GLOBAL - Pension fund governance and risk management needs to be improved to avoid exposure to risky assets and investments that are not fully understood the Organisation for Economic Co-operation and Development (OECD) has warned.

In a working paper on Private Pensions and Policy Responses to the Crisis the OECD noted the financial crisis had caused global pension assets to decline by around 20%, or $5.4trn (€4.2trn), by the end of 2008, which has placed pressure on defined benefit (DB) funding levels and reduced prospective retirement income for defined contribution (DC) members nearing retirement.

However, while the OECD recognised volatility in the markets had impacted funding levels it argued "some of the decline in assets recently experienced by pension funds around the world may well have been avoided through better pension fund governance and stronger risk-management systems".

It echoed earlier comments from the UK's Hector Sants, of the FSA, and Lord Paul Myners, financial secretary to the UK Treasury, who both blamed investors including pension funds for failing to actively engage as shareholders. (See earlier IPE articles: Myners want legal governance duty for managers and FSA attacks investors for not doing enough)

The report added: "Some funds seem to have been exposed to instruments whose risk profiles they did not fully understand. The current financial turmoil has therefore highlighted the importance of proper risk systems, controlling investments and other risks, which shows that sound risk architecture of pension funds is essential for their prudent operation and the stability of the financial system as a whole."

The OECD has also suggested pension funds and other institutional investors "may make a greater contribution to the stability of the financial system in future through greater shareholder activism".

That said, the report warned governments and regulatory authorities against over-regulating in response to the crisis as "short-term policy responses do not always strike the right balance and can have unintended consequences over the long-term".

Figures from the working paper showed the funding levels of DB pensions had fallen "well below 90% in most OECD countries", with the cover ratio in most Dutch pension funds down to below 95% despite the minimum regulatory requirement being 105%, while levels have slipped in the UK from 94% in 2007 to 85% a year later.

However, it argued to avoid forced scheme closures or employer insolvency, regulatory frameworks should be "robust and flexible" and continue to protect benefits while allowing measures including increased recovery periods and extra security relating to employer covenants, in conjunction with increased contributions in better economic times.

The OECD claimed "unless funding and solvency increases occur as market conditions improve, DB plans will remain endemically underfunded", though it argued against measures such as the deferral of levy payments being debated by the UK's Pension Protection Fund (PPF) as it suggested although "such flexibility may be warranted", analysis of guarantee schemes "stresses the need to ensure levies are properly risk-based in order for these funds to operate effectively".

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