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DISCUSSION PAPER PI-0101

Portfolio Regulation of Life Insurance Companies and Pension Funds

E Philip Davis

ABSTRACT

This paper examines the rationale, nature and financial consequences of
two alternative approaches to portfolio regulations for the long-term institutional
investor sectors life insurance and pension funds. These approaches are,
respectively, prudent person rules and quantitative portfolio restrictions. The
argument draws on the financial-economics of investment, the differing
characteristics of institutions' liabilities, and the overall case for regulation
of financial institutions. Among the conclusions are:

• regulation of life insurance and pensions need not be identical;
• prudent person rules are superior to quantitative restrictions for
  pension funds except in certain specific circumstances (which
  may arise notably in emerging market economies), and;
• although in general restrictions may be less damaging for life
  insurance than for pension funds, prudent person rules may
  nevertheless be desirable in certain cases also for this sector,
  particularly in competitive life sectors in advanced countries,
  and for pension contracts offered by life insurance companies.

These results have implications inter alia for an appropriate strategy of liberalisation.