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PENSION REFORMS: EXPERIENCES IN LATIN AMERICA Seminar “The Future and the Reform on Pension PENSION REFORMS: EXPERIENCES IN LATIN AMERICA Seminar “The Future and the Reform on Pension Funds” Madrid, Spain October 2003 Guillermo Arthur E. , President of FIAP Author: Asociación de AFP de Chile

CONTENTS I. III. IV. V. Countries with Reform Bases of the New Pension Systems CONTENTS I. III. IV. V. Countries with Reform Bases of the New Pension Systems Results of the Reforms Political Economics of the Capitalization Systems Final Remarks

I. Reforms in Latin America Chile (1981) Peru (1993) Argentina (1994) Colombia (1994) Uruguay I. Reforms in Latin America Chile (1981) Peru (1993) Argentina (1994) Colombia (1994) Uruguay (1995) Bolivia (1997) Mexico (1997) El Salvador (1998) Costa Rica (2000) Dominican Rep. (2003) Ecuador (*) Nicaragua (*) Not yet implemented

I. Reforms in Central Europe, Eastern Europe and Asia Hungary (1998) Kazakhstan (1998) Poland I. Reforms in Central Europe, Eastern Europe and Asia Hungary (1998) Kazakhstan (1998) Poland (1999) Latvia (2001) Estonia (2002) Bulgaria (2002) Croatia (2002) Macedonia (2003) Lithuania (*) Rep. of Slovakia (*) Ukraine (*) In process of reform

II. Bases of the Pension System OLD SYSTEM NEW SYSTEM - Pay-as-you-go - Individual II. Bases of the Pension System OLD SYSTEM NEW SYSTEM - Pay-as-you-go - Individual capitalization - State administration - Private, competitive administration - Inflexibility - Individual freedom: w To choose and change AFP w How much to contribute (over the minimum) w When and how to become a pensioner w Which fund to choose (Multifunds) - Discretionary - Standard - Without fund accumulation - Net worth separation: AFP and Pension Funds - Role of the State: Administrator - Role of the State: w Supervisory w Subsidiary - Benefits: Old age, disability and survivorship pensions Disability and survivorship insurance: collective and mutually supportive

Characteristics of the New Pension Systems: Latin America COUNTRIES INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM Characteristics of the New Pension Systems: Latin America COUNTRIES INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM Single LATIN AMERICA Integrated Mixed (Individual Cap. ) (PAYG and Indiv. Cap. ) Argentina Bolivia (PAYG and Indiv. Cap. ) a a Colombia a Costa Rica Chile Mixed in Competition a a Ecuador a El Salvador a Mexico a Nicaragua a Peru Dominican Rep. Uruguay a a a

Characteristics of the New Pension Systems: Europe and Asia COUNTRIES EUROPE AND ASIA INDIVIDUAL Characteristics of the New Pension Systems: Europe and Asia COUNTRIES EUROPE AND ASIA INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM Single Integrated Mixed (Individual Cap. ) (PAYG and Indiv. Cap. ) Bulgaria a Croatia a Estonia a Hungary a Kazakhstan a Latvia a Macedonia a Poland a Mixed in Competition (PAYG and Indiv. Cap. )

New Pension Systems Proportion of the pension financed by the PAYG system Costa Rica New Pension Systems Proportion of the pension financed by the PAYG system Costa Rica Uruguay Argentina Dominican R Colombia El Salvador Chile Mexico 0 Source: Palacios (2003) 25 50 75 100

III. Results of the Reforms 1. - Return of the Funds The rates of III. Results of the Reforms 1. - Return of the Funds The rates of return of the funds exceed the growth of real wages and per capita income Country Argentina Bolivia Colombia Chile El Salvador Mexico Peru Uruguay Return of Funds 11. 70% 16, 20% 11, 80% 10, 50% 11, 30% 10, 60% 5, 70% 9, 50% Source: Palacios (2003) Growth of Real Wages -0, 80% 8, 80% 1, 40% 1, 80% -0, 20% 0, 00% 1, 80% 3, 60% Difference Return Funds. Growth Wages 12, 50% 7, 60% 10, 40% 8, 70% 11, 50% 10, 60% 3, 90% 5, 90% Ratio Growth Maximum Real Returns to income per Minimum capita Returns 1, 17 n. d. 1, 13 1, 05 1, 3 n. d. 1, 06 -0, 40% -0, 30% 4, 50% 0, 50% 2, 80% 2, 40% -0, 30% Difference Return Funds. Growth Income per capita 12, 10% 15, 80% 12, 10% 6, 00% 10, 80% 7, 80% 3, 30% 9, 80%

2. - Rapid growth of the funds MM US$ PENSION FUNDS IN LATIN AMERICA 2. - Rapid growth of the funds MM US$ PENSION FUNDS IN LATIN AMERICA Total (30. 06. 2003): MM US$ 106. 018 Mexico Argentina Chile Peru Colombia Uruguay Bolivia El Salvador C. Rica Jun’ 03

Pension Funds and GDP (June 2003) Country Fund (MM US$) Latin America Argentina (2) Pension Funds and GDP (June 2003) Country Fund (MM US$) Latin America Argentina (2) Bolivia Colombia Costa Rica (1) Chile (1) El Salvador (1) Mexico (2) Peru Uruguay Europe and Asia Bulgaria Kazakhstan Poland (1) GDP as of 31. 12. 2001 (2) GDP as of 30. 09. 2002 Source: FIAP GDP (MM US$) Fund/GDP 15, 328 1, 258 6, 403 218 39, 672 1, 289 35, 405 5, 296 1, 149 236, 631 8, 160 71, 297 15, 781 67, 236 14, 000 584, 147 30, 592 12, 321 4. 82% 15. 42% 8. 98% 1. 38% 59. 00% 9. 20% 6. 06% 17. 31% 9. 33% 113 1, 432 9, 486 15, 563 6, 987 343, 934 0. 73% 20. 49% 2. 76%

3. - Rapid growth of membership MEMBERSHIP IN LATIN AMERICA Total (30. 06. 2003): 3. - Rapid growth of membership MEMBERSHIP IN LATIN AMERICA Total (30. 06. 2003): Mexico 58. 747. 165 Argentina Chile Colombia Peru Bolivia C. Rica El Salvador Jun’ 03

4. - Economic Effects of the Reforms QUALITATIVE EFFECTS: • It offers investors the 4. - Economic Effects of the Reforms QUALITATIVE EFFECTS: • It offers investors the possibility of combining risk (better combination of risk return and diversification). • It reduces intermediation costs. • It encourages the creation of innovative long-term financial instruments. • It improves transparency and corporate governance. • It boosts the industry in custodial services, risk assessment, etc.

SOME EXAMPLES - Corporate Bonds CHILE PERU MEXICO Note for Chile: Average life of SOME EXAMPLES - Corporate Bonds CHILE PERU MEXICO Note for Chile: Average life of bonds in the first five years of the 1990 s: between 10 and 15 years. Currently between 15 and 20 years. They have been issued at 30 years.

- Equities CHILE PERU - Equities CHILE PERU

- Mortgage-Backed Securities and Bank Bonds CHILE Stock of Housing Financed with MBS - Mortgage-Backed Securities and Bank Bonds CHILE Stock of Housing Financed with MBS

- Investment Fund Shares CHILE - Investment Fund Shares CHILE

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

6. - Coverage • When the costs of the formal sector decrease sector increases. 6. - Coverage • When the costs of the formal sector decrease sector increases. • A strong link is formed between contributions paid and benefits received. • Incentives are created for both workers and employers to pay contributions into the pension system: lowering of contribution rates, increasing credibility in the system. Employment in this GREATER COVERAGE HOWEVER, THERE IS STILL MUCH TO BE DONE TO ENLARGE THE FORMAL SECTOR IN THE ECONOMY

IV. Political Economics of the Individual Capitalization Systems • Relative political risk: • Government IV. Political Economics of the Individual Capitalization Systems • Relative political risk: • Government pressures: - Capitalization - Pay-as-you-go - Fiscal - Redistributive • Resistance of the Individual Capitalization system: - Individual “defined contribution” accounts - Visibility of redistributions - Redistribution of stocks and not flows - Redistribution produces greater impact - Ownership Rights - Private management • Two examples: Chile and Argentina • Political economics of adjustment: - Market versus political system - Visibility

V. Final Remarks • In addition to making a significant contribution towards solving the V. Final Remarks • In addition to making a significant contribution towards solving the problem of pensions, this reform has positive economic effects. • The macroeconomic, labour market and capital market reforms contribute to increasing the positive effects of the pension reform on the economy. • Although the capitalization system has suffered considerable political threats, it is still stronger than the pay -as-you-go system when it comes to facing up to “political risk”.

V. Final Remarks • The effects on the pension funds of the economic crisis V. Final Remarks • The effects on the pension funds of the economic crisis of the past few years would have been less if their investment portfolios had been better diversified. Latin America: Investment Diversification (2002) Country Argentina Bolivia Chile Colombia Costa Rica El Salvador Mexico Peru Uruguay State instruments 78% 69% 30% 49% 67% 85% 83% 15% 64% Source: Palacios (2003) Local Foreign Investment 11% 14% 32% 34% 19% 1% 15% 53% 6% 9% 1% 17% 5% 0% 0% 0% 7% 0% Cash and Fixed Income Time Deposits 2% 90% 16% 100% 21% 75% 12% 93% 14% 100% 14% 99% 2% 100% 25% 71% 30% 100% Equities 10% 0% 25% 7% 0% 1% 0% 29% 0%

V. Final Remarks • The inadequate diversification is explained by the combined effect of V. Final Remarks • The inadequate diversification is explained by the combined effect of limited development in some local capital markets and regulations. Latin America: Differences in Investment Limits State and Bank Deposits Private Investments and Mutual Funds Chile Argentina Bolivia El Salvador Peru Dominican Rep. Nicaragua Uruguay Colombia Costa Rica 0% Source: Palacios (2003) 50% 100% 150% 200% 250%

V. Final Remarks • Fortunately there is evidence that regulation may move in this V. Final Remarks • Fortunately there is evidence that regulation may move in this direction in the near future, and in some cases that is has already done so: ü CHILE: ü MEXICO: ü ARGENTINA: ü PERU: - Multifunds - Increase in limit for investment abroad - Multifunds (Reform to SAR Law) - Investment allowed in foreign securities - Possibility for the AFJPs to buy dollars without limits (Project) - Multifund - Increase in limit for investment abroad

Chile : Results of the Multifunds (October 2003) FUNDS (Millions US$) % YIELD (Jan. Chile : Results of the Multifunds (October 2003) FUNDS (Millions US$) % YIELD (Jan. – Oct. 03) Fund A 1. 912, 88 4, 09 24, 7% Fund B 6. 590, 38 14, 09 14, 9% Fund C 31. 426, 23 67, 20 10, 0% Fund D 4. 779, 30 10, 22 8, 3% Fund E 2. 057, 03 4, 40 3, 1% TOTAL 46. 765, 82 100, 00 The Funds are differentiated by their minimum and maximum proportion of equities.