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# **I. INTRODUCTION**

Over the past several decades privately managed pensions have evolved from their origins as a supplemental form of deferred compensation to become an important, and in some cases central, element of social insurance systems. Their supervision has made a similar transition to meet the requirements of this new role, evolving from an initial emphasis on ensuring compliance with tax laws and labor contracts and relatively simple methods to limiting investment risk, towards a much more comprehensive approach designed to ensure proper management of all the risks associated with complex institutions relied on to provide secure sources of retirement income.

The wave of innovation and reforms in Latin America and Central and Eastern Europe beginning in the early 1980s transformed pension funds from primarily employer sponsored defined benefit (DB) arrangements into more diverse forms including most significantly the emergence of special purpose financial intermediaries operating on a defined contribution (DC) basis. This largely removed the capacity to rely on employers to guarantee outcomes placing financial risks squarely on the shoulders of members. This transition shifted the nexus of supervision from controlling agency risks to managing systemic financial and operational risks. Initially the new supervision regimes were based on simple portfolio limits with very pro-active compliance enforcement. Bounding downside risk over short periods through investment controls was the primary concern. The risk-return efficiency or effective capital allocation were very secondary considerations.

By the beginning of the new millennium several factors combined to accelerate these changes in supervision methods. Private pension funds in a number of countries accumulated asset levels exceeding those of more traditional financial institutions, in some cases more than 100% of GDP, leading to a commensurate increase in attention to their systemic importance. A “perfect storm” of rapidly declining interest rates coincident with collapsing equity prices exposed the fragility of the loose funding requirements for the remaining DB schemes. Concerns about the capacity of the new DC plans to produce adequate levels of retirement income also focused attention on the efficacy of their design and operation. This led a number of countries to begin to adopt supervision systems based on various risk-based approaches that established new standards for the operation of pension funds and guided the conduct of their oversight activities.

The objective of this paper is to review the experience in four of the pioneers in developing risk-based supervision for pension funds: Australia, Denmark, Mexico, and the Netherlands. These countries each have large well established pension systems that provide a useful initial review because they constitute a representative sample of the characteristics of pension systems worldwide, including occupational and open pension funds as well as both defined benefit and defined contribution arrangements. The paper draws on individual country studies that form part of a joint project of the World Bank and the International Organization of Pension Supervisors (IOPS), as well as discussions with pension supervisors and market participants in these countries. The reader is referred to the case studies for a more detailed analysis of individual countries.<sup>1</sup> The paper is structured as follows. The second section reviews the origins of riskbased supervision in banking and insurance, and the progress that has been achieved in developing further the risk-based approach under the Basel II and Solvency II