1. INTERNATIONAL PERSPECTIVES: DEVELOPMENT AND PROSPECTS OF MANDATORY FUNDED PENSION SYSTEMS IN LATIN AMERICA AND EASTERN EUROPE * Guillermo Arthur E. FIAP April, 2003 * Presented at the Annual Conference of the World Pension Association - “The Impact on Pension Fund of Major Global Exchange”. Dublin, Ireland, April, 2003.

2. INTERNATIONAL PERSPECTIVES: DEVELOPMENT AND PROSPECTS OF MANDATORY FUNDED PENSION SYSTEMS IN LATIN AMERICA AND EASTERN EUROPE IV Conferencia Internacional de Fondos de Pensiones Dublín, Irlanda Abril 2003 Guillermo Arthur E., Presidente FIAP Autor: Asociación de AFP de Chile

3. I. The “reformist” countries (*) Not yet implemented Source: FIAP

4. PENSION REFORM IN LATIN AMERICA AND EASTERN EUROPE (as of December 2002) Source: FIAP

5. PENSION FUND IN LATIN AMERICA Source: FIAP MM US$ Accumulated FIAP: MMU$ 101.409

6. II. The impacts of pension reform Although it may be too soon to make a complete assessment of pension reform, some remarkable results can already be observed: Although it may be too soon to make a complete assessment of pension reform, some remarkable results can already be observed: 1.High rates of return of pension funds investment. 2.Positive impact on capital markets development. 3.Positive impact on savings and economic growth. 4.In some countries social security debt did stop growing after pension reform. In others, social security debt growth rates did decrease.

7. 1.High rates of return of pension fund investments (Continue) Source: FIAP

8. 1.High rates of return of pension fund investments Actual pension fund investment returns have been higher than the levels estimated at the inception of pension reform. Actual pension fund investment returns have been higher than the levels estimated at the inception of pension reform. If the rates of return of pension funds are 5%, old age pension will be 64% of final wage (*). If the rates of return of pension funds are 5%, old age pension will be 64% of final wage (*). So, looking at the level of future pensions, pension reform should help to increase pensions and decrease their costs. So, looking at the level of future pensions, pension reform should help to increase pensions and decrease their costs. (*) Male; joint pension with wife; 35 years of contributions; real wage growing 2% a year for the first 20 years; 10% of wages is contributed to the pension fund.

9. 2.Positive impact on capital markets development There is growing evidence that the creation of a funded pension system: There is growing evidence that the creation of a funded pension system: Facilitates the accumulation of “institutional capital” (i.e.: risk rating systems; better corporate governance practices; better regulation regarding conflicts of interest; etc.). Facilitates the accumulation of “institutional capital” (i.e.: risk rating systems; better corporate governance practices; better regulation regarding conflicts of interest; etc.). Decreases the cost of capital for firms. Decreases the cost of capital for firms. Incentivates the creation of new financial instruments (economies of scale incentivate financial innovation). Incentivates the creation of new financial instruments (economies of scale incentivate financial innovation). Improves the allocation of resources in the financial market (transaction costs decrease; incentives for international integration of financial markets; increased specialization in the investment decision-making process). Improves the allocation of resources in the financial market (transaction costs decrease; incentives for international integration of financial markets; increased specialization in the investment decision-making process). (See Iglesias (1996 and 1998); Holzmann (1996); Walker and Lefort (2000); Catalán, Impávido, Musalem (2000)) (Continue)

10. 2.Positive impact on capital markets development The magnitude of these effects depends on the starting point of capital markets (in well developed capital markets the impact of the creation of mandatory pension funds will be less important), and on the existence of some concurrent conditions in the economy (market - oriented economy; macroeconomic stability; adequate tax regimes; progressive capital control liberalization; adequate regulation of financial markets; etc.). However, in all cases pension funds can become an important force behind capital market development. The magnitude of these effects depends on the starting point of capital markets (in well developed capital markets the impact of the creation of mandatory pension funds will be less important), and on the existence of some concurrent conditions in the economy (market - oriented economy; macroeconomic stability; adequate tax regimes; progressive capital control liberalization; adequate regulation of financial markets; etc.). However, in all cases pension funds can become an important force behind capital market development.

11. 3.Positive impact on savings and economic growth Evidence from Chile shows that: Evidence from Chile shows that: 31% of the increase in the national savings rate in the 90’s (with respect to the national savings rate in the 60’s and first half of the 70’s) is explained by pension reform (Schmidt-Hebbel, 2000). 31% of the increase in the national savings rate in the 90’s (with respect to the national savings rate in the 60’s and first half of the 70’s) is explained by pension reform (Schmidt-Hebbel, 2000). Pension reform increases the national savings rate in more than 2% of GDP (Coronado, 1997). Pension reform increases the national savings rate in more than 2% of GDP (Coronado, 1997). 26% of the increase in the GDP growth rate in the 90’s (with respect to the GDP growth rate in the 60’s and first half of the 70’s) is explained by pension reform (Schmidt-Hebbel, 2000). 26% of the increase in the GDP growth rate in the 90’s (with respect to the GDP growth rate in the 60’s and first half of the 70’s) is explained by pension reform (Schmidt-Hebbel, 2000). In the long term, pension reform should increase the GDP growth rate in 3.1% (and between 2.4% - 3.9% in Colombia). (Schmidt-Hebbel, 2000). In the long term, pension reform should increase the GDP growth rate in 3.1% (and between 2.4% - 3.9% in Colombia). (Schmidt-Hebbel, 2000).

12. 4.Lower social security debt When a new funded pension system substitutes an existing pay-as-you-go system, the growth rate of the implicit social security debt will first decrease and afterwards it will stop. When a new funded pension system substitutes an existing pay-as-you-go system, the growth rate of the implicit social security debt will first decrease and afterwards it will stop. When a funded pension system partially substitutes a pay-as-you-go system, the growth rate of the implicit social security debt will decrease When a funded pension system partially substitutes a pay-as-you-go system, the growth rate of the implicit social security debt will decrease (There are transitory negative effects on fiscal deficit flows because: Revenue of the old pensions system will decrease (as contributors move to the new system). Revenue of the old pensions system will decrease (as contributors move to the new system). Obligations of the old system with workers who switch to the new system are usually recognized and paid.) Obligations of the old system with workers who switch to the new system are usually recognized and paid.)

13. Implicit Social Security (Pension) Debt (ISSD) and Public Debt (%GDP) Source: Holzmann; Palacios; Zviniene (2002) * 4% discount rate

14. III. Prospects of mandatory pension funds 1. Challenges In some reformist countries, the new pension systems are under some criticism because of political reasons; because the impact of pension reform on the cash flow fiscal deficit; and because some groups of workers which did receive privileged pension conditions in the old system, lost their privileges with pension reform. In some reformist countries, the new pension systems are under some criticism because of political reasons; because the impact of pension reform on the cash flow fiscal deficit; and because some groups of workers which did receive privileged pension conditions in the old system, lost their privileges with pension reform. The weakness of the world economy has a negative impact on pension fund returns. This situation could strengthen opposition to pension reform. The weakness of the world economy has a negative impact on pension fund returns. This situation could strengthen opposition to pension reform. (Continue)

15. ANNUAL AVERAGE PENSION FUND INVESTMENT RETURNS (IN REAL TERMS) Source: FIAP

16. III. Prospects of mandatory pension funds In some countries pension fund investment rules do not allow fund managers to diversify the portfolio in the most efficient way.In some countries pension fund investment rules do not allow fund managers to diversify the portfolio in the most efficient way. In many countries it’s difficult to extend the coverage of the new funded pension systems because the relatively large size of the informal sector.In many countries it’s difficult to extend the coverage of the new funded pension systems because the relatively large size of the informal sector.

17. Maximum Investment Limits (% of Pension Fund - May, 2002)

18. Investment Portfolio (% of Pension Fund - May, 2002)

19. SOCIAL SECURITY COVERAGE (*) PrimAmérica Estimat. Source: Palacios, Pallarés-Millares (2000).

20. III. Prospects of mandatory pension funds 1. Opportunities In most reformist countries the results of the new mandatory pension funds are encouraging. This should help to give momentum to the reform impulse in other countries (Slovakia, Czech Republic, Dominican Republic, Nicaragua, etc.). In most reformist countries the results of the new mandatory pension funds are encouraging. This should help to give momentum to the reform impulse in other countries (Slovakia, Czech Republic, Dominican Republic, Nicaragua, etc.). The practical experience of reformist countries should help other countries which are considering pension reform, to improve the design of their own new systems. The practical experience of reformist countries should help other countries which are considering pension reform, to improve the design of their own new systems.

21. III. Prospects of mandatory pension funds 1. Conclusion Pension funds are playing a growing role within social security system. This trend opens great opportunities for the industry. Pension funds are playing a growing role within social security system. This trend opens great opportunities for the industry. However the new mandatory funded pension systems are facing a tough world economic scenario and pension reform is been challenged by their opponents. However the new mandatory funded pension systems are facing a tough world economic scenario and pension reform is been challenged by their opponents. To overcome this situation the industry must show discipline, creativity and a strong compromise with the principles of the new pension system. To overcome this situation the industry must show discipline, creativity and a strong compromise with the principles of the new pension system.