COSTA RICA: The Outcomes- and Risk-Based Supervision Approach in Pensions
In 2013, the Costa Rican pension system was growing steadily in volume and complexity; to sustain stability, the legal and regulatory frameworks that defined the system required reforms. There were over 2.5 million individual entitlements, with coverage for the population of 4.8 million, which was high relative to regional comparators*, and a rapidly growing asset base that exceeded US$14 billion, over 26 percent of GDP in 2014.
The Superintendencia de Pensiones (SUPEN; Supervisor of Pensions), established in 1995, is responsible for regulating and supervising all pension funds and pension plans and for protecting the system’s stability and participants’ benefits. The expansion of Costa Rica’s private pension system in recent years has presented challenges to SUPEN. Despite the significant volume of pension assets managed, supervision remains mostly compliance based and involves limited risk assessment. The most recent FSAP, conducted in 2008, acknowledged that Costa Rica’s pension system needed to be strengthened. The assessment also recognized that the concentration of assets in public sector instruments was not ideal.
Since the global financial crisis, the International Organization of Pension Supervisors (IOPS) has identified RBS of pension fund systems as a critical component in a modern supervisory system, and it has included RBS of pension funds in the IOPS Principles of Supervision.
SUPEN has highlighted the need for improved regulation and supervision of the sector as a key priority. Authorities recognized the critical need to replace SUPEN’s compliance- based supervision practices with an RBS methodology that employed effective tools to reduce risks to achieving improved long-run outcomes. Another key objective was to tackle poor governance and underfunding of promises at a number of defined benefit funds. These reforms would enable liberalization of investment rules and the development of multiple pension portfolios in the longer term through improved governance, regulation, and supervision.
In 2013, SUPEN approached FIRST to fund TA to support the development and implementation of RBS of pension funds. From the start, the World Bank team had a very proactive and positive engagement with the authorities. The four components of the project included a review and a road map, a risk-based methodology, proposals for legislative reforms, and capacity building.
The project focused first on developing a diagnostic review and a road map to guide the process of establishing RBS of the pension market, including recommended policy and regulation changes. The resulting High-Level Design Report explained the overall objectives and design principles of RBS.
Second, the project developed a robust risk-based methodology to enable decisions based on risk to be rigorous and defensible, and to sharpen the focus on pension fund governance and risk management. The outcomes- and risk-based supervision (ORBS) framework provides guidance to focus on the long-run outcomes, identify the risks to achieving these outcomes, and implement the most effective solutions.
Next, in order to fully mitigate risks and facilitate the implementation of RBS, the team identified several legislative reforms required to overcome weak governance issues and legal barriers to a more detailed governance regime. The team proposed several draft regulations, and recommended legislative revisions related to actuarial regulation, risk management, calibration, solvency, investment limits, and governance at financial services institutions.
The project team adopted an approach that focused on education, orientation, and enforcement to implement better fund management, risk mitigation, and supervision of the sector. This approach required training to improve understanding of international best practices, effective consultation with pension fund managers to gain feedback and buy-in, and courses designed to develop the skills required to implement RBS in practice.
During 2015, the team delivered a wide range of training events and a series of presentations tailored for the SUPEN staff, pension fund administrators, and members of CONASSIF (the National Council on Financial System Supervision), including the governor of the Central Bank. In total, the team delivered over 100 reports, presentations, and training sessions, including risk strategies, as well as principles and guides, which covered both off-site and on-site supervision.
This project has been considered a success and its deliverables have led to positive outcomes. SUPEN has adopted recommendations from the High-Level Design Report and consequently streamlined the number of inspections conducted for risk assessment from 40 to a single series of 12–15. The ORBS framework also led to a greater focus on results, and on monitoring and evaluation. A new regulation was passed to allow greater flexibility in the investment regime and to strengthen the supervision of pension funds. Other regulations (for example, of risk assessment) are being prepared and will be rolled out in phases over four years. This education, orientation, and legislation approach has educated fund managers on international best practices, enhanced communication and transparency between the authorities and relevant stakeholders,
and improved enforceability—to compel reforms, penalize noncompliance, and empower supervisors to intervene when necessary.
Since the project ended, SUPEN has changed its organizational structure, including a new investment team, a new strategy and planning process, and two new committees. The Strategic Risk Committee is responsible for determining SUPEN strategy by peer reviewing each supervisory strategy and approving the planned budget. The Supervision Committee peer reviews risk assessments, and formulates or recommends responses to new risk situations as they arise.
The tools, templates, guides, and training provided have enabled supervisors to identify risks comprehensively across the system and within individual pension funds, thus improving SUPEN’s efficiency, strengthening risk management, and increasing the capacity to adapt to market advances and innovations. From a broader perspective, the project has improved institutional investment governance, thus enabling a longer-term focus with greater diversification and increased returns. Today, Costa Rica’s pension fund supervisory regime is more aligned with international best practices, providing more effective oversight, reducing risk, and increasing financial stability.
* Rofman, Rafael, Ignacio Apella, and Evelyn Vezza (2015), “Beyond Contributory Pensions: Fourteen Experiences with Coverage Expansion in Latin America,” World Bank, Washington, D.C.