For release: Sept. 25, 2003

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Incentives To Encourage Private Behavior in the Public Interest Are Key in Designing New Pension System, St. Louis Fed’s Poole Tells Russian Audience

Link to speech.

MOSCOW. — Governments will be involved for many years in regulating private pension plans. Because taxpayers are ultimately responsible for shortfalls in retirement savings, either through supporting pension plan guarantees or financing public assistance to retirees lacking enough resources, regulation must ensure that pension plans are adequately funded and prudent investment rules followed.

Those were among the key points made by William Poole, president of the Federal Reserve Bank of St. Louis, in a conference on Russian pension reform conducted by the Organization for Economic Cooperation and Development (OECD) with assistance from the Government of the Russian Federation and the U.S. Department of Commerce among other groups.

Poole’s remarks were titled “The Role for Self-Regulation and Voluntary
Compliance Incentives in the Design of Pension Systems.” The conference is being held in the wake of Russian legislation providing that, beginning January 2004, private pension funds become part of the national mandatory pension system of the Russian Federation.

“It’s important for regulation of pension plans to be as simple as possible to reduce the cost of compliance and make it easier for workers and retirees to monitor the behavior of their firms,” Poole said. “Government also has an obligation to taxpayers,” he added. “Obligations to retirees, future retirees and taxpayers can be met if pension systems are efficiently designed. Incentives to encourage private behavior that is in the public interest are essential to that design.” he said.

Poole said there are several dimensions to a set of efficient incentives. “On one hand, we want to discourage risky behavior. In the United States, premiums for pension insurance that inadequately reflect risk give firms with underfunded plans an incentive for riskier behavior. The ability of firms to voluntarily terminate their underfunded plans also increased this behavior. Changes have been made to address some of these problems, but it may be time to restructure premiums to better reflect credit risk,” Poole said. “Under U.S. banking regulation, regulators insist that banks monitor and control risk rather than eliminate it. Banks with higher capital can take more risk because they have a cushion to shield depositors and the deposit insurance fund against losses.”

Poole told the Russian audience that an often-overlooked area is the need for
financial education. “If we are to encourage workers to assume more responsibility for their retirement savings, we need to make sure they have the proper tools to monitor the activities of their firms’ defined-benefits plans or make decisions regarding portfolio allocations in their defined-contribution plans.” He noted that the U.S. Federal Reserve System is making a key contribution to that effort, creating a web site and materials devoted to personal financial education.

“Another role for the Federal Reserve is maintaining overall financial stability,” said Poole. “It should be clear that there is a link between the health of the financial system and that of the U.S. pension system. Despite recent problems in equity markets, the U.S. financial system remains healthy, in particular the banking system.”

Alluding to the coming Russian pension reforms, Poole said that “although it is much easier to introduce a pension plan in an economy with well-developed capital markets, it is also true that the pension system can be an important source of saving for a growing economy.”

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