fund sector in most countries, including the Caribbean face several current and emerging challenges Low nominal and real long term interest rates Lack of long maturity bonds in local markets to match pension
liabilitiesUnderfunding of defined benefit plans (and social security
schemes) A search for yield, driven by pressures to invest in low risk assets Rising longevity (see chart on next slide) Increased preference for and/or conversion of defined benefit
(DB) to defined contribution (DC) plans – beneficiaries may be impacted
Regulatory challenges (accounting standard for DB; regulatory burden/cost; DB guarantees)
DC Plans – Key Policy Challenges (1) - Cass Business School, London, UK 5 March 2013
Dramatic global shift in pensions policy away from public (state) and private employer-sponsored schemes, in which benefits are pre-defined (defined benefit or DB), towards private retirement saving plans, in which benefits depend on the value of accumulated assets (e.g. defined contribution or DC)
Risk is transferred from the state and employers to individuals, including inflation, interest rate, investment and longevity risk.
The transition from DB to DC has been accompanied by a trend towards lower overall contribution rates.
These developments raise very significant concerns about the adequacy and security of future retirement income at a time when longevity is increasing and when the global experience of low returns and high volatility, following the 2008 financial crisis, have reduced public confidence in retirement savings.
DC Plans – Policy Response (2) - Cass Business School, London, UK; March 2013
DC is an integral feature of the private sector pension systems in the United States, United Kingdom, Australia, Chile and New Zealand, among others. However, DC systems might not produce adequate outcomes due to the following factors:
Low contributions Low levels of public confidence and understanding of DC plans Individuals are unable or unwilling to choose appropriate funds Investment strategies offer little or no protection Funds are too volatile in the pre-retirement phase
Public education saving for retirement requires a long-term commitment and also that it
is important to diversify the sources of retirement income implementation of full compulsion or auto-enrolment
DC Plans – Recommended Policy Response (3) - Cass Business School, London, UK; March 2013
OECD research suggests that where the investment period lasts 30-40 years, it is possible for DC systems to produce attractive returns within a low-volatility environment that can help to deliver adequate retirement incomes; provided the design and delivery features are optimal in relation to the overall pension system. These features include: Ensure the design of DC pension plans is internally coherent between the
accumulation and payout phases and with the overall pension system, including a robust investment governance framework that addresses key risks and the uncertainty inherent in saving for retirement;
Encourage high participation rates and adequate contributions (relative to the required outcome) paid over the long-term;
Promote well-designed incentives to save for retirement, particularly where participation and contributions to DC pension plans are voluntary;
Promote low-cost retirement savings instruments; Establish appropriate default investment strategies, but also provide individuals with
a choice of funds with different risk profiles and investment horizons; Encourage annuitization as a protection against longevity risk, including the supply
of annuities and cost-efficient competition in the annuity market; Ensure effective communication and to address financial illiteracy and lack of
awareness.
Conversion from DB to DC – Regulatory Issues (Kiel and Bacchas, 2017) Majority of plans in the Caribbean are not pure DC plans Typical ‘DC plans’
Guaranteed or declared interest; few credit market yield Pension benefits paid from the plan; some may annuitize Investments are not member directed
Measuring Risks and Vulnerabilities - Stress Testing Stress testing has only recently been introduced to the pensions sector in
some countries. Practices also vary depending on the type of pension plan supervised (DB/DC/hybrid). How a portfolio will react to certain (extreme) conditions is only partially useful information when it comes to pensions, as the issue is not so much “what will the size of the accumulated pension portfolio be” as “will this deliver an adequate retirement income”
Stress testing in DC plans – process is evolving/very limited experience Stress testing DC pension funds raises the question of what is the objective of the
test, and what is being tested for/“what to stress test the pension fund against”. How to apply stress tests to pure DC pension plans is challenging since DC pension plans do not have any promised benefit or outcome goal.
Stress testing DB pension funds is more popular - DB plans provide a benefit guarantee or promise and must therefore manage their assets closely with regard to their liabilities The objective of stress testing in a DB context is to determine to what extent the assets
may be sufficient to meet future payments, given different risk scenarios.
Measuring Risks and Vulnerabilities – Financial Stability Indicators (1) Development of Financial stability indicators for the pension sector is still work in
progress The IMF has suggested compilation of the following four indicators for the
pension sector Liquid assets to estimated pension payments in the next year (Liquidity ratio) Return on Assets (Earnings and Profitability) Pension Fund Assets/Total Financial System Assets Pension Fund Assets/GDP
World Bank consultants - Outcome-based Assessment (OBA) framework for pensions, but this relates more to social security considerations (W. Price, J. Ashcroft and M. Hafeman, Report, IBRD; 2014) Coverage: Maximizing proportion of working age population accumulating retirement income
entitlements. Adequacy: Protecting retirees against severe drops in living standards and poverty by ensuring that they
have accumulated adequate retirement benefits. Sustainability: Delivering promised retirement income without placing burdens that will not be met on
government, employers or workers. Efficiency : How well pension plans transfer contributions to pension income. Security: Minimizing the risk that funds that have been accumulated to provide retirement benefits are
misappropriated.
Measuring Risks and Vulnerabilities – Financial Stability Indicators (2) – Source: Developing Appropriate Financial Stability Indicators for the Pension Industry in the Caribbean; June 2016; By E. Philip Davis
Measuring Risks and Vulnerabilities – Financial Stability Indicators (3) – Source: Developing Appropriate Financial Stability Indicators for the Pension Industry in the Caribbean; June 2016; By E. Philip Davis
Measuring Risks and Vulnerabilities – Financial Stability Indicators (4) – Source: Developing Appropriate Financial Stability Indicators for the Pension Industry in the Caribbean; June 2016; By E. Philip Davis
Measuring Risks and Vulnerabilities – Financial Stability Indicators (5) – Source: Developing Appropriate Financial Stability Indicators for the Pension Industry in the Caribbean; June 2016; By E. Philip Davis
Final Words Since we have touched on some the issues relating to both DB and DC plans, I thought it
might be instructive to conclude by sharing excerpts from an article that was published on May 19, 2017 in the Canadian media on measures being taken by Ontario government (Canada) to implement a new framework for DB pension plans:
“The government will introduce legislation this autumn to implement a new framework for DB pensions that include changes to the going concern funding rules; requiring the funding of a reserve within plans; increasing the guarantee provided under the Pension Benefits Guarantee Fund (PBGF) by 50%; and requiring plans that fall below the 85% funding level to be funded on a solvency basis.
The government is making a variety of other complementary changes designed to improve transparency to plan beneficiaries, enhance income security, set funding rules for benefit improvements and restrict contribution holidays. The government also announced that it will be reviewing the rules governing the wind-up of DB pensions and studying a proposal to establish an agency to administer the pension benefits of wound-up plans.
The reforms are intended to help shore up DB pensions by ensuring that they are funded appropriately and establish a reserve to protect benefits while also giving employers greater flexibility in managing their pension contributions, the province states. - "Everyone deserves a secure retirement”.”
References1. Brunton, P. Desmond, and Pietro Masci (Editors); Workable Pension Systems Reforms in the Caribbean; 2005
(Inter-American Development Bank and the Caribbean Development Bank)2. Davis, E Philip; Developing Appropriate Financial Stability Indicators for the Pension Industry in the Caribbean
(Presentation at the CAPS Conference, June 2016)3. E Philip Davis; Trends and Risks in the Global Pension Fund Industry – With Implications for the Caribbean
(Presentation at the CAPS Conference, June 2016)4. E Philip Davis; Evolving Roles for Pension Regulators – Towards Better Control of Risk (2013)5. Kiel, Al, Audia Bacchas and Marcia Tam-Marks; Proposed Prudential Reporting Regime for Pension Plans in
the Caribbean; Caribbean Association of Pension Supervisors, (2016)6. Kiel, Al, and Audia Bacchas; Conversion from DB to DC Pension or Hybrid Plan and its Implications for
Pension Regulators – Caribbean Regulators (2017)7. Nicholls, S; Pension Funds and Financial Stability (2016)8. Rabelo, Flavio Marcilio; Comparative Regulation of Private Pension Plans9. Cass Business School, London, UK; Design and Delivery of Defined Contribution (DC) Pension Schemes -
Policy challenges and recommendations (2013)10. IMF WP WP/07/28 - Public Pension Reform: A Primer; Alain Jousten11. IMF Working Paper (WP/11/29); Stress Tests for Defined Benefit Pension Plans – A Primer; Gregorio Impavido12. IMF WP/16/206; National Insurance Scheme Reforms in the Caribbean; By Koffie Nassar, Joel Okwuokei,
Mike Li, Timothy Robinson and Saji Thomas13. IOPS Working Papers on Effective Pensions Supervision, No.19 - Stress Testing and Scenario Analysis of
Pension Plans; Liviu Ionescu and Juan Yermo, March 201414. OECD Core Principles of Private Pension Regulation (2016)15. World Bank Report No. 47673-LAC; Strengthening Caribbean Pensions - Improving Equity and Sustainability16. World Bank; Issues and Prospects for Non-Financial Defined Contribution (NDC) Schemes (2006)
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