Impact of the Financial Crisis on Pension Systems in LAC Waldo Tapia Labor Market Unit Inter-American Development Bank (IDB) OECD/IOPS GLOBAL FORUM ON PRIVATE PENSIONS: PENSION REFORM AND DEVELOPMENTS IN LATIN AMERICA Rio Janeiro, Brazil October, 2009

Agenda Introduction Private pensions in LAC and the financial crisis Evaluating the impact (assets, returns) Asset allocation Coverage Putting the crisis into a pension context Conclusions

Introduction The financial crisis has affected many aspect of the economy, including private pension arrangements. In Latin America private pensions play an important role in mandatory pension provision. In Latin America 11 have implemented mandatory individual account pension systems. Private pensions leaves workers’ retirement income vulnerable to investment risk. In DC pensions, benefits depend directly on accumulated contributions and investment returns.

Market value of pension assets By December 2008, the total assets of pension funds in LAC had decline by about US$ 52 billion, or nearly 14% relative to December 2007

Which countries were affected? Some of the countries most affected were Chile, Argentina, Peru. This lower value of the investment should not be interpreted as a loss, particularly where long-term savings are concerned

Assets as % of GDP As a % of the economy mandatory private pension funds in LAC fell from 16% in 2007 to 14% 2008 In OECD countries the ratio for pension funds decreased from 76% of GDP in 2007 to 63% of GDP in 2008

The impact on investment returns Almost all countries experienced a negative return in real terms over January to December 2008 Some of the countries most affected are those where equities represent a higher proportion of total assets invested

The experience in OECD countries 2008 pension fund nominal and real returns in selected countries (%) Pension funds in OECD countries experienced during 2008 a negative real return of: 17.4% (unweighted average) 23.0% (weighted average)

Shifts in asset allocation Gov. bonds Domestic equities Foreign instruments Investments by group of instruments (as % of total asset)

Impact on coverage The decline in the value of pension funds is not the only problem. It is also necessary to address the drop in coverage that will result from the economic slowdown. The unemployment persons will increase between 2.8 – 3.9 millions

Putting the crisis into pension context Pensions are, by their nature, long-term and so their performance must be evaluated over a lengthy horizon. A temporarily lower value is note the same as a real loss Pension systems in LAC are relatively young Younger workers can hope for some good years to make up the recent falls in asset value. Some countries in the region have implemented investment choice or multiples portfolios Multiples portfolios include conservative options for workers close to retirement.

The markets are recovering…. Chile Peru Mexico ….and, with them, the value of the investments.

Long-term investment Performance should be evaluated in a long time horizon Evaluating the results of a short period may distort the perception of their performance

Pension systems in LAC are relatively young A major drop in asset values may not matter much to younger workers who can expect the markets to recover overall in the long term The proportion of the elderly experiencing major declines in pension income is relatively small in most LAC

Investment choice Multiples portfolios shield workers close to retirement from most of the losses in asset values

Investment choice A multifund model linked to the affiliates’ life cycle has been an important element in strengthening the pension fund system Provide a default options that involves a switch to less risky investment as people get closer to retirement Restrict investment choices for older workers to lower risk options

Conclusions The impact on pension funds is clearly negative over the last 12 months The consequences of the crisis on the pension systems are important in LAC (mandatory and DC systems) Pension funds work with a long time horizon Negative investment return cannot be interpreted directly as a loss Pension fund performance has been positive over the last years Pension systems in LAC are relatively new For younger workers, pensions are long term savings

Conclusions Some countries have implemented individual choice Financial education is necessary to ensure that members understand the risk they are exposed to It is also to address the drop in coverage that will result from the economic slowdown Diversify retirement schemes The balance between public and private schemes should not be framed solely around the crisis Government should resist to reactions that threaten the long term stability of retirement income provision