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Annuities and Other Retirement Products
decentralized providers incur. The main disadvantages are the potentially weaker incentives for product innovation and operational efficiency that may result from compulsory participation and monopoly market positions.23 With public ownership or extensive public regulation, there is also a high risk of extraneous interference in annuity pricing and asset management. Such interference may well result in transferring the investment and longevity risks back to the state. However, because of scale economies, decentralized markets veer over time toward oligopolistic structures that negate their innovation and efficiency advantages. Recent progress in several countries in adopting robust governance safeguards and high levels of transparency for their public pension funds strengthens the case for the centralized provision of lifetime annuities, meeting at least some of the retirement needs of pensioners.24
Creation of Robust and Effective Prudential Regulation and Supervision Another major challenge concerns the creation of a robust and effective prudential regulatory and supervisory framework for the providers of retirement products. The framework should involve risk-based supervision rather than a checklist of rule compliance. It should also rely on riskbased solvency rules that specify solvency capital requirements on the basis of the asset and liability risks borne by providers. Providers of retirement products should be able to price their products freely and use mortality tables that are most appropriate for their own clientele. Any regulated parameters should be kept up to date by frequent validation and revision and should use market-based criteria to minimize persistent biases in pricing and selection. Providers of retirement products should be allowed to offer all types of retirement products, avoiding the market segmentation that has been prevalent in Chile. However, the institutions involved should be required to maintain separate accounting data for different products, distinguishing clearly between products with and without guaranteed benefits and avoiding cross-subsidization among different products. Strict regulation of risk management should also be introduced, requiring providers of retirement products to maintain adequate levels of technical reserves and risk capital and regularly apply rigorous stress tests to their various products, depending on the allocation of investment and longevity risks. Clear rules should apply to the valuation of assets and liabilities and to the capital buffers that would be needed to cover the financial impact of asset and liability mismatches. These issues are challenging