This year will see the fifteenth anniversary of Peru's Private Pension System, which was based on the Chilean model. Fernando Muñoz-Nájar looks at how the system has taken root in the Andean country
In Peru back in 1991, the government was in serious financial difficulties and the coffers were empty. Public pensions, the only ones existing at the time, were extremely low and pensioners lived in abject poverty. The public pensions system had collapsed. Analysis performed by the Peruvian Institute of Economy (IPE) revealed a system which should have had reserves of US$10bn in fact only had a few dollars in cash and some assets valued at $300m. It was wholesale bankruptcy.
The inefficiency of the PAYGO systems was still not entirely clear. In addition to poor public pension administration, there were two key issues: families were having fewer children than before, and - thanks to medical advances - people were living longer. These facts made it impossible for the elderly to retire on the contributions of the increasingly fewer younger active workers. All this made the PAYGO system unviable. Moreover, the individual accounts system in Chile had been functioning for nine years and had been successful. The way ahead was clearly charted.
Under these circumstances, the creation of the private pension system, with the purpose of trying to achieve good pensions for Peruvian workers, began to take shape. The law that created the Private Pension System (SPP) was passed in December 1992, stating that the Pension Fund Administrators (AFPs) could start operating in July 1993. Six AFPs were ready by that date, with a seventh coming into play a few months later.
The government at the time decided that the National System would not be closed down and would compete with the Private Pension System. An attempt was also made to order the accounts of the bankrupt National Pension System (SNP). Today, fourteen years later, the SNP is still bankrupt, even though it has a more orderly structure.
In the beginning
The first years of the SPP were difficult due to several factors:
• There was mistrust of the financial system; several banks and a very popular pyramid savings system had recently gone bankrupt;
• The law made it mandatory for only payrolled employees to contribute to the SPP or SNP. In a country where 80% of the economy is informal, that 80% majority was automatically excluded from access to pensions;
• The AFPs had poor financial results and - in a deliberate attempt to stir up trouble - the tabloid press warned they would soon go bankrupt, which turned out to be exactly the opposite of what really occurred;
• When the law was passed, an article allowing workers' pension contributions to be deducted from income tax, which is permitted almost everywhere in the world, was abrogated, and has not been reinstated to this day. The logic and fairness of this tax deduction is based on the fact that the government makes it mandatory for individuals not to use part of their resources and instead contribute them to a pension system.
The trials and tribulations of the beginning years, in which the AFPs competed commercially on the basis of their solid backing, capital, seriousness, etc., are now part of the past.
In the past few years, Peru has begun to progress as never before, due to several factors:
1. Political stability;
2. Sustained economic growth over the past few years;
3. Excellent international raw material prices.
The economic progress of the country has been backed, to a great extent, by the savings amounts captured by the AFPs, which have been efficiently managed, giving rise to a significant income-percapita increase: it almost doubled in the six years from 2001 to 2007, rising from US$2,080 to US$3,931. Moreover, the AFPs have also achieved unprecedented success, accumulating a huge fund, the first time in the history of the country that a fund of this magnitude has been destined exclusively to pension payment.
Private Pension System has been successful. But Peru and the AFPs cannot rest on their laurels. We are now in a challenging phase. Even though the Private Pension System is almost 15 years old and can be considered to be mature, important challenges lie ahead, some of the most pressing of which are analysed below:
1. The need to increase coverage. This is the main social security problem in the country, which has a mostly informal economy. Curiously enough, the laws for pension and health service access are aimed at the formal sector, in other words, individuals on company payrolls. This has given rise to a system of exclusion which in the pension system is manifested in the five different classes of Peruvians in the economically active population:
a. First class: consisting of 600,000 individuals who are members of the National Pension System (SNP) and are formal employees who pay their taxes and have pension and health rights. On retirement they receive a good pension subsidy, financed by the contribution of 20% of the taxes paid by all Peruvians.
b. Second class: somewhat more than 4 million individuals who are members of the Private Pension System, are formal employees and pay taxes and have access to pension and health services. They pay part of the first class subsidy with their taxes.
c. Third class: some 2.5 million self-employed individuals (lawyers, engineers, consultants etc.) who pay taxes, do not have access to pensions and some of whom take out private health insurance. They pay part of the first class subsidy with their taxes.
d. Fourth class: some 2.5 million self-employed individuals (chauffeurs, carpenters, electricians, skilled tradesman in general) who have no access to pensions and health services. The characteristic of this group is that they believe they do not pay taxes. Nonetheless, through the extremely high General Sales Tax (IGV) and the Selective Tax on Consumption (ISV) on gasoline, they pay a high percentage of their small or mediumsized incomes, which also finances the pensions of the first class.
e. Fifth class: some 3.9 million individuals living in extreme poverty, with very limited or no access to social security, who only have access to programmes of a welfare nature.
2. The need to modernise the capital markets. The SPP came into being when the Peruvian Stock Exchange hardly existed. Nonetheless, the Stock Exchange has grown with the system, together with its corresponding legislation, making the institutional investor trustworthy to the public and performing its activities under stable rules and regulations. It is currently essential to make some changes: i) reduce costs for the issuer; ii) adjust the existing transaction fees to the large volumes currently being moved by institutional investors; and iii) simplify prior controls of the supervisor.
3. The need to improve the information available on the SPP. Members are not very familiar with the functioning of the system, leading to doubts with respect to their current and future rights. There is naturally scarce interest among younger people regarding the future of their funds. Nonetheless, the average person is beginning to take an interest in pensions as they begin to increase and it is very important they have thorough knowledge of the system. On some occasions, populism takes advantage of gaps in public awareness to try and sow mistrust, attempting to introduce legislative changes that can harm AFP members. It is therefore very important for members to be fully informed with regard to their system, in order to be able to defend it.
Overall, the outlook for AFP members in Peru is very promising. 2008, which has been named 'the year of World Conferences in Peru', will surely bring the expected changes for resolving SPP challenges. On 28 and 29 May, Peru will be the venue of the Conference of the International Federation of Pension Fund Administrators (FIAP) with the subject "Pensions for the Future: Developing Individually Funded Programs". Representatives of the 36 member agencies, from different countries, will attend, as well as pension specialists.
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