Rodrigo Amaral asks whether Colombia's new government will continue with vital pension reforms
Colombia’s pension fund industry is on the rise and the future could look even better if further economic reforms are implemented. Some positive developments have taken place already: new rules have widened the range of services that Colombia’s pension fund managers, AFPs, can offer to participants in their pension schemes. However, labour market inefficiencies and distortions in the pension system have prevented the industry from developing more rapidly.
Even though the number of participants has been growing steadily, further progress has been hampered by the pervasive black economy and resilient unemployment, factors that have not improved significantly despite the good performance of Colombia’s economy in the past few years. If those problems are tackled, there certainly seems to be scope for growth. According to a recent study by Universidad de Rosario, 63% of all Colombian workers are not putting any money aside for their retirement.
“Pension funds have consolidated themselves in recent years by systematically increasing their role in the pensions system,” said AFP Porvenir’s chief executive officer Miguel Largacha. AFP Porvenir manages the highest volumes of assets of Colombia’s six AFPs. “But the market has been conditioned by high levels of labour informality and unemployment.”
The configuration of the Colombian system doesn’t help much either. Colombian workers have to contribute to mandatory schemes, some of which are managed by AFPs. The AFPs have also pushed forward the option for workers to complement their meagre mandatory pensions via voluntary schemes.
According to Superfinanciera, the financial sector supervisor, by the end of June mandatory funds managed by AFPs amounted to COP86.3trn ($47.2bn), after increasing by over 25% in one year. A further COP9trn, were kept in voluntary schemes, reflecting an 18% rate of growth since June 2009. AFPs also manage severance pay funds, to which workers contribute in order to guarantee some income in case they lose their jobs. They amounted to a little more than COP6trn at the end of June.
For most Colombians, a public pension would barely cover their basic needs after retirement. But a considerable share of participants benefit from special pension regimes managed by ISS, a public body, and funded by taxpayer money. They guarantee a minimum level of income in retirement for certain workers such as university teachers, the police and other civil servants. These arrangements pay out a higher level of income than other workers as they are effectively subsidised by the taxpayer.
The whole system means that public pensions make a huge dent on the government’s budget, and at the same time benefit some of the better-off people in the country. It also contributes hugely to make the whole system very exclusive: only one in every four Colombians of retirement age enjoy some kind of pension payments. Fedesarrollo, a business association, has frequently urged the government to change the emphasis of the system, promoting the affiliation to privately managed individual pension schemes where a pension is defined by contributions and returns achieved by a workers’ savings. That would provide a big boost to AFPs.
Notwithstanding the existing hurdles, the number of participants in voluntary schemes have increased steadily since the current system was established back in 1993. By the end of 2008, almost nine million workers were participating, against less than two million in the end of 1995, according to Fedesarrollo. However, fidelity levels could be much better. Of all the participants in both mandatory and voluntary schemes, less than half make regular contributions to their pension pot. It is also estimated that almost 40% of all workers are self-employed, many in the black economy, and more than 80% of this group don’t make any contributions.
Finding ways of bringing more people into the formal economy and reducing unemployment are two major tasks for the new Colombian president, Juan Manuel Santos, who took over in August. Santos is expected to follow the reformist zeal of his predecessor and ally, Alvaro Uribe, who implemented the security and economic policies that, in the past ten years, have turned Colombia from a failed virtual narco-state to one of the most promising economies in Latin America. But even the usually fearless Uribe has proved himself unable, or unwilling, to face unions’ opposition to shaking off Colombia’s expensive labour market or distorted pension system to a considerable extent. Largacha said that the government ushered in important changes for pension funds in recent years, especially in operative aspects of the contribution process, but much still needs to be done. “It remains necessary to tackle the structural elements that prevent not only the penetration of individual savings regimens, but also the pension system in general,” he said. First of all, Colombia needs labour reform, Largacha argues. Taxes on wages are among the highest in Latin America, which make it hard for companies to hire. The minimum wage is also high for regional standards, Largacha notes.
“It is also very important that the government evaluates the means-tested pension system, as it has been thoroughly demonstrated that in the way it was shaped and the current demographic circumstances, it is not viable by itself and generates very high costs,” he said. “You only have to take a look at Europe, which is precisely facing the consequences of having this kind of system and is being forced to adopt reforms like the increase of retirement ages.”
Santos once declared himself an admirer of José Piñera, the architect of Chile’s privately-based pension system, so there are hopes that he won’t be shy to tackle this sensitive subject. In Chile, contributions to private pension schemes are mandatory to all workers, no matter if they are employed by the public or private sectors. The contributions are managed by private AFPs. The system is similar to that in Colombia except that contributions in Colombia are voluntary and the level of participation is yet to match that in Chile.
In the meantime, the government has promoted some reforms that could help existing participants in pension schemes make the most of their savings. The most important was the introduction of a multi-fund regime by a financial reform law that was approved in July 2009. Participants of individual savings schemes, including mandatory ones, now can chose whether their portfolios will take a conservative, moderate or risky approach. Severance pay funds have also been changed and can now have a short or long term horizon, according to the choice of participants.
The new rules create opportunities for AFPs to offer a more daring set of investment products for their clients. They have been busy trying to get the message through. AFP Porvenir, for instance, has invested $11m to adapt its information technology capabilities in order to allow participants to make their own investment choices. The effort also includes the setting up of a dedicated website, www.aprendiendojuntosconporvenir.com, where the new system is explained in accessible terms, as well as a media campaign and education work within companies.
“The introduction of the multi-fund system represents an important step forward for pension savings in Colombia, as it allows a better management of clients’ portfolios according to their risk profile,” Largacha said. The government is still working on the definition of investment limits for each of the three new risk profiles, but the CEO of AFP Porvenir expects that the riskier option will make it possible for a larger ratio of the portfolio of mandatory funds to be invested in equities. As of today, the limit is no more than 40%.
At the moment, AFP Porvenir has 38% of its assets invested in equities, and 58% in fixed income vehicles. It has achieved rates of return of 14.7% on average for the past three years, Largacha said. That is more than 10 points above the domestic inflation rate in the same period. According to Superfinanceira, AFP Porvenir manages COP25.3trn in their various pension funds, topping the second largest firm, AFP Protección, by some COP800bn. The industry as a whole has performed well, according to Asofondos, the pension funds association. Historical return rates for their investment portfolio stand at 15.8% a year in average.
Against the tide
The good performance of AFPs in times of global financial and economic crisis is a reflection of how much the economy has developed as a result of the liberalisation policies adopted by Uribe during his two mandates as president. The country has progressed in rankings of business competitiveness by reducing red tape for companies and creating incentives for the development of businesses. More importantly, security has improved to the extent that businesses don’t feel as afraid of investing in the country as before. Between 2004 and 2008, GDP growth reached an average of 5.2% a year, and even in dire 2009 Colombia managed to post a small, but positive 0.8% growth rate.
Now Colombia is beginning to roll again. Booming oil production has pushed the economy forward, consumption is on the rise, and the GDP grew by a 4.4% in the first quarter of 2010, compared to the same period of the previous year. The Economist Intelligence Unit’s latest GDP growth forecast is of 4.6% for 2010, which signals a stronger economic recovery than at first expected. The most conspicuous black mark in Colombia’s economy is the unemployment rate, which has shot up 0.4 percentage points in the twelve months to May, reaching 12.1% of the active population, or more than 2.5 million Colombians, despite the recent burst of economic growth. Santos has promised urgent measures to create jobs, but economists claim that thorough labour reform looks more necessary by the day. It would help most Colombians to take advantage of economic growth, and would also certainly constitute very good news for AFPs.
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