The structure, regulation, and performance of pension funds in nine industrial countries

The author offers an overview of issues relating to the development of funded pension schemes in industrial countries. The analysis applies the economic theory of pension regulation to experience with the structure, regulation, and performance of funds in nine countries - Canada, Denmark, Germany, Japan, Netherlands, Sweden, Switzerland, the United Kingdom, and the United States - seeking to shed light on the finance of old age security in developing countries and the reform of pension funds in industrial countries. The main points of the analysis follow. Pension funds are either defined benefit or defined contribution. The individual bears more risk with defined contribution plans because the pension benefit depends on asset returns. Conceptually, defined benefit funds offer better employee retirement insurance. Private defined benefit pensions are generally available only through companies and typically include some restriction of labor mobility. Because of some shortcomings of fully or largely funded plans, especially for income redistribution, governments have chosen to maintain at least basic levels of pay-as-you-go social security. The scope of such unfunded social security schemes is the key determinant of the scale of private retirement savings. The extent to which pension funds are used as a vehicle for retirement saving depends on the regulatory regime. Tax advantages are the most important incentive, but a wide range of other regulatory choices also make pension funds more or less attractive to firms and employees. And some regulations, such as those affecting the portability of pensions, may have important consequences for economic efficiency. Though countries differ widely in their regulation of pension funds, some suggestions for good practice can still be made. Whether pension funds are a cost effective way of providing pensions depends on the real asset returns that can be attained, in relation to the growth of real wages. Ideally, there should be a gap of 2 to 3 percent between them. Portfolio distributions and fund management are the key determinants of returns to pension funds, subject to the returns available in the market. Prudent diversification in domestic and foreign markets and indexation of much of pension funds'portfolios both appear to be important. Pension funds affect capital markets in many ways. They influence market structure and demand for securities; stimulate innovation, allocative efficiency, and market development; and have a positive effect on overall saving. They may also have some deleterious effects, such as increases in volatility, short termism, and weakening of the control exerted by investors and creditors over firms. Prospects for pension funds in industrial countries vary with the maturity of existing funds and the generosity of social security benefits. In countries such as France, Germany, and Italy, growth in coming decades could be sizable. The key recommendations for countries that are just starting pension funds are for a mix of social security and private funds; for separate funding rather than book reserves; for defined benefit plans, subject to appropriate regulation; and for company-based pension funds.