Pension Fund Management: Implications For Sound Financial And Economic Management

1. Pension Fund Management: Implications For Sound Financial And Economic Management By M. K. Ahmad Director General National Pension Commission

2. Outline • Characteristics of Pension Funds • Pension Fund Management • Impact on Financial and Economic Management • Lessons from Nigeria

3. Characteristics of Pension Funds • Sponsorship of Pension funds • contribution by employers and/or employees • wholly by employers • Pension Funds as Institutional investors: • collect, pool and invest funds for future pension entitlements of beneficiaries • ensure sound financial and economic management through financial intermediation, which affect financial markets in particular and economic activity in general

4. Characteristics of Pension Funds …Cont’d • Returns to members of pension plans • may be purely dependent on the market or may be overlaid by a guarantee of the rate of return by the sponsor • Portfolio diversification to mitigate against risk: • spread of domestic securities • international investment • Pooling of risk for small investors • Long term liabilities allowing holding of long-tenured and high yielding instruments

5. Characteristics of Pension Funds …Cont’d • Ability to absorb and efficiently process information on capital market operations • Large size and thus economies of scale, which result in lower average cost for investors • The countervailing power of pension funds that is often used to reduce transaction costs and custodial fees

6. Pension Fund Management • Pension Funds are managed by: • Pension Fund Administrators – take investment decisions • In some jurisdictions, pension fund management can be by asset management and insurance companies • Some management decisions may be the responsibility of Boards of Trustees in some corporate organisations • Pension Fund Custodians – keep custody of pension funds • Custodial services may be provided by Central Banks in some jurisdictions • In the UK, Pension Protection Fund provides compensation to contributors where employers become insolvent

7. Pension Fund Investment... Cont’d • Regulations required to promote both the performance and the financial security of pension assets • Regulations of pension funds require • the appointment of a custodian, depository institution or trustee • standards of conduct and minimum suitability of the operators of pension funds • the rights of investors to withdraw funds • the right of investors to full, timely and accurate information disclosure

8. Pension Fund Management … cont’d • The main goals of pension investment are to: • Ensure adequate, affordable and sustainable benefits to contributors • Secure safety & security of funds • Ensure adequate liquidity to pay all pension benefits of contributors as and when due • Achieve an optimal trade-off of risk and return through strategic asset allocation

9. Pension Fund Investment … cont’d • Risk Management for pension assets established on • Quantitative limits: maximum limits for individual, class or class of mix assets • Principle of Prudent Man - the preservation of capital, while obtaining a reasonable income • Benchmark: indicator of market, sub-market or a mix of assets commonly traded and used as a point of reference

10. Pension Fund Management... Cont’d • In practice, 60% of pension funds invested in local markets • Foreign investment might not overcome collective systemic risks to world capital markets • Investment of pension funds in international market • International diversification may reduce risk since shocks to equity markets tend to be country specific

11. Impact on Economic Management • Pension funds can have positive impact on the economy through: • generation of savings that leads to capital accumulation and hence promotes investment • transfer of resources in favor of long-term assets would have significant impact on GDP growth • Shift to long-term assets tend to reduce the cost of capital and increase the availability of equity and long-term debt financing to companies, and hence promotes growth

12. Impact on Economic Management ... Cont’d • Increase in capital investment and labour productivity • Development of labour intensive, low productivity “informal sector” to a capital intensive, high productivity “formal sector” • Availability of long-term financing will simplify government deficit financing through the issuance and purchase of government securities

13. Impact on Economic Management ... Cont’d • Promotion of infrastructural development • Development of other institutions • Insurance • Annuity • Life insurance • Rating • Mortgage • REITs

14. Impact on Financial Management • Development of the Capital Market • Increased demand for new investment outlets would stimulate innovation and development of new long term instruments • Increased market integrity/transparency and corporate governance • Re-enforcement of Improved regulation and supervision of the market and its efficiency • Creation of domestic institutional investors (PFAs/CPFAs), with long term focus, would moderate stock market and price volatility • Trigger the modernisation of capital market infrastructure such as clearing and settlement

15. Impact on Financial Management ... Cont’d • International portfolio of investment • risk reduction to pension funds • reduction of volatility of returns • Qualitative developments in the financial markets • financial innovation • development of corporate bonds market • development of indexed instruments • better accounting and auditing • better information disclosure • Efficient provision liquidity and price formation

16. Lessons from Nigeria • Rationale for Pension Reform • Defined benefit (DB) – Pay As You Go (PAYG) • Largely dependent on budgetary provision for funding • Unstainable pension liabilities • Weak & inefficient administration • Demographic shifts and ageing make DB schemes unstainable • Low compliance ratio due to ineffective control & regulation • Many workers in the private sector were not covered by any form of retirement benefits arrangement • Existence of diversified arrangements which were largely unregulated in the private sector Public Sector Private Sector

17. LESSONS FROM NIGERIA … Cont’d • Characteristics of the Contributory Pension Scheme in Nigeria • contributory: Contributions by both employer and employee • fully Funded: Funds set aside for retirement • individual Accounts: Nature of the account, portability and withdrawals (Lump sum, Annuity & Programmed withdrawal) • privately managed: by PFAs, CPFAs and PFCs • life Insurance Cover • coverage and exemptions • strictly regulated and supervised by PenCom

18. LESSONS FROM NIGERIA … Cont’d • Pension Fund Investments managed by two institutional investors • Pension Fund Administrators • Closed Pension Fund Administrators • Investment Instruments • subjected to both quantitative and qualitative regulations • all instruments must have rating grades as stipulated in the Regulations • rating carried out by Risk Rating Institutions • performance benchmark stipulated for each asset class

19. LESSONS FROM NIGERIA … Cont’d • Securitization & Listing • Pension fund investments assets must be securitized and listed for trading on the floor of the NSE or Electronic Platform of MMAN • Pension Fund Assets: • Generated pool of long term investible funds for the first time in Nigeria • The industry has approximately N679.55 worth of assets as at 31 October, 2007 • RSA assets – N159.05 billion • CFPA assets – N195.01 billion • AES assets – N325.50 billion

20. LESSONS FROM NIGERIA … Cont’d • Quantitative limits and performance benchmarks stipulated • Assets invested in various instruments - FGN and State Governments’ securities, equities, money market instruments, mutual funds, corporate debt instruments • Offshore investments and derivatives are future developments

21. LESSONS FROM NIGERIA … Cont’d • Development of other institutional operators: • Enhancement of the skills of rating agencies • Development of mortgage industry • Development of insurance industry • Provision of group life insurance policies • Developments of annuities market • Anticipated fall in premium rates • Provision of statistics for national development • National databank • Pensioner verification exercise

22. Thank You! National Pension Commission Plot 174, Adetokunbo Ademola Crescent Wuse II, Abuja 09 – 4138736 – 40 info@pencom.gov.ng www.pencom.gov.ng