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27 February 2020 Issue Brief

Pension Funds

A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme that provides retirement income. Pension funds are pooled monetary contributions from pension plans set up by employers, unions, or other organizations to provide for their employees' or members' retirement benefits. Pension funds are the largest investment blocks in most countries and dominate the stock markets where they invest. When managed by professional fund managers, they constitute the institutional investor sector along with insurance companies and investment trusts. Typically, pension funds are exempt from capital gains tax and the earnings on their investment portfolios are either tax-deferred or tax exempt.

Willis Towers Watson’s 2017 Global Pension Assets Study covers 22 major pension markets, which total USD 36.4 trillion in pension assets and account for 62% of the GDP of these economies. The Federal Old-Age and Survivors Insurance Trust Fund (which is part of US Social Security Fund) is the world's largest public pension fund which oversees $3 trillion in assets.

Private Sector Pension Plans

Private industry pension plans primarily are regulated by the Employee Retirement Income Security Act of 1974 (ERISA), which sets forth minimum standards for retirement plans in the private sector, as seen in the next section.

Employee Retirement Income Security Act of 1974 (ERISA)

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for retirement plans in private industry. ERISA does not require any employer to establish a retirement plan. It only requires that those who establish plans must meet certain minimum standards. The law generally does not specify how much money a participant must be paid as a benefit.

Prudent Person Rule

ERISA also clarifies what is known now as the “prudent person rule.” This rule stipulates that investments have to be made for the exclusive benefit of plan beneficiaries. It makes clear that the only criteria that can be considered by fiduciaries are financial — not other objectives that might be in the broader interest of beneficiaries, such as the investment’s impact on the economy or the environment.

ERISA Requirements for Pension Plans

ERISA requires the following:

  • Plans must provide participants with information about the plan including important information about plan features and funding. The plan must furnish some information regularly and automatically.
  • Plans must set minimum standards for participation, vesting, benefit accrual and funding.
  • Plans must specific accountability of plan fiduciaries. ERISA generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan's management or assets, including anyone who provides investment advice to the plan. Fiduciaries who do not follow the principles of conduct may be held responsible for restoring losses to the plan.
  • Plans must give participants the right to sue for benefits and breaches of fiduciary duty.
  • Plans must guarantee payment of certain benefits if a defined plan is terminated.

ERISA Rules for Fiduciaries

ERISA imposes the following rules on pension plan fiduciaries. In addition to these rules, a fiduciary must meet common law fiduciary standards of care:

  • Exclusive Purpose Rule. The fiduciary must act (1) solely in the interest of participants and beneficiaries and (2) exclusively to provide benefits to participants and beneficiaries and to defray reasonable plan administrative costs.
  • Prudent Man Rule. Fiduciaries must act with the care, skill, prudence, and diligence, under the circumstances prevailing at the time, that a prudent man acting in a like capacity and familiar with such matters would use in conducting an enterprise of a like character with like aims.
  • Diversification Rule. Fiduciaries must diversify plan investments to minimize the risk of large losses, unless, under the particular circumstances, it is clearly not prudent to do so.
  • Acting in Accordance with Plan Documents Rule. Fiduciaries must act in accordance with the documents and instruments governing the plan to the extent that those documents and instruments are consistent with ERISA provisions.

Public Sector Pension Plans

According to a 2016 survey by the US Census Bureau, 299 state-administered funds and 5,977 locally administered defined benefit public pension systems in the United States, with assets totaling $3.7 trillion. In 2010, the SEC tightened restrictions against “pay-to-play” practices in the municipal securities market. This measure was another attempt to close loopholes that allowed political influence to corrupt aspects of the public pension business.

The SEC voted to bar investment managers who make political contributions to officials with influence over public pension funds from managing those funds for two years. The SEC also barred investment managers from paying a third party to solicit pension business on their behalf unless the third party is registered with the SEC or other regulators and thus subject to similar pay-to-play bans. Mary Schapiro, the then-chair of the SEC, called pay-to-play an unspoken but entrenched and well-understood practice. The SEC has made several attempts in recent years to crack down on these pay-to-play practices.

Because of the unique nature of public pension plans, they are regulated largely by state and local law, although federal regulation of these plans continued to evolve. When ERISA was enacted, Congress excluded government pension plans from some sections of ERISA because additional time was considered necessary to determine the need for federal regulation of these plans.

ERISA called for a congressional study of several aspects of government pension plans, including the adequacy of their financing arrangements and fiduciary standards. The study, The Pension Task Force Report on Public Employee Retirement Systems, which was completed in 1978, reported some deficiencies in public plans— including plans covering federal employees— in the areas of funding, reporting and disclosure, and fiduciary practices. The report found public pension plan terminations and insolvencies to be rare, however. (Later the same year, the federal government imposed reporting and disclosure requirements on pension systems for its own employees.)

Many sections of ERISA do apply to public-sector plans. Government plans are exempt from ERISA’s reporting, disclosure, and funding requirements, and plan-termination insurance. Although some observers continue to believe that state and local plans would benefit from the federal imposition of ERISA-like standards, state and local plans are financially sound. Even though some underfunded plans can still be found (primarily at the local level), public pension systems generally are well financed.

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