A discussion paper presented by Pacific University for a debate on the Peruvian Retirement System, covering the period 1996-2013 with projections to 2050, branded as “failures” both the public and private systems.
Led by academics María Amparo Cruz-Saco, Juan Mendoza and Bruno Seminario, the report identifies three basic errors in the existing models. First, it criticizes the attempt to finance pensions through a tax on workers’ wages in a market where about two thirds of employment is informal. Second, it questions compulsory pension savings in the context of the current system, arguing that there is no evidence that people are not saving voluntarily for old age. And finally, the authors comment on existing law, which they believe “suffocates” initiative and competition between AFPs.
The paper also proposes a universal non-contributory pension for those over 65, funded by consumption taxes to replace the compulsory saving system, and would allow the AFPs to continue to operate with their existing balances and new voluntary contributions.
As of September 2014, the private pension fund system managed USD 39 billion, equivalent to 19.2% of GDP, with 60.5% of the fund invested in domestic financial assets and 39.5% in foreign financial assets.
When asked about the level of support there might be in Peru for the proposal by the report’s authors, the academic María Amparo Cruz-Saco said the dialogue on these issues should move beyond the models recommended and implemented by international financial institutions, transnational insurance companies, banks and local regulators. “Analysis of the effects of pension schemes on workers’ behavior and a better understanding of which incentives raise or could raise long-term savings must be part of a wide-ranging study leading to formulation of a consensus proposal which is technically and politically viable,” she said.
According to Cruz-Saco, the proposal is based on two fundamental principles. The first is the human right to social protection that provides a minimum of decorum and dignity for older persons living in poverty. “President Michelle Bachelet led this initiative in the UN to create a minimum level of social policies that reduce personal vulnerability. This initiative includes a basic pension for older adults, which already exists in several countries in Latin America and has existed for a long time in European countries.”
The second principle is the free choice and independence of pension product consumers. “This is particularly important in the absence of a comprehensive social security system in Peru. Compulsory tripartite social security contributions or taxes are the actuarial basis of national insurance for payment of defined or notional benefits guaranteed by the State. But in Peru, there is no Bismarck-type social security. When pension saving is the monopoly of an industry controlled by four financial companies whose technology is extremely expensive, compulsory membership eliminates competition and freedom of choice and creates a series of unforeseen effects (subsidy for informal activity, inefficiencies in the search for pension alternatives, stagnation of coverage). Other disadvantages are the operational inefficiency of the public pension system, which competes with the private system and signs up workers despite running an actuarial deficit.”
The academic said that, for obvious reasons, no support could be expected from the AFP industry, particularly for the idea of an end to compulsory pension savings, and she recognized that not a few voices believe that a basic pension could discourage saving and that it would be difficult to fund. However, she said the major underlying worry is the threat to the returns of the AFPs and related insurance services, which would be lost if pension savings are no long obligatory.
– What legislative process would a proposal like the one you have presented require?
None at the moment. These proposed principles set out in a discussion paper are part of a more detailed analysis of the pension structure, its projections and what might be the costs of transition to a different scheme. When the study is completed and the details can be shared with the political actors, progress can be made with preparing a new reform of the 1991 pension reform. Clearly, the current pension system needs reform to increase its efficiency and coverage.
– What other measures could be taken to increase competition and improve the return of the funds without a radical change to the private pension system?
This is the main objective of the regulator of the four AFPs. For the time being, the second bidding process for new participants, won by AFP Habitat in 2012, has been postponed. The management fee is put out for bidding along with payment of the disability and death premium offered by insurance companies. The purpose is to reduce the transactional cost of the product, the highest in Latin America. One of the measures adopted to expand diversification of instruments and reduce risk is for the pension funds to invest abroad. Since returns on individual accounts are determined by the conditions that affect financial return, they would improve with better performance by the real economy. The United States economy has been recovering: growing 5% annualized in the third quarter of 2014, while the Peruvian economy has slowed. Return on investment will be affected when US interest rates rise. The investment options of the workers or “consumers” of AFP services are very limited. There are three closed-end investment funds going from higher to lower risk, but each workers’ savings has to go into one or another fund. The main problem – insufficient coverage of the population – is still the Achilles heel of the system.
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