Comments on

Old-Age Income Support in the 21st

Century: An International Perspective on Pension Systems and Reforms

by R. Holzmann and R. Hinzplus several colleagues

Guillermo Larrain RiosSuperintendent of Pension Funds Administrators, Chile

President of AIOS

Cartagena de Indias, May 20th, 2005

General View• Multipillar pension systems are new. Excluding Chile,

none has more than 12 year old (Peru).• It is one of the few socio-economic institutions created in

developing countries and being adopted by developed ones: Sweden, ¿US?

• Implication: no OECD country is an example in this, there are no international standards (ie, no public good of good governance: Basle Accords, IOSCO, etc…)

• We, developing countries, must take this challenge in our hands and proceed to reflect, to model and to make funded pension systems coherent with the principles of social security. We are not making the appropriate effort

We rely on the kind help from the… World Bank

Therefore, the

clarificatio

n of official

World Bank policies

concerning pension

reform is welcomed

This Policy Report• Not a research paper. The report describes well the

criteria used by the WB in pension reform issues. • It is not as easy to read as a paper, there are few data,

but it is relevant to understand how the Bank articulates its reflection and policy suggestions in this topic.

• The WB approach is much more complex and nuanced than what is often perceived from outside.

• There is no unilateral argument in favour of capitalization systems, that is:– the P2 may constitute per se the main component of the pension

system,– that P0 and/or P1 are residuals

• There is a sense that countries are different and deserve a unique combination within the multipillar approach. This is a serious approach.

This Policy Report

• It starts increasing the number of pillars originally included in “Averting the Old Age Crisis”, giving therefore reason to those who think that coverage issues are relevant and require a treatment outside Pillar 2.

• But then, it reflects on how to improve Pillar 2 from various perspectives, giving reason to those who think that the system can be improved significantly from its current situation.

• One particular aspect of this is that there is no policy criteria suggesting that P1 should be strengthen at the expense of P2.

Six disordered and contradictory questions for the WB and for you

1. WB has a general emphasis on poverty prevention. For the sake of pension systems, isn´t it too much?

2. Maybe the WB has devoted less resources to promote a better P1, but have we made all relevant progresses in improving P2?

3. As enjoying a pension is a question of spending the money, have we devoted enough resources to improve the disbursement phase? Where are the LICs?

Six disordered and contradictory questions for the WB and for you

4. In moving towards a funded system people supposedly should be responsible for their future. Are they capable of managing those risks? And the other actors, State + AFPs?

5. Have we dealt appropriately with transitional problems? Is the political economy worse due to unresolved transitional problems?

6. The claim for more competition is also derived from the fact that pension savings are mandatory. Have we looked for a relevant and sustainable solution to competition? One implication: can we ask Parliaments for subsidies to strengthen P3, if we agree that there are IO problems in P2?

1) The discussion of pillar weight:

Too much emphasis in poverty prevention? – Poverty incidence at old-age– Myopia– Inertia

Relationship between different pillars.

• Incidence of Poverty is lower at old age.• Proposal for a universal pension looses ground in a

context where fiscal budget is limited

AgeExtremely

Poor Poor Not Poor Total0-10 7.7 19.9 72.4 10011-20 6.2 18.0 75.7 10021-30 3.8 12.0 84.3 10031-40 4.5 14.2 81.4 10041-50 3.8 11.4 84.8 10051-60 2.8 8.6 88.6 10061 or more 1.4 8.3 90.3 100Total 4.7 14.1 81.2 100Source: Mideplan, División Social. Casen 2003.

Situation of Poverty

There is a meaningful opportunity

cost of alleviating

poverty at old age: poverty when young

0%5%

10%15%20%25%30%35%40%45%

% d

e Re

spue

stas

menos de 50 entre los 51 y los60

entre los 61 y los70

entre los 71 y los80

más de 80

Espera vivir...

Expectativa de Vida de personas entre 15 y 35 años

0%5%

10%15%20%25%30%35%40%45%

% d

e Re

spue

stas

menos de 50 entre los 51 y los60

entre los 61 y los70

entre los 71 y los80

más de 80

Espera vivir...

Expectativa de Vida de personas entre 35 y 60 años

0%5%

10%15%20%25%30%35%40%45%

% d

e Re

spue

stas

menos de 50 entre los 51 y los60

entre los 61 y los70

entre los 71 y los80

más de 80

Espera vivir...

Expectativa de Vida para personas de más de 60 años

Expectativa de vida según tablas de 1985

Objectives of a Pension System: Old-Age Poverty Alleviation and Consumption Smoothing

• Strong evidence in favor of myopia.

• Too much focus on poverty alleviation may leave out policies directed to smooth consumption.

• People under-estimate their Life Expectancy and correct these estimation too late.

Question: At what age do you think you will die?

Coverage increases with Planning horizon

Cobertura

mas de 10 años; 80,1%

próximo año; 75,6%

próximos meses; 70,1%

próximos años; 79,4%

próximos 5-10 años; 78,3%

50%

55%

60%

65%

70%

75%

80%

85%

90%

People who plan further in advance are more likely to contribute in the pension system.

Source: EPS(2002)

Question: How far do you organise your expenditures?

2) Have we cared enough about complementary reforms?– Financial markets– Labour Markets

• Women• Informality

In Financial Markets: why diversification is so poor?

Deudagubernamental

Institucionesfinancieras

Institucionesno

financieras

Acciones Fondos mutuos

y deinversión

Emisoresextranjeros

Otros

Argentina 16.222 68,1% 4,5% 2,1% 10,4% 2,9% 9,4% 2,5%Bolivia 1.617 64,9% 6,5% 18,2% 7,9% 1,6% 0,9%Chile 48.992 21,2% 28,3% 7,1% 13,3% 2,5% 27,5% 0,1%Costa Rica 378 74,1% 10,8% 9,4% 1,5% 4,2%El Salvador 1.819 84,2% 10,2% 5,3% 0,3%México 37.930 85,6% 4,3% 10,1%Perú 6.699 21,2% 16,2% 11,0% 36,9% 1,6% 9,5% 3,5%R. Dominicana * 245 24,4% 66,5% 2,4% 6,5% 0,2%Uruguay 1.323 55,5% 37,7% 5,4% 1,4%Total 115.224 51,2% 15,9% 7,7% 9,4% 1,6% 13,6% 0,7%Total S/Chile 66.232 73,4% 6,7% 8,1% 6,5% 0,9% 3,3% 1,1%Total S/Chile y Perú 59.533 79,3% 5,7% 7,8% 3,1% 0,9% 2,6% 0,9%

(porcentaje respecto al fondo total)

TOTAL(millonesde U$S)

País

Are you incompetent?

In Chile, the achievement of diversification has been progressive

Evolution of Asset Diversification in Chile

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Public Sector Financial Sector Private Sector Foreign Sector

Some institutional prerequisites for asset diversification

Fixed Income:Mortage

CreditCorporate

Bonds

Variable IncomeCorporate culture, accountability, transparencyCorporate governanceMinority shareholder´s rights

1. Macro stability (inflation, shocks,…)

2. Growth: investment opportunities

3. Contract´ stability

4. Quality of regulation

5. Elimination of tax distortions

6. Risk classification

7. Custodians … etc

The reform agenda besides

pension reform is large.

It needs effort,

persistence and

patience…

Because several interest groups

(within the financial sector as

well) will certainly try to block it

Labor Markets. Female Labor Force Participation is still low in Latin America

Country Year Male Female

Argentina 2002 72 46

Bolivia 2002 77 57

Brasil 2001 79 53

Chile 2003 73 45

Colombia 2002 79 57

Costa Rica 2002 77 46

Ecuador 2002 81 53

El Salvador 2002 73 51

Guatemala 2002 85 58

Honduras 2003 78 50

México 2002 79 45

Nicaragua 2001 83 52

Panamá 2002 79 54

Paraguay 2000 81 57

Perú 2001 74 54

Dominican Rep. 2003 80 51

Uruguay 2002 72 50

Venezuela 2003 83 56

Source: ECLAC based on National Household Surveys

Labor Force Participation by Gender

Latin America

What explains low female participation rates?

Some Chilean thoughts:

• Lack of appropriate labor contracts for women

• Child care

• … machismo

Labor Markets. Informality is high in Latin America.

Do we know what to do? Do we know where to start doing something?

Private Sector Small Firms

(5 or less workers)

América Latina 46.7 23.6 7.0 16.1 53.3 13.8 39.5

Argentina 46.5 19.5 7.3 19.7 53.5 20.9 32.6Brazil 44.6 21.0 9.3 14.3 55.4 13.8 41.7Bolivia(a) 66.7 44.6 4.3 17.8 33.3 11.6 21.7Chile 38.8 21.1 6.8 10.9 61.2 12.3 48.9Colombia 61.4 38.7 6.3 16.5 38.6 7.7 30.9Costa Rica 43.4 18.1 5.3 20.2 56.6 15.6 41.0Ecuador 56.5 31.9 5.2 19.4 43.5 12.6 30.9El Salvador 54.3 32.1 5.7 16.4 45.7 10.0 35.4Honduras 59.4 40.8 4.8 13.8 40.6 9.0 31.6México 41.8 19.5 4.4 17.9 58.2 14.2 44.0Nicaragua 58.0 34.0 24.0 42.0 11.7 30.3Panamá 42.6 24.7 7.1 10.7 57.4 20.5 36.9Paraguay 61.7 30.0 11.8 19.9 38.3 13.0 25.2Perú 55.9 34.5 5.7 15.8 44.1 7.9 36.2Dominican Rep. 48.8 33.7 5.3 9.8 51.2 14.4 36.8Uruguay 39.1 17.6 9.9 11.6 60.9 18.9 42.0Venezuela 53.8 32.8 3.1 17.9 46.2 15.7 30.5

Source:

(a): Figures for 2002.

TotalPublic Sector

ILO "Panorama Laboral" Regional Office for Latina America and the Caribean

(Firms with more than 5 workers)

Latin America and the Caribbean: Structure of Urban Employment. 2003(percentages)

Country

Informal Sector Formal Sector

Total Self-EmployedDomestic Service

Informality is important because it is stronger among poorer people…

Categoría Ocupacional por Decil de Ingreso

38%28% 25% 22% 18% 16% 13% 11% 9% 6%

25%

19%18% 19%

20% 21% 24% 24% 24%20%

0%

0%0% 1%

1% 2% 2% 4% 7% 19%

36%

53% 56% 58% 61% 61% 61% 61% 61%54%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10

empleado sin contrato cuenta propia patrón o empleador empleado con contrato

Source: CASEN Survey 2003

Fuente: Encuesta CASEN 2000

Informalidad en el empleo

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74 Edad

Con contrato Sin contrato

… and youngsters.

3) Pension reform is not only about savings accumulation, but also about spending the bucks!– Disbursement phase

Big Focus on Accumulation Phase, but what happens in Disbursement Phase?

• Effect of SCOMP on Annuities Fees

• New Mortality Tables, updated to take into account higher Life Expectancy levels

2,01 %

6%

0%

1%

2%

3%

4%

5%

6%

7%

Dic.90 Dic.91 Dic.92 Dic.93 Dic.94 Dic.95 Dic.96 Dic.97 Dic.98 Dic.99 Dic.00 Dic.01 Dic.02 Dic.03 Feb-05

Comisión Promedio

Life Expectancy at different ages, years

55 years 60 years 65 years

Female 32,43 27,88 23,54

Male 25,83 21,62 17,66

Average early retirement age: 56 (men) and 54 (women)

Men

0%

10%

20%

30%

40%

50%

60%

70%

80%

90 91 92 93 94 95 96 97 98 99 OO O1 O2 O3Year

% o

f to

tal r

eti

rem

en

ts

54

55

56

57

58

ag

e

% of early retirees average age of early retiress

Women

0%

5%

10%

15%

20%

25%

30%

35%

40%

90 91 92 93 94 95 96 97 98 99 OO O1 O2 O3Year

% o

f tot

al r

etir

emen

ts

53

54

55

56

age

% of early retirees average age of early retiress

Another challenge: Early retirement

4) Who bears which risks?– Individuals– Firms (AFP)– State

Risk in the Individual Accumulation Pension System

• Which is the relevant concept of risk?• How to measure this risk?• How is it assigned among the system

participants?

• The most relevant risk is the risk of Poverty at Old-Age.

• Neither the own affiliates, nor the Government or the Managers seem to be covering this risk appropriately.

Individuals have limited knowledge: how can we expect them to know about and manage risk ?

Distribución de puntajes del índice

0%

2%

4%

6%

8%

10%

12%

14%

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36

PromedioHombreMujer

What serious effort the government has made to improve information, to teach people how the system works?

Why could you expect this to happen with IO problems?

0%

20%

40%

60%

80%

100%

Si sabe el monto de lascomisiones fijas que paga

Si sabe el monto de lascomisiones variables que paga

Hombre Mujer

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Pensiones menores a PM sin GE Pensiones menores a PM con GE Pensiones mayores a PM

Base scenario

Minimum pension growth 2% Yield 5%

State: coverage of Minimum Pensions seem fairly low, should we strengthen P0 and P1?

Only 10% of retirees will receive minimum pension benefit while almost 50% of them will obtain self-financed pensions below the minimum pension level

Source: Berstein, Larrain and Pino

(2005)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Pensiones menores a PM sin GE Pensiones menores a PM con GE Pensiones mayores a PM

Reachable scenario

Minimum Pension growth 2% Yield 7%

Source: Berstein, Larrain and Pino

(2005)

The definition of P1 is poor

AFP: Managers are more worried about risk of falling below Minimum Return

AFP A B C D ECUPRUM 13.50 11.36 9.32 6.71 5.68HABITAT 12.87 10.39 8.97 7.19 5.80PLANVITAL 11.94 9.68 8.99 6.91 5.02PROVIDA 12.73 9.98 8.82 6.60 5.18SANTA MARIA 12.27 9.59 8.05 6.54 4.38SUMMA BANSANDER 12.61 10.16 9.02 7.16 5.84System Average 12.86 10.26 8.86 6.80 5.44Standard Deviation 0.5343 0.6440 0.4299 0.2805 0.5698

Return on Funds by Manager and Type of Fund. 2004

• Returns tend to be very similar across different Managers. Evidence of Herd Behavior. Is it due to minimum return guarantee?

• More investment flexibility cannot imply that affiliates absorb the marginal risk. Who and how deals with it?

6) Transitional issues– Recognition bonds– Past macroeconomic events– Fiscal adjustment

There are also Transition Issues

– Recognition Bonds: calculated over an inconvenient base because unemployment was too high between 1975 and 1979

– Previsional Damage– High Unemployment

in 80s y 00s

These unresolved issues bias political economy

against the reform

Déficit Bonos de Pensiones Pensiones Déficit Civil Déficit Militar Déficit TotalPeríodo Operacional Reconocimiento Asistenciales Mínimas Sistema de Sistema de Sistema de

Civil Pensiones Pensiones Pensiones

(1) (2) (3) (4) (5) (6) (7)(1)+(2)+(3)+(4) (5) + (6)

1981-2003 3,2% 0,6% 0,4% 0,02% 4,2% 1,5% 5,7%

2004-2010 2,4% 1,2% 0,4% 0,2% 4,2% 1,3% 5,5%

DÉFICIT DEL SISTEMA DE PENSIONES EN CHILE: 1981-2020(promedio anual como % del PIB)

Sistema de Pensiones y Finanzas Públicas

Fuente: Dirección de Presupuestos

7) Industrial Organization issues

Industrial Organization Issues

Demand:• Mandatory

“Consumption”• Limited Knowledge• Low Sensibility towards

Management Fees

Supply:• Important Economies of

Scale• Quasi- Natural Monopoly • Few providers and High

Concentration• Competition based on

Sales Forces and Spurious Incentives (gifts)

Comments on

Old-Age Income Support in the 21st

Century: An International Perspective on Pension Systems and Reforms

by R. Holzmann and R. Hinzplus several colleagues

Guillermo Larrain RiosSuperintendent of Pension Funds Administrators, Chile

President of AIOS

Cartagena de Indias, May 20th, 2005