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Risk Based Supervision And Interest Rate Guarantee

On January 1, 2004, Government of India has introduced the New Pension Scheme (NPS) for the new entrants to the service of the Central Government (other than Armed Forces). NPS is a Defined Contribution Scheme (DC Scheme). The contribution rate is 10 per cent of the gross salary for the employee: the employer would also make an equal contribution to the employee’s individual pension account. There would be no pre-retirement withdrawal. The member has the option to allocate the fund among a limited number of investment schemes. At age 60, the accumulated amount would be divided into a compulsory annuity component and a lump sum withdrawal component. The sum that the pensioner would receive as pension or as lump sum post retirement money would depend on the yield rate of the scheme(s) the individual had opted for. The investment in mutual funds increases the risk along with increase in return possibilities.

It was made operational for Central Government employees from 1st April 2008. Besides the Central Government, 22 State Governments of India have introduced the NPS. The NPS architecture has been in operation for over a year now and NPS corpus of Central Government employees amounting to over Rs.2100 crore stands invested in it. This does not include State Governments corpus yet, but they are also joining it soon. In addition to it, the scheme is also open for other citizen of country from 1st May 2009 onwards. Therefore, a huge amount of money is going to be invested in mutual funds on a regular basis through NPS. The investment is expected to grow exponentially and soon it will capture major portion of the total corpus of Indian Mutual Funds Industry.

1.1. Historical Background

The evidence of the old tradition of pension as a social security in India can be traced to 3rd Century B.C. Kings granted 50% of the wages to the workers after they have reached the age of 40 years. Since then, the social security system took different forms depending upon the demographics and practices followed by the kingdoms. In 1881, the Royal Commission of Civil Establishments introduced the civil service pension benefit system for the Government employees. The Provident fund system, as alternate form of social security was then extended to public sector employees through Acts of 1919 and 1935. After Independence, the coverage was further broadened by introduction of Coal Mines Provident Fund Scheme of 1948 and Employees Provident Fund and Miscellaneous Provisions Act (EPF and MP Act). In 1972, the Payment of Gratuity Act was passed, which provide lump sum payment for faithful continuous service in the organization.

1.2 Fiscal Burden

The Pension system provided in India was Defined Benefit type, which is a non-funded pension. This is also called PAYG (Pay-as-you-go) system, funded by Government Tax Collections and causing an increasing financial burden on Central and the State governments. The pension expenditure of Central Government increased from Rs.32.72 billion to Rs.211.17 billion during 1990-91 to 2000-01, with a growth rate of more than 20%. In the year 2001-02 the pension liability of the Central government was Rs.224 billion, which is 9.7% of the governments’ total revenues and 1% of India’s GDP.

The sharp increase in the fiscal burden is based on the following factors: -

Inflation indexed pension.

Salary structure of pension changes with serving employees.

Increasing life expectancy: -The population of elderly people (60 years or more) in India is expected to increase by 107% to 113 million by 2016 [1] .

1.3 Pension Reform (DB to DC)

The rising fiscal deficit due to population aging and increasing pension load due to inflation indexation and pay commissions, made it financial unsustainable for the government to continue with non-funded defined benefit system. In addition, the following deficiencies of old age DB pension and other PF schemes are not able to solve the main purpose of providing social security to every needy person.

Poor Coverage (nearly 10% of the total working population)

Low rate of return on PF funds

Restrictive Investment Regulations

Poor Administration

Underdeveloped private annuity market

To tackle these growing issues, the first initiative for reform process was started in 1994, when Malhotra Committee suggested opening up of insurance sector to private players. The opening up of insurance sector introduced new players in the private sector market, as the private sector business is part of the life insurance business in India. Subsequently, Old Age Social and Income Security Project (OASIS Project) provided a detailed plan for New Pension system based on the Individual Account system. The scheme made operational w.e.f. 1st January 2004.

The New Pension System has Individual Accounts of every person who is enrolling in the scheme. Private or unorganised sector employees can also open their accounts. All the accounts of the Government and the private employees are treated as same from the point of view of investment and costs associated with it.

The New Pension system can handle the above mentioned problems in much efficient way. The introduction of private pension fund managers will ensure the large-scale diversification of the investment savings. Diversification of funds will reduce the risk and the efficient management would increase the rate of return on the savings, which would lead to a higher rate of capital accumulation

1.4 Need for the Study

The investment under NPS, which has an equity component, is expected to perform better because, as the past records indicate (barring recent recession of 2008-09), return on equities is much higher than any guaranteed return scheme. In India, equity indexed returns data is available for 28.5 years. The nominal rate of return on index fund is 18.5 per cent. The financial experts think that over next thirty years, the inflation might be around 3 per cent; short-term government bonds might yield around 4 per cent and index fund might yield roughly 12 per cent. A superior return on equity indexed fund, as they say, is thus assured. There would therefore be a strong opinion in favour of the NPS among a large section of the informed people. As they plan for their retirement, they would strongly support the new scheme. The NPS is therefore expected to become popular among income earners in India in near future.

The default portfolio in NPS is however playing safer side, the equity share is kept at a very low level (maximum is 50% below the age of 35 years upto 0% at the age of 60 yrs.), which reduces the possibility of substantial returns, defeating one of the main purpose of investment in the capital market. The early 2004 recruits who will get Pension under Defined Benefit system will anyhow get more benefit than Defined Contribution scheme (NPS), as they will get full PF refunded with interest at the time of superannuation, in addition to monthly pension benefits, which cannot be compared with the benefits in the Defined Contribution Scheme (NPS). Higher return on Pension funds in NPS is the only way to make it somewhat comparable with the DB Scheme.

The estimation of the future returns on stock depends upon the overall economic health of the country and the world, which is not easily predictable. The recent financial crisis of 2008-09 is the latest example of such an uncertainty. The financial crisis has dramatically demonstrated how a collapse in equity prices can decimate retire­ment accounts. The crisis highlights the fragility of the Defined Contribution Pension plans, which is the major supplement to Social Security and has sparked proposals to reform the retirement income system. Shareholders lost more than 70% of their money in the Indian stock market and the situation was worse in United States and other Western countries. If a person were going to retire just after the financial crisis, his reduced pension account would result in considerable loss of the pension annuity. Further, if the recession takes the form of depression in exceptional cases, the stock market will not be able to come out of the trap in just one or two years. It may take many years for the stocks market to turns its direction again in these worst situations.

This unpredictable economic uncertainty derives the requirement of some guarantee on the returns of pension funds. Pension is fulfilling the requirement of basic need in the old age, which is also the basic purpose of Social Security System. Therefore, it is required that the rate of return on pension funds should have a certain minima cap to protect the only regular retirement support for the employees.

Many Latin American Countries including Mexico and Netherlands have adopted this downside risk ceiling in pension funds [2] . In India this system is neither adopted, nor there is any research done in this area as Defined benefit (NPS) is a very new system in India, its pros and cons are still not clear in Indian context. But this study for downside risk ceiling will definitely help New Pension System to be a successful social security measure for Indian work force. In addition to this, there is a need for Risk based supervision system followed in these countries.

Chapter II


The Project OASIS Report, 2000 [1] discussed about the growing concern of population aging in India resulting in increasing burden on fiscal deficit. It highlights the existing provisions of pension for Government employees and other mandated provisions from organised sectors. The unorganised sector is left with only PPF for some means of old Age security. PPF is successfully adopted by the unorganised sector employees but it matures in 15 years, which is inadequate for generating meaningful accumulation for the old age security for younger workers. This report has recommended a new pension system that can cover the working population of all the sectors by giving the modest contributions.

The Poirson[2], in IMF working paper draws lessons from international experience on the financial market implications of India’s Pension funds. The Indian NPS broadly seems to be comparable with the International parameters of the best privately managed systems in other countries. It raises the questions on the faster critical mass coverage through NPS. It emphasises the requirement of flexibility in regulatory structure for investment in foreign financial market to diversify the country specific risk.

Regulation in Pension Funds

Berkowitz, Finney & Logue [3] surveyed that investment performance of pension funds is systematically poorer than that of mutual funds. This is despite of the fact that in some cases same fund managers are taking decisions on their pension and mutual funds. Difference is coming out of the fact that the pension funds are more regulated that mutual funds. This strengthens the issue of flexibility in regulatory standards raised by Poirson in IMF paper.

Harold Skipper [4], explains the importance of strong fiscal policy that fosters the economic growth and well established and efficient financial markets as a prerequisite for a good Pension system. In addition to it, in funded system of pension the risk is further inherited in capabilities of fund managers, types of the investment funds, incompetence of the advisors, annuity pricing mistakes, employees ignorance, etc. This supports the concept of strong regulation, regular audits and tight control of the whole process. But strong regulatory standards lead to sluggish growth in the IA savings. The fiscal instability is highlighted as the biggest enemy of any type of savings and investments. Both PAYG and funded system is affected by the fiscal instability. The risk of fiscal instability in beard by the government in case of PAYG system but in funded system the load comes to the individual account holder. The fiscal stability on any country or the world can’t be certified for a long periods. There must be some measures designed to offload the IA accumulations in funded system from the large and unpredicted fiscal instabilities to save the hard earned savings of the employees.

Before the recent financial crisis everybody was arguing against the strong regulatory standards of pension systems. This worldwide economic crisis crashed the stock markets all over the world. Some highly flexible DC Pension system having significant proportion of investment in equity market got affected very badly. As studied by Berstein [1], the retirement savings in Individual Accounts has decreased in almost all of the countries where DC pension system is in operation. In Ireland the retirement savings upto 35% is wiped off during the year 2008. The pension system of very few countries have shown positive return on pension investments, due to greater restrictions in equity investments.

The concern for some guarantee in New Pension System has increased since recession. The requirement of downside risk safety and risk based supervision of the IA savings is arising more than getting higher returns. The utilization of Risk-based supervision methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries including pension funds and insurers. The trend toward risk-based supervision of pensions is closely associated with the movement towards the integration of pension supervision with that of banking and other financial services into a single national authority. Gregory Brunner, Richard Hinz, Roberto Rocha examined a range of countries, which provide a series of experiences that illustrate both the diversity of pension systems and approaches to risk-based supervision, but also a commonality of the focus on sound risk management and effective supervisory outcomes. Pension supervision system in Australia, Denmark, Mexico and the Netherlands are described and an initial evaluation of the results achieved in relation to the underlying objectives, which may help in designing a robust Supervision system for Indian Pension System.

Rate of return Guarantee:

Lachance & Mitchell, 2003 [6], describes about the Guarantee to the returns on Individual Accounts designed to protect IA investments. This guarantee system is adopted in some Latin American Countries, Japan and Germany. Guarantees can be designed to protect the Pension investors from market risk, but different costs are associated with different levels of guarantees. The cost also depends upon the portfolio of investment in equity & bonds. The guarantee cost can be fully avoided if the investment of entire IA portfolio is in bonds. There is moral hazard problem of choosing the more riskier strategy by the IA holders. This problem can be mitigated by restricting the guarantee based on the return on the standardized portfolio irrespective of the individuals’ portfolio positions. There are two ways of financing the guarantee. Government may finance the guarantee through PAYG system (Tax collections) or individual participant can purchase the guarantee as per his willingness or requirement.

The guarantee cost is the price charged by the market to provide the guarantee payments. This market cost can be obtained by using an option-pricing technique called risk-neutral valuation. The cost of alternative pension guarantees can be estimated by varying the guarantee design, the investment portfolio, and the investment horizon. The impact of guarantee design on cost can be evaluated by contrasting a principal guarantee with a bond guarantee. The former provides for the return of the contributions without interest (i.e., zero return), and the latter reflects a 10-year Treasury-bond portfolio [3] . Two alternative investment portfolios in the Individual Account can be considered: either half stocks and half bonds, or all in stocks.

Sharon S. Yanga, Meng-Lan Yuehb, Chun-Hua Tang [4] have analysed the values of guarantees in the DC plans. Employees with a DC plan bear the investment risk, because the retirement benefits depend on the performance of investment portfolios. To avoid the downside risk for the employee, some guarantee should be provided with DC plans, the cost of which normally is covered by the pension plan provider. Estimating the value of the guarantee is very important for the pension plan provider to set its budget, because a poor estimation may cause it to suffer significant financial problems. They derived formulae for valuation of minimum guaranteed rate of return for a DC pension system. The guaranteed rate in the formulae is linked to the δ-year spot rate. The payoff is the function of exchange option. Margrabe’s option pricing approach is used to derive the general pricing formulae with the assumption that the asset prices follow a geometric Brownian motion. This formulation can be utilised to determine the interest rate guarantees for Indian New Pension system.

Robert C. Merton and Zvi Bodie (1992), mentions that the efficient management of implicit and explicit guarantee is critical to success for every financial intermediary. There are essentially three ways to provided guarantee against the default risk: -

By putting additional capital beyond the required investment limit. That additional capital will cover the basic investment fund and insure it by providing the necessary guarantee.

By purchasing guarantees by third party. This approach works best when the risk can be hedged in the capital market as in the case of stock market or interest rate risk.

Through Government guarantees, where the risk cannot be diversified or hedged through the capital market.

The guarantor has to follow the three methods to be manage its business on a sound basis:

Monitoring: -The assets of the insured party has to be frequently marked to market and to be seized as soon as the net worth falls below the predetermined maintenance limit.

Asset Ristriction: The insured party has to hedge the assets and limit the volatility of the net worth.

Risk based Supervision: Guarantor charges fee that is in proportion to the riskiness of the asset it guarantee.

Chapter III


Objectives of the research

Based on the research topic, the following objectives of research are identified: -

To determine a Risk Based Supervision system for Indian New Pension Scheme.

To determine the minimum returns ceiling limit on the Pension Funds in New Pension Scheme.

To determine the cost to guarantee the return on Pension Funds?

Research questions

To determine a Risk Based Supervision system for Indian New Pension Scheme.

What factors influence the risk of investment in DC Pension Funds?

What are the main components of Pension Supervision.

To determine the minimum returns ceiling limit on the Pension Funds in New Pension Scheme.

What factors to be taken into consideration while determining the minimum return ceiling limit (Valuation of interest rate guarantee)?

What should be the structure of minimum return guarantee?

To determine the cost to guarantee the return on Pension Funds.

What are the methods of stabilisation of returns on Pension funds?

What is the relation between the level of guarantee to the cost of guaranteeing a pension fund?

Research Hypothesis

Based on the Research Objectives and Questions, the following Hypothesis has been defined:

Complexity of Financial Instruments & markets increased the risk of investment in DC pension Scheme.

Lack of knowledge to Investors & scare supervisory resources increased the risk of investment.

Designing a proper Risk Based Supervision system for NPS will reduce the negative fluctuations in pension funds.

It is practically feasible to decide a minimum return ceiling on Pension Funds.

The Maturity-Guarantee is better than the Multi-Period Guarantee system.

It is overall economical to have Guarantee on return, by paying some cost for it, than to have a Pension fund without guarantee.

Theoretical framework

Risk base supervision: -In order to examine the way pension supervisors should address the supervision challenge, the following table is considered that identifies the three main groups of players involved in the overall architecture of risk management [5] .

The Basic Risk Management Architecture

For the institution:

Risk management strategy

Board committees

Risk management functions in the managerial structure

Internal controls

Reporting responsibilities

For the supervisor:

Regulations, including minimum risk management standards

Risk-based solvency rule

Risk scoring model guiding supervisory actions

Internal organization of the agency, with specialist risk units

Market Discipline:

The contribution of the actuary, auditor, fund members, rating companies, and market analysts to sound risk management

One of the main objectives of risk-based supervision is to ensure sound risk management at the institutional level. As indicated in the left box of above figure, the capacity of the institution to identify, measure, and manage all the relevant risks, would be reflected in the presence of a sound internal architecture of risk management that includes a reasonable risk management strategy, evidence of Board involvement in risk management, the existence of risk management functions performed by competent, independent, and accountable professionals, and proper internal controls.

The supervisory toolkit broad includes the regulations issued by the supervisor, including direct regulations focused on the risk management architecture and risk management procedures, a risk-based capital rule, and a risk-scoring model that guides supervisory strategies and procedures. Finally, the third group of relevant players includes those market participants, which may contribute to market discipline and the adoption of sound risk management practices by the institutions. The role of some of these players depends on regulations issued by the supervisor as well.

Brunner, Richard Hinz, Roberto Rocha has identified the following factors influencing the risk of investment in the DC Pension funds, which can be done in Indian Context also:

Insolvency of DC plans due to sudden & adverse price movements.

Loss to members of DC plans due to adverse movements in asset prices

Increasing complexity of financial instruments and markets.

Scarce supervisory resources, etc.

Main Components of Risk-Based Supervision in these Four Countries are identified as:

Requirements for the Internal Risk Management Architecture

Risk-Based Solvency Rule

Risk Scoring Model

Role of Market Discipline/Disclosure

Organization of Supervision Agency

Brunner, Richard Hinz, Roberto Rocha has done study for four different countires and identified the factors, which influence the risk of investment. Main components of Pension system are also worked out for those countries based on their regulatory system. The factors of risk are then evaluated on the basis of the supervision components. The Similar study is can also be done for Indian Context and the Pension supervision can be worked out for NPS.

Minimum Guarantee

Rate of return guarantees consists of two fundamentally different types. A maturity guarantee is binding only at the expiration of the contract and ensures a minimum pension payment to the participants in the contract, whereas a multi-period guarantee works on a periodic basis and secures a periodic return not less than a guaranteed minimum return. We consider both maturity and multi-period relative rate of return guarantees herein. In particular, we analyse the value of the relative rate of return guarantee on a defined contribution scheme, according to which a fixed proportion of a participant’s wage is assumed to be credited to an underlying investment portfolio.

Interest rate guarantee can be valuated, which is linked to the δ-year spot rate, as done by Sharon S. Yanga, Meng-Lan Yuehb, Chun-Hua Tang. The payoffs of interest rate guarantees can be viewed as a function of the exchange option. By employing Margrabe’s option pricing approach, we derive general pricing formulae under the assumptions that the interest rate dynamics follow a single-factor interest rate model and the asset prices follow a geometric Brownian motion. The volatility of the forward rates is assumed to be exponentially decaying. The formula is explicit for valuing maturity guarantee. For multi-period guarantee, the analytical formula only exists when the guaranteed rate is the one-year spot rate. The accuracy of the valuation formulae is illustrated with numerical analysis. We also investigate the effect of mortality and the sensitivity of key parameters on the value of the guarantee. We find that type-II guarantee is much more costly than the type-I guarantee, especially with a long duration policy. The closed form solution provides the advantage in valuing pension guarantees.

The relative rates of return guarantees linked to the market δ-year spot rates is analysed and two methods for crediting the guaranteed rate to the pension fund are considered. If the guaranteed minimum rate is binding only at the expiration of the contract, it is called as maturity guarantee and referred as a type-I guarantee; if the guaranteed minimum rate of return is binding for each period, it is a multi-period guarantee or type-II guarantee.

R Maurer, C Schlag has described a method to stabilise the returns on the investment thereby guaranteeing the returns [6] . A shortfall expectation formulation is used as an intuitive way of measuring the shortfall risk, which connects the probability and the extent of the conditional shortfall. Next the “Calibration” is done to quantify and compare the shortfall risk. To gain the information about the relevant risk measures, an ex ante approach of is employed imposing and exogenous structure on the probability distribution governing the uncertainty of future asset returns. With such a model, it is possible to look into the future and compute the risk measures in which we are interested. The results for the development of the shortfall probability of the saving plan using stock and bond saving funds over time imply that the risk of not maintaining nominal capital decreases monotonically with an increasing investment period for bond and stocks. It is also identified that the dynamic strategy is the best strategy (switching between stocks and bonds) in terms of maintaining the returns over a long period of time.

Cost to Guarantee

Munnell, Golub-Sass, Kopcke and Webb studied the relation between the level of guarantee and the cost of guarantee. US historical data has been used to find out the relation. The results reveal that a 2-percent and 3-percent guarantee would never have required any payments. The reason is that, over the period under consideration, a portfolio fully invested in equities never yielded less than 3.8 percent aver­aged over an individual’s work life. A 4-percent guar­antee would have required payments in three years out of the 84 years; a 5-percent guarantee would have required payments in eight years; and a 6-percent guarantee would have required payments in 27 out of the 84 years. Similar type of study can be done in Indian Context also, which can reveal the long-term relation between the cost and level of guarantee. Although the period for which the data is short than that data used in the above study.

Information Needs

Based on the Research Objectives and Questions/Hypothesis, the following information would be required: -

Literature available for different types of Risk based Supervision Systems adopted in countries worldwide for minimizing the risk of investment in Pension Funds.

Experience of different countries providing the minimum return Guarantee on pension schemes. The modifications made thereafter for improvement.

The present Regulation standards used for New pension Scheme is required to assess the level of restrictions and flexibility available with NPS in terms of investment & handling of Pension Funds.

The Fund Manager’s History of performance in terms of risk taking & returns provided on investments. Information related to portfolio of investment and daily NPV since the inception of Fund Manager.

The Year wise investment details of total Assets Under Management. The major sectors of investment and the risk profile of the Company/Industry where the investments are made.

The details for NPS accounts are required for no. of account holders in each year, data for the fund amount investment each year and their portfolio, data of Compulsory and Voluntary accounts.

Expert views and comment on terms of present New Pension system by financial expert.

Data collection approach

Primary Data: -The primary data would be collected through specially designed Questionnaire for the focus group who is doing research in the same field, financial experts, etc. The data may be collected through personal interview (wherever possible), sending questionnaire through e-mail or interview over phone.

Secondary Data: -This research mainly depends upon the secondary data. The analysis of the fund, risk of the investment, etc. can only be calculated by the figures and facts of the past data. Studying similar type of research, its success and failure parameters can be judged by analysis of its past data where it was implemented. The Guaranteed return Pension system is already followed by many countries, studying their performance based on the available records and literature will give a reasonable idea for design and implementation of that system in Indian context. Many institutes, like Center for Retirement Research, Employee benefit research institute Washington, etc working in the same field are using the secondary data analysis for there research works.

Instrument for data collection

The following data collection instruments would be used: -

Previous Researches available in the electronic form.

Electronic and hard copy Journals.

Manuals and instructions issued by PRFRA and other International regulators on their official websites.

Questionnaire for Interview.

Website would be used for collecting funds performance related data, etc.

Data analysis plan

The data received from various sources are not fully useful, may be wrong or corrupted. Data usually contains many other information, which has to be clean out before use. The editing is therefore required in the initial stage before using the data for analysis. After editing the data, the type of the measurement (domain type) is identified and recorded in the data collection application.

For calculating the risk in any fund type or investment option, SPSS software would be used be utilized for regression analysis of the data for calculating various statistical parameters like Standard Deviation, degree of relation of return on investment (as a dependent variable) with the independent variables like GDP growth rate, inflation, industry growth rate, etc. The minimum guarantee ceiling would be calculated based on the Standard Deviation of the best fund portfolio identified.

AHP application would be used for finding the best fund manager and the best portfolio option available based on the data analysis done before and Primary data collected. Finally AHP would be used for the proper selection of the Risk based Supervision system for NPS.

Similar to other financial sectors, Pension supervisory authorities are also moving towards the risk based approach to pension supervision. Risk based supervision is a structured process which identifies the most critical risks faced by pension funds. Risk based regulation allows broader range of investment options than a strict rules based regulation approach (even if there are some quantitative limits and asset eligibility criteria). In Risk based supervision, most of the responsibility for managing the risk lies with the Fund Managers, the supervisory authorities just keeps an eye on the quality of the fund’s risk management process through routine checks.

OECD has given some guidelines regarding the risk-based management of Pension funds. It states that the risk management system of pension funds should evaluate the investment, governance and operational risk, in addition to internal reporting and auditing mechanism.

OECD Guidelines on the Licensing of Pension Entities (OECD 2008) elaborate on the topic of risk management and the procedure that contribute to sound corporate practice and also helps in establishing risk measurement and management system for licensing the pension entities. OECD Guidelines for Pension Fund Governance (OECD 2009) also addresses the requirement of risk based internal and auditing for efficient risk based governance. The International Organisation of Pension Supervisors (IOPS) has also given guidelines for Supervisory assessment of Pension funds.

Risk Management systems

The requirements of the risk management systems are more or less similar, internationally. OECD working paper on Pension Funds’ Risk Management Framework [7] elaborates these risk management guidelines given by different financial experts which are assessed together and explained in four broad categories.

Management oversight and Control Culture

Broad responsibilities

Organizational structures

Control Culture and code of conduct

Assessment of risk and strategy

Risk Strategy

Organisational risk management

Investment Strategy

Control systems

IT systems

Monitoring systems

Internal Audit

Performance Measurement and Compensation Mechanisms

External Controls

Information, Reporting and Communication

Information and reporting


Management oversight and Control Culture

Broad responsibilities

The board of Governors of the Pension fund defines and implements the strategy for risk management system. The Board should continuously monitors the effectiveness of the risk management strategy, identify the shortcomings and take corrective measures immediately to improve the system. The Boards requires that complete and unaltered information should reach it.

Another control function of the Board is to clarify and distribute the responsibilities of decision-making, execution and other functions to the divisions down the line.

Organizational Structure

The successful operation of risk based management system is also dependent on the size and scope of the organization. A large organization requires a number of committees, which can help the board in taking the decisions. These committees are audit committee who looks after the financial reporting and internal control systems, Risk Management committee headed by Chief Risk Officer, Compensation Committee, and Compliance Committee etc.

The functions and the responsibilities of the Risk Management system must be properly documented, clearly defined and well communicated to all the committees and its staff members.

A well-defined organizational structure for pension funds must have the following: -

Well establish & effective cooperation, flow of information at all levels within the organization.

Properly defined documentation of responsibility.

Sufficient experienced, qualified and knowledgeable management.

All staff members must be well informed about the their responsibilities and expected output.

Multi task by staff should not affect that persons’ ability to discharge his individual tasks properly and professionally.

Record maintenance must be proper and in order.

Confidentiality of the work and information must be maintained wherever required.

Risk management functions should work properly with timely compliance.

Proper record keeping, asset management, financial education and disclosure to the customers, asset liability management functions must be clearly assigned and monitored.

Control Culture and code of conduct

Governing Board has to ensure that the risk management system is in place and working properly as well. It requires strong internal control and feedback system within the organization. Board should set an example by itself to follow the risk management culture, which lead other down the line to adapt the same culture code of conduct. An organizational code of conduct, policies and practices must be designed in a way to avoid tantalization to do unfair activities while performing duty.

Assessment of risk and strategy

Risk Strategy

Organisational risk management

Investment Strategy

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