PENSION REFORMS: EXPERIENCES IN LATIN AMERICA

Seminar “The Future and the Reform on Pension Funds”

Madrid, SpainOctober 2003

Guillermo Arthur E., President of FIAP

Author: Asociación de AFP de Chile

I. Countries with Reform

II. Bases of the New Pension Systems

III. Results of the Reforms

IV. Political Economics of the Capitalization Systems

V. Final Remarks

CONTENTSCONTENTS

I. Reforms in Latin AmericaI. Reforms in Latin America

Chile (1981) Peru (1993)

Argentina (1994) Colombia (1994)

Uruguay (1995) Bolivia (1997)

Mexico (1997) El Salvador (1998)

Costa Rica (2000) Dominican Rep. (2003)

Ecuador (*) Nicaragua (*)

(*) Not yet implemented(*) Not yet implemented

I. Reforms in Central Europe, Eastern Europe and AsiaI. Reforms in Central Europe, Eastern Europe and Asia

Hungary (1998) Kazakhstan (1998)

Poland (1999) Latvia (2001)

Estonia (2002) Bulgaria (2002)

Croatia (2002) Macedonia (2003)

Lithuania (*) Rep. of Slovakia (*)

Ukraine (*)

(*) In process of reform(*) In process of reform

OLD SYSTEM NEW SYSTEM

- Pay-as-you-go - Individual capitalization

- State administration - Private, competitive administration

- Inflexibility - Individual freedom:

To choose and change AFP

How much to contribute (over the minimum)

When and how to become a pensioner

Which fund to choose (Multifunds)

- Discretionary - Standard

- Without fund accumulation - Net worth separation: AFP and Pension Funds

- Role of the State: Administrator - Role of the State: Supervisory

Subsidiary

- Benefits: Old age, disability and - Benefits: Old age, disability and survivorship pensions survivorship pensions

Disability and survivorship insurance: collective and mutually supportive

II. Bases of the Pension SystemII. Bases of the Pension System

Characteristics of the New Pension SystemsCharacteristics of the New Pension Systems: Latin America: Latin America

COUNTRIES

Single Integrated Mixed Mixed in Competition

LATIN AMERICA (Individual Cap.) (PAYG and Indiv. Cap.) (PAYG and Indiv. Cap.)

Argentina

Bolivia

Colombia

Costa Rica

Chile

Ecuador

El Salvador

Mexico

Nicaragua

Peru

Dominican Rep.

Uruguay

INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM

Characteristics of the New Pension SystemsCharacteristics of the New Pension Systems::Europe and AsiaEurope and Asia

COUNTRIESSingle Integrated Mixed Mixed in Competition

EUROPE AND ASIA (Individual Cap.) (PAYG and Indiv. Cap.) (PAYG and Indiv. Cap.)

Bulgaria

Croatia

Estonia

Hungary

Kazakhstan

Latvia

Macedonia

Poland

INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM

0 25 50 75 100

Mexico

Chile

El Salvador

Colombia

Dominican R

Argentina

Uruguay

Costa Rica

Proportion of the pension financed by the PAYG system

New Pension SystemsNew Pension Systems

Source: Palacios (2003)

1.- Return of the Funds1.- Return of the Funds

The rates of return of the funds exceed the growth of real wages and The rates of return of the funds exceed the growth of real wages and per capita incomeper capita income.

Source: Palacios (2003)

CountryReturn of

Funds

Growth of

Real Wages

Difference Return

Funds-Growth Wages

Ratio Maximum

Returns toMinimum Returns

Growth

Real income per

capita

Difference Return Funds-

Growth

Income per capita

Argentina 11.70% -0,80% 12,50% 1,17 -0,40% 12,10%

Bolivia 16,20% 8,80% 7,60% n.d. 0,40% 15,80%

Colombia 11,80% 1,40% 10,40% 1,13 -0,30% 12,10%

Chile 10,50% 1,80% 8,70% 1,05 4,50% 6,00%

El Salvador 11,30% -0,20% 11,50% 1,3 0,50% 10,80%

Mexico 10,60% 0,00% 10,60% n.d. 2,80% 7,80%

Peru 5,70% 1,80% 3,90% 1,06 2,40% 3,30%

Uruguay 9,50% 3,60% 5,90% 1,06 -0,30% 9,80%

III. Results of the ReformsIII. Results of the Reforms

PENSION FUNDS IN LATIN AMERICAPENSION FUNDS IN LATIN AMERICA

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 '00 '01 '02

Chile

Argentina

Mexico

UruguayBolivia

C. Rica

Colombia

Peru

El Salvador

Total (30.06.2003):

MM US$ 106.018

MM US$

Jun’03

2.- Rapid growth of the funds2.- Rapid growth of the funds

Pension Funds and GDP (June 2003)

Source: FIAP

Country Fund GDP Fund/GDP(MM US$) (MM US$)

Latin AmericaArgentina (2) 15,328 236,631 4.82%Bolivia 1,258 8,160 15.42%Colombia 6,403 71,297 8.98%Costa Rica (1) 218 15,781 1.38%Chile (1) 39,672 67,236 59.00%El Salvador (1) 1,289 14,000 9.20%

Mexico (2) 35,405 584,147 6.06%Peru 5,296 30,592 17.31%Uruguay 1,14

912,321 9.33%

Europe and AsiaBulgaria 113 15,563 0.73%

Kazakhstan 1,432 6,987 20.49%Poland 9,486 343,934 2.76%

(1) GDP as of 31.12.2001(2) GDP as of 30.09.2002

0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 '00 '01 '02

MEMBERSHIP IN LATIN AMERICAMEMBERSHIP IN LATIN AMERICA

Chile

Mexico

Argentina

Colombia

PeruBolivia C. Rica

El Salvador

Total (30.06.2003):

58.747.165

Jun’03

3.- Rapid growth of membership3.- Rapid growth of membership

4.- Economic Effects of the Reforms4.- Economic Effects of the Reforms

QUALITATIVE EFFECTS:

• It offers investors the possibility of combining risk (better combination of risk return and diversification).

• It reduces intermediation costs.

• It encourages the creation of innovative long-term financial instruments.

• It improves transparency and corporate governance.

• It boosts the industry in custodial services, risk assessment, etc.

SOME EXAMPLESSOME EXAMPLES- Corporate Bonds- Corporate Bonds

Debentures or Coporarte Bonds (MM of US$ as of 2002)

7.459

71,40

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

1981 2002

Share of Social Security Funds 2002

40,7%CSV

34,3%AFP

25,1 %

AFP C.S.V. Others

CHILECHILE PERUPERUCorporate Bonds

(MM of US$ as of 2002)

851.105

0

2.000

4.000

6.000

8.000

10.000

12.000

1994 2002

MEXICOMEXICOCorporate Bonds

(MM of US$ as of 2002)

5.039

11.626

0

2.000

4.000

6.000

8.000

10.000

12.000

1997 2002

Share of Social Security Funds 2002

47%

53%

AFP Others

Share of Social Security Funds 2002

35%

3%

62%

AFP C.S.V. Others

Note for Chile: Average life of bonds in the first five years of the 1990s: between 10 and 15 years. Currently between 15 and 20 years. They have been issued at 30 years.

- Equities- Equities

Share of Social Security Funds 2002

7,5%

0,7%

91,8%

AFP C.S.V. Others

Stock Market Net Worth(Millions of US$ as of 2002)

47.430

6600

5.00010.00015.00020.00025.00030.00035.00040.00045.00050.000

1985 2002

PERUPERUStock Market Net Worth

(Millions of US$ as of 2002)

5.084

12.593

05.000

10.00015.00020.00025.00030.00035.00040.00045.00050.000

1993 2002

CHILECHILE

Share of Social Security Funds 2002

11,3%

88,8%

AFP Others

- Mortgage-Backed Securities and Bank Bonds- Mortgage-Backed Securities and Bank Bonds

MBS and Bank Bonds(Millions of US$ as of 2002)

8.431

513

0

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

10.000

1981 2002

Share of Social Security Funds 2002

42,4%CSV

55,2%AFP

2,5 %

AFP C.S.V. Others

CHILECHILE

N° Loan OperationsHousing MBS

529.321

31.918

0

100.000

200.000

300.000

400.000

500.000

600.000

1980 2002

Stock of Housing Stock of Housing Financed with MBSFinanced with MBS

- Investment Fund Shares- Investment Fund Shares

Share of Social Security Funds 2002

10,9%CSV

78,6%AFP

AFP C.S.V. Others

10,5%

Investment Fund Shares(Millions of US$ as of 2002)

1.117

00

200

400

600

800

1.000

1.200

1981 2002

CHILECHILE

5.- Projection of the Fiscal Deficit of the Reform: Chilean Case5.- Projection of the Fiscal Deficit of the Reform: Chilean Case

0

0,5

1

1,5

2

2,5

3

3,5

4

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Recognition Bond Fiscal Contribution to Old System Total Fiscal Cost

% GDP

6.- Coverage6.- Coverage

• When the costs of the formal sector decrease Employment in this sector increases.

• A strong link is formed between contributions paid and benefits received.

• Incentives are created for both workers and employers to pay contributions into the pension system: lowering of contribution rates, increasing credibility in the system.

GREATER COVERAGEHOWEVER, THERE IS STILL MUCH TO BE DONE TO ENLARGE THE

FORMAL SECTOR IN THE ECONOMY

IV. Political Economics of the Individual Capitalization SystemsIV. Political Economics of the Individual Capitalization Systems

• Relative political risk: - Capitalization - Pay-as-you-go

• Government pressures: - Fiscal - Redistributive

• Resistance of the Individual Capitalization system: - Individual “defined contribution” accounts - Visibility of redistributions - Redistribution of stocks and not flows - Redistribution produces greater impact - Ownership Rights - Private management

•Two examples: Chile and Argentina

• Political economics of adjustment: - Market versus political system - Visibility

V. Final Remarks

• In addition to making a significant contribution towards solving the problem of pensions, this reform has positive economic effects.

• The macroeconomic, labour market and capital market reforms contribute to increasing the positive effects of the pension reform on the economy.

• Although the capitalization system has suffered considerable political threats, it is still stronger than the pay-as-you-go system when it comes to facing up to “political risk”.

Latin America: Investment Diversification (2002)

Source: Palacios (2003)

Country State

instrumentsLocal Investment

Foreign Investment

Cash andTime

Deposits

Fixed Income Equities

Argentina 78% 11% 9% 2% 90% 10%Bolivia 69% 14% 1% 16% 100% 0%Chile 30% 32% 17% 21% 75% 25%Colombia 49% 34% 5% 12% 93% 7%Costa Rica 67% 19% 0% 14% 100% 0%El Salvador 85% 1% 0% 14% 99% 1%

Mexico 83% 15% 0% 2% 100% 0%Peru 15% 53% 7% 25% 71% 29%Uruguay 64% 6% 0% 30% 100% 0%

• The effects on the pension funds of the economic crisis of the past few years would have been less if their investment portfolios had been better diversified.

V. Final Remarks

• The inadequate diversification is explained by the combined effect of limited development in some local capital markets and regulations.

V. Final Remarks

State and Bank State and Bank DepositsDeposits

0%0% 50%50% 100%100% 150%150% 200%200% 250%250%

Costa RicaCosta Rica

ColombiaColombia

UruguayUruguay

NicaraguaNicaragua

Dominican Rep.Dominican Rep.

Peru Peru

El SalvadorEl Salvador

BoliviaBolivia

ArgentinaArgentina

ChileChile

Private Private Investments and Investments and

Mutual FundsMutual Funds

Source: Palacios (2003)Source: Palacios (2003)

Latin America: Differences in Investment Limits

• Fortunately there is evidence that regulation may move in this direction in the near future, and in some cases that is has already done so:

CHILE: - Multifunds- Increase in limit for investment abroad

MEXICO: - Multifunds (Reform to SAR Law)- Investment allowed in foreign securities

ARGENTINA: - Possibility for the AFJPs to buy dollars without limits (Project) PERU: - Multifund

- Increase in limit for investment abroad

V. Final Remarks

Chile : Results of the Multifunds (October 2003)

FUNDS (Millions US$) % YIELD

(Jan. – Oct. 03)

Fund AFund A 1.912,881.912,88 4,09 4,09 24,7%24,7%

Fund BFund B 6.590,386.590,38 14,09 14,09 14,9% 14,9%

Fund CFund C 31.426,2331.426,23 67,20 67,20 10,0% 10,0%

Fund DFund D 4.779,30 4.779,30 10,22 10,22 8,3% 8,3%

Fund E Fund E 2.057,03 2.057,03 4,40 4,40 3,1% 3,1%

TOTAL 46.765,82 100,00

Fund Maximum L. Minimum L. Fund A 80% 40%

Fund B 60% 25%

Fund C 40% 15%

Fund D 20% 5%

Fund E 0% 0%

The Funds are differentiated by their minimum and maximum proportion of equities.