Impact of the Financial Crisis on Pension Systems in LAC

Waldo TapiaLabor Market Unit

Inter-American Development Bank (IDB)

OECD/IOPS GLOBAL FORUM ON PRIVATE PENSIONS:PENSION REFORM AND DEVELOPMENTS IN LATIN AMERICA

Rio Janeiro, Brazil14-15 October, 2009

Agenda

• Introduction• Private pensions in LAC and the financial crisis

• Evaluating the impact (assets, returns)• Asset allocation• Coverage

• Putting the crisis into a pension context• Conclusions

Introduction

• The financial crisis has affected many aspect of the economy, including private pension arrangements.

• In Latin America private pensions play an important role in mandatory pension provision.

• In Latin America 11 have implemented mandatory individual account pension systems.

• Private pensions leaves workers’ retirement income vulnerable to investment risk.

• In DC pensions, benefits depend directly on accumulated contributions and investment returns.

Market value of pension assets

By December 2008, the total assets of pension funds in LAC had decline by about US$ 52 billion, or nearly 14% relative to December 2007

0

50,000

100,000

150,000

200,000

250,000

300,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

Mill

ions

of U

S$

Which countries were affected?

• Some of the countries most affected were Chile, Argentina, Peru.

• This lower value of the investment should not be interpreted as a loss, particularly where long-term savings are concerned

-40,000

-30,000

-20,000

-10,000

0

10,000

Chile

Méx

ico

Arge

ntina

Perú

Urug

uay

Cost

a Ri

ca

El S

alva

dor

Boliv

ia

Colo

mbi

a

(-23%)

(34%)

(-33%)

(6%)(8%) (13%)

(-11%)(-17%)

(-15%)

Assets as % of GDP

• As a % of the economy mandatory private pension funds in LAC fell from 16% in 2007 to 14% 2008

• In OECD countries the ratio for pension funds decreased from 76% of GDP in 2007 to 63% of GDP in 2008

0

20

40

60

80

Arge

ntina

Boliv

ia

Chile

Colo

mbi

a

Cost

a Ri

ca

El S

alva

dor

Méx

ico

Perú

R. D

om.

Urug

uay

OEC

D

2007 2008

20072008

The impact on investment returns

• Almost all countries experienced a negative return in real terms over January to December 2008

• Some of the countries most affected are those where equities represent a higher proportion of total assets invested

-25%

2%

-3%

6%1%

-1%1% 3%

20%

1%-2%-11%

-3%-9%

-2%-7%

-29%-22%

-40%-30%-20%-10%

0%10%20%30%

Argentina

Bolivia

Chile

Colombia

Costa Rica

El Sa

lvado

r

Méx

ico Perú

Urugu

ay

2007 2008

The experience in OECD countries

2008 pension fund nominal and real returns in selected countries (%)

Pension funds in OECD countries experienced during 2008 a negative real return of:

17.4% (unweighted average)

23.0% (weighted average)

Shifts in asset allocation

14

48

68

24

58

43

36

57

17

61

46

9

0

10

20

30

40

50

60

70

Chile Colombia México Perú Uruguay Total

15

23

8

41

1512

6

25

20

14

05

1015202530354045

Chile Colombia México Perú Uruguay Total

36

1114 15

3

21

4

1612

109

29

0

5

10

15

20

25

30

35

40

Chile Colombia México Perú Uruguay Total

Gov. bonds

Domestic equitiesForeign instruments

0%

3%

6%

9%

12%

Jun-08 Dec-08

0%

3%

6%

9%

12%

Jun-08 Dec-08

Investments by group of instruments (as % of total asset)

Impact on coverage

•The decline in the value of pension funds is not the only problem. It is also necessary to address the drop in coverage that will result from the economic slowdown.•The unemployment persons will increase between 2.8 – 3.9 millions

2007 2008 2007 2008 2007 2008

Chile 4,329 4,572 61.2 62.8 53.8 54.6Colombia 3,522 3,840 17.1 18 45.1 44.8Mexico 14,710 14,170 32.2 31.4 38.2 36.3Peru 1,699 1,770 13.4 13.8 41.4 41.2Uruguay 453 510 27.7 30.6 58.6 60.6Total 32,162 31,611 33.3 32.2 43.4 42.3

Contributors/Affiliates (%)Country Contributors (thousands) Contributors / EAP (%)

Putting the crisis into pension context

• Pensions are, by their nature, long-term and so their performance must be evaluated over a lengthy horizon.

• A temporarily lower value is note the same as a real loss• Pension systems in LAC are relatively young• Younger workers can hope for some good years to

make up the recent falls in asset value.• Some countries in the region have implemented

investment choice or multiples portfolios• Multiples portfolios include conservative options for

workers close to retirement.

The markets are recovering….

60,000

80,000

100,000

120,000

140,000

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

12,000

16,000

20,000

24,000

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

50,000

60,000

70,000

80,000

90,000

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Chile

PeruMexico

….and, with

them, the value of the investments.

Long-term investment

• Performance should be evaluated in a long time horizon

• Evaluating the results of a short period may distort the perception of their performance

9%7%

11%

7%

9%8%

10%

5% 6%

11%

7%

9%

4% 4%

8%6%

8% 8%

0%

3%

6%

9%

12%

Argentina

Bolivia

Chile

Colombia

Costa Rica

El Sa

lvado

r

Méx

ico Perú

Urugu

ay

2007 2008

Pension systems in LAC are relatively young

• A major drop in asset values may not matter much to younger workers who can expect the markets to recover overall in the long term

• The proportion of the elderly experiencing major declines in pension income is relatively small in most LAC

País < 30 30-44 45-59 > 60

Argentina 29 45 21 5

Bolivia 23 44 25 8

Chile 30 41 26 3

Colombia 38 48 14 0

Costa Rica 40 35 20 5

El Salvador 42 42 14 1

México 35 42 17 6

Perú 31 47 19 3

Uruguay 25 51 23 1

Total 35 43 18 4

Investment choice

• Multiples portfolios shield workers close to retirement from most of the losses in asset values

Investment choice

• A multifund model linked to the affiliates’ life cycle has been an important element in strengthening the pension fund system

• Provide a default options that involves a switch to less risky investment as people get closer to retirement

• Restrict investment choices for older workers to lower risk options

Distribution of participants by age

1-group 2-group 3-group Investment option Men up to

35 Women up to

35 Men

45 - 55 Women 35 - 50

Men from 55

Women from 50

More Conservative (E) 1 1 2 2 3 3

Conservative (D) 0 0 1 1 53 53

Intermediate (C) 3 4 65 66 36 36

Risk (B) 73 73 20 24 6 7

Riskiest (A) 23 22 11 8 2 2

Source: Superintendencia de Pensiones, Chile

Conclusions

• The impact on pension funds is clearly negative over the last 12 months

• The consequences of the crisis on the pension systems are important in LAC (mandatory and DC systems)

• Pension funds work with a long time horizon• Negative investment return cannot be interpreted directly

as a loss• Pension fund performance has been positive over the

last 10-15 years• Pension systems in LAC are relatively new• For younger workers, pensions are long term savings

Conclusions

• Some countries have implemented individual choice• Financial education is necessary to ensure that

members understand the risk they are exposed to• It is also to address the drop in coverage that will result

from the economic slowdown• Diversify retirement schemes • The balance between public and private schemes

should not be framed solely around the crisis• Government should resist to reactions that threaten the

long term stability of retirement income provision