Comments on OldAge Income Support in the 21st Century: An International Perspective on Pension Syste

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Comments on Old-Age Income Support in the 21st
Century An International Perspective on Pension
Systems and Reformsby R. Holzmann and R.
Hinzplus several colleagues

• Guillermo Larrain Rios
• Superintendent of Pension Funds Administrators,
  Chile
• President of AIOS
• Cartagena de Indias, May 20th, 2005

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General View

• Multipillar pension systems are new. Excluding
  Chile, none has more than 12 year old (Peru).
• It is one of the few socio-economic institutions
  created in developing countries and being adopted
  by developed ones Sweden, US?
• Implication no OECD country is an example in
  this, there are no international standards (ie,
  no public good of good governance Basle Accords,
  IOSCO, etc)
• We, developing countries, must take this
  challenge in our hands and proceed to reflect, to
  model and to make funded pension systems coherent
  with the principles of social security. We are
  not making the appropriate effort
• We rely on the kind help from the World Bank

Therefore, the clarification of official World
Bank policies concerning pension reform is
welcomed
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This Policy Report

• Not a research paper. The report describes well
  the criteria used by the WB in pension reform
  issues.
• It is not as easy to read as a paper, there are
  few data, but it is relevant to understand how
  the Bank articulates its reflection and policy
  suggestions in this topic.
• The WB approach is much more complex and nuanced
  than what is often perceived from outside.
• There is no unilateral argument in favour of
  capitalization systems, that is
• the P2 may constitute per se the main component
  of the pension system,
• that P0 and/or P1 are residuals
• There is a sense that countries are different and
  deserve a unique combination within the
  multipillar approach. This is a serious approach.

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This Policy Report

• It starts increasing the number of pillars
  originally included in Averting the Old Age
  Crisis, giving therefore reason to those who
  think that coverage issues are relevant and
  require a treatment outside Pillar 2.
• But then, it reflects on how to improve Pillar 2
  from various perspectives, giving reason to those
  who think that the system can be improved
  significantly from its current situation.
• One particular aspect of this is that there is no
  policy criteria suggesting that P1 should be
  strengthen at the expense of P2.

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Six disordered and contradictory questions for
the WB and for you

• WB has a general emphasis on poverty prevention.
  For the sake of pension systems, isnt it too
  much?
• Maybe the WB has devoted less resources to
  promote a better P1, but have we made all
  relevant progresses in improving P2?
• As enjoying a pension is a question of spending
  the money, have we devoted enough resources to
  improve the disbursement phase? Where are the
  LICs?

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Six disordered and contradictory questions for
the WB and for you

• In moving towards a funded system people
  supposedly should be responsible for their
  future. Are they capable of managing those risks?
  And the other actors, State AFPs?
• Have we dealt appropriately with transitional
  problems? Is the political economy worse due to
  unresolved transitional problems?
• The claim for more competition is also derived
  from the fact that pension savings are mandatory.
  Have we looked for a relevant and sustainable
  solution to competition? One implication can we
  ask Parliaments for subsidies to strengthen P3,
  if we agree that there are IO problems in P2?

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• The discussion of pillar weight
• Too much emphasis in poverty prevention?
• Poverty incidence at old-age
• Myopia
• Inertia

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Relationship between different pillars.
There is a meaningful opportunity cost of
alleviating poverty at old age poverty when young

• Incidence of Poverty is lower at old age.
• Proposal for a universal pension looses ground in
  a context where fiscal budget is limited

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Objectives of a Pension System Old-Age Poverty
Alleviation and Consumption Smoothing
Question At what age do you think you will die?

• Strong evidence in favor of myopia.
• Too much focus on poverty alleviation may leave
  out policies directed to smooth consumption.
• People under-estimate their Life Expectancy and
  correct these estimation too late.

Expectativa de vida según tablas de 1985
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Coverage increases with Planning horizon
Question How far do you organise your
expenditures?

• People who plan further in advance are more
  likely to contribute in the pension system.
• Source EPS(2002)

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• 2) Have we cared enough about complementary
  reforms?
• Financial markets
• Labour Markets
• Women
• Informality

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In Financial Markets why diversification is so
poor?
Are you incompetent?
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In Chile, the achievement of diversification has
been progressive
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Some institutional prerequisites for asset
diversification

• Macro stability (inflation, shocks,)
• Growth investment opportunities
• Contract stability
• Quality of regulation
• Elimination of tax distortions
• Risk classification
• Custodians etc

• Fixed Income
• Mortage
• Credit
• Corporate
• Bonds
• Variable Income
• Corporate culture, accountability, transparency
• Corporate governance
• Minority shareholders rights

The reform agenda besides pension reform is large.
It needs effort, persistence and patience
Because several interest groups (within the
financial sector as well) will certainly try to
block it
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Labor Markets. Female Labor Force Participation
is still low in Latin America

• What explains low female participation rates?
• Some Chilean thoughts
• Lack of appropriate labor contracts for women
• Child care
• machismo

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Labor Markets. Informality is high in Latin
America. Do we know what to do? Do we know where
to start doing something?
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Informality is important because it is stronger
among poorer people
Source CASEN Survey 2003
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and youngsters.
Fuente Encuesta CASEN 2000
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• 3) Pension reform is not only about savings
  accumulation, but also about spending the bucks!
• Disbursement phase

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Big Focus on Accumulation Phase, but what happens
in Disbursement Phase?

• Effect of SCOMP on Annuities Fees
• New Mortality Tables, updated to take into
  account higher Life Expectancy levels

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Another challenge Early retirement
Average early retirement age 56 (men) and 54
(women)
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• 4) Who bears which risks?
• Individuals
• Firms (AFP)
• State

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Risk in the Individual Accumulation Pension System

• Which is the relevant concept of risk?
• How to measure this risk?
• How is it assigned among the system participants?
• The most relevant risk is the risk of Poverty at
  Old-Age.
• Neither the own affiliates, nor the Government or
  the Managers seem to be covering this risk
  appropriately.

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Individuals have limited knowledge how can we
expect them to know about and manage risk ?

• What serious effort the government has made to
  improve information, to teach people how the
  system works?
• Why could you expect this to happen with IO
  problems?

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Base scenario
State coverage of Minimum Pensions seem fairly
low, should we strengthen P0 and P1?
Only 10 of retirees will receive minimum
pension benefit while almost 50 of them will
obtain self-financed pensions below the minimum
pension level
Source Berstein, Larrain and Pino (2005)
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Reachable scenario
The definition of P1 is poor
Source Berstein, Larrain and Pino (2005)
Minimum Pension growth
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AFP Managers are more worried about risk of
falling below Minimum Return

• Returns tend to be very similar across different
  Managers. Evidence of Herd Behavior. Is it due to
  minimum return guarantee?
• More investment flexibility cannot imply that
  affiliates absorb the marginal risk. Who and how
  deals with it?

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• 6) Transitional issues
• Recognition bonds
• Past macroeconomic events
• Fiscal adjustment

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There are also Transition Issues

• Recognition Bonds calculated over an
  inconvenient base because unemployment was too
  high between 1975 and 1979
• Previsional Damage
• High Unemployment in 80s y 00s

These unresolved issues bias political economy
against the reform
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Sistema de Pensiones y Finanzas Públicas
Fuente Dirección de Presupuestos
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• 7) Industrial Organization issues

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Industrial Organization Issues

• Demand
• Mandatory Consumption
• Limited Knowledge
• Low Sensibility towards Management Fees

• Supply
• Important Economies of Scale
• Quasi- Natural Monopoly
• Few providers and High Concentration
• Competition based on Sales Forces and Spurious
  Incentives (gifts)

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Comments on Old-Age Income Support in the 21st
Century An International Perspective on Pension
Systems and Reformsby R. Holzmann and R.
Hinzplus several colleagues

• Guillermo Larrain Rios
• Superintendent of Pension Funds Administrators,
  Chile
• President of AIOS
• Cartagena de Indias, May 20th, 2005