portfolio performance of selected social security

WDP-1 39

IFLL C'OPY

World Bank Discussion Papers

PortfolioPerformanceof Selected SocialSecurity Institutesin Latin AmericaCarmelo Mesa-Lago

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1 3 9 1z1 World Bank Discussion Papers

PortfolioPerformanceof Selected SocialSecurity Institutesin Latin America

Carmelo Mesa-Lago

The World BankWashington, D.C.

Copyright C 1991The International Bank for Reconstructionand Development/THE WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.S.A.

All rights reservedManufactured in the United States of AmericaFirst printing October 1991

Discussion Papers present results of country analysis or research that is circulated to encourage discussionand comment within the development community. To present these results with the least possible delay, thetypescript of this paper has not been prepared in accordance with the procedures appropriate to formalprinted texts, and the World Bank accepts nc responsibility for errors.

The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) andshould not be attributed in any manner to the World Bank, to its affiliated organizations, or to members ofits Board of Executive Directors or the countries they represent. The World Bank does not guarantee theaccuracy of the data included in this publication and accepts no responsibility whatsoever for anyconsequence of their use. Any maps that accompany the text have been prepared solely for the convenienceof readers; the designations and presentation of material in them do not imply the expression of any opinionwhatsoever on the part of the World Bank, its affiliates, or its Board or member countries concerning thelegal status of any country, territory, city, or aLrea or of the authorities thereof or concerning the delimitationof its boundaries or its national affiliation.

The material in this publication is copyrighted. Requests for permission to reproduce portions of it shouldbe sent to Director, Publications Department, at the address shown in the copyright notice above. TheWorld Bank encourages dissemination of its work and will normally give permission promptly and, when thereproduction is for noncommercial purposes, without asking a fee. Permission to photocopy portions forclassroom use is not required, though notification of such use having been made will be appreciated.

The complete backlist of publications from the World Bank is shown in the annual Index of Publications,which contains an alphabetical tide list (with fiull ordering information) and indexes of subjects, authors, andcountries and regions. The latest edition is available free of charge from the Publications Sales Unit,Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or fromPublications, The World Bank, 66, avenue d'[ena, 75116 Paris, France.

ISSN: 0259-210X

When this paper was written, Carmelo Mesa-Lago was a consultant to the Human Resources Division ofthe Technical Department of the World Bank's Latin America and the Caribbean Regional Office. He is adistinguished service professor of economics and Latin American studies at the University of Pittsburg.

Library of Congress Cataloging-in-Publication Data

Mesa-Lago, Carmelo, 1934-Portfolio performance of selected social security institutes in

Latin America / Carmelo Mesa-Lago.p. cm.-(World Bank discussion papers; 139)

ISBN 0-8213-1954-X1. Pension trusts-Latin America-Investements-Case studies.

2. Portfolio management-Latin America-Case studies. 3. Socialsecurity-Latin America-Case studies. I. Tide. II. Series.HD7105.45.L29M47 1991332.6'7254-dc2O 91-35950

CIP

iii

FOREWORD

In the growing effort to improve the performance of public sectors in the countries ofLatin America and the Caribbean, several social security institutes have been reexamining theeffectiveness of their portfolio management. Fully-funded pension schemes, which wereplanned in most countries of the region as means to provide for disability and retirementsecurity for modem-sector workers, necessarily generate funds that must be invested toguarantee returns that can pay contracted benefits.

Most systems in Spanish-speaking Latin America were decapitalized over the pastscore of years. Social security institutes, even though they are autonomous under publiccharters, have been required to invest exclusively in government bonds that paid negativereal rates of interest during periods of high rates of inflation. As the real value of theirportfolios declined, the institutes depended each year more on current revenues to financecurrent expenditures on health care services, disability and pension payments. By the end ofthe 1980s none of the traditional systems held portfolios capable of supporting certain futureobligations for pensions and survivor benefits.

Only Chilean social security institutes, among those in South America, faced up toessential reforms and, by privatizing future entrant payments and benefits, created self-financed pension systems that could provide reliable benefits without unjustifiable publicsubsidy. There are now a number of private Chilean insurance companies that have realizedexcellent returns from their diversified portfolios.

The social security institutes of the English-speaking Caribbean performed better thanthose of the Spanish-speaking countries, managing small but respectable returns to theirinvestment portfolios in most cases. Since the unification of the several Brazilian socialsecurity institutes into a single system in 1977, there has been no intention to maintain andmanage a large portfolio aimed at financing future benefits. Instead, the Government ofBrazil has attempted to match each year's revenues and expenditures (on pension benefits andhealth care) to avoid any large annual deficits or surpluses.

The interest of the World Bank in these issues stems from an ongoing effort to helpborrowers in the region improve their economic management and to reallocate publicresources, where possible, to alleviate poverty and protect poverty groups from the socialcosts of adjustment processes through which virtually all countries have been passing in thepast decade. This study by Professor Mesa-Lago is one of a series of studies sponsored bythe Latin America and Caribbean Technical Department that is made available to interestedgovernments that are seeking to improve portfolio performance of social security instituteswithin the context of adjustment and improved economic management.

George PsacharopoulosSenior Human Resources Advisor

Technical DepartmentLatin America and The Caribbean Region

V

ABSTRACT

This paper analyzes the management of investment portfolios by social securityinstitutes in eight Latin American countries, the Bahamas, Barbados, Chile, Costa Rica,Ecuador, Jamaica, Mexico, and Peru. In general, pension reserves have not been invested ininstruments with the highest economic returns. Capital markets are poorly developed,inflation has had a pervasive negative effect on the value of reserves held in financial assets,and fund managers lack the training and skills necessary to manage their portfolios. As aresult, only three of the eight countries, Chile, the Bahamas, and Barbados, enjoyed positivereal rates of return on their investments over the period 1980-87.

The paper offers four recommendations that would improve portfolio management.Investment policy should rest solely with the autonomous social insurance institute to avoidcounterproductive government intervention. Longer-term and more diversified investments,particularly in fixed-term deposits with higher real returns, would strengthen the portfolios ofmost institutes. Social security institutes in many countries would benefit from study of theprivatization process undertaken in Chile over the past decade. Pension-fund managers willrequire technical assistance and training in portfolio management to achieve positive results.Since the funds managed by these institutes constitute significant shares of national savings inmany countries, better portfolio management could contribute substantially to overalldevelopment objectives.

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TABLE OF CONTENTS

Page No.

Executive Summary xi

I. INTRODUCTION 1

1. The Shift in Technical Financing Methods in LACand Their Impact on Savings and Investment 1

2. The Contribution of Investment Returns to SocialInsurance Financing in LAC 6

3. The Selection of Case Studies 10

II. BAHAMAS 11

1. Overall Review 11

2. Investment 11a. Significance 12b. Composition 12c. Yields 13

III. BARBADOS 13



IV. CHILE 16



V. COSTA RICA 19



viii

Table of Contents (continued)

Page No.

VI. ECUADOR 22


2. Investment 23a. Significance! 23b. Composition 24c. Yields 25

VII. JAMAICA 26



VIII. MEXICO 30



IX. PERU 34



X. CONCLUSIONS 38

1. Major Findings 38a. Significance 38b. Composition 38c. Yields 39d. Reasons for the Divergent Investment

Performancie 39

2. Policy Recommendations 41a. Autonomy of Social Insurance Agency 42b. Reduction of Fixed and Net-Current Assets 42c. Portfolio Diversification 43d. Priority to :Instruments with Higher Yields 43

ix

Table of Contents (continued)

Page No.

BIBLIOGRAPHY 45

TABLES

1. Financing Methods of Social Insurance PensionFunds in Selected LAC Countries: Late 1980s 51

2. Percentage Distribution of Social Insurance'plus Family Allowances Revenue by Source inLAC: 1983 52

3. Period of Introduction of Social InsurancePension Programs by World Region: 1889-1985 53

4. Percentage of Social Insurances plus FamilyAllowances (and Pension) Revenue Generated byInvestment Returns in LAC: 1965-1983 54

5. Major Characteristics of Social Insurance Fundsof the Eight Countries Selected for Study: 1980s 55

6. Amount, Composition and Real Yield of InvestedAssets of NIB, Bahamas: 1980-1985 56

7. Amount, Composition and Real Yield of InvestedAssets of NIO, Barbados: 1980-1987 57

8. Amount, Composition and Real Yield of InvestedAssets of AFPs (Pensions), Chile: 1981-1988 58

9. Amount, Composition and Real Yield of InvestedAssets of CCSS (Pensions), Costa Rica:1977-1987 59

10. Amount, Composition and Real Yield of InvestedAssets of IESS, Ecuador: 1979-1986 60

11. Amount, Composition and Real Yield of InvestedAssets of NIS, Jamaica: 1980-1987 61

12. Amount, Composition and Real Yield of InvestedAssets of IMSS, Mexico: 1980-1988 62

13. Amount, Composition and Real Yield of InvestedAssets of IPSS (Pensions), Peru: 1981-1988 63

14. Comparison of Significance, Composition, RealGrowth and Real Yields of Social InsuranceInvested Assets in Case Studies: 1980-1987 64

xi

EXECUTIVE SUMMARY

1. Introduction

The goal of all methods of financing social insurance programs is to balance theirrevenues and expenditures. However, this balance can be attained over time periods ranging fromone year to infinity, with larger reserves being required as the equilibrium period lengthens. Thereare three main methods of financing: (1) full capitalization maintains the equilibrium for anindefinite period by means of a fixed contribution or premium; (2) partial capitalization withincomplete reserves which maintains the equilibrium for a given period (e.g., one decade)establishing a fixed premium within it but increasing the premium in subsequent periods; and (3)pay-as-you-go or pure assessment where the equilibrium is usually calculated on an annual basisand there is a small contingency reserve. Pension programs usually have the largest reserves; ifthose programs are fully or partially funded they normally have a positive impact on savings.Initially, many countries in Latin America adopted full capitalization but violated their essentialrequisites and, therefore, gradually shifted to partial capitalization, while the pioneer countries(the first which introduced pension programs) use pay-as-you-go. The non-Latin Caribbeancountries, which are latecomers, started their programs with partial capitalization. As thefinancing methods have subsequently changed from full to partial capitalization and pay-as-you-go,the reserves and their investment have declined or vanished. Furthermore, the share of investmentyields on total pension revenue of the program has gradually declined.

Pension funds in "latecomer' countries (60% of the total in LAC, with programsintroduced mostly in the late 1950s, 1960s and 1970s) use partial capitalization methods, generatea sizable investment share of total revenue, and such shares are increasing. "Middle" countries(21% of LAC with programs mostly established in the 1940s) use partial capitalization methodsand have a lower investment share which is basically declining. "Pioneer' countries (18% of LACwith programs initiated in the 1920s and 1930s) are on pay-as-you-go and lack substantial reserves,therefore, their investment share is either zero or very small (except for Chile's new pensionprogram).

In general, pension reserves have not been invested in LAC in instruments with thehighest economic returns; social insurance institutions have not been designed to play the role offinancial intermediaries, their personnel lack experience in this field and no investment plans havebeen formulated. Capital markets are poorly developed in the region and inflation has had apervasive effect on the value of the reserves.

The eight countries analyzed in the study are: Bahamas, Barbados, Chile, Costa Rica,Ecuador, Mexico, Jamaica and Peru. They were selected as a representative sample of variousfeatures such as: date of inception of the pension program, investment share of socialinsurance/pension fund revenue, financing method and investment yields. In each country, threeaspects of investment are studied: relative significance, portfolio composition and real yields.

2. Major Findings

a. Si2nificance. In 1987, invested assets as a percentage of GDP ranged from a highof 15% in Chile to less than 1% in Mexico. Real growth of total net assets and invested assets in1981-1987 occurred in Chile, Bahamas, Barbados and Costa Rica, while in the remaining countriesa decline took place.

b. Composition. There is a nil or very small proportion of total net assets (reserves)in either fixed or net-current assets in three countries: Jamaica (practically zero), Chile (zero to0.3% in 1982-1987) and Bahamas (declining from 4% to 3% in 1980-1985). Higher but stillreasonable proportions are found in two other countries: Costa Rica (declining from 20% to 5%

xii

in 1980-1987) and Barbados (increasing from 1% to 13% in 1980-1987). In the remaining twocountries, the majority of the reserves is in fixed and net current assets: Ecuador (declining from66% to 57% in 1980-1987) and Mexico (increasing from 82% to 88% in 1980-1987).

In 1987, government bonds were the main instrument for invested assets in Jamaica(91%), Bahamas (66%), Chile (45%) and Costa Rica (44%); the remaining four countries investedfrom 4% to 16% in this instrument only. Mortgage, personal and other loans were the principalinstruments for investment in Ecuador (83%) and Barbados (47%), while mortgage bonds wereimportant but declining in significance in Chile (23%); the other countries invested from 3% to16% in these instruments. Fixed term deposits were the single most important type of investmentin Peru (72%) and the second most important in Costa Rica (35%), Barbados (35%), Chile (26%)and Bahamas (18%); the other three countries did not use this instrument. Shares were a minortype of investment in Chile (6%, but increasing), Ecuador (3%) and Barbados (2%); the othercountries did not use this instrument. Real estate probably was the most important instrument ofinvestment in Mexico (84%), the second most important in Peru (18%), and a minor one inEcuador (3%); the remaining countries did not use this instrument.

c. Yields. Only three countries had positive average annual real yields of investmentin 1980-1987: Chile (13.8%), Bahamas (2.7%), and Barbados (0.7%). The other five countrieshad negative yields. The three countries with real positive yields are those in which invested assetsare relatively the most significant (in relation to GDP, etc.) and have experienced the highest realgrowth also. Conversely, the two countries with the worst real negative yields have the leastrelative significant invested assets and have suffered a real decline in such assets. That reciprocalrelationship is logical because high real yields have largely influenced the growth of invested assetsand their relative macroeconomic significance.

d. Reasons for the Diverzent Investment Performance. Six factors can explain thedivergent performance (in real yields, real growth and significance of invested assets) of the eightcountries: inflation, composition of the portfolio, terms, proportion of total net assets invested,government intrusion, and age of the program.

i. Inflation. In 1980-1987, the countries with the highest average investment yieldshad the lowest average inflation rates, and vice versa. One exception was Chile which had thehighest positive yield but an inflation rate similar to that of Ecuador and Costa Rica whose yieldswere negative. High steady inflation rates rapidly turn positive yields into negative yields anderode the real value of the reserves because the vast majority of investment has a fixed interest.

ii. Portfolio composition. The composition of the portfolio and the yields ofparticular instruments explain the overall yield performance. Five countries (Jamaica, Ecuador,Mexico, Peru and Bahamas) have from 91% to 66% of their invested assets concentrated in onesingle instrument.

Government bonds normally have a fixed interest, lower than that of commercial bankinterest. Jamaica has 91% of its invested assets in this instrument which has had consistentnegative yields; this is also true of Costa Rica (44%). Conversely, Bahamas has 66% of itsinvestment in this instrument but the government has paid interest rates above inflation as well asabove the commercial bank interest.

Loans to the government, as well as mortgage and personal loans, usually are notindexed to inflation and their yields are lower than those paid for fixed-term deposits incommercial banks. Ecuador has 83% of invested assets in this type of instrument, basically inmortgage and personal loans which have had declining nominal interest rates while inflationskyrocketed. In the early 1980s, a sizable part of investment went to the sickness-maternityprogram in Costa Rica (40%), Peru (25%), and Ecuador (10%) in the form of loans but, inpractice, those were donations. Later in the 1980s, laws and other restrictions either eliminated orsubstantially reduced such loans but, in Peru and Ecuador, transfers continued through other ways.

xiii

These loans and transfers contributed to the average real negative yields in the 1980s in thosecountries. On the other hand, Barbados has 47% of its assets in treasury bills but their interesthas apparently been higher than commercial bank interest.

Fixed-term deposits normally pay the highest yield. Peru has 72% of its investment inthis instrument, mainly in U.S. dollars which generated positive yields until 1985 when the forcedconversion of those deposits into national currency turned their yield negative. Barbados, CostaRica and Chile have a sizable proportion of their investment in this instrument (increasing in thelast two but decreasing in the first) with positive results. In Bahamas, this type of investment hasrelatively declined since 1982 due to excess national liquidity. In spite of high yields of frxed-termdeposits, investment in that instrument is nil in three countries.

Real estate investment is often in building or housing for rental which has some ofthe lowest yields in the market. In Mexico, an overwhelming proportion of assets are in "mueblese inmuebles" largely hospitals and equipment in the sickness-maternity program, office buildings,rental buildings and recreational facilities, all of which are unprofitable. In Peru, 18% ofinvestment is in rental buildings and housing which costs more to maintain than the rent itgenerates.

Investment in shares exists only in three countries and is of minor importance. Theproportion is increasing in Chile, however, stimulated by high yields and more flexible legislation.In most countries, the lack of or the poor state of local stock exchanges has been an impedimentto investment in shares; the introduction of such exchanges in a few countries (Bahamas,Barbados) may help to expand investment in this type of instrument.

iii. 'lbrms. Also contributing to low or negative yields in some countries is the factthat most investment is in short or medium-term instruments which pay lower yields than long-runinstruments. In 1985-1987, investment in short-term instruments had the following proportions:77% in Mexico, 73% in Barbados, and 40% in Bahamas (in Chile the average term was 2 years).In spite of recommendations in Bahamas and Barbados to increase the proportion of investmentin long-run instruments, little progress has been made due to the lack of investment options.Furthermore, in countries with high inflation rates, long-term investment with fixed interest isobviously not a solution but part of the problem they face.

iv. Proportion of total net assets invested. In Ecuador and Mexico, high proportionsof reserves in net-current assets (often unpaid state obligations) and/or fixed assets, have reducedinvested assets and contributed to their poor investment performance.

v. Government intrusion. In Barbados, and especially in Jamaica, the Ministry ofFinance control over investment decisions has proved to be harmful because of postponement ininvesting the fund surplus, use of reserves for government purposes, delays in transferring accruedinterest and other mishandling of investment.

vi. Age of program. Finally, the age of the pension program is important. The mostrecent programs (in Chile, Bahamas and Barbados) are still in the capitalization stage, while olderprograms (in Ecuador and Peru) are more mature and, hence, have less resources for investment.The fully-funded program of Chile accumulates more reserves than the partially-funded programsin the rest of the case studies.

3. Policy Recommendations

Policy recommendations to improve investment performance are limited by exogenousfactors to the social insurance system, the most important being inflation which negatively affectsinvested assets growth and yields (government intrusion is another limiting factor). Countrieswhich suffer from very high inflation rates, such as Peru and Mexico find it much more difficult todevelop successful policies than those with low inflation rates such as Bahamas and Barbados.

xiv

Therefore, an overall policy to control inflation is crucial as a base to improve investmentperformance in high inflation countries.

To improve investment performance, particularly in low-inflation countries, fourgeneral policies should be followed:

a. Autonomy of social insurance agencv on investment policy to avoidgovernment interference;

b. Reduction of fixed and net current assets to maximize invested assets;

c. Portfolio diversification to compensate low yields of some instruments withhigh yields in others and for the long-run stability of the system; and

d. Priorities to instruments with higher yields such as fixed-term deposits.

In closing, social insurance funds in LAC have become significant sources of capitalin a few countries and have the potential for playing such a role in many other countries,particularly in those with relatively new programs (which are a majority) but also in pioneercountries as the case of Chile illustrates. Negative performance in real yields has been partly dueto high inflation rates and partly to poor investment policies. The latter could be improved with aseries of measures, in spite of exogenous limitations such as high inflation, governmentinterference, excessive liquidity and poor capital markets. For those policies to be successful, it isessential to learn from past mistakes and elicit the support of domestic governments andinternational financial agencies.

1

I. INTRODUCTION

This report first reviews the overall trends in social insurance*(pension) funds portfolio investment in Latin America and the Caribbean(LAG): the shift in financial methods, the contribution of investment tofinancing social insurance, and investment efficiency. This analysisallows us to establish differences in investment performance among LACcountries and do some comparisons with other developing countries as wellas industrialized ones.

The core of the report is an in-depth analysis of social insuranceinvestment portfolio in eight countries. In most cases all socialinsurance funds are considered and, in a few, only pension funds whichare the most significant. Countries were selected as a representativesample of various features such as: date of inception of the pensionprogram, investment share of social insurance/pension fund revenue,financing method, and investment yields. The countries selected are:Bahamas, Barbados, Chile, Costa Rica, Ecuador, Mexico, Jamaica, and Peru.Field research and data collection on all these countries was conductedin 1987-1988, except in Ecuador for which additional data were obtained.In each case study the following investment aspects are analyzed:relative significance of social insurance/pension fund investment,composition of the portfolio, and real yields.

The concluding section of the report reviews major findings andmakes some policy recommendations.

1. The Shift of Technical Financing Methods in LAC and theirImpact on Savings and Investment

The goal of all methods of financing social insurance programs is tobalance their revenues and expenditures but in different time periodsranging from one year to infinity, larger reserves being required as theequilibrium period lengthens. There are three main methods of financing:full capitalization, partial capitalization and pay-as-you-go [3, 73].

The full capitalization method or general fixed-premium with fullreserves (fully funded) attempts to maintain the equilibrium for anindefinite time by means of a fixed contribution or premium. The latteris actuarially calculated to finance estimated future pension obligationsbased on demographic, economic and other factors. One advantage of thismethod is that the premium is fixed, hence the contributors knowbeforehand what the burden is going to be, and there is no transfer of

*The term social security is used herein following the InternationalLabour Office (ILO) concept, as embracing both social insurances andother programs such as public health, family allowances and socialwelfare. Social insurances cover, in turn, several schemes: old-age,disability and survivor pensions (the focus of our report), sickness-

maternity, employment injury and unemployment compensation. Pensionfunds have the largest reserves within LAC social insurance/security.

2

that burden to future generations. However to guarantee the stability ofthe premium and the equilibrium of the program, this method requiresthat: (a) benefits are not increased or entitlement conditionsliberalized without a corresponding adjustment in revenues; (b) premiaand other obligations are paid by all punctually and in their entirety;(c) reserves are invested efficiently generating a positive real yield(adjusted for inflation); and (d) actuarial studies are conductedperiodically to make any needed adjustments.

The most common partial capitalization method is the scaled premiumwith incomplete reserves. This method maintains the equilibrium for agiven period (for example one decade) establishing a fixed premium withinthat period but normally increasing the premium (scaling it up) insubsequent periods. The same requisites to maintain the equilibrium,discussed above, apply to this method which has the advantage of needingsmaller reserves and hence reduces the pressure to invest large reservesefficiently. On the other hand, the premium is not fixed indefinitelybut normally requires periodic increases that must be implemented in atimely fashion and there is a transfer of part of the burden to futuregenerations.

In pay-as-you-go or pure assessment method, the equilibrium isusually calculated on an annua:L basis and often there is a reserve onlyfor contingencies and fluctuations. The reserves required in this methodare small and hence investment is nil or of little significance. Butthis method requires more frequent increases in contributions andinvolves a higher transfer of the burden to future generations thanpartial capitalization.

Short-term risk social insurance programs (e.g., sickness-maternity,family allowances and unemployment) generally use pay-as-you-go, whilelong-term risk programs (e.g., old-age, disability, survivors andemployment-injury pensions) may employ any of the three methodsexplained. A key question is which method is the more appropriate tofinance long-term risks, particularly pension programs.

The impact of a pension program on savings and investment depends onthe surplus it may generate and the effects of that surplus on othersources of domestic savings (private and public) and external savings[2]. The surplus or deficit is a result of factors endogenous to theprogram (e.g., financing methods, degree of maturity and administrativecosts) as well as exogenous factors (e.g., age structure of thepopulation, rate of salary increase and overall economic situation).Fully or partially-funded programs should generate a surplus but not pay-as-you-go. The maturity of the pension program depends, among otherfactors, on its age, the retirement age for pensions and the agestructure of the population. Thus the older the program, usually thelower the retirement age, the older the population, the smaller thecontributor/pensioner ratio and the lower the surplus, and vice versa. Ayoung population tends to grow rapidly, expanding the labor force and ifthe program's coverage grows, its revenues also rise. On the other hand,in an aging population, the potential number of contributors declines and

3

the number of pensioners rises. If real salaries are rising, thecontribution base for the pension program also expands. A severerecession that reduces both employment and real salaries tends to have anegative impact on the pension program revenues and to lower the surplus.Pension programs can raise the cost of exports making them lesscompetitive (so that countries without such programs or a lower burdenare favored) and can thus reduce potential external savings.

Concerning impact on domestic savings, it has been traditionallyargued that pension programs financed by the pay-as-you-go method reduceboth individual savings and the demand for private insurance, andincrease consumption [2, 44]. New pensioners have an increase in theirincome and raise their consumption while contributing insured assume theywill receive a future pension related to their wages and contributionshence reduce their savings to match their payments. The net result wouldbe an increase in consumption and a reduction in savings. And yet thishypothesis assumes that all retirement income is consumed, that savings(both of active and passive insured) cannot be stimulated, and thatcurrent active insured have confidence that adequate pensions will indeedbe paid when they retire. In developed countries with more solventpension programs and both economic and financial stability, insuredconfidence could be stronger than in IAC, particularly in countries thathave suffered acute disequilibrium in social insurance andhyperinflation.

Fully or partially-funded pension programs are assumed to havepositive impact on savings because additions to their reserves increasecapital formation on an equal amount. But this would not be the case ifthese reserves are used (as is common) in some LAC countries largely tofinance additional public expenditures or reduce taxes, unless theprivate sector views its contribution to the program as a tax instead offorced savings. An additional serious problem in many LAC countries ishigh inflation which can reduce or even wipe out real reserves of thefund due to the lack of investment indexation [44].

The research and debate on these issues conducted primarily in theUnited States and other developed nations have produced contradictoryresults [7, 42]. If the impact of pension funds on savings is difficultto evaluate in developed countries, where statistics are more precise andcoverage is practically universal, it is virtually impossible to reach aconclusion in LAC. Different interpretations exist even within onecountry; thus one study done in Chile found that social insurance had anegative effect on savings, whereas a later study concluded that, afterthe necessary adjustment, social insurance had generated a surplus(although a diminishing one) rather than negative savings [2, 76]. Arecent analysis conducted by an IMF expert concludes that it is notpossible to make a blanket recommendation in favor of funded or notfunded pension programs in LAC [44].

Independent of the above discussion, there is an indisputable factin LAC: social insurance pension funds have gradually shifted theirfinancing method from full to partial capitalization and, in the pioneer

4

countries, to pay-as-you-go. Table 1 identifies the financing methodused in pension programs of selected LAC countries towards the end of the1980s.

Initially, many countries in Latin America adopted fullcapitalization but violated its essential requisites: (a) the legislativebranch added new benefits and liberalized entitlement conditions withoutadjusting the premium upward; (b) employers' evasion and payment delays,as well as lack of fulfillmlent of the state financial obligations,reduced the revenue; (c) unexpected increases in life expectancy modifiedthe actuarial estimates, and ages of retirement were not raisedaccordingly in many countries (in Costa Rica, the age for earlyretirement was reduced while life expectancy increased dramatically); and(d) inflation provided incentives to delinquent payments and eroded thereal value of investment yields.

As a result of the violat:ions explained above, practically all LatinAmerican countries shifted, liegally or de facto, from full to partialcapitalization (mostly to the scaled premium). By the end of the 1980sprobably the only example of a fully-funded pension fund was Chile's newpension program established in 1981. Furthermore, many Caribbeancountries, probably taking into account the Latin American experience,started their new pension programs using partial capitalization too. Bythe end of the 1980s most LAC countries on Table 1 used the scaledpremium method. But legal rigidity (several countries fix contributionsby law) and opposition from unions and business have been strongobstacles to scaling up the premium. In practice, various countries havefixed only the initial premium and failed to do actuarial reviews,determine the duration of the time periods and adjust the premium.

The pioneer countries in Latin America subsequently shifted frompartial capitalization to pay-abs-you-go: Argentina, Brazil, Chile (in theold system which now covers only 14% of the active insured but 97% ofpensioners), Cuba (which since 1963 followed the centrally plannedapproach) and Uruguay. (In addition, civil servants and military pensionfunds in several countries use pay-as-you-go also.) The reason for theshift was a lack of actuarial equilibrium under partial capitalizationbecause expenditures grew faster than revenues. Causes for fast growingexpenditures were: universalization of coverage, too liberal entitlementconditions (including low ages of retirement) and generous benefits(including cost-of-living adjustment of pensions), and maturation ofpension programs with a growing number of pensioners who live longer thananticipated and hence collect pensions for a longer period.**

**As the pension program matures a higher percentage of socialinsurance expenditure is allocated to it: in 1965-1983, the pensionshare of expenditures steadily increased in practically all LACcountries; in the pioneer countries the share ranged from 59% to 85%,while in countries with relatively recent pension programs, the sharevaried from 9% to 45% [38 bis].

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Revenues were less than anticipated because of incorporation oflower income groups, increasing rates of pensioners to contributors,employers' evasion and payment delays aggravated by inflation, political-economic obstacles to raise the contributions or taxes further, and low(or real negative) capital returns due to poor investment policies andhigh inflation rates.

The adoption of pay-as-you-go in the pioneering countries was only atemporary postponement of the time of reckoning. As has been said, thismethod has an annual base and hence requires frequent increases inrevenue (contributions) a task even more difficult to achieve than underthe longer periods on which the fixed and scaled-premium methods arebased. Even worse, if the pension programs were incapable of attainingequilibrium when the pensioners/contributors ratio was lower, it is evenless feasible when that ratio has increased significantly (e.g., one-to-one in Uruguay). No longer able to replace one financing method byanother to postpone the crisis, the pioneer countries finally had toconfront it. In most of these countries the state temporarily came tothe rescue of pension programs by subsidizing them (in 1975-1983 statesubsidies increased in all pioneer countries). And yet the economiccrisis of the 1980s and the heavier burden of the system is eventuallyforcing the state to stop or reduce such subsidies or let pensions erode.In a survey conducted in 1980, before the crisis began, the InteramericanDevelopment Bank concluded: "The persistence of a deficit is thesituation generally confronted by the social security systems in LatinAmerica financed by the pure assessment method. This is confirmed bystatistics and annual balances of the social security institutions,numerous national and international studies, and the IDB survey's resultsin the countries of the sample"[3]. The crisis has induced a furthershrinkage of revenue due to increasing unemployment and informal work,decline in real wages, growing evasion and payment delays fueled byskyrocketing inflation, a rising state debt, and decreasing investmentyields partly a result of high inflation rates. On the other hand, morepeople request welfare pensions or, being unemployed, have chosen earlyretirement, and mount the pressure to adjust the badly eroded pensions[201.

Chile tackled the problem in 1981 with the creation of a fully-funded private pension program, but the old system continues with pay-as-you-go, suffers an enormous deficit and requires increasing statesubsidies. Argentina is now studying a reform (more moderate than theChilean); one alternative being considered is the introduction of afully-funded supplementary pension program. Uruguay has studied theproblem but failed so far to implement the reform. In Cuba, the statesubsidy jumped from 24% to 56% of expenditures in 1974-1983 in spite ofsome erosion in real pensions but there is no talk of reform yet.

As the financing method has successively changed from full topartial capitalization and pay-as-you-go, the reserves (and theirinvestment) have declined or vanished. Furthermore, countries that stillenjoy substantial surpluses (because their pension programs still are inthe capitalization period and have neither universalized coverage nor

6

reached maturity) may eventually face the pioneers' fate unless theychange their policies. On the other hand, the reintroduction of a fully-funded pension program in Chile and consideration of supplementarypensions (also fully-funded) in Argentina and Costa Rica may be thebeginning of a new trend in LAC. But these new fully-funded programsmust prove in the long run that large reserves can be efficientlyinvested in an inflationary environment and guarantee the payment ofpensions in the future.

2. The Contribution of Investment Returns to Social Insurance FundFinancing in LAC

Social insurances and family allowances are financed mainly by awage tax. Table 2 provides financial information on 28 LAC countriesreported by the ILO. In 1983, employers had the highest contribution,averaging 43% of total revenue in the region (more than 50% in eightcountries) although they might have transferred part or all of suchcontribution to the workers (backward transfer) and/or the consumers(forward transfer) [46,47]. Only in Chile and Suriname was the employercontribution nil or very small. The insured contribution averaged 26.5%of revenue in 1983 (zero in Cuba). State payments (in addition togovernment contributions as employer) either through direct budgetaryallocations or special taxes, averaged 14% of revenue; however, in tencountries the state did not contribute at all and in five the statefinanced from 36% to 66% of thle system (mainly in the pioneer countriesexcept Brazil).

The share of investment returns to total revenue averaged 15% in LACbut exceeded 20% in seven countries and was 5% or less in eight; theshare ranged from zero to 48%. If instead of social insurance plusfamily allowances revenue we would have taken total social securityrevenue, the share of investment would have been smaller because thereare social security programs that do not have reserves at all, such aspublic health and social assistance. Conversely, when desegregatingpension programs (possible in all but seven LAC countries in 1983; seelast column of Table 4), the investment share of pension revenueincreased in practically all countries and averaged 20%. This is becauseof the exclusion of both family allowances and other short-term-risksocial insurances such as sickness-maternity which require less reservesand generate a lower yield. Table 2 shows that total social insuranceplus family allowance revenue in LAC averaged 4.5% of GSP in 1983 (butfrom 7.5% to 16.7% in the pioneer countries, Costa Rica, Panama andGuyana). More than half of that: revenue (an average of 2.4% of GDP) wentto the pension program and the investment share of that program was 20%or equal to 0.5% of GDP.

In 1983, the LAC investment share of social insurance plus familyallowances revenue was relatively higher than the share of industrializedcountries but lower than the share of developing countries in Africa,Asia and Oceania. Among the industrialized countries the share rangedfrom zero to 12% according to three groups: (a) in Eastern Europe, theinvestment share was zero; (b) in most of Western Europe, Oceania and the

7

United States the share fluctuated from zero to 2%; and (c) in Japan,Canada, Israel and a few Western European countries the share ranged from4% to 12%. In the majority of African developing countries the shareranged from 15% to 51%, while in two-thirds of the Asian developingcountries the share varied from 20% to 48%, and in the few developingcountries of Oceania, it fluctuated from 9% to 34% [38 bis].

Lack of disaggregated data in many countries and significantdifferences in programs among countries make a comparative evaluation ofthe investment contribution to the financing of social insurancesdifficult. For instance, many developing countries in Asia and Africaonly have provident or pension funds which usually have proportionallylarger reserves and higher investment yields than short-term programsabundant in LAC (such as sickness-maternity) hence the investment shareof the former appears higher than that of the latter. Still we couldadvance the hypothesis that two major factors determine the difference ininvestment shares among countries. First is the age or maturity of thepension program: an older program should have a tendency to shift itstechnical-financing method from full capitalization to pay-as-you-go,hence reducing the size of the reserves and its return (demographics mayplay a role too). Second, is the efficiency in the investment of thereserves: the more efficiently a fund is invested, the higher its yieldshould be.

We lack data on investment efficiency for all countries reported bythe ILO, but we do have information on the year of introduction of socialinsurance pension programs for all of those countries [75]. Based on thelatter, we can partly explain the investment performance of LAC comparedwith other world regions as well as among IAC countries. Table 3 showsthat LAC pension programs were implemented later than in industrializedcountries but earlier than in other developing countries; by 1950 allindustrialized countries had pension programs, as well as 38% of LACcountries and 8% of other developing countries, and by 1980 all LACcountries had pensions but only 84% of other LDCs. Within LAC, there ismore than a half-century span between the pioneer countries and thosewhich initiated pensions late, and there is a strong relationship betweendate of inception and share of investment revenue (see Table 4).

In the five Latin American pioneer countries, pension programs wereinstalled in the 1920s and 1930s (Argentina, Brazil, Chile, Cuba andUruguay) and by 1983 they either lacked pension reserves or had a smallcontingency fund, thus their investment share averaged 0.9% (excludingChile) and ranged from zero to 2%. Chile was the only exception becauseof its new pension program initiated in 1981, but until 1980 its oldsystem share was lower than 2%. Argentina's share of 2% was largelygenerated by other programs but, within the pension program the share wasonly 0.2%. Uruguay's share of 1.6% came from a few small professionalpension funds rather than from the general pension program whose sharewas zero. The investment share of the pioneer group (zero or nil) wasthe lowest in the Western Hemisphere in 1983 and hence comparable to thatof Eastern European and most Western European countries which were worldpioneers in social insurance pension programs.

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Within Latin America, a second group of six "middle" countriesfounded their pension programs mostly in the 1940s and first half of the1950s: Mexico, Costa Rica, Ecuador, Panama and Colombia; in addition,Peru is included here because one of its pension programs began in the1930s and others at the beginning of the 1960s. The investment share ofthis group averaged 11% (17% in pensions) and fluctuated from 5% to 13%(shares of Rension programs varied from 9% to 23%). An exception isEcuador with a share of 22%, although its investment share of pensionrevenue was 16%, closer to thie parameters of this group. The share ofthis group is much higher than that of the pioneers' but considerablylower than the share of most LDCs and similar to that of countries thathave the highest share within the industrialized world (4% to 12%).

The six Latin American "late comers" (Nicaragua, Bolivia, Venezuela,Guatemala, El Salvador, and Honduras) organized their pension funds fromthe mid-1950s to the beginning of the 1970s and, in 1983, their shareaveraged 15.6% (30% in pensiois) and varied from 12% to 20% (shares ofpension programs ranged from 15% to 46%). In this group we should alsoinclude the new pension program of Chile, established in 1981, whichpushed the investment share ul) to 16% in 1983 (23% in pensions alone).These shares are therefore the highest within Latin America but somewhatlower than in the non-Latin Caribbean.

The eleven non-Latin Caribbean countries were the latest toestablish social insurance pensions in the Western Hemisphere (from themid-1960s to the end of the 1970s) and, with the exception of Surinameand Grenada, their investment share averaged 24% and ranged from 13% to48% (15% to 49% in pensions), hence similar to shares of other LDCs andthe highest in LAC. Notice that Grenada's investment share in 1982 was66%; a change in the law in 1983 (shifting from a provident fund tosocial insurance) introduced insured's contributions and increasedemployers' contributions and the new pension fund began that year. Welack institutional information to explain the lack of investment returnsin Suriname.

Trends in the investment shares in LAC in 1965-1983 show a similarpattern with those discussed above on the size of the share (see Table4). The pioneers' share basic-ally stays at zero or is very small andshows little variation. In the middle group there is either a decreasingshare or an increase followed by a decline. Conversely, latecomercountries in Latin America and the Caribbean, with very few exceptions,have an increasing share throughout the period.

In summary, pension funds in "latecomer" countries (60% of the totalin LAC, with programs introduced mostly in the late 1950s, 1960s and1970s) use partial capitalization methods (except in one which has afully-funded method), generate a sizable investment share of totalrevenue, and such share is increasing. "Middle" countries (21% of LACwith programs mostly established in the 1940s) use partial capitalizationmethods and have a lower investment share which is basically declining.Finally, in pioneer countries (18% of LAC with programs initiated in the1920s and 1930s) pension programs are on pay-as-you-go and lack

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substantial reserves; therefore their investment share is either zero orvery small (except for Chile's new program).

Some of the exceptions in the size and trend of the investment sharecould be explained by management efficiency in investing pensionreserves. In general those reserves have not been invested in LAC ininstruments with highest economic returns. Social insurance institutionsin LAC have not been designed to play the role of financialintermediaries. Their personnel lack experience in investments and noinvestment plans have been formulated. Furthermore, capital markets arepoorly developed, and inflation has had a pervasive effect on the valueof the reserves.

In Latin America, pension funds reserves have normally been investedin: a) loans to the government and government stocks and bonds, oftennon-negotiable and seldom indexed to inflation, which in practice havebeen forced loans to cover state budget deficits, thus flooding socialinsurance agencies with bonds without value; b) personal or mortgageloans, generally for the insured individuals who, aided by inflation (andthe lack of indexing of the loans) have obtained capital practically freeand have thus contributed to decapitalizing the fund; c) loans to thesickness-maternity insurance programs to develop its infrastructure andeven to cover their deficits, which are laudatory from a social point ofview but not economically sound; d) administrative buildings and housingconstruction, often for the insured, which generates very low ornonexistent revenues because of the freezing of rents, inefficiency ofcollection, and payments in depreciated money; and e) in a few cases, incommerce (for example, stores with state-subsidized prices for thebenefit of the insured), and in services (for example, cinemas, theatersand sports) that also have yielded very low or negative returns.Investment in bank deposits are probably the most profitable in LatinAmerica but are often not too significant while investment in shares israre [47].

In the non-Latin Caribbean, the bulk of the funds has been investedin government stocks, bonds and treasury bills. However, in somecountries these securities earn a higher yield than in Latin America, anda significant part of the reserves is in bank deposits with an evenhigher yield. But in several countries, the Ministry of Finance, ratherthan the social insurance institute, controls investment in practice and,in at least one country, has retained part of the yields earned by theinvested funds [48].

Although yields appear to be higher in the Caribbean than in LatinAmerica, in practically the entire region the return of social insurancefunds is much lower than the bank interest and, in many cases, the realinvestment yield has been negative, particularly in the 1980s withincreasingly high rates of inflation. Chile is an interesting casebecause prior to the process of privatization of pension funds, theinvestment share of total social insurance revenue was almost nil but hasbeen growing thereafter and, in 1983, was the eleventh highest among 28countries.

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3. The Selection of the Cases of Study

It was not possible, with the financial and time limitations of thisstudy, to analyze social insurance or pension fund investment in all LACcountries. Therefore, we had to select a number of countries bothrepresentative from the region and distinctive as unique models. Sincethere is no substantial investment in pioneer countries, it was decidedto discard them. However Chile, a pioneer country, was included becauseit introduced a fully-funded pension program in 1981 and still has theburden of the old pension program. Three latecomer countries, from thenon-Latin Caribbean (Bahamas, Barbados and Jamaica) with a divergentperformance in terms of investment yields were also selected. Finally,we chose four "middle" countries from Latin America (Costa Rica, Ecuador,Mexico, and Peru) with different dates of inception of their pensionprograms, sizes of investment shares, and performance in investmentyields. In three countries only pension fund investment was analyzedwhile in five countries all social insurance funds were studied becauseit was not possible to disaggregate pension investment; however, in allthese five countries, the large majority of the reserves/investment is inthe pension fund. Table 5 summarizes the major characteristics of socialinsurance/pension investment of the eight countries selected for study.

The time period of the data varies somewhat: Bahamas, 1980-1985;Barbados, 1980-1987; Chile, 1981-1988 (the new pension program began in1981); Costa Rica, 1977-1987; Ecuador, 1979-1986; Mexico, 1980-1988; andPeru, 1980-1988. Field research was conducted in all countries in 1987-1988 with the exception of Ecuador (1984), where recent data wereobtained later for this country. Therefore, we have a 1980-1987 seriesin all countries but two. Accuracy of the data differ with the mostdetailed and disaggregated statistics available from the non-LatinCaribbean, Chile and Costa Rica; data on Mexico are fair, and the mosttroublesome data are from Ecuador and Peru.

An attempt has been made to standardize statistics as much aspossible by following the format used in an ILO 1983 internationalcomparative study on social insurance investment [38]. A standard tableis used in all countries, providing data on: (a) total net assets,invested assets (total net assets less fixed and net-current assets) andinvestment returns (all three given in the national currency, in currentprices); (b) nominal yields of invested assets, inflation rates, and realyields (adjusted for inflation) of invested assets (all given inpercentages); and (c) percentage distribution of invested assets byinstrument (government bonds, loans/mortgages, fixed-term deposits,shares and real estate).

The analysis of each case also follows the same format. First thereis a summary of the historical development of social insurance, itspopulation coverage, significance of various programs, financialstability and latest actuarial evaluation. Next comes a briefdescription of the financingr methods used by each program, thedistribution of the reserves among various programs, and overallinvestment policy. The core of each case study is an analysis of: (a)

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the size and real growth of total net assets and invested assets, andtheir significance in terms of other macroeconomic indicators (e.g.,money supply, gross fixed capital formation, GDP); (b) the composition ofinvestment by instrument and its trends, explaining causes of majorshifts; and (c) the estimation of real yields, overall and for specificinstruments, and discussion of recent steps taken to improve such realyields. The study ends with a comparison of the significance,composition and real yields of social insurance/pension invested assetsamong the eight cases, as well as some policy recommendations derivedfrom such a comparison.

II. BAHAMAS

1. Overall Review

The National Insurance Board (NIB) established in 1972 beganoperations in 1974 providing compulsory social insurance coverage foremployees (since 1976 for the self-employed) on: old-age, disability andsurvivor pensions, employment injury benefits and short-term benefits(sickness-maternity payments in lieu of salary and funeral grants). TheNIB also administers non-contributory disability and survivor pensions.Health care is provided by a national health program, independent fromthe NIB, but the latter created in 1985 a Medical Benefit Branch toimprove public health facilities. In 1985 from 83% to 86% of the laborforce was covered by the NIB. The percentage distribution of revenue in1986 was: 25.6% insured, 41.8% employers, 1.4% state, 30.6% investmentreturns, and 0.6% other income. The share of investment increased from17.7% to 30.6% in 1978-1986 thus becoming the most important NIB revenuesource after employers' contributions. In 1986, 50.4% of expenditureswent to pensions, 22.8% to short-term benefits, and 2.3% to employmentbenefits, while 23.2% was spent on administration (one of the highest inthe region, partly due to the newness of this program). The NIBgenerated an annual surplus throughout 1978-1986, although it declinedfrom 72% to 57% of revenue. The latest (1985) actuarial review availableconsidered NIB finances sound and assured a period of equilibrium of 17years for the pension program, but this was based on questionableassumptions: an investment yield of 6% (the real yield averaged 2.7% in1980-1985); containment of excessively high and increasing administrativecosts; and payment of government contribution (in 1986 only 43% of it waspaid) [48, 50]. Information on the 1988 actuarial review is notavailable yet.

2. Investment

In 1985 the reserves were distributed as follows: 66% in the pensionprogram, 12% in employment injury, 17% in the new medical branch, and 5%in short-term benefits. NIB programs use the following financingmethods: scaled-premium in pensions, assessment of constituent capitalsin employment injury, and pay-as-you-go in short-term programs [60, 61,62].

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The Ministry of Finance provides general rules on investment andadvice on types of instruments but the final decisions are made by theNIB. It is difficult for an economy of the size of Bahamas to absorb allof the NIB reserves and there has been discussion on the best way toinvest them, opinions ranging from turning these funds to the privatesector to a state investment plan.

a. Significance

Total net assets increased by 134% in 1980-1985 but, adjusted forinflation, the increment was reduced to 76%; if invested assets are used,real growth was 77% in the sarne period (see Table 6). Out of the totalnet assets, a small percentage (3.4% in 1985) was in fixed and netcurrent assets and 96.6% was in financial investment. In 1985, totalinvested assets were equal to 123% of the national money supply, 68% ofgovernment revenue, 67% of gross fixed capital formation and 11.3% of GDP[13, 40, 74]. These are among the highest proportions of the eight casestudies.

b. Composition

The percentage distribution of NIB investment by instrument is givenin the bottom of Table 6: (a) government stocks took most of theinvestment, although with a declining share of the total (70.3% to 55.8%)and paid a high yield (from 8.75% to 9.5% in 1985); (b) bank deposits,mostly in commercial banks (67% in 1985) also had a declining share(20.9% to 17.8%) and paid a lower yield fluctuating from 7% to 9%; (c)Treasury bills had an increasing share from 8.8% to 12.9% and paid thelowest yield (less than 2%); (c) government mortgage bonds are relativelynew and had a rapidly rising share (from 0.7% to 10.5%); and (d) loans togovernment corporations had a stagnant share (3%) since 1983. There wasno investment in shares or real estate.

In 1985, almost 90% of total invested assets was in state financialinstruments or deposited in state banks, up from 85% in 1980. The demandfor government stocks is enormous and the NIB has to compete withnumerous public and private investors. Treasury bills pay a very lowyield but, according to the NIB, there are not many alternatives andhence it is better to get a low interest than nothing. Return on bankdeposits is declining because banks have more money than they can use,and due to the slowdown in inflation. There is no local stock exchangealthough there seems to be an ongoing effort to start one. According toone expert's opinion, less than 20 corporations in the Bahamas wouldqualify and many would not be interested in NIB funds. Finance/investmentexperts disagree on whether to invest NIB funds in tourism, fishing,agriculture and housing. Concerning the latter, there was considerablehesitation in 1987 on using NIB funds for housing: union leaderscomplained that current government housing could not be afforded byworkers, while managers of private savings associations opposed NIBdirect housing investment although accepted its participation in thedevelopment of a second-mortgages financing system [48].

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In 1982, 52% of investment was in short-term instruments, 47% inmedium term and only 1% in long term. By 1985, the distribution hadimproved: 40% short-term, 35% medium term; and 25% long-term. But whilein 1981 69% of instruments were public, by 1985, the proportion had risento 85%. The high concentration in low yield short-term instruments andpublic instruments prompted the 1985 actuarial review criticism and therecommendation to diversify the portfolios in order to get a highercapital return and protect the future financial stability of the system[NIB, 1981, 1985, 1987].

c. Yields

The nominal investment yield averaged 8.4% in 1980-1985. Actuarialprojections have assumed an interest yield of 6% hence the outcome of NIBinvestments is positive in nominal terms. However, the evaluation of theyields must be done in real terms or adjusted for inflation. In 1980-1981, inflation rates were high but declined in 1982-1985, as a result,investment yields were negative in the first two years but becamepositive thereafter and averaged 2.7% annually in 1980-1985. Althoughlow, these real yields are the second highest among the case studies.Contributing to the positive outcome has been relatively low inflationrates and relatively high yields paid by government stocks. Thedeclining share of NIB investment in government stocks (due tocompetition for this instrument) combined with dwindling interest paidfor fixed deposits in 1983-1985 and low yields of treasury bills forcedthe NIB in 1983-1985 to invest funds in mortgage bonds, and governmentloans mostly to finance housing. It is too soon to know how profitablethis investment has been. The alternative of investment in privatesector shares is limited by the lack of a local stock exchange and thelow number of corporations that would qualify.

III. BARBADOS

1. Overall Review

The National Insurance Office (NIO) was established in 1966 andbegan operations the following year, granting compulsory social insurancecoverage for employees (self-employed, since 1971-1974 on: old-age,disability and survivor pensions, employment injury benefits and short-term benefits (sickness-maternity, unemployment and severance paymentsand funeral grants). Since 1982 the NIO has administered a non-contributory old-age pension program. Health care is provided by anational health program independent from the NIO. In 1983 about 82% ofthe labor force was covered by the NIO. The percentage distribution ofrevenue in 1986 was 81.9% insured's and employers' contribution (aboutone-half each), 17.4% investment returns and 0.7% others (the state doesnot contribute except as an employer). The share of investment decreasedfrom 28.6% to 17.4% in 1975-1986 and hence it is considerably lower thanin Bahamas. In 1986, 32.9% of expenditures went to contributorypensions, 23% to unemployment compensation and short-term benefits, 1.2%to employment injury, 37.9% to non-contributory pensions, 4.7% toadministration (very low by regional levels), and 0.3% to other

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expenditures. The NIO generated a surplus throughout 1975-1986 butdeclined from 71% to 20.5% of revenue. The latest actuarial reviewavailable (1985) evaluated as sound the employment injury and short-termprograms, but raised doubts on the pension programs. The period ofequilibrium of the contributory pension program has been cut by fouryears, to 10 years, and this period is based on the double assumption ofdeclining costs of the non-contributory pension program (which hasdepleted part of the NIO fund in the past) and a real investment yield of2% (exceeded in 1983-1986 but underfulfilled in 1979-1982 when yieldswere negative). Furthermore, the actuarial review did not tackle otherfinancial problems such as the serious erosion in the reserves of boththe severance and unemployment: programs [48, 50]. Information on the1988 actuarial review is not available yet.

2. Investment

The NIO operates on a "pooled fund" basis: most revenues are notsegregated by risk/program but consolidated in a National Insurance Fundwhich covers long-term and short-term programs; however, employment-injury, unemployment and severance programs have separate contributionsand accounts. Contributory and non-contributory pensions share the same"pooled fund," and reserves of the former have been used to subsidizecurrent deficits of the latter. A 1983 IMF recommendation to separateaccounts of all the programs was discarded by the NIO based on the amountof work it would entail [39, 62]. NIO programs use the followingfinancing methods: scaled premium in pensions; assessment of constituentcapitals and pay-as-you-go for employment injury pensions and short-termbenefits respectively; and pay-as-you-go for other short-term benefits(and probably unemployment and severance programs) [48].

It is not clear who is mainly responsible for the NIO investmentpolicy. NIO executives as well as employer and union leaders asserted in1987 that the Ministry of Finance sets the investment policy, adependency considered harmful by some because the government could useNIO funds for its own purpose. Also the IMF had noticed harmfulpostponement in the investment of NIO surpluses due to delays inapprovals by the Ministry. But a spokesman for the Ministry of Financecontradicted the above, saying that the Minister does not decide whereinvestment should be made but only sets guidelines, and that the NIOBoard has the power to recommend specific investments. Obviously, thereis a need for a well-defined irnvestment policy and clear distribution ofresponsibility [39, 48].

a. Significance

An analysis of NIO investment is not an easy task because datapublished in the NIO annual reports are fragmentary, incomplete anddifficult to put together (this problem was already pinpointed by the IMFin 1983). Such reports have long, detailed lists of individualinvestments but lack a global picture and analysis. NIO total net assetsincreased by 133% in 1980-1986 but, adjusted by inflation the incrementwas smaller: 59%; if invested assets are used, real growth was 36% in the

15

same period (see Table 7). In 1985, 83% of the reserves were in the NIO"pool fund", 6% in employment injury, 10% in unemployment and 1% inseverance. The NIO does not have reserves in fixed assets (it does noteven own its headquarter's building, which is rented) but the percentagein net current assets is much higher than in Bahamas and has increasedfrom 5.3% in 1981 to 14.8% in 1985 although it declined to 13.3% in 1986(see Table 7). In 1983 (when the percentage was 13.8%) the IMFrecommended ways to reduce the cash surplus but such measures had notbeen implemented by mid-1987 [39]. In 1987, NIO invested assets (86.7%of reserves) were equal to: 79% of money supply, 53% of governmentrevenue, 79% of gross fixed capital formation, and 12.7% of GDP. Theseare among the highest proportions of all case studies. Top governmentofficials and one member of the NIO board pinpointed in 1987 that thereis excess liquidity in Barbados financial system (as in Bahamas) and thatthe large size of NIO invested assets is difficult to be absorbed by themarket.

b. Composition

The percentage distribution of NIO invested assets by instrument in1981-1987 is given in the bottom of Table 7: (a) treasury bills (loansto the government) increasing from 25.7% to 46.9%; (b) fixed-term bankdeposits, decreasing from 49.4% to 35.1%; (c) government bonds anddebentures, decreasing from 21.5% to 16%; and (d) shares, decreasing from3.4% to 2% (there is no investment in real estate). Therefore, 21% ofinvestment which in 1981 was in bank deposits, government bonds andshares, has been transferred to treasury bills. Some employers and tradeunionists argued in 1987 that such a shift was influenced by politics ata cost to NIO; conversely, a top government official claimed that thetreasury bill yield had been in the long run higher than commercial bankinterest rates. The Central Bank historical series of yields for 1980-1986 tend to support the second opinion [10, 481.

In 1981, 62% of invested assets were in public instruments(government bonds, debentures, treasury bills and less than one-third offixed deposits) while 38% was in deposits in private banks and shares.By 1987, the state share had increased to 86% and the private share haddeclined to 14% [38, 48]. This seems to confirm the noted concern thatthe government increasingly controls investment probably through theMinistry of Finance.

Another problem, noticed in the latest two actuarial reviews (1982,1985), is that the bulk of investment is in short-term instruments ratherthan in long-term, in spite of the fact that this is not consideredfinancially necessary for the scheme. The latest two actuarial reportsrecommended a shift from short-term to long-term instruments in order toincrease the yield. In 1981, 77% of invested assets were short-term, 21%medium term and 2% long-term; in 1984, short-term investment had declinedto 71% and in 1987, to 64%. However, if instruments which 2 years orless had been considered short-term these proportions would have been 76%in 1984 and 73% in 1987 [38, 48, 63, 64]. Therefore, short-terminvestment has decreased somewhat but still is excessively high.

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c. Yields

In contrast with Bahamas, actuarially set investment yields aregiven in real terms. According to the latest two actuarial reviews, thereal yield was -6.5% in 1979 and -7.4 in 1980 [63, 64]. Table 7 presentsour own calculations of the real yield for 1980-1986: it was negative in1980-1982 (averaging -4.7%) and positive in 1983-1986 (averaging 4.8%)for an annual average of 0.7% for the entire period. Yields given by the1985 actuarial review for 1980-1984, when deflated with figures given inthe review, averaged -1.2% for that period (-0.8% according to ourcalculations). This contradicts the actuarial review conclusion that theaverage rate of investment return exceeded the inflation rate. The 1982review used a minimum yield of 4% for estimating the equilibrium periodof the pension program but recommended a more dynamic yield of 7%; the1985 review reduced the actuarial yield to 2% [63, 64]. Obviously, thereal yield in 1980-1986 was well below the actuarially set norm. The1985 actuarial review warned that a persistent negative rate of returnwould steadily diminish the real value of the reserves.

The technically correct recommendation to shift investment fromshort to long-term instruments is difficult to implement in practice dueto the large size of NIO investment assets and excess liquidity in thefinancial system. Some alternatives suggested have been to invest in theprivate sector, in housing, in small businesses and in socialdevelopment, but there are higher risks in most of these alternatives.The 1985 actuarial review (even with its optimistic assessment ofinvestment yields) recommended that strong priority be given to safety ofinvestment (to maintain its real value through higher yields) over socialconsiderations. One potential alternative for NIO investment could bethe planned introduction (for mid-1987) of a stock exchange in Barbadospraised by the Ministry of Finance as a legally regulated market whereshares (including government stocks) could be traded speedily and safely[48].

IV. CHILE

1. Overall Review

Chile was one of the pioneer countries in introducing socialinsurance in IAC. The first pension programs (for blue collars, whitecollars and civil servants) were initiated in the mid-1920s and manyother similar funds were established later for specific occupationalgroups. Multiple funds gradual:Ly evolved providing coverage on sickness-maternity, unemployment and family allowances also. In 1974-1979 thisfragmented system was reformed and partly unified and standardized(leaving out the armed forces). In 1981, a new uniformed system wascreated for pensions (old-age, disability and survivors) administered byprivate corporations (AFPs) and for health-care partly operated by thestate (FONASA) and partly by private corporations (ISAPREs). In 1988,from 76% to 79% of the labor force was covered on pensions; 14% in theold system and 86% in the new [46, 49, 52].

17

The reforms eliminated the employer contribution (except foremployment injury) and, by the end of 1988, the insured was the onlycontributor in both systems. However, the state subsidizes the hugedeficit of the old pension system and supports the new one by recognizingthe time served and contributions paid by their insured In the oldsystem. Furthermore, the state has taken full fiscal responsibility forwelfare pensions, unemployment compensation, and family allowances. As aresult, the state subsidy to the social security system increased from4.6% of GDP in 1980 to 8.9% in 1986 (68% of total expenditures in 1986were subsidized by the state). The deficit in the pension system alone(combining old and new) increased from 2.2% to 6.6% of GDP in the sameperiod (75% of pension expenditures in 1986 were subsidized by thestate). In 1983 (when a small employer contribution still remained) thepercentage distribution of social insurance revenue was as follows: 36%insured, 2% employer, 44% state, 17% investment and 3% others. The shareof investment increased from 2% to 17% in 1980-1983 (22.6% in pensionsalone in 1983). In 1986, 67% of social security expenditures went topensions [17, 38 bis, 52]. We will concentrate our analysis on the newpension program since the other programs are on pay-as-you-go and havenone or small reserves.

2. Investment

The old pension system covers 14% of the active insured (mostlyolder people who saw an advantage in staying in the old system) but has97% of the total number of pensioners in the country. It operates onpay-as-you-go and about three-fourths of its expenditures are subsidizedby the state. Conversely, the new pension system covers 86% of theactive insured (much younger, as an average, than in the old system) and,since it was established in 1981, it has not matured and has only 3% ofthe total number of pensioners. It is fully-funded and accumulates hugereserves.

Investment policy is set by the law and supervised by theSuperintendency of AFPs (SAFP) which also interprets the law and enactsabundant, complex regulations. According to the law, pension fundsshould only be invested in marketable assets, in securities notrestricted to particular investors and should not be lent directly toconsumers. Within these legal parameters, the AFPs make investmentdecisions trying to maximize the yield.

a. Significance

There are 13 AFPs in the new pension system and four of themconcentrate 75% of the insured. The reserves are practically allinvested except for about 0.3% in banking accounts. Total net assets aswell as invested assets increased 14 times in 1982-1987 and, adjusted forinflation, augmented five times (see Table 8). In 1987, invested assetswere equal to 54% of government revenue, 96% of gross fixed capitalformation, 43% of total deposits in the financial system (in pesos), and13.3% of GDP [6, 13, 40, 52, 69, 74]. These proportions were among thehighest (with Bahamas and Barbados) in LAC.

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b. Composition

Dropping the year 1981 (the new pension system began in May of thatyear) Table 8 shows the following trends in the percentage distributionof investment assets by instrument in 1982-1988: (a) an increase ingovernment bonds (emitted by the treasury and the Central Bank, and to alesser extent, by public corporations) from 26% to 47% in 1981-1986 and adecline to 40% in 1988; (b) a decline in mortgage bonds (basicallyemitted by financial institutions) from 47% to 26%; (c) a stagnantpercentage in fixed-term deposits at 26% (with a trough in 1983); (d) asteady increase in shares from 0.6% to 7.7%; and (e) a small fraction in"others" (about 0.3%). The law prohibits direct loans to consumers(including mortgage loans) or to the state or other institutions as wellas direct investment in real estate and abroad. The major changes in thecomposition of the portfolio have been an increase in government bondsand a decline in mortgage bonds, as well as an increase in shares.

The percentage of invested assets in government instruments (bondsand mortgage bonds) as well as in deposits in state banks declined from73% in 1984 to 52% in 1986. Major reasons for this shift have been thetermination of state intervention in commercial banks and the decline inthe portfolio share of bonds. The average term of all invested assets istwo years.

A law enacted in 1987 has given more flexibility to invest in shareswith the goal of further diversifying the portfolio. Investment is notpermitted in corporations where one stockholder has more than 50% of thestocks or where the minority of stockholders holds less than 10%. Inaddition, the maximum allowed for investment in corporations is set bythe law according to a "concentration factor." The law now permitsprivate corporations to classify risks and there are two corporationsalready in operation and 15 more in the process of registration. Theseprivate corporations can classify all types of instruments (includingthose suitable for AFP investment) and reportedly have more informationavailable than the public Commission for Risk Classification. Althoughthe latter is the only one allowed to rank stocks suitable for AFPsinvestment, the informal private classifications could challenge theofficial one and induce potential revisions. The SAFP believes that,after seven years of operation, the AFPs have enough experience (even thesmaller ones) to invest in shares and the increased legal flexibilitywould not carry any significant risk to the safety of the pension fund.

c. Yields

Table 8 shows that the arnual average real yield for all investedassets in the new pension system has been positive for the entire period1981-1987 and averaged 13.8%. This is the highest yield among allcountries studied in this report. The yield peaked in 1982 andthereafter has had a declining trend. However, a comparison of pensionfunds annual real yield with annual interest paid on bank deposits (30 to89 days and 1 to 3 year-indeaxed) in 1982-1987 shows that the pensionyield was higher in every year except for medium term deposit interest in

19

1984; and the pension average yield for the entire period (13.8%) wasmuch higher than the average short-term deposit interest (6.2%) and theaverage medium-term deposit interest (8.5%) [6, 52].

The yield performance is impressive particularly taking into accountthat the average term of all invested assets is two years. Helping tomaintain a high yield in 1986 in spite of declining interest rates wasthe significant increase in the value of shares in that year. Some APPsmanagers argued at that time that legal restrictions severely limited thenumber of corporations eligible for pension fund investment henceincreasing the demand for their shares and artificially raising theirprices. It is too soon to know if the new law passed in August 1987 willsignificantly change the situation [52].

In 1987-1988 the average real yield among the 13 AFPs varied from7.5% (in "Santa Maria," the second largest) to 8.6% (in "Invierta,"ranked sixth in size). There was not a relationship between percentageof insured affiliated to AFPs and their real yields. In theory, AFPscompete for the insured largely based on their efficiency inadministering the fund: as higher the yield more insured. In practice,affiliation appears to be determined by publicity and image and, until1988, real investment yields by AFP were not published. Dissemination ofthe information, combined with educational efforts and new legislationenacted in 1987 (which makes more flexible the entrance of new AFPs intothe system) should hopefully make the insured more knowledgeable andincrease the competitiveness of the system and its efficiency [49, 52].

V. COSTA RICA

1. Overall Review

The Costa Rican Social Insurance Fund (Caja Costarricense de SeguroSocial: CCSS) was established in 1941 granting compulsory socialinsurance coverage for employees on: old-age, disability and survivorpensions as well as sickness-maternity benefits (extended to theinsured's dependents in 1955-1965). In addition, the CCSS administers anon-contributory pension program. There are 21 autonomous pension fundswhich cover civil servants; compulsory coverage of employment injury isdone through a state insurance agency, and there is a public healthprogram (mostly preventive); all of these programs are independent fromthe CCSS. In 1985, the pension program of the CCSS covered 45% of thelabor force and another 7% was covered by civil servant funds; indigentswere protected by CCSS non-contributory pensions. In the same year, 85%of the total population was covered by CCSS sickness-maternity programmostly as insured and a minority as welfare cases [47, 51].

The percentage distribution of CCSS revenue in 1985 was 32% insured,47% employer, 15% state, 5% investment returns and 1% others. The shareof investment decreased from 12% to 5% in 1970-1985. In 1985, 70% ofCCSS expenditures went to sickness-maternity, 21.5% to pensions, 4% tonon-contributory pensions, and 4.5% to administration. The CCSSgenerated a surplus throughout 1975-1985 (except in 1981) but the

20

sickness-maternity program was deficitary in 1975-1981 and was subsidizedby the pension program. As a percentage of revenue, the CCSS surplusdeclined from 21.4% to 1.6% in 1975-1980 and turned into a deficit(-0.3%) in 1981, but increased to 26% in 1985, due to an increase incontributions for sickness-maternity. The latest actuarial review (1985)projected an equilibrium of the pension program for 10 years (1994) butanother projection done in 1987 shortened the equilibrium period to 1990or 1991. Several measures were recommended to extend the equilibrium:increase in the contributions (unchanged since the creation of theprogram) and the investment yield, state punctual payment of its share,raise in the age of retirement, and less generous adjustment of pensionsto inflation. But by the end of 1987 none of the recommendations hadbeen implemented [8, 38 bis, 51].

2. Investment

In 1985, 85% of the CCSS total investment was in the pension programand the remaining 15% in the sickness-maternity program. The former isstill legally fully-funded but, in practice, uses the scaled-premiummethod; sickness-maternity operates with pay-as-you-go with a contingencyfund. Because of the high proportion of investment in the pensionprogram and more abundant dataL available we will limit our analysis tothis program.

The CCSS exercises full authority to invest the reserves accordingto the law.

a. Significance

Total net assets increased by 405% in 1980-1987 but, adjusted forinflation, declined by 11%; however, if 1981 is used as a base, total netassets increased by 22% (due to very high inflation in 1981). Investedassets declined by -7% in 1980-1987 but increased by 45% in 1981-1987(see Table 9). As in the case of Jamaica, the CCSS has faceddifficulties to maintain and increase the level of its reserves, partlydue to high rates of inflation but also to poor investment yields.Current net assets are very high due to two reasons: the failure of thestate to pay its contributions on time (however, the state debt declinedfrom 23% of total reserves in 1977 to 2.6% in 1987), and unusually largecash surpluses (which increased from zero to 16% of the reserves in 1977-1987 but declined to 2.6% in 1987). Current net assets, however, hadbeen reduced to 5.4% of the reserves in 1987, down from 23% in 1977. In1986, invested assets (95% of the reserves) equaled: 33% of total moneysupply, 26% of government revenue, 29% of gross capital formation, 16% oftotal net credit in the national banking system, and 5.7% of GDP [13, 40,51, 74]. These proportions are lower than those of the three previouscase studies.

b. Composition

The percentage distribution of invested assets by instrument, in1977-1987 is presented in Table 9: (a) government bonds increased from

21

25.4% to 43.7%; (b) loans to the CCSS sickness-maternity program declinedfrom 35.7% to zero in 1986; (c) mortgage loans and other loans toindividuals decreased from 26.3% to 14.7%; (d) fixed-term depositsincreased from zero to 35.3%; (e) real estate augmented from 6.5% to12.7% in 1977-1984 (largely due to revaluation) but declined to 5.6% in1987; and (f) "others" diminished from 6.1% to 0.7%. In summary, therehas been a decrease of 47% in loans/mortgages: 35% shifted to fixed-termdeposits (a positive change because of much higher yields) and 18%shifted to government bonds (not so good because of very low yields instate bonds).

Contrary to the Caribbean and other Latin American pension funds,the proportion of CCSS investment in public instruments is a minorityalthough it has been increasing. Public bonds are of three types: (a)30% are state bonds to pay for the debt to the CCSS (both to the pensionprogram and the sickness-maternity program, the latter transferred itsstate bonds to the former) with a 40 year period and an interest rateranging from 2% to 10%; (b) 54% are Central Bank bonds with shorterperiods and higher interest; and (c) 16% are public corporation bonds, at15-20 years and paying 8% to 16% interest. The average yield of publicbonds in 1970-1985 was 6.4%; because of high inflation rates in the 1980sand lack of indexation the state actually received a transfer from theCCSS and contributed to the decapitalization of the pension fund. Ifinvestment in bonds would have been avoided, the real negative yield ofCCSS investment would have turned positive.

The second worst investment was internal loans to the sickness-maternity program to build hospitals and subsidize current expenditures;these loans were at 40 years with 6% interest. In 1981, a law prohibitedthis type of investment which had disappeared by 1986. Mortgage loansare granted to the insured (15 years and 20% interest indexed toinflation) and CCSS employees (20 years and 16% to 19% fixed interest).The average yield of these loans was 15% in 1984, higher than state bondsbut lower than banking deposits, and administrative costs are high.Investment in real estate has generated very low returns; in 1984, 80% ofbuildings were rented to the sickness-maternity program and the returnwas 2.8%.

The most profitable investment has been in fixed-term deposits, withan average term of six months and yields almost three times higher thanstate bonds. The short term allows for readjustment to inflation andhence real yields have been positive, compensating for real negativeyields in other instruments. Recently, special banking deposits arebeing used to help develop the private sector, for instance, CCSSdeposits in the Banco Anglo-Costarricense (which earned 23% interest in1987 for an 8% real yield) are being lent to small sugar growers andproducers.

c. Yields

Actuarial reviews of the CCSS have traditionally set nominal yieldswhich have been met or exceeded most of the time. The annual nominal

22

yield averaged 12% in 1977-:1987, but adjusted for inflation (whichreached historical peaks in 1981-1982) the real yield averaged -7.7% inthe period and -10.5% in 1980-1987. This largely explains why the CCSSreserve shrunk in real terms in 1980-1987. Since 1985 there have beenpositive yields explained by: the increment in the proportion ofinvestment in fixed-term deposits; the elimination of the loans to thesickness-maternity program; the reduction of the proportion of reservesin net-current assets (particu:Larly the state debt); and the slowdown ininflation rates. A very high and growing proportion of invested assetsis still in state bonds whose yields are 33% to 40% the commercial bankinterest. And yet state payment in bonds is better than the debt whichgradually shrinks due to inflation. All in all the efficiency ofinvestment has increased: in 1980, 73% of the reserves were in statebonds, loans to sickness-maternity and the state debt, while in 1987 thatproportion had declined to 44%. But there is a need to reduce furtherthe proportion of investment in state bonds or, at least, to negotiateadequate yields and to diversify the portfolio.

VI. ECUADOR

1. Overall Review

The first pension fund in Ecuador (for civil servants and othergroups) was established in 1928, followed by social insurance (pensionsand sickness-maternity) for blue and white collar workers in 1937, andlater on for several other groups. In 1963 all private, public andmilitary funds were merged and, in 1970, the Ecuadorian Institute ofSocial Security (Instituto Ecuatoriano de Seguridad Social: IESS) wascreated to incorporate all social insurance programs including employmentinjury, a dismissal fund and a supplementary voluntary fund. In spite ofrelatively old programs, social insurance coverage expanded very slowly:in 1983, 23% of the labor force and only 11% of the total population werecovered by the IESS; rough estimates for 1986 suggested that coverage hadincreased to 24% and 13% respectively [18, 23, 45].

The percentage distribution of social insurance and family allowancerevenue in 1983 was: 38.6% insured, 38.1% employer, 1.3% state, and 22.1%investment return. The share of investment return declined from 24.8% in1972 to 17.7% in 1980 and increased to 22.1% in 1983. In the latteryear the distribution of benefit expenditure was: 75.8% pensions, 16.9%sickness-maternity and 1.6%; employment injury. Administrativeexpenditures, as a percentage of total IESS expenditure, reached 26% in1983, the highest in LAC. The IESS generated a surplus throughout 1978-1983 but, as a percentage of revenue, the surplus declined from 40% to23% [38 bis].

According to the law, actuarial reviews of the pension fund must bedone every three years but that obligation has not always been fulfilled[38 bis]. The 1982 review, using data until 1980 and projecting a 20year period, estimated an actuarial deficit of 458 billion sucres. Notedcauses of the disequilibrium were: addition or increment of benefitswithout raising revenue, transfers to other programs, huge state debt,

23

and low investment yields. To correct the deficit, the actuarial reviewrecommended raising contributions and the age of retirement, controllingthe state debt, increasing the investment yield and cutting some benefits[22]. In 1981-1984, contributions were increased but the state debtcontinued growing and real investment yields declined even more [45].Early in 1985, the chief actuary said that there were basically enoughresources to cover the costs of pensions, and a serious liquidity crisisoccurred in June of that year. In 1980-1986, the pension fund (except in1983) as well as the supplementary voluntary fund and the severance fundgenerated an annual surplus but both the sickness-maternity and armedforces funds suffered deficits. In August 1986 a new liquidity crisisoccurred and there was an open crisis of the system in 1987-1989 [27, 43,72 bis].

2. Investment

Legally, the IESS pension program is fully-funded but, since 1971, ashift to scaled premium was recommended by the actuary and introduced.In 1982 a period of equilibrium of 20 years was considered. Thesickness-maternity program operates on pay-as-you-go; there is noinformation on the financing methods used by other programs.

IESS data on investment are fragmentary and contradictory. There isnot a series of total net assets, figures in Table 10 come from ILO for1978-1980 and the rest are the author's estimates based on the reservesof the various IESS programs. The invested asset series in the Table hasbeen consistently published by the IESS since 1974 at the least; however,for 1978-1980 the ILO reported figures 3.5 times higher than the IESSseries. The most conflicting data are on investment returns: (a) theseries in the Table comes from the IESS and is the longest (1974-1986)and most consistent, but the IESS has recently released another series(1980-1986) of "budgeted investment returns" with figures from 30% to400% higher than the other series and without explaining the difference;(b) the World Bank has a series (1978-1983) with higher (100% to 200%)figures also than those in Table 10; and (c) an ILO series (1978-1983)has data from 26% to 170% higher than those in the Table. We decided touse in Table 10 the IESS data that are the most consistent through time[21, 24, 27, 38, 78].

The IESS exercises full authority in the investment of its reservesaccording to the law.

a. Significance

Total net assets increased 190% in 1980-1986 but adjusted forinflation decreased -38%; invested assets increased 216% in currentprices but declined -24% in constant prices (see Table 10). In 1986,invested assets were equal to 20% of money supply, 21% of governmentrevenue, 15% of gross fixed capital formation, and 2.8% of GDP;corresponding proportions for total net assets were: 48%, 49%, 36%, and6.6% [27, 13, 40, 74]. These proportions are middle size compared withthose of other case studies. In 1982 more than two-fifths of the total

24

credit granted by the national financial system came from the IESS whichwas the main, at times unique, purchaser of state bonds and long-termmortgage bonds [45].

According to Table 10, fixed and net current assets took a huge butdeclining share of total net assets: 75% to 57%. This may be explainedby the huge state debt and IESS infrastructure such as administrativebuildings, hospitals, etc. However, in 1978-1980, the ILO reportednegative net current assets and a small amount in fixed assets [38]. Wehave not been able to clarify this discrepancy.

b. ComRosition

Trends in the percentage distribution of IESS invested assets in1978-1986 (Table 10) were as follows: (a) government bonds steadilydeclined from 40.3% to 10.2%; (b) personal loans declined from 32.5% to27.6% in 1978-1980 but increasied to 42% in 1985 although declined to 38%in 1986; (c) mortgage loans averaged 12% in 1978-1981 but steadilyincreased thereafter, reaching almost 40% in 1986; (d) loans to IESSprograms (e.g., sickness-maternity, peasant insurance) and the publicsector (municipalities, armed forces, universities) peaked at 10% in 1980but declined to 5% in 1986; (e) fixed-term deposits peaked at 18% in 1980but were negligible in 1982-1987; (f) shares declined from 5% to 3%; and(g) real estate (land, construction) peaked at 16% in 1977, but declinedto 3% in 1986. In summary, loans/mortgages are the most importantinvestment (83% in 1986) and within it, personal loans were the mostsignificant until 1985 but had been surpassed by mortgage loans in 1986.The second most important (but declining) instrument are government bondswith 10% in 1986; all remaining instruments show a declining trend andtotalled less than 7% in 1986.

Contrary to the other case! studies, where almost the totality or atleast a majority of social insurance reserves are invested in governmentbonds or loans, in Ecuador a Ideclining share (from 40% to 10%) was inthese instruments. But investment in the private sector was increasinglydone through direct loans to individuals rather than the secondarymarket. The IESS investment is officially classified in two broadcategories: directly beneficial to the insured, such as personal andmortgage loans, and hospital construction (about 78% in 1986) and notdirectly beneficial to the insured such as bonds, bank deposits, shares(22% in 1986). In 1981-1986 the proportion of the former in totalinvestment steadily increased while the share of the latter declined.This shift was hailed in 1984 by an IESS study as a positive move awayfrom the prior "economicist" orientation that opposed such a move,arguing that it would decapital:ize the fund [25].

It should be noted that personal loans are not indexed and, due tothe high inflation rates of 1983-1986, they have tended to decapitalizethe fund. Even worse, a key element in the investment policy of 1982-1986 has been new liberal conditions for mortgage loans. These loansformerly paid a fixed interest rate (as the personal loans) but, since1982, the rate became variable, fixed every five years, beginning with a

25

very low rate that gradually increased. The policy was extremelybeneficial for the borrower, particularly since 1983, when inflationrates jumped dramatically, but the IESS Economic-Financial Divisionestimated it cost the fund a loss from 2 billion to 3.6 billion sucres in1983 alone, and this without taking inflation into account. Anotherharmful effect of the mortgage loan policy was that the borrower paid aninsurance premium to IESS to assure that cancellation of the mortgage incase of his death or total disability. According to the Economic-Financial Division, this premium did not fully cover the IESS against thepotential loss of capital. To make things worse, a medical examinationpreviously required before granting the insurance was abolished and somegravely ill insured took mortgage loans, knowing that they were going todie soon [45].

In contrast with Costa Rica and Peru where a substantial amount ofthe investment goes to the sickness-maternity program, until 1983 Ecuadorhad only about 1% invested in the construction of hospitals andacquisition of equipment. However, in 1984-1985, about 92% of thesickness-maternity program revenue was expected to come from the generalfund rather than from its own revenue. In 1986, the proportion of IESSinvestment going to construction of hospitals and loans to sickness-maternity was 5% and it increased to 13% in 1986. These loans are reallytransfers because they are neither paid back nor do they generate anyinterest [27, 45].

c. Yields

Table 10 shows that the IESS annual real investment yield wasnegative in 1978-1986 except for two years, averaged -7.6% in the period(-0.3% in 1978-1982) and deteriorated to -16.7% in 1983-1986 due to highrates of inflation. Fixed interest rates for personal loans and low-starting rates for mortgage loans were the main culprits for thatnegative outcome.

Mortgage loans had a stagnant average nominal rate of 9.9% in 1980-1981 but declined to 6.6% in 1982-1983 and to 4.8% in 1984-1986 wheninflation rates were increasing, hence the real yield, which was -3% in1980, worsened to -15% in 1986 (-34% in 1983). Personal loans had anaverage nominal rate of 9.6% in 1980-1982 but decreased to 7.5% in 1983-1986; their real yield worsened from -3% to -13% (-26% in 1983).Government bonds nominal rates steadily increased from 16% to 23% in1980-1986 but their real yields deteriorated from 2.6% to zero (stillmuch better than personal/mortgage loans). It has been mentioned alreadythat loans to sickness-maternity do not earn interest. Fixed-termdeposits had the highest nominal yield in 1980 (16.8%) and were the onlyinstrument to have a real positive yield (3.3%) that year and in most of1974-1981 but were practically eliminated in 1982-1983 and these fundsshifted to mortgage loans which have increasingly negative real yields.The worst performance of all instruments was in shares, in 1983 theirreal yields were -30% [27, 45].

26

To improve investment yields, in 1984 the IESS Economic-FinancialDivision recommended several measures: (a) recalculation of mortgage loaninterests (to compensate for the losses) as well as the insurancepremium, and reintroduction of medical exams for the latter; (b)limitation of concession of mortgage loans to the first three months ofthe year, hence reducing the total amount of investment going to theseloans; and (c) limitation of concession of personal loans to the firsthalf of each month and increase of two percentage points to the rate ofinterest charged to these loans. In a report delivered to the IESS in1985, the World Bank concluded that these measures, although couldsomewhat increase the yield, would not stop the decapitalization processand recommended for that purpose to shift investment away from loans(both personal and mortgage) towards more profitable investment, such as:fixed-term deposits, and to index personal and mortgage loans toinflation [45, 79]. The IESS did not follow these recommendations.

In June 1985, a liquidity crisis occurred and the chief actuaryrecommended more drastic measures such as: an increase in contributions,a transfer to reserves from the severance to the pension fund,negotiations with the state to procure payment of its debt, an increasein the age of retirement, and restrictions in benefits [68]. Apparently,none of these measures was introduced. In August 1986, the IESS budgetfor the entire year was exhausted. An attempt was made to increasemortgage payments through monthly discounts as high as 40% of thedebtor's salary, but public protests forced the cancellation of thismeasure. At the end of the year, the IESS enacted regulations increasingamortization payments by 100% and interest to 22% (still below the 1986-1987 inflation rate). Additional measures tightening personal loansincluded: reduction of the amount available for these loans, increase oftheir interest to 28% (stilL below the 1987 inflation rate), andprohibition of the renewal of these loans [43]. Unfortunately all ofthese measures were passed too late when the IESS reserves had beenseverely eroded by the mishandling of their reserves through an ill-conceived investment policy. The crisis became worse in 1988-1989 [3bis, 72 bis].

VII. JAMAICA

1. Overall Review

Jamaica was the first country in the non-Latin Caribbean tointroduce social insurance. The National Insurance Scheme (NIS) wasestablished in 1965 and began operations the following year, grantingcompulsory social insurance coverage for employees (self-employed since1968) on: old-age, disability and survivor pensions, employment injurybenefits (since 1970), and short-term benefits (survivor, maternity, andfuneral grants). Both social assistance and the national health systemare independent from the NIS. In 1985 about 93% of the labor force wascovered by the NIS [50]. The percentage distribution of revenue in 1986was: 20.7% insured, 25.3% employer, 2.8% state, 51% investment and 0.2%others. The share of investment increased from 29% to 51% in 1977-1986and is the major source of NIS revenue (much higher than in Bahamas and

27

particularly than in Barbados). But the growing trend in the investmentshare is deceiving since it is the result of a freeze, since theinception of the NIS, of contribution rates and minor increases of thecontribution ceiling in spite of very high rates of inflation. In 1986,89.4% of NIS expenditures went to pensions, 4.9% to employment injury,4.4% to grants and other benefits, 9.2% to administration and 2.7% toother expenditures. The NIS generated a surplus throughout 1977-1986which declined from 80% to 66% in 1977-1983 but then increased to 70% in1986 (the highest of the three non-Latin Caribbean countries and largelydue to very low benefits). There has not been a thorough actuarialreview of the NIS since 1977 (due to inadequacy of data on insured andfinances) although it is legally mandated for every five years. In 1985,an "interim" actuarial review was done but a full copy was not availablealthough it was possible to obtain some of its basic information. Thereport approved government proposed increases in benefits but subject toa two-fold increase in the percentage contribution, a raise in thecontribution ceiling and increases in the investment ceiling and theinvestment yield above 5%. In 1987, benefits were raised butcontributions were left untouched arguing that the gap would be filled byhigher investment yields (something doubtful in view of the dismal pastrecord). It has been roughly estimated that as a result of the 1987benefit increase, the NIS reserve might be depleted around 1995 [481.

2. Investment

The evaluation of NIS investment is complicated by the lack ofcomprehensive data and historical series. Employer and union leadersreported in 1987 that practically no information on investment wasavailable to them. Most of the NIS reserves come from the pensionprogram which uses the scaled-premium method; short-term benefits are onpay-as-you-go, and no information is available on the method used inemployment injury [48].

There is confusion as to which agency is responsible for NISinvestment decisions. Top NIS officials asserted in 1987 that theMinistry of Finance makes all decisions on investment and that the Bankof Jamaica (Central Bank) pays the accrued interest to the NIS followinginstructions from such a Ministry; these officials were not satisfiedwith the current arrangement because--they thought--funds could be moreefficiently invested. A scholar specialized in social security held thesame opinion and recommended that investment decisions be transferredfrom the Ministry of Finance to an Investment Board (with active NISparticipation) leaving to the Ministry only guideline and supervisionfunctions. An official at the Ministry of Finance responded to the aboveclaims saying that, according to the law, the Ministry is not entrustedwith day-to-day management of NIS investment but to provide directives,look at investment options and give suggestions. However, he commentedthat NIS personnel do not have expertise in investment and that the NISneeds authorization of the Ministry to actually make any investment. Inview of these comments (and the facts discussed below) it can beconcluded that the Ministry of Finance is indeed basically responsiblefor NIS investment and that NIS officials have little input not only in

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decision making but in controlling the Ministry and avoiding itsmishandling of investment [48].

a. Significance

NIS total net assets increased by 170% in 1980-1987 but, adjusted byinflation, the increment was only 2.5%. If the comparison in constantprices is done using 1981 as a base, the reserve actually declined by3%. Therefore, due partly to very high inflation rates (and partly topoor investment yields) the NIS has been unable to maintain its realreserves, while its counterparts in Bahamas and Barbados have been ableto increase such reserves substantially. The only NIS fixed asset is theownership of its headquarters' building (other NIS offices are rented)and current net assets, except for 1986, have been much lower than inBarbados and slightly lower than in Bahamas: 2.2% of total reserves in1980, and 0.2% in 1987 (see Table 11). In 1986, NIS invested assets(99.8% of total net assets) were equal to 36% of total money supply, 21%of government revenue, 33% of gross fixed capital formation, and 5.8% ofGDP. All these proportions were considerably smaller than those ofBahamas, Barbados, and Chile but similar to Costa Rica's and higher thanin the other case studies [13, 40, 48, 65, 74].

b. Composition

The percentage distribution of NIS-invested assets by instrument isgiven in Table 11. Practically all funds are invested in "localregistered government stocks" (an average of 98.5 in 1980-1987) and anegligible sum in unit trust. In 1986, the government stock dividendranged from 7% to 22% and averaged 15.9% almost the same as the inflationrate. In 1987, $J80 million was loaned to several government developmentcorporations for 8.8% of investment; these loans earned a fixed interestof 18% to 20%. Fixed-term deposits have fluctuated from 0.2% to 8.4%(averaging 2.3%); most are in commercial banks which in 1986 paid aninterest of 18% (24% for overdriafts).

In 1987, almost all NIS investment (99.8%) was in public instrumentsbasically in government bonds whose real yield is negative (noinformation could be obtained on the terms of investment). Governmentcontrol of NIS investment has obviously played a negative role in itsefficiency and contributed to the erosion in the reserves. Since 1983,the government has retained (not transferred to the NIS) part of theinvestment return: a cumulative total of J$126.7 million in 1983-1987(see Table 11). In 1987, a NIS technician reported that, in 1983, theMinistry of Finance cashed stocks before they reached maturity resultingin a loss of J$52 million, altlhough the sum was later reinvested by theMinistry. The same NIS source added that in recent years the Ministry ofFinance has delayed the payment of due interest to the NIS for as much asone year, and that payment of interest of NIS loans to governmentcorporations are being delayed also. In addition, a high NIS officerreported that J$71 million in NIS funds had not been invested by theMinistry of Finance and that a complaint had been sent to the PrimeMinister. Questioned about these irregularities in 1987 a high officer

29

of the Ministry of Finance confirmed that J$55 million (instead of J$71million) had not been invested but that the problem had just beencorrected with a special bond emission. The same source alsoacknowledged the Ministry's delay in paying J$41 million in interest tothe NIS but justified it as an emergency provoked by a grave shortage ofgovernment funds (due to the IMF stabilization program); to cope withthat debt, the government had signed a promissory note. In 1987, therewas a one-year moratorium postponing all government payments on thecombined debt of J$96 million to NIS; interest was however expected to bepaid. According to a knowledgeable technician, the Prime Minister wasinformed in 1987 of the negative consequences for the NIS of thesefinancial operations and he promised to pay the debt [48].

c. Yields

The latest full actuarial review (1977) assumed a nominal yield of5% per annum for its estimates and the annual average nominal yield was7% in 1967-1976 (10.4% in 1980-1986). However, the review neglectedcompletely an evaluation of the impact of inflation on investment yield.The interim review of 1985 set as a goal a nominal yield above 5%, onceagain, not taking high rates of inflation during the 1980s into account.

The real investment yield was negative in 1980-1986 except for twoyears (see Table 11). Real yields in 1974-1979 were also negative: -9.7%in 1974, -9.2% in 1975, -1.3% in 1976, -2.3% in 1977, -25.6% in 1978 and-16.1% in 1979 [4, 54]. The annual average real yield was -7% in 1974-1987 and -5% in 1980-1987. In the 1980s, the negative average real yieldof Jamaica (-5%) compares with a positive fair yield for Bahamas (2.7%)and a positive although low yield for Barbados (0.7%). If the governmenthad promptly transferred to the NIS the retained investment returns, theaverage real yield in 1983-1987 would have been still negative but 3.4percentage points better: -1.8% versus -5.2%.

Reasons for the negative yields are very high rates of inflation,concentration (99%) of the investment in government stocks which pay ayield lower than commercial banks and control of investment by theMinistry of Finance which has mishandled at least J$96 million byretaining accrued interest and not investing significant sums. The NISshould fully disclose investment data, diversity its portfolio, andpursue a more independent and dynamic investment policy withoutsacrificing safety. Current investment policy has been judged tooconservative by several experts interviewed in 1987 who advised atransfer of part of the investment in government stocks to long-term bankdeposits as the safest option. Even an official of the Ministry ofFinance candidly said that, if he were in charge of NIS investment, hewould place it in commercial banks. But even protecting the safety ofthe investment some experts suggested that the NIS could take some risksin pursuit of more profitable and diversified investment. One optioncould be Jamaica's stock market, which was the first introduced in theCaribbean (1969) and one of only two currently in operation in thatregion. The stock market rapidly expanded in the early years but by thelate 1970s was badly affected by political uncertainties, the government

30

takeover of private corporations and a sharp reduction in profits.Although in 1984-1987 there was a dramatic revival of the stock market,the dividend yield was still low in 1987 in comparison with the highyields of the late 1960s and early 1970s. But Jamaica at least has astock market that has been functioning for a long time, in contrast withBahamas and Barbados which either don't have one or have just introducedit. Hence a cautious investment of part of NIS funds in shares could betried.

In 1987 the Prime Minister announced the creation of an InvestmentBoard that should try to diversify the NIS portfolio, and maximize itsyields. This was a step in the right direction but it is important thatthe NIS increase its authority in managing its own investment vis-a-visthe Ministry of Finance.

VIII. MEXICO

1. Overall Review

The Mexican Institute of Social Insurance (Instituto Mexicano delSeguro Social: IMSS) was established in 1943 covering blue and white-collar workers (mostly urban) in the private sector, on pensions,sickness-maternity, and employment injury. Prior to that, federal civilservants and several special groups in the public sector (armed forces,teachers, petroleum, railroad, electricity) were covered on similar risksby independent funds. In 1959, programs for all civil servants (exceptfor the special groups) became administered by what is today the secondmost important social insurance agency in Mexico, ISSSTE. Coverage byIMSS has gradually expanded to other sectors of the population such asrural workers, peasants, domestic servants, etc. In 1983 about 42% ofthe labor force and 60% of the population was covered by all socialinsurance funds, 84% of them by IMSS [47]. In 1988, 40% of the laborforce was estimated to be covered by all insurance funds [77]. Becauseof the importance of IMSS and the lack of investment data from otherfunds, we will limit our analysis to the former.

The percentage distribution of IMSS revenue in 1983 was: 19.7%insured, 62% employer, 12.3% state, 5.2% investment and 0.8% otherincome. The share of investment declined from 4.9% to 1.6% in 1965-1974and increased to 5.2% in 1983. In 1983, 48% of total expenditures wentto the sickness-maternity program, 16% to pensions, 7% to employmentinjury, 19% to administration (one of the highest in LAC) and 10% toother expenses. The IMSS generated a surplus from its creation until1983 but, as a percentage of revenue the surplus decreased from 13% in1972 to 1% in 1983 [38bis]. The pension program was the key producer ofthe surplus (since it was relatively recent) while the sickness-maternityprogram was deficitary every yetar in 1943-1983 except for three, and theemployment-injury program was also deficitary in 1983. These deficitshave been subsidized by the pension program. An actuarial review has tobe conducted every three years. The 1982 review predicted that the IMSSoverall surplus would continue its decline and, in 1983-1985, this wouldmake it very difficult to maintain the needed reserves and to allocate

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resources for investment; it also forecasted that investment yields woulddecline in 1984-1985. Causes of the problem were: (a) The sickness-maternity program contribution has been insufficient to cover its costsand has been subsidized through investment and transfers mainly from thepension fund and, also for some time, from the employment-injury fund,therefore decapitalizing both. The review estimated that a contributionof 13% would be needed for the sickness-maternity program to be inequilibrium and start paying back to the pension program with a verysmall rate of interest (in 1988 the contribution continued to be 9%).(b) The pension program has had exactly the same contribution since itsinception in 1943; a 1977 study recommended an increase in such acontribution from 6% to 10% to maintain the equilibrium for 25 years andassuming that transfers to sickness-maternity would stop (thatrecommendation was not followed). The 1982 review concluded that thepension contribution would be sufficient only until 1985 and recommendeda sharp increase in the pension reserves, but the very high inflationrates of 1983 actually induced a reduction of the real reserves so thatthey were only slightly higher than the cost of pensions in 1983 (twoyears later, the reserve scarcely covered the cost of pensions). (c) Thereserves of the employment-injury program have also suffered adecapitalization by its transfer to the sickness-maternity program andhave been eroded by inflation. (d) Personnel costs have been very highand should be controlled [28, 471. In 1987, all IMSS reserves were only13% higher than the cost of pensions in that year, however, the reservesin buildings and equipment ("muebles e inmuebles") were adjusted byinflation and increased their value 14 times (see below) only apparentlysolving the problem [30].

2. Investment

In 1988, total reserves were distributed as follows: 60% actuarialreserve (of which 46% was for pensions, 47% for employment injury and 7%for other obligations), 13% for contingency reserves (probably sickness-maternity) and 27% for other unspecified reserves [30]. The pensionprogram theoretically is fully-funded but since 1973 has applied thescaled premium method and since 1983 has been in practice close to pay-as-you-go. Employment injury uses assessment of constituent capitals andsickness-maternity applies pay-as-you-go [47, 73].

The IMSS has full authority to invest its reserves according tolegislation in force.

a. Significance

IMSS total net assets increased 12 times in 1980-1987 but, adjustedby inflation, decreased by -75%; invested assets declined by 84% in thesame period (see Table 12). However, in 1987, the building-equipmentcomponent of total net assets was adjusted to inflation increasing thelatter 6.6 times (from 662 to 4,388 billion pesos). Based on thisreadjustment total net assets increased by 1.7% in 1980-1987 [30] (butsee below). In 1987 IMSS invested assets (excluding "muebles einmuebles") were equal to: 0.6% of the money supply, 0.3% of government

32

revenue, 0.2% of gross fixed capital formation, and 0.04% of GDP.Including "muebles e inmuebles" as invested assets, these proportionsrose to 3%, 1.5%, 1.1%, and C).2% respectively [13, 40, 74]. In eithercase, these are the lowest proportions of all the case studies.

The distribution of IMSS total net assets is unique in LAC in threeways: (a) a very high proportion of such assets are net current assets(cash, current accounts, uninvested funds), that proportion rose from 36%to 59% in 1980-1984, declined to 30% in 1987 and became negative (-7%) in1988; (b) an even higher proportion of total net assets is in buildingsand equipment ("muebles e inmuebles") most of which are hospitals andadministrative buildings, but: part might be considered real estateinvestment (disaggregate data are not available); that proportiondeclined from 46% to 32% in 1980-1985 but increased to 96% in 1988; and(c) a very small proportion of total net assets is in invested assets,which declined from 18% to 4% in 1980-1982 and increased to 11% in 1988(see Table 12). In 1987 the distribution of total net assets was: 58.3fixed assets (possibly part in real estate), 30.4% net current assets and11.3% invested assets. In comparison, other case studies (exceptEcuador) had in 1987 combined fixed and net current assets fluctuatingfrom 0.3% to 13% of total net assets and 87% to 99.7% in invested assets.The very large proportion of I]MSS total net assets either uninvested orin fixed assets which do not: produce any yield or a very small onetestifies to the IMSS managerial inefficiency of investment.

b. Composition

We face a serious difficulty to compare the composition andparticularly yields of IMSS invested assets with the rest of the casestudies; i.e., most of the IMISS total net assets are in fixed assets(some of which produce a capital return) and in net current assets (whichhave either a nil or tiny capital return, e.g., current accounts).Furthermore, we cannot disaggregate fixed assets which produce a yield(e.g., rental buildings, theaters) from those which don't (e.g., IMSSoffice buildings, hospitals). If we follow the ILO accountingmethodology, the yield comparison would be meaningless because only one-fifth of the reserves are invested and part of the capital return comesfrom "muebles e inmuebles" which are not strictly fixed assets, hence thenominal yield would appear abnormally high (see below). To partly copewith this problem, in Table 12 we have estimated invested assets in twoways: (I) excluding fixed assets (following ILO methodology), and (II)including fixed assets. The latter is used for the analysis ofcomposition.

The percentage of invested assets (II) in real estate (part of whichare fixed assets) reached a peatk of 91% in 1981, a trough of 71% in 1986and increased to 89% in 1988, hence overwhelmingly dominating the use ofthe reserves (see Table 12). 'The IMSS is bound by law to invest 85% ofits available funds in this way, a procedure which hinders an adequateinvestment policy. Furthermore, these assets have not been revaluatedthus are being kept well below real value [73]. In 1987 this componentof the reserves was adjusted for inflation ("reexpresado") increasing its

33

value from 386 to 4,008 billion pesos; if the adjusted value is used forthe percentage distribution, 98% of invested assets were in "muebles einmuebles." The second most important instrument was government bondswith a declining trend from 25% to 8% of invested assets in 1980-1988.Third were mortgage loans which, basically, had a stagnant proportion of2% to 3% (with a 5-6% peak in 1983-1984). There was no sizableinvestment in either fixed-term deposits or shares.

Only a small percentage of invested assets are in governmentsecurities (8% in 1988) but, a large percentage of the reserves may bedeposited in banks which in the early 1980s were nationalized. In 1981,77% of invested assets were in short-term instruments, 18% in medium termand 5% in long-term.

c. Yields

Unfortunately, we only have data on investment returns for 1981-1983. The real yield in these three years was negative, averaged -20.8%and showed a deteriorating trend (see Table 12). If instead of takinginvested assets (II) we had used invested assets (I) the average realyield in 1981-1983 would have been higher than 1,000% (which ratifiesthat "muebles e inmuebles" cannot be excluded from the calculations). Ifinstead of taking invested assets we had used total net assets (thustaking into account the high proportion of reserves in net currentassets), the average real yield would have been -29% (giving a morerealistic evaluation of investment performance than using invested assetsII). Yields might have improved somewhat (but still be negative) in1984-1985 when inflation declined, but probably deteriorated in 1986-1988when inflation skyrocketed.

In 1982, 98% of invested assets had a fixed interest and only 2% avariable interest. This gives an idea of the negative impact of highinflation rates in the 1980s upon investment in government bonds andmortgage loans (specific nominal yields for these instruments are notavailable). On the other hand, the fact that 74% of these instrumentswere short-term could have helped to readjust them to inflation but itdid not; thus the real value of government bonds in 1980-1988 declined by-83% hence worse than the decline in value of the reserve, while thevalue of mortgage loans declined -59%, thus performing better than thereserve as a whole.

The reassessment of "muebles e inmuebles" in 1987 has not solved theinefficiency of IMSS investment. As has been said already, most of theseassets are IMSS administrative offices, hospitals, ambulatories,laboratories and equipment as well as recreational facilities most ofwhich cannot be sold. Furthermore the sickness-maternity program hasbeen unable to amortize the investment of the pension fund on itshospital-medical facilities and has paid 5% on its nominal value (notadjusted for inflation). Therefore, these are not liquid assets and arefinancially unprofitable.

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In 1988, net current assets declined by 127% hence becoming negative(-55 billion pesos) because for the first time in the 1980s (and probablyin IMSS history) current liabilities were higher than current assets,creating a liquidity crisis. On the other hand, the value of fixedassets increased two-fold and it is not clear whether this was simply apartial adjustment to inflation (30]. Finally, the combined real valueof invested assets (I) (goverrnment bonds plus mortgage loans) declined-80% in 1980-1988.

The IMSS could improve its investment performance taking somedrastic measures: (a) increasing contributions to both sickness-maternityand pension programs in order to restore equilibrium in both and have newfunds for investment (but such increases are both economically andpolitically difficult in the midst of the economic crisis); (b) stop allinvestment and transfers of the pension fund (and the employment injuryfund) to the sickness-maternity program (the latter should function withits own resources); (c) reduce administrative costs substantially toincrease resources for investment; (d) try to sell any fixed asset whichis not essential and is unprofitable (e.g., sport and entertainmentfacilities); (e) diversify the portfolio placing a sizable proportion ofnet assets in fixed-term deposits at rates higher than inflation; (f)stop mortgage loans or index their interest to inflation; (g) try torenegotiate government bonds to raise their interest or reduce theirterms or both, future bonds should have indexed rates; and (h) cautiouslyexplore the profitability of investment in shares.

XI. PERU

1. Overall Review

Social insurance pensions (old-age, disability and survivors) forcivil servants were introduced in Peru in 1936 and separately for blueand white-collar workers in 1961-1962. The sickness-maternity programfor blue-collars was established in 1936 and for white-collars (in boththe private and public sectors) in 1948. Other minor groups werecovered, on both risks, by independent funds. Between 1973-1980 therewas a process of reform and gradual unification and standardization ofall existing funds (except for the armed forces) which in 1980 werefinally integrated into the Peruvian Institute of Social Security(Instituto Peruano de Seguridad Social: IPSS). The IPSS also administersthe employment injury program for blue collars. In addition, there is apublic health program under the Ministry of Health. In 1987, 28% of thelabor force and about 19% of the total population was covered by IPSS[45, 53].

The percentage distribution of IPSS revenue in 1983 was: 29.4%insured, 59% employer, 10.3% investment return and 1.3% others. There isnot a historical series on the share of investment on total revenue butit roughly declined from 11% in 1981 to 0.5% in 1987 [35, 38bis]. Thepercentage distribution of benefit expenditure on the same year was:58.7% for sickness-maternity, 34.1% for pensions and 7.2% for employmentinjury.

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Financial data on the IPSS are very deficient, probably the worstamong all case studies. The scarce information available suggests thatthe IPSS generated a surplus in 1975-1981, a deficit in 1982-1984, asubstantial surplus in 1985, and growing deficits in 1987-1988. Thesickness-maternity program has been mainly responsible for that outcomebecause it has annually ended in deficit throughout 1977-1988 except forthe year 1985. These deficits have been covered with funds from thepension program. In 1988, escalating inflation (2,000%), and evasion,combined with increases in both pensions and IPSS employees' salaries, aswell as a previous expansion of health-care infrastructure and populationcoverage induced a severe financial crisis in the pension and sickness-maternity programs, the worst crisis in IPSS history. As a result, thereserve of the sickness-maternity program was practically exhausted andthat of the pension program severely depleted. An Emergency Plan waslaunched in the fall of 1988 in trying to cope with the crisis [32-37,53]. An actuarial evaluation of IPSS conducted in October of 1988concluded that: (a) in 1989, both the pension and sickness-maternityprogram would have a deficit and need to use the reserves which wouldlast only two years; (b) loans/transfers from the pension fund tosickness-maternity would not be possible due to lack of funds;(c)contributions in the pension program should be raised from 9% to 12% in1989 (to cover costs for four years) and would have to be raised again to15% in 1993; and (d) contributions to sickness-maternity should beincreased from 9% to 10.5% in 1989 (to cover costs for four years) andraised again in 1983. The recommended total increase in contributionswas 4.5%, quite difficult to implement due to the severity of thepolitical and economic crisis in Peru [5]. In all these actuarialcalculations a very optimistic real investment yield of 2% was used but,in the 1980s, such rate has averaged from -20% to -40%.

2. Investment

Data on investment are fragmentary, contradictory and suffer fromserious gaps. Table 13 figures are based on a painstaking reconstructionof data done in collaboration with IPSS experts on investment and shouldbe taken with caution. The pension program operates on scaled premium,employment injury on assessment of constituent capitals, and sickness-maternity on pay-as-you-go. In 1984, 96.8% of the reserve invested infinancial instruments was in the pension programs, 0.6% in employmentinjury, 0.1% in sickness-maternity and 2.5% in other minor fundsadministered by the IPSS. In 1987, 95% of all the reserves were in thepension program [321. Because of the significance of the latter and lackof data on other programs we will concentrate on the pension program.

The IPSS is the agency in charge of investment of its reserves,according to legal regulations but the Central Bank fixes the nominalinterest of bonds, loans and deposits.

a. Significance

There are no data on total net assets but, due to the high rates ofinflation, there is an urgency to invest all of them, hence there should

36

be little difference between the total net and invested assets. Thelatter increased 60 times in 1981-1987 but, adjusted by inflation,declined by 18%. Furthermore, by the end of 1988, real invested assetswere 5.6% below the 1980 level [37]. In 1987 invested assets were equalto 6.7% of money supply, 8.1% of government revenue, 3.5% of fixedcapital formation and 0.7% of GDP, all these proportions are the lowestof all case studies after Mexico [13, 37, 40, 74].

b. Composition

Trends in the percentage distribution of invested assets byinstrument are presented in Table 13: (a) government bonds increased from2.5% to 27% in 1981-1984 and thereafter declined to 1.2% in 1988; (b)loans rose from 19.7% to 28.5% in 1981-1983 and decreased to 6.7% in1988; (c) fixed-term deposits augmented from 58.8% to 74.7% (with adecline in 1983-1984); and (d) real estate decreased from 19% to 17.4%.There was a negligible percentage of investment in shares in 1987-1988.In summary, since 1983-1984 there has been a dramatic drop in investmentin government bonds and loans and a parallel jump in fixed-term deposits.

In 1981-1982 half of the invested assets were in fixed-term depositsin national currency with nominal rates set by the Central Bank. Risinginflation reduced the real interest of these deposits and induced agradual shift to deposits in US dollars, as a way to protect the value ofthe reserve. These deposits are given in Table 13 converted to intis (atthe official exchange rate which was close to the market rate in 1980-1985) and their share of investment rose from 10% to 73% in the period.However, in August 1985 the government fixed the exchange rate of thosedeposits and prohibited their withdrawal in dollars. As the gap betweenthe market and the official exchange rate has expanded, the value of thedeposit (converted to intis) has shrunk.

The second most important investment instrument has been loans. In1981-1982 most of these were mortgage and personal loans but, in 1983-1984, loans to the sickness-maternity program (to cover its deficits)took about one-fourth of all the IPSS investment. A report prepared bythe IPSS financial department in 1984 asserted that these loans neitherpaid capital nor interest in spite of their size, and hence wereprovoking heavy losses. These loans were prohibited in 1983 andthereafter their percentage of investment declined to 5.6% in 1988. Butsubsidies of the pension fund to the sickness-maternity program hascontinued through accounting transfers and administrative ways hencegradually decapitalizing the pension fund [32, 53]. Investment in realestate is the third in importance. Assets are invested in land andbuildings for rental. The increase in value of these assets is basicallydue to their re-evaluation to take inflation into account. Finallyinvestment in government bonds that exceeded one-fourth of totalinvestment in 1984 was the result of the state emission of bonds to paypart of its debt to the IPSS with nominal rates set by the Central Bank.Due to their low yield and the absence of new bond emissions (in spite ofan escalating state debt) the share of this instrument became negligibleby 1988 [37].

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c. Yields

The IPSS series on investment return (including real estate rent)was available only for 1981-1985 and is shown in the Table as I. We alsoestimated invested returns (II) for 1980-1987 based on the weightedaverage of all instruments nominal yields (except real estate); thesevalues are higher because of the very low yield of real estate and itssignificant weight as well as the "inflation" effect of the devaluationof intis vis-a-vis the dollar. In addition to nominal yields (I and II)based on invested assets and the two series of investment returns (I andII) the Table introduces a third series of nominal yields (III) which isthe weighted average of all instruments nominal yields. Threecorresponding series on real yields are therefore estimated all showingnegative rates throughout the period: (I) shows the worst real yields, anannual average of -40% for 1982-1985 compared with averages of -17.4% and-30% for the other two series; (II) shows the relatively best yields withan average of -20.7% for 1981-1988; and (III) shows yields in between theother two series, with an average of -37.4% for the entire period.Average real yields I and III are the worst in all eight case studies,while average II is similar to Mexico's.

Government bonds had the lowest yields, the nominal rate in somecases was fixed at 4.5%, while in others at a declining rate (from 69% to34%) therefore they induced the highest negative real yields (-95% in1988). Mortgage loans also had a fixed rate (13%) while loans tosickness-maternity had a declining rate in 1983-1987; real yields forthese instruments averaged -89% in 1988. Fixed-term deposits in nationalcurrency had the highest nominal yields but still induced negative realyields through the entire period (-57% in 1988). Deposits in US dollarsgenerated positive real yields until 1985 (exercising an upward positiveeffect on the overall yield) but, thereafter had negative yields (-22%in 1988) although not as low as those of other instruments. Real estateinvestment was mostly in buildings (92% of the total in 1988) which wereeither rented to other state agencies or to individuals at a ridiculouslylow rent. According to IPSS, maintenance costs of these buildings werehigher than the rent they generated. Furthermore, a huge building("Torre Arenales") has been left unfinished for more than a year. In1981-1987 the average real yield of rental buildings was -42% [36, 37,66].

IPSS investment performance is the worst of all the case studies.The Emergency Plan had several policy recommendations to improveinvestment yields: (a) develop a technical investment plan givingpriority to instruments that pay the highest yields instead of makingdecisions based on political criteria; (b) explore the capital market asan alternative for investment; (c) request from the Central Bank areadjustment of nominal rates according to inflation; (d) readjustinterest of personal loans and enforce collection of bad debts; (e)readjust building rentals based on the cost of living; and (f) completeconstruction of the huge office building mentioned above. These arepositive recommendations but until hyperinflation is controlled, the

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economic crisis subsides, and the IPSS is put on a sounder financialbase, no investment policy can be successful.

X. CONCLUSIONS

1. Major Findings

Table 14 summarizes the principal features of social insurance/pension fund portfolio investment performance among the eight countries:(a) significance (comparing invested assets in 1987 with GDP, governmentrevenue, gross fixed capital formation and money supply), and real growthof total net assets and invested assets in 1981-1987; (b) portfoliocomposition in 1987 (percentage distribution of invested assets byinstrument); and (c) average real yields in 1980-1987. In addition, theTable shows the average rate of inflation in 1980-1987.

a. Significance

In 1987, invested assets were most significant in Chile, Barbadosand Bahamas, relatively significant in Costa Rica, Jamaica and Ecuador,and of little significance in Peru, and particularly, in Mexico. As apercentage of GDP and gross fixed capital formation, invested assets wererespectively: 15% and 96% in Chile; 13% and 79% in Barbados; 11% and 67%in Bahamas; 6% and 29% in Costa Rica; 6% and 27% in Jamaica; 3% and 15%in Ecuador (7% and 36% if total net assets are used); 1% and 4% in Peru;and zero and 1% or less in Mexico.

Real growth of total net assets and invested assets in 1981-1987occurred in Chile, Bahamas, Barbados and Costa Rica, while in theremaining countries a decline took place. Respective growth rates were:Chile 425% and 424% (based on 1982, since the new pension program startedin mid-1981); Bahamas 67% and 62%; Barbados 54% and 38%; Costa Rica 22%and 45%; Jamaica -3% (in both); Peru -18% (of invested assets, no dataare available for total net assets); Ecuador -18% and -23%; and Mexico-78% and -73%. A change in the base year could result in lower or higherrates in a few countries. For instance, if 1980 is used as a base, thereal increases of assets in Costa Rica turn into real declines (-11% and-7%) due to a very high rate of inflation in 1981, while the oppositeoccurs in Jamaica (3% real growt:h instead of -3%). In the case of Chile,if 1981 is used as a base, real growth is much higher but this is due tothe fact that the new pension program began in mid-1981 hence assets werevery low in that year.

b. Composition

There is a nil or very small proportion of total net assets(reserves) in either fixed or net-current assets in three countries:Jamaica (practically zero), Chile (zero to 0.3% in 1982-1987) and Bahamas(declining from 4% to 3% in 1980-1985). Higher but still reasonableproportions are found in two otler countries: Costa Rica (declining from20% to 5% in 1980-1987) and Barbados (increasing from 1% to 13% in 1980-1987). In the remaining two countries the majority of the reserves is in

39

fixed and net current assets: Ecuador (declining from 66% to 57% in 1980-1987) and Mexico (increasing from 82% to 88% in 1980-1987, however if"muebles e inmuebles" are considered real estate rather than fixed assetsthe proportion declines from 36% to 30%).

In 1987, government bonds were the main instrument for investedassets in Jamaica (91%), Bahamas (66%), Chile (45%) and Costa Rica (44%);the remaining four countries invested from 4% to 16% in this instrumentonly. Mortgage, personal and other loans were the principal instrumentsfor investment in Ecuador (83%) and Barbados (47%, in treasury bills),while mortgage bonds were important but declining in significance inChile (23%); the other countries invested from 3% to 16% in theseinstruments. Fixed term deposits were the single most important type ofinvestment in Peru (72%, part in U.S. dollars), and the second mostimportant in Costa Rica (35%) Barbados (35%), Chile (26%) and Bahamas(18%); the other three countries did not use this instrument. Shareswere a minor type of investment in Chile (6%, but increasing), Ecuador(3%) and Barbados (2%); the other countries did not use this instrument.Real estate probably was the most important instrument of investment inMexico (84% if "muebles e inmuebles" are considered real estate), thesecond most important in Peru (18%), and a minor one in Ecuador (3%); theremaining countries did not use this instrument.

c. Yields

Only three countries had positive average annual real yields ofinvestment in 1980-1987: Chile (13.8%), Bahamas (2.7%), and Barbados(0.7%). The other five countries had negative yields: Jamaica (-4.8%),Ecuador (-10%), Costa Rica (-10.5%), Mexico (-20.8%) and Peru (from-20.6% to -29.4%).

The three countries with real positive yields are those in whichinvested assets are relatively the most significant (in relation to CDP,etc.) and have experienced the highest real growth also. Conversely, thetwo countries with the worst real negative yields have the least relativesignificant invested assets and have suffered a real decline in suchassets. In fact, the ranking of the eight countries in those threeindicators is very similar (except that Costa Rica's ranking in realyield is well below its ranking in significance and real growth ofinvested assets.) That reciprocal relationship is logical because highreal yields have largely influenced the growth of invested assets andtheir relative macroeconomic significance.

d. Reasons for the Divergent Investment Performance

Six factors can explain the divergent performance (in real yields,real growth and significance of invested assets) of the eight countries:inflation, composition of the portfolio, terms, proportion of total netassets invested, government intrusion, and age of the program.

i. Inflation. Table 14 shows that in 1980-1987, the countrieswith the highest average investment yields had the lowest average

40

inflation rates, and vice versa. One exception was Chile which had thehighest positive yield but an inflation rate similar to that of Ecuadorand Costa Rica whose yields were negative. High steady inflation ratesrapidly turn positive yields into negative yields and erode the realvalue of the reserves because the vast majority of investment has a fixedinterest.

ii. Portfolio composition. The composition of the portfolio andthe yields of particular instruments explain the overall yieldperformance. Five countries (Jamaica, Ecuador, Mexico, Peru and Bahamas)have from 91% to 66% of their invested assets concentrated in one singleinstrument.

Government bonds normally have a fixed interest, lower than that ofcommercial bank interest. Jamaica has 91% of its invested assets in thisinstrument which has had consistent negative yields; this is also true ofCosta Rica (44%). Conversely, Bahamas has 66% of its investment in thisinstrument but the government has paid interest rates above inflation aswell as above the commercial bank interest.

Loans to the government, as well as mortgage and personal loansusually are not indexed to inflation and their yields are lower thanthose paid for fixed-term deposits in commercial banks. Ecuador has 83%of invested assets in this type of instrument, basically in mortgage andpersonal loans which have had declining nominal interest rates whileinflation skyrocketed. In the early 1980s, a sizable part of investmentwent to the sickness-maternity program in Costa Rica (40%), Peru (25%),and Ecuador (10%) in the form of loans but, in practice, those weredonations. Later in the 1980s, laws and other restrictions eithereliminated or substantially reduced such loans but, in Peru and Ecuador,transfers continued through other ways. These loans and transferscontributed to the average real negative yields in the 1980s in thosecountries. On the other hand, Barbados has 47% of its assets in treasurybills but their interest has apparently been higher than commercial bankinterest.

Fixed-term deposits normally pay the highest yield. Peru has 72% ofits investment in this instrument, mainly in U.S. dollars which generatedpositive yields until 1985 when the forced conversion of those depositsinto national currency turned their yield negative. Barbados, Costa Ricaand Chile have a sizable proportion of their investment in thisinstrument (increasing in the 'Last two but decreasing in the first) withpositive results. In Bahamas, this type of investment has relativelydeclined since 1982 due to excess national liquidity. In spite of highyields of fixed-term deposits, investment in that instrument is nil inthree countries.

Real estate investment is often in building or housing for rentalwhich has some of the lowest yields in the market. In Mexico, anoverwhelming proportion of assets are in "muebles e inmuebles" largelyhospitals and equipment in the sickness-maternity program, officebuildings, rental buildings and recreational facilities, all of which are

41

unprofitable. In Peru, 18% of investment is in rental buildings andhousing which costs more to maintain than the rent it generates.

Finally, investment in shares exists only in three countries and isof minor importance. The proportion is increasing in Chile, however,stimulated by high yields and more flexible legislation. In mostcountries, the lack of or poor local stock exchanges has been animpediment to investment in shares; the introduction of such exchanges ina few countries (Bahamas, Barbados) may help to expand investment in thistype of instrument.

iii. Terms. Also contributing to low or negative yields in somecountries is the fact that most investment is in short or medium-terminstruments which pay lower yields than long-run instruments. In 1985-1987, investment in short-term instruments had the following proportions:77% in Mexico, 73% in Barbados, and 40% in Bahamas (in Chile the averageterm was 2 years). In spite of recommendations in Bahamas and Barbadosto increase the proportion of investment in long-run instruments, littleprogress has been made due to the lack of investment options.Furthermore, in countries with high inflation rates, long-term investmentwith fixed interest is obviously not a solution but part of the problemthey face.

iv. Proportion of total net assets invested. In Ecuador andMexico, high proportions of reserves in net-current assets (often unpaidstate obligations) and/or fixed assets, have reduced invested assets andcontributed to their poor investment performance.

V. Government intrusion. In Barbados, and especially in Jamaica,the Ministry of Finance control over investment decisions has proved tobe harmful because of postponement in investing the fund surplus, use ofreserves for government purposes, delays in transferring accrued interestand other mishandling of investment.

vi. Age of program. Finally, the age of the pension program isimportant. The most recent programs (in Chile, Bahamas and Barbados) arestill in the capitalization stage, while older programs (in Ecuador andPeru) are more mature and, hence, have less resources for investment.The fully-funded program of Chile accumulates more reserves than thepartially-funded programs in the rest of the case studies.

2. Policy Recommendations

Policy recommendations to improve investment performance are limitedby exogenous factors to the social insurance system, the most importantbeing inflation which negatively affects invested assets growth andyields (government intrusion is another limiting factor). Countrieswhich suffer from very high inflation rates, such as Peru and Mexico findit much more difficult to develop successful policies than those with lowinflation rates such as Bahamas and Barbados. Therefore an overallpolicy to control inflation is crucial as a base to achieve significantimprovement in social insurance investment performance in high-inflation

42

countries. The following general policies should be able to improveinvestment performance although more so in low-inflation countries.

a. Autonomy of Social Insurance Agency

Although the social insurance agency should coordinate itsinvestment policy with other public agencies (e.g., planning office,central bank, ministry of finance or economy) the former should be fullyin charge of policy making (according to the legislation in force), andpolicy implementation, e.g., allocation of the reserves among availableinstruments. It is true that the autonomy of the social insurance agencyby itself is not guarantee of good investment performance, but it is keyto impede government intrusion to use social insurance funds for its ownpurposes. Recent measures, as the creation of an Investment Board inJamaica, are positive steps in that direction within the non-LatinCaribbean. But government interference is also exercised in LatinAmerica albeit in a less obvious manner such as payment of state debt inbonds with fixed low interest, and pressure upon the social insuranceagency to lend to public agencies or invest in government stocks. (Chileis an interesting case of government interference beneficial for the newpension program but at the cost of an increasing state subsidy to theoverall social security system.) With an increased autonomy, the socialinsurance agency should put more emphasis in hiring skilled personnel tohandle its investment policy or upgrading the skills of those alreadyappointed, through specialized training. International financialagencies could support such training efforts.

b. Reduction of Fixed and Net Current Assets

To maximize invested assets, an effort should be made to reduce tothe minimum necessary, the amount of total assets which are either fixedor net-current assets. This shall require at least: better control ofrevenue collection, evasion and payment delays (from both privateemployers and the state); reduction of administrative costs (particularlyhigh in Barbados, Ecuador and M4exico); and more diligence to detect cashflows and rapidly invest them. Increases in contributions are needed inseveral countries but they are difficult to implement in the midst of theeconomic crisis. Elimination of generous benefits should be tried also.The problem of fixed assets is also complex particularly in LatinAmerica. In the non-Latin Caribbean, fixed assets are relativelyinsignificant because social insurance does not have hospitals and oftendoes not even own its administrative offices as is typical in most ofLatin America. In the latter it is of utmost importance to stop allfuture investment in office buildings. Furthermore, an attempt should bemade to sell those fixed assets which are not essential and areunprofitable (e.g., sports and recreational facilities). Concerninghospitals and other medical facilities, these should be the exclusiveresponsibility (in construction and maintenance) of the sickness-maternity program which, for that purpose, should have the propercontributions.

43

c. Portfolio Diversification

This is important in order to compensate low yields of someinstruments with high yields in others and for the long-run stability ofthe system. In 1987 invested assets in public instruments had thefollowing percentages: 99.8% in Jamaica, 85% in Bahamas, 62% in Barbados,52% in Chile, 44% in Costa Rica, 10% in Ecuador and 8% in Mexico. Highconcentration of investment in low-yield instruments (e.g., governmentbonds, mortgage loans, rental buildings) should be avoided at all costs.But even countries which enjoy high yields in these types of instruments(e.g., Bahamas) should be cautious of excessive concentration,particularly in government bonds, because a change in administration mayterminate the payment of privileged yields. In some countries (e.g.,Mexico) the law would have to be modified in order to give moreflexibility to the social insurance agency to diversify its portfolio.

Diversification faces exogenous barriers, for instance, excessivenational liquidity in Bahamas and Barbados; lack of or poor local stockexchanges in most countries of the region. Chilean policy makersoverestimated the capacity of their nation's capital market to absorbrapidly growing pension funds. Furthermore, few stocks were eligible forinvestment due to excessive legal restrictions hence increasing thedemand for such stocks and artificially raising their yield. Acombination of more flexible legislation, government supervision, andclassification of instruments according to their risks (by both publicand private corporations) could help to expand the role of the capitalmarket.

d. Priorities to Instruments with Higher Yields

Fixed-term deposits should have first priority because they usuallypay the highest yields, are relatively safe, and do not require specialskills of the personnel in charge of investment. The CCSS in Costa Ricahas recently introduced a new policy of bank deposits combined with aspecial plan (administered by the banks) to use such deposits for creditto small agricultural producers. This policy has successfully blendedthe need for investment profitability and safety with socio-developmentobjectives. Banking sources for deposits should be diversified to avoidexcessive concentration in state banks. In countries with a history oflow inflation, long and medium-term deposits (and other instruments)should be preferred over short-term deposits, while an opposite policyshould be pursued in countries with a tradition of high inflation. In asituation of hyperinflation, deposits in U.S. dollars or another hardcurrency may be the only protection even if temporary.

Government bonds should have variable yields, indexed to inflation.Personal and mortgage loans are bad investments because of their lowyields, high administrative costs and collecting difficulties; thesecondary market, e.g., mortgage bonds with indexation, should bepreferred. Loans to the sickness-maternity or other programs should notbe allowed. Rental buildings should be avoided at all costs for the samereasons as personal and mortgage loans. Investment in shares is

44

advisable in countries with a well established stock exchange, governmentsupervision and available mechanisms for risk classification.

In closing, social insurance funds in LAC have become significantsources of capital in a few countries and have the potential for playingsuch a role in many other countries, particularly in those withrelatively new programs (which are a majority) but also in pioneercountries as the case of Chile illustrates. Negative performance in realyields has been partly due to high inflation rates and partly to poorinvestment policies. The latter could be improved with a series ofmeasures, in spite of exogenous limitations such as high inflation,government interference, excessive liquidity and poor capital markets.For those policies to be successful it is essential to learn from pastmistakes and elicit the support of domestic governments and internationalfinancial agencies.

45

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11. Cheyre, Hernan, La Previsi6n en Chile. Ayer y Hoy: Imoacto de unaReforma (Santiago: Centro de Estudios Publicos, 1988).

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13. , Anuario Estadistico de Am6rica Latina 1988

(Santiago, 1989).

14. Commonwealth of the Bahamas, Ministry of Finance, StatisticalAbstract 1984 (Nassau: Department of Statistics, October1985).

46

15. Commonwealth of the Bahamas, The National Insurance Board (NIB),Annual Report 1981 to 1985 (Nassau, 1981 to 1986).

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17. Consejo Nacional de Desarrollo (CONADE), "Avance del Programa deInversiones Prioritarias," Quito, 1984.

18. , "Informe del Presidente del Consejo Nacional deDesarrollo al Congreso Nacional," Quito, August 1987.

19. Contracting Corporation of America, Estudio del Sistema deInversiones de la Caia Costarricense del Seguro Social (SanJose, 1984).

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22. , "Estudio Financiero Actuarial del Fondo dePensiones," Quito, 1982.

23. , Memoria Institucional 1982 to 1986, Quito,1983-1988.

24. , Informe de Labores 1981-1984, Quito, 1984.

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26. , "Presupuesto de Inversiones para 1984," Quito,n/d.

27. , Aspectos Econ6micos v Financieros del IESS,Quito, August 1987.

28. Instituto Mexicano de Seguro Social (IMSS), "Informe Financiero yActuarial del IMSS al 31 de diciembre de 1982," Mexico D.F.,September 1983, and "Reporte de Auditoria a la Valuaci6nFinanciera y Actuarial al 31 de Diciembre de 1982," MexicoD.F., October 1983.

29. , Memoria Estadistica 1986 (Mdxico, D.F., 1987).

30. , Data on Reserves and Investment from theActuarial Services Section, Mexico D.F., April 6, 1989.

47

31. Instituto Nacional de Estadisticas, Compendio Estadistico 1981 to1987 (Santiago, 1982 to 1988).

32. Instituto Peruano de Seguridad Social (IPSS), Situaci6nFinanciera del IPSS 1984, Lima, 1985, and Situaci6nFinanciera del IPSS 1985 (elaborado por Rosa L6pez, et. al.)Lima, 1986.

33. , Direcci6n General de Tesoreria, "Ingresos yEgresos 1988,n Lima 1988.

34. , Plan de Emer-encia del IPSS, Lima, August-December 1988.

35. , "Evaluacion de la Ejecuci6n Presupuestal delIPSS 1987," and 1988, Lima, 1987, 1988.

36. , "Plan de Emergencia: Gerencia de Inversiones,"1988.

37. __, Investment data prepared by Rosa L6pez, withthe support of Homero Gutierrez, Jorge Beltran, GermdnUrruflaga, and Jose Cavero Vicentelo, Lima, November 1988.

38. International Labour Office (ILO), Social Security Department,"Statistical Analysis of Assets of Social SecurityInstitutions in Developing Countries," Meeting of Experts onthe Investment of Social Security Funds in DevelopingCountries (Geneva, 1983).

38 bis. _ _ __, The Cost of Social Security: TwelfthInternational Enguire. 1981-1983 and Basic Tables (Geneva,1988).

39. International Monetary Fund (IMF), "Barbados Accounting System ofthe National Insurance Scheme," December 12, 1983.

40. , International Financial Statistics Yearbook1988 and monthly January through April 1989.

41. International Social Security Association (ISSA), Los ProblemasActuales de las Pensiones en America Latina (Buenos Aires:AISS, 1987).

42. Koskela, Ekki and Viren, Matti, "Social Security and HouseholdSavings in an International Cross Section," AmericanEconomic Review, 73:1 (March 1983), 212-217.

43. 'La Crisis del Seguro Social Ecuatoriano," Hoy, Quito, February1, 1987, p. 2-A.

48

44. Mackenzie, G.A., "Social Security Issues in Developing Countries:The Latin American Experience," Washington, D.C., IMF StaffPapers, 35:3 (September 1988): 496-522.

45. Mesa-Lago, Carmelo, "Social Security in Ecuador," Report to theWorld Bank, Publir Investment Mission, Pittsburgh, December1984.

46. , The Crisis of Social Security and Health Care:Latin American Experiences and Lessons (Pittsburgh: LatinAmerican Documents and Monograph Series, No. 9, 1985).

47. , El Desarrollo de la Seguridad Social en Am6ricaLatina (Santiago: Estudios e Informes de la CEPAL, no. 43,1985).

48. , "Social Security in Bahamas, Barbados, andJamaica," (A Report for the ILO), Pittsburgh, July 15, 1987.

49. , "Chile SAL III: Final Report on PensionSystem," Report to the World Bank, Pittsburgh, August 17,1987.

50. , "Social Insurance: The Experience of ThreeCountries in the English Speaking Caribbean," (summary ofReport to ILO), Injternational Labour Review, 127:4 (1988):479-496.

51. , "Anilisis Econ6mico de los Sistemas dePensiones en Costa Rica y Recomendaciones para su Reforma,"A Report to Development Technologies, Inc., Pittsburgh,March 16, 1988.

52. , "Review of Chile SAL III Conditions: PensionSystem," Report to the World Bank, Pittsburgh, November 28,1988.

53. , "Informe Econ6mico sobre la Extensi6n de laCobertura Poblacional del Programa de Enfermedad-Maternidaddel IPSS," Convenio IPSS-USAID (HCF/LAC), Pittsburgh,December 9, 1989.

54. Ministry of Social Security and Consumer Affairs, Report forPeriod 1/4/77 - 31/3/78 Incorporating the 12th Annual Reportof the NIS (Kingston 1981).

55. , National Insurance Scheme (NIS), "The 13thAnnual Report 1978-1979," n.d.

56. , "Minister of Social Security Budget Speech1985/1986," 1985.

49

57. , "Information for Minister's Budget Speech1987/1988," 1987.

58. , "Statement of the National Insurance FundAccount for Years 1978-79 to 1983-84," n.d. and ibid. "1984-85 and 1985-86,n 1987.

59. , "Investment and Income from Investment forPeriods 1980-81 to 1985-86," 1987.

60. National Insurance Office (NIO), Financial Reports from 1982 to1987.

61. , "Comments on the Fourth Actuarial Report"(n.d.); and "Comments on the Fifth Actuarial Review" (n.d.).

62. , "Comments on the IMF Report on the NationalInsurance Accounting System, 1983" (n.d.)

63. Organization of American States (OAS), Technical AssistanceMission to the Government of Barbados, "Fourth ActuarialReview of the National Insurance Scheme," Washington, D.C.,1982.

64. , "Report to the Government of Barbados on theFifth Actuarial Review of the National Insurance Scheme,"Washington, D.C., 1985.

65. Planning Institute of Jamaica (PIJ), "Social Security," inEconomic and Social Survey Jamaica 1979 to 1986 (Kingston,1980 to 1987).

66. Romero Montes, Francisco, "Privatizaci6n y Obligatoriedad delSeguro Social," Analisis Laboral, 134 (August 1988): 10-11.

67. Secretaria de Planificaci6n y Presupuesto (SPP), InstitutoNacional de Estadistica, Geografia e Informatica, AgendaEstadistica 1986 (Mexico D.F., 1987).

68. "Situaci6n Financiera del IESS a Punto del Colapso," ExDreso,Guayaquil, February 11, 1985, p. 8.

69. Superintendencia de Administradoras de Fondos de Pensiones(SAFP), Boletin Estadistico Mensual, Santiago, Nos. 1 (1981)to 86 (1989).

70. , Statistics prepared on request, August 1987 andNovember 1988.

71. Superintendencia de Seguridad Social (SSS), Costo de la SeguridadSocial Chilena 1981 to 1986, Santiago, 1984 to 1988.

50

72. , Seauridad Social Estadisticas 1981 to 1986,Santiago 1985-1989.

72 bis. Torres, Rodriguez, Luis, IESS: Una Agonia en Cifras (Quito:Fundaci6n Ecuatoriana de Estudios Sociales, 1989).

73. Thullen, Peter, "The Financing of Social Security Pensions:Principles, Current Issues and Trends," in Mesa-Lago, TheCrisis, p. 147-177.

74. United Nations (UN), Monthly Bulletin of Statistics, 43:2(February 1989).

75. U.S. Social Security Administration (US-SSA), Social SecurityPrograms Throughout the World 1985 (Washington, D.C., GPO,1986).

76. Wallich, Christine, "Savings Mobilization Through SocialSecurity: The Experience of Chile 1916-1977," Washington,D.C., World Bank Staff Working Papers, No. 553, 1982.

77. Wilkie, James W., "Social Security and Health Programs in Mexicoto 1988," Washington, D.C., World Bank, August 1988 (draft).

78. World Bank, "Ecuador: Analysis of the Public Investment Program,"Working Paper, Was]hington, D.C., May 1984.

79. , Ecuador: Public Investment Review (Washington,D.C., December 16, 1985).

80. , "Financing Social Security," World DevelopmentReDort 1988 (Washington, D.C.: The World Bank, 1988), pp.138-140.

51

TABLE 1

Financing Methods of Sociat Insurance Persion Fuids in Selected LAC Countries:Late 1980s

Full Scaled Assessment of Pay-as-Countries Capitalization Premiun Constituent you-go

Capitals

Argentina X

Bahamas X

Barbados X

Brazil X

Chile (Old) XNew X

Colombia (ISS) XCivil Servants X

Costa Rica (CCSS) xaCivil Servants X

Cuba X

Ecuador xa

Guatemala X

Jamaica X

Mexico (IMSS) xa

Panama X

Peru X

Uruguay X

a Full capitalization in theory or by Law, but scaled premium in practice.

Sources: 1, 3, 45, 46, 48, 49, 51, 53.

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TABLE 2

Percentage Distribution of Social Insurance plus Family AlLowancesa Revenue by Source in LAC: 1983

State & Revenue as % of GDPCountries Insured Employer Taxes Investment Others Total Pensions

ALL CapitalRevenue Return

Antigua-Barbuda 29.3 48.8 0.0 19.2 2.8 3.3

Argentina 34.5 27.2 36.0 2.0 0.3 7.5 4.9 0.0

Bahamas 23.2 38.0 5.2 33.6 0.1 2.8 1.6 1.3

Barbados 36.2 37.5 0.0 22.3 4.1 6.2

BeLize 11.6 69.1 0.0 14.3 5.0 2.1 0.2 0.0

Bolivia 25.5 34.8 24.2 12.4 3.1 2.7 1.0 0.2

Brazil 15.6 74.0 8.2 0.0 2.2 5.4 0.0

Chile 31.1 2.1 48.9 15.9 2.0 16.7 11.4 2.6

Colombia 26.6 62.8 0.0 10.2 0.4 1.8 0.6 0.1

Costa Rica 28.4 47.0 18.6 5.3 0.8 9.2 2.2 0.3

Cuba 0.0 44.3 55.7 0.0 0.0 11.5 0.0

Dominica 27.3 45.6 0.0 26.2 0.8 3.4 2.5 0.7

Ecuador 38.6 38.1 1.3 22.1 0.0 3.6 2.0 0.3

El Salvador 23.7 55.8 0.0 20.0 0.6 1.8 0.8 0.3

Grenada 48.2 48.3 0.0 3.3 0.2 1.6 0.0 0.0

Guatemala 29.5 51.0 3.6 13.2 2.7 1.4 0.5 0.2

Guyana 20.6 30.9 0.0 48.5 0.1 8.5 6.2 3.0

Honduras 25.9 47.9 7.2 16.8 2.2 1.3 0.5 0.2

Jamaica 24.3 29.7 7.4 38.5 0.1 2.4

Mexico 19.7 62.0 12.3 5.2 0.8 2.0 0.7 0.1

Nicaragua 22.8 59.9 3.2 12.9 1.2 2.1 1.7 0.2

Panama 28.8 44.6 3.3 13.3 10.0 9.9 5.4 1.3

Peru 2 9 .4a 59 .0a 0.0 10.3 1.3 2.0 0.9 0.0

St. Lucia 43.5 43.5 0.0 13.0 0.0 1.8

Suriname 23.9 9.7 66.4 0.0 0.0 1.4 0.9 0.0

Trinidad 18.1 36.2 27.2 18.5 0.0 2.5 1.8 0.5& Tobago

Uruguay 23 .5a 23 .3a 49.2 1.6 2.3 8.8 3.9 0.1

VenezueLa 28.6 39.3 13.7 18.3 0.1 1.8

Region X 26.5 43.1 14.0 14.9 1.5 4.5 2.4 0.5

aFamily allowances only in Argentina, Brazil, Colombia, Chile, Suriname, and Uruguay.

Sources: 38 bis.

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TABLE 3

Period of Introduction of Social Insurance Pension Programs by Yortd Region: 1889-1985

Year of Industrializeda Latin Am. & Caribbean Asia. Oceania. Middle E. AfricaIntroduction No Cumulative % No Cumulative % No Cumulative % No CumuLative %

1889-1920 15 15 52 0 0 0 0 0 0 0 0 0

1921-1930 6 21 72 4 4 12 0 0 0 1 1 3

1931-1940 6 27 93 3 7 20 0 0 0 0 1 3

1941-1950 2 29 100 6 13 38 2 2 8 2 3 8

1951-1960 0 29 100 2 15 44 11 13 52 10 13 34

1961-1970 0 29 100 14 29 85 3 16 64 15 28 74

1971-1980 0 29 100 5 34 100 5 21 84 4 32 84

1981-1985 0 29 100 0 34 100 0 21 84 0 32 84

Without 0 29 100 0 34 100 4 21 84 6 32 84

TotaL 29 29 100 34 34 100 25 21 84 38 32 84

aIncludes seven European countries not considered fully industrialized according to the World Bank classification.

Sources: Author's calculations based on 75.

54

TABLE 4

Percentage of Social Insurances Plus Family Allowances (and Pension) Revenue Generated byInvestment Returns in LAC: 1965-1983

Year(s) of Investment Returns as Percentage of:Countries Pension Social Insurance Plus Fam. Atlowances Pensions only

Program(s)a 1965 1970 1975 1980 1983 1983

Latin America (1920s-1960s)

Pioneers (1920s-1930s)Brazil 1920s-30s 0.0 0.0 0.0 0.0 0.0 0.0Uruguay 1920s-30s 1.1 0.6 1.5 1.6 2.4Argentina 1930s-40s-50s 1.1 2.2 2.0 0.2Cuba 1920s-50s/1963 0.0 0.0 0.0 0.0 0.0 0.0Chile 1924/1981 2.2 1.1c 2.0 1.8 15.9 22.6

Middle (1940s) fMexico 1941 4.9 2.4 1.6e 3.6 5.2 8.9Costa Rica 1943 10.6 12.2 7.6 5.2 5.3 15.1Ecuador 1930s-42 18.6 24 .8d 20 .3e 17.7 22.1 15.9Panama 1941-54 19.2 11.3d 8.3 10.1 13.3 23.5Colombia 1945-56 0.0 5.1 6.9 13.5 10.2 19.0Peru 1936-61-62 11.1f 10.3 20.4

Late Comers (mid 50s-60s)Nicaragua 1955 4.8 3.6 5.3 2.8 12.9 15.0Bolivia 1959 0.9b 2 .5d 3.4 7.9 12.4 16.4VenezueLa 1966 - 5.6 12.2 12.7 18.3Guatemala 1969 - 1.4 0.0 7.7 13.2 33.1EL SaLvador 1969 2.1 2.4 7.6 13.6 20.0 45.9Honduras 1971 2.1 2.8 11.5 16.8 40.8

Non-Latin (mid 1960s-70s)CaribbeanJamaica 1966 14.6 14.8 31.4 43.6f 38.5Barbados 1967 - 1 6 .9c 28.6 25.4 22.3Grenada 1969-83 - - 66.2f 3.3Guyana 1969 - 12.1 20.4 26.7 48.5 49.0St. Lucia 1970 - - 25.3 13.0Dominica 1970 - - 21.3 26.2 26.2Trinidad & 1971 - - 12.9 25.6 18.5 25.49Tobago

Antigua- 1972 - - 19.8 19.2Barbuda

Suriname 1973 - - 0.0 0.0Bahamas 1974 - - 26.1 33.6 30.7Belize 1979 - - - 3.0 14.3 14.6

- Not in force yet

a Countries ordered by year(s) in which the major pension program(s) was imptemented; when separatedby a / it means: oLd program/new program.

b 1961 c 1971 d 1972 e 1974 f 1981 9 social insurances only

Sources: Date of pension program from 75; percentages from 38 bis.

55

TABLE 5

Major Characteristics of Social Insurance Funds of the Eight Cointries Selected for Study: 1980s

Countries Date of Actuarial % of Revenue Real StudyPension Method from Inv't Inv't Yield Scope8

Program

Bahamas 1970s Scaled Very High Positive Atl FundsPremium Medium

Barbados 1960s Scaled High Positive AlL FundsPremium Low

Chile 1920s/1980s General High Positive PensionLeveL Premiun High Funds

Costa Rica 1940s General Level Low Negative Pensionbut scaled premniun Medium Fundsin practice

Ecuador 1930s-1940s General Level High Negative All Fundsbut scaled premium Mediumin practice

Mexico 1940s General Level Mediun- Negative All Fundsbut scaled Low Highpremium in practice

Jamaica 1960s Scaled Premiun High Negative AUl FundsLow

Peru 1930s/1960s Scaled Premium Mediun Negative Pension FundsHigh

alnvestment to be analyzed in this study: either all social insurance or pensions only.

Source: TabLes 2, 4, 6-13.

56

TABLE 6Amount, Composition and Real Yield of Invested Assets of

NIB, Baha_s: 1980-1985a

1980 1981 1982 1983 1984 1985

Total Net Assets 112.7 138.3 161.4 190.0 220.8 264.7(millions B$)

Invested Asse s 108.5 132.3 156.3 183.3 210.8 256.3(millions 8S)

Investment Return 8.5 11.3 13.5 16.3 17.6 21.2(millions B$)

Nominal Yield (%)c 9.7 9.8 9.8 10.1 9.3 9.5

Rate of Inflation (%) 12.1 11.1 6.0 4.0 3.9 4.6

Real Yield (%)d -2.1 -1.2 3.6 5.8 5.2 4.7

Composition (% distribution)

Government Bonds 70.3 57.4 48.6 60.2 62.3 66.3Stocks 70.3 57.4 48.6 59.5 57.2 55.8Mortgage Bonds 0.0 0.0 0.0 0.7 5.1 10.5

Loans 8.8 7.4 18.5 16.7 10.4 15.9Treasury Bills 8.8 7.4 18.5 13.6 7.2 12.9Loanse 0.0 0.0 0.0 3.1 3.2 3.0

Fixed-Term Deposits 20.9 35.2 32.9 23.1 27.3 17.8

Shares 0.0 0.0 0.0 0.0 0.0 0.0

ReaL Estate 0.0 0.0 0.0 0.0 0.0 0.0

Totala 100.0 100.0 100.0 100.0 0.0 100.

a At the end of the year

b Excludes fixed and net-current assets

c Based on the formula (applied in all countries): (investment return x 200).(investment at the start of the year +investment at the end of the year - investment return). The NIB has published higher yields but based on the yields mean notin the actuaL return: 1980: 8.8%; 1981: 9.4%; 1982: 9.0%; 1983: 9.7%; 1984: 8.9%; 1985: 9.1%.

d Based on the formuLa: [ * - X1100, where y = nominaL yield coefficient, and i = inflation coefficient.

e Loans to government corporations

f Mostly in commercial banks; in 1980, 30% of total deposits were in the Central Bank, in 1981: 13%, and in 1985: 33%.

Sources: Author's calculations based on 12, 13, 14, 15, 16, 60.

57

TABLE 7Anomt, Couqosition and Real Yields of Invested Assets of

NIO, Barbados: 1980- 19 87a

1980 1981 1982 1983 1984 1985 1986 1987

Total Net Assets 181.8 215.0 261.2 318.7 364.7 407.7 424.2(millions BdsS)

Invested Assets 180.0 203.5 230.2 274.5 313.4 347.5 367.9 370.3(millions BdsS)b

Investment Return 12.0 11.7 19.8 28.3 24.8 25.5 22.4(millions Bds$)c

NominaL Yield (%)d 7.2 6.4 9.6 11.9 8.8 8.0 6.5

Rate of Inflation (X) 14.5 14.6 10.3 5.3 4.6 3.9 1.3 3.3

Real Yield (X)d -6.4 -7.2 -0.6 6.3 4.0 3.9 5.1


Government Bonds 21.5 19.8 18.2 13.7 14.8 16.1 16.0

Loans to Governmente 25.7 31.1 39.3 47.3 48.4 46.9 46.9

Fixed-Term Deposits 49.4 45.9 39.2 36.2 34.3 34.6 35.1

Shares 3.4 3.2 2.9 2.8 2.5 2.4 2.0

Real Estate 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total 100.0 100.0 000.0 100.0 100.0 100.0 100.0

a At the end of the year; 1987 as of March 31.b ExcLudes fixed and net-current assets.c The Central Bank reported higher returns by adding other NIO receipts including transfers for the administration of otherprograms.

d Based on the same formula used in Table 6.e Treasury Bills.

Sources: Author's calculations based on 10, 13, 60, 61, 63, 64.

TABLE 8

Amount, Coqposition and Real Yields of Invested Assets ofAFPs (Pensions), Chile: 1981-19Wa

1981 1982 1983 1984 1985 1986 1987 1988

Total Net Assets 14.0 44.9 99.9 162.6 283.0 434.4 644.5 891.7(billion pesos)

Invested Assetsb 14.0 44.9 99.6 161.8 281.6 432.7 642.5 891.4(billion pesos)

Investment ReturnC 2.8 12.3 29.4 30.9 79.4 96.8 137.9(billion pesos)

Nominal Yield (M)d 20.1 52.7 51.1 26.8 43.6 31.3 29.4

Rate of Inflation (X) 3.9 20.7 23.1 23.0 26.4 17.4 21.5 10.9

Real YieLd (%)u 12.7 26.5 22.7 3.1 13.6 11.8 6.5

00


Government Bondse 30.6 26.0 45.9 42.3 42.6 46.8 45.0 36.4

Mortgage Bondsf 8.1 46.8 48.3 43.6 35.8 25.6 22.9 27.0

Fixed-Term Deposits 60.6 26.6 5.2 12.3 20.5 23.0 26.1 28.5

Real Estate 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Shares 0.7 0.6 0.6 1.8 1.1 4.6 6.0 8.1

Total 10T 0.0 100.0 1000 1O0.0 100.0 100.0 100.0 100.0

a End of the year; the year 1981 is July to December.b Excludes fixed assets.c Calculated by author based on other data in the Table.d Based on the same formulas used in Table 6.e BasicaLLy State Treasury and Central Bank, plus public enterprises.Emitted by financial institutions; includes a small fraction in banking bonds.

Sources: Author's calculations based on 13, 69, 70.

TABLE 9Amout, Composition wan Reat Yield of Invested Assets of

CCSS (Pensions), Costa Rica: 1977-1987a

1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

Total Net Assets 2,014 2,449 2,940 3,482 4,193 5,248 7,583 9,562 12,030 14,890 17,591

(million coLones)

Invested Assetsb 1,559 1,903 2,755 3,145 3,346 3,857 6,984 8,563 11,066 14,086 16,676

(million colones)

Investment Return 146 434 180 250 260 440 821 1,395 2,027 2,348

(million colones)

NominaL Yield (%)c 8.8 20.5 6.3 8.0 7.5 8.5 11.2 15.3 17.5 16.5

Rate of Inflation (%) 5.3 8.1 13.2 17.8 65.1 81.7 10.7 17.3 11.1 15.4 13.6

Real Yield (%)c 0.6 6.4 -9.7 -34.5 -40.8 -2.0 -5.2 3.8 1.8 2.6

Composition (% distribution) kn

Goverrnment Bonds 25.4 20.3 38.5 34.8 32.5 31.6 31.3 27.7 33.3 33.7 43.7 '0

Loans/Mortgages 62.0 68.9 53.8 56.9 59.9 55.2 31.1 26.9 22.1 14.1 14.7

Loans to S-Kd 35.7 43.7 32.3 37.0 39.9 34.7 16.6 13.2 8.4 0.0 0.0

Mortgages & Others 26.3 25.2 20.5 19.9 20.0 20.5 14.5 13.7 13.7 14.1 14.7

Fixed-Term Deposits e e e 0.9 0.5 4.9 19.0 31.1 32.6 42.6 35.3

Shares 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Real Estate 6.5 6.4 3.0 4.4 4.5 3.8 2.2 12.7f 9.5f 7.0f 5.6f

Others 6.1 4.4 5.7 3.0 2.6 4.5 16.4 1.6 2.5 2.6 0.7

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

b At the end of the year; except 1987 at September 30.b Excludes fixed and net-current assets; the Latter includes unpaid state contributions.C Based on the formulas used in Table 6.d SM = Sickness-maternity program of CCSS.e Not disaggregated from others.

Increment partly due to revalorization of real estate.

Sources: Author's calculations based on 4, 9, 13, 19, 51.

TABLE 10Amount, Composition and Real Yield of Invested Assets of

IESS, Ecuador: 1979-1986a

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

Total Net Assetsb 23,202 30,741 35,879 31,472 37,432 42,256 60,867 75,409 91,499(million sucres)

Invested AssetsC 5,802 8,977 12,360 14,245 15,266 15,814 23,510 28,258 39,061 46,365(miLlion sucres)

Investment Returnd 595 874 1,496 1,723 1,745 1,615 1,967 2,155 3,076(million sucres)

Nominal Yield (%)e 11.5 12.5 15.1 13.8 12.5 11.0 10.5 8.7 9.9

Rate of Inflation (%) 11.6 10.3 13.0 16.3 16.3 48.4 31.2 28.0 23.0 29.5

Real Yield (%)e -0.1 2.0 1.8 -2.1 -3.3 -25.2 -15.8 -15.1 -10.6


Government BoRds 40.3 26.0 38.8 35.2 19.0 17.2 9.8 10.2

Loans/Mortgages 42.2 51.1 50.6 61.3 78.8 80.2 87.5 83.1

PersonaL 32.5 27.6 29.9 33.0 39.5 35.9 42.5 38.2

Mortgage 9.5 13.2 13.9 23.5 34.6 39.3 37.8 39.6

Othersf 0.2 10.3 6.8 4.8 4.7 5.0 7.2 5.3


Shares 5.2 0.4 0.2 0.4 0.2 0.0 0.1 3.3

Real Estate 3.9 4.7 5.0 3.0 1.9 2.5 2.5 3.2Others 9 0.9 0.1 0.1 0.1 0.1 0.1 0.1 0.2

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

a At the end of the year.b 1978-1980 from ILo; rest estimated by the author based on IESS reserves for each program.c Excludes fixed and net current assets; ILO data for 1978-1980 give 3.5 times the figures in the table.d The IESS gives budgeted data on investment returns (1978-1986) which are from 30% to 400% higher than the other IESS series given in the

Table; the World Bank also has a series (1978-1983) which is from 100% to 200% higher than the Table's; the ILO series (1978-1983) is from26% to 170% higher than the Table's.

e Estimated by the author based on the formulas used in Table 6; the IESS nominal yields are systematically smaLler because they divide theinvestment return by the invested assets, both in the same year.Loans to IESS programs (sickness-maternity, peasants, etc.) and public sector.

9 Pawn Loans, non-specified stocks, etc.

Sources: Author's caLculations based on 21-27.

TABLE 11

Amount, Composition and Real Yield of Invested Assets of

NIS, Jamaica: 198 0-1987a

1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87

Total Total Net Assets 337.6 403.7 505.8 661.8 609.7 712.3 772.3 912.9

(millions JS)

Invested Assegs 337.6 403.7 505.8 661.8 609.7 712.3 772.3 912.9

(millions J$)

Investment Return 28.7 35.3 46.3 52.2 45.1 82.8 88.8 83.2

(millions J$)c

Sun Retained ty Gov't 0.0 0.0 0.0 8.8 31.6 10.5 34.5 41.3

(millions JS)

Nominal Yield Me 9.7 10.0 10.7 9.4 7.4 13.4 12.7 10.3

Rate of Inflation 27.3 12.7 6.6 11.6 27.8 25.7 15.1 6.4

Real Yield (%)e -13.8 -2.4 3.8 -2.0 -15.9 -9.8 -2.1 3.7

Real Yield with SumRetained by Gov't (%)f -0.5 -11.8 -8.4 2.6 9.0


Government Bonds 97.8 97.6 99.9 114.0 98.6 98.0 91.6 91.0

Loans to Gov't 0.0 0.0 0.0 0.0 0.0 0.0 0.0 8.8

Fixed-Term Depositsg 2.2 2.4 0.1 -14.0 1.4 2.0 8.4 0.2

Shares 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Real Estate 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Totala 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Fiscal year April 1 - March 31b Excludes fixed assets but includes an undetermined amount of cash.

d Sum actually received by NIS from Ministry of Finance.

e Sum retained by Ministry of Finance and owed to NIS.

f Based on sum actually received by NIS. Calculations use the same formulas of Table 6.

Includes sum retained by Ministry of Finance.

9 Includes an undetermined amount of cash; in 1982-83 there was a withdrawal to invest in gov't bonds.

Sources: Author's calculations based on 13, 40, 55-59.

62TABLE 12

Amount, Composition aMd Real Yield of Invested Assets ofINSS, Mexico: 1980-1988

1980 1981 1982 1983 1984 1985 1986 1987 1988

Total Net Assets 56.6 81.5 119.0 138.2 168.0 290.0 463.0 6 62 .09 806.8(billion pesos)

Net Current Assetsa 20.2 33.8 62.0 75.4 91.8 170.8 227.2 201.0 -55.4(billion pesos)

Fixed Assetsb 26.1 37.5 52.1 53.2 62.5 94.1 166.5 386.2 770.4(billion pesos)

Invested Assets IC 10.3 10.2 4.9 9.7 13.7 25.1 69.3 74.8 91.8(billion pesos)

Invested Assets IId 36.4 47.7 57.0 62.9 76.2 119.2 235.8 461.0 862.2(billion pesos)

Investment Return 5.2 13.8 18.2(billion pesos)

Nominal YieLd (%)e 12.6 30.3 35.3

Rate of Inflation (%) 26.3 28.0 58.8 101.9 65.5 57.8 86.2 131.8 51.7

Real Yield (M)e -12.0 -17.9 -32.7

Composition (% distribution)d

Goverrnent Bonds 24.9 17.9 4.1 10.3 11.9 16.8 25.8 13.6 8.2

Mortgage Loans 2.9 3.1 4.5; 5.2 6.0 4.7 3.5 2.6 2.4

Fixed-Term Deposits 0.0 0.0 0.C' 0.0 0.0 0.0 0.0 0.0 0.0

Shares 0.5 0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Real Estatef 71.7 78.6 91.4 84.5 82.1 79.0 70.7 83 .89 89.4

Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

a Cash, current accounts, uninvested funds (includes an emergency fund). Includes "other net assets."b Buildings and equipment of IMSS, such as hospitals, administrative offices, sport facilities, cinemas andtheatres, etc.c Without fixed assets.d Including fixed assets; probably excludes some fixed-term deposits included in net current assets.e Calculated based on formulas used in Table 6.f "Muebles e inmuebles:" probably most are fixed assets.9 In 1987 "Muebles e inmuebles" were adjusted for inflation increasing 10 times its value and raising the totalvalue of the reserves to 4,388 billion pesos and the proportion of invested assets (11) in "Muebles e inmuebles" to98%.

Sources: Author's calculations based on 30 (for 1982-1988) and 38 (for 1980-1981).

63

TABLE 13Amount, Composition and ReaL YieLd of Invested Assets of

IPSS (Pensions), Peru: 1981-1988a

1981 1982 1983 1984 1985 1986 1987 1988

Total Net Assets(millions intis)

Invested Assets 89.4 121.1 321.8 623.0 1,461.5 2,465.1 5,362.1 8,569.1(millions intis)b

Investment Return IC 24.0 39.2 55.9 62.8 127.1(miLlions intis)

Investment Return Ild 51.9 101.9 223.5 801.7 482.2 2,849.5(million intis)

Nominal Yield I J e 45.7 28.8 14.2 12.9

Nominal Yield II (X)e 49.6 65.4 59.8 62.0 125.0 28.0 28.0

Nominal Yield III (M)f 42.9 50.9 55.3 51.5 37.1 24.1 16.3 30.1

Rate of Inflation (X) 72.7 72.9 125.1 111.5 158.3 62.9 114.5 2,000.0

Real Yield I (%)e -15.7 -42.8 -46.0 -56.3

Real Yield II (X)e -13.4 -4.3 -29.0 -23.4 -12.9 -21.4 -40.3

Real Yield III (M)e -17.2 -12.7 -31.0 -28.4 -46.9 -23.8 -45.8 -93.5


Government Bonds 2.5 1.9 22.5 27.3 17.3 9.8 3.6 1.2

Loans/Mortgages 19.7 12.1 28.5 24.3 14.5 10.7 6.8 6.7

Loans to SM9 0.0 0.0 24.9 23.0 13.9 10.4 6.3 5.6

Others 19.7 12.1 3.6 1.3 0.6 0.3 0.5 1.1


U.S. Dollars h 10.1 16.4 22.2 31.8 44.1 27.1 56.3 73.4

National Currency 48.7 53.0 14.6 4.0 8.8 30.5 15.5 1.3

Sharesi 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Real Estate 19.0 16.6 12.2 12.6 15.3 21.9 17.8 17.4

Totala 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

a At the end of the yearbExcludes fixed and net current assetsc Official IPSS data including real estate return.d Estimated by the author based on invested assets and the weighted average of the nominal yields of alleinstruments; excludes real estate.Estimated by the author using the formula in Table 6.Weighted average of nominal yields of all instruments, except real estate.

9 Loans and transfers to sickness-maternity program.hConverted to intis using official exchange rate.1 There was a small amount in 1987-88.

Sources: Author's calculations based on 32, 35, 36, 37.

TABLE 14

Comparison of Significance, Composition, Real Growth and Real Yields of

Social Insurance Invested Assets in Case Studies: 1980-1987

Invested Assets (1987)aas % of: Compostition (% distribution 1987a) Average ReaL Growth 1981 - 87)C Average

Countries Money Gross Fixed Govt. GDP Govt. Loans/ Fixed- Shares Real Inflation Total Net lnv't. Real Yielg

Supply Capital Form. Revenue Bonds Mortg. Term D. Estate Others Rate Assets Assets (1980-87)(1980-87)

Bahamas 123.2 66.8 68.0 11.3 66.3 15.9 17.8 0.0 0.0 0.0 6.6 67 62 2.6

Barbados 79.3 79.3 52.9 12.7 16.0 46.9 35.1 2.0 0.0 0.0 7.2 54 38 0.7

Chile 96.4 54.0 15.4 45.0 22.9 26.1 6.0 0O0 0.0 24.3 425 424 13.8

Costa Rica 39.1 29.4 37.5 5.9 43.7 14.7 35.3 0.0 5.6 0.7 29.1 22 45 -10.50'

Ecuador 20.4 15.3 20.9 2.8 10.2 83.1 0.0 3.3 3.2 0.2 25.7 -18 -23 -10.0 4.

Jamaica 40.5 26.7 20.9 5.8 91.0 8.8 0.2 0.0 0.0 0.0 16.6 -3 -3 -4.8

Mexicod 1 0.59 0.21 0.29 0.04t. 69.5 -78 -73 -20.8f

II 3.1 1.1 1.5 0.2 13.6 2.6 0.0 0.0 83.8 0.0 3Peru 6.7 3.5 8.1 0.7 3.6 6.8 71.8 0.0 17.8 0.0 93.4 -18 -20.6

-29. 4 e

a Bahamas 1985; Ecuador 1986b Bahamas 1980-1985; Barbados 1980-1986; Chile and Peru 1981-1987; Ecuador 1980-1986; Mexico 1981-1983

c Bahamas 1981-85; Chile 1982-87; Ecuador 1981-86d 1: excludes "Imuebles e inmuebles", II: includes "muebles e irnmuebles".e Based on two different estimates, a third gives -40% for 1982-85.

Average for 1981-1983

Sources: Author's calculations based on 12, 13, 40, 74 and Tables 6-13.

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Recent World Bank Discussion Papers (continued)

No. 113 World Bank Lendingfor Small and Medium Enteiprises. Leila Webster

No. 114 Using Knowledgefrom Social Science in Development Projects. Michael M. Cernea

No. 115 Designing Major Policy Reform: Lessonsfrom the Transport Sector. Ian G. Heggie

No. 116 Women's Work, Education, and Family Welfare in Peru. Barbara K. Herz and Shahidur R. Khandker, editors

No. 117 Developing Financial Institutionsfor the Poor and Reducing Barriers to Accessfor Women. Sharon L. Holtand Helena Ribe

No. 118 Improving the Performance of Soviet Enterprises. John Nellis

No. 119 Public Enterprise Reform: Lessonsfrom the Past and Issuesfor the Future. Ahmed Galal

No. 120 The Information Technology Revolution and Economic Development. Nagy K. Hanna

No. 121 Promoting Rural Cooperatives in Developing Countries: The Case of Sub-Saharan Africa. Avishay Braverrnan, J. LuisGuasch, Monika Huppi, and Lorenz Pohlmeier

No. 122 Performance Evaluationfor Public Enterprises. Leroy P. Jones

No. 123 Urban Housing Reform in China: An Economic Analysis. George S. Tolley

No. 124 The New Fiscal Federalism in Brazil. Anwar Shah

No. 125 Housing Reform in Socialist Economies. Bertrand Renaud

No. 126 Agricultural Technology in Sub-Saharan Africa: A Workshop on Research Issues. Suzanne Gnaegy and Jock R.Anderson, editors

No. 127 Using Indigenous Knowledge in Agricultural Development. D. Michael Warren

No. 128 Research on Irrigation and Drainage Technologies: Fifteen Years of World Bank Experience. Raed Safadi andHerve Plusquellec

No. 129 Rent Control in Developing Countries. Stephen Malpezzi and Gwendolyn Ball

No. 130 Patterns of Direct Foreign Investment in China. Zafar Shah Khan

No. 131 A New View of Economic Growth: Four Lectures. Maurice FG. Scott

No. 132 Adjusting Educational Policies: Conserving Resources While Raising School Quality. Bruce Fuller and Aklilu Habte,editors

No. 133 Letting Girls Learn: Promising Approaches in Primary and Secondary Education. Barbara Herz, K. Subbarao,Masooma Habib, and Laura Raney

No. 134 Forest Economics and Policy Analysis: An Overview. William F. Hyde and David H. Newman, with a contributionby Roger A. Sedjo

No. 135 A Strategyfor Fisheries Development. Eduardo Loayza

No. 136 Strengthening Public Service Accountability: A Conceptual Framework. Samuel Paul

No. 137 Deferred Cost Recoveryfor Higher Education: Student Loan Programs in Developing Countries. Douglas Albrechtand Adrian Ziderrnan

No. 138 Coal Pricng in China: Issues and Reform Strategy. Yves Albouy

The World Bank

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