1. PENSION REFORMS: EXPERIENCES IN LATIN AMERICA Seminar “The Future and the Reform on Pension Funds” Madrid, Spain October 2003 Guillermo Arthur E., President of FIAP Author: Asociación de AFP de Chile

2. I.Countries with Reform II.Bases of the New Pension Systems III.Results of the Reforms IV.Political Economics of the Capitalization Systems V.Final Remarks CONTENTS CONTENTS

3. I. Reforms in Latin America Chile (1981)Peru (1993) Argentina (1994)Colombia (1994) Uruguay (1995)Bolivia (1997) Mexico (1997)El Salvador (1998) Costa Rica (2000)Dominican Rep. (2003) Ecuador (*)Nicaragua (*) (*) Not yet implemented

4. I. Reforms in Central Europe, Eastern Europe and Asia Hungary (1998)Kazakhstan (1998) Poland (1999)Latvia (2001) Estonia (2002)Bulgaria (2002) Croatia (2002)Macedonia (2003) Lithuania (*)Rep. of Slovakia (*) Ukraine (*) (*) In process of reform

5. OLD SYSTEM NEW SYSTEM - Pay-as-you-go- Individual capitalization - State administration- Private, competitive administration - Inflexibility- Individual freedom:  To choose and change AFP  How much to contribute (over the minimum)  When and how to become a pensioner  Which fund to choose (Multifunds) - Discretionary- Standard - Without fund accumulation- Net worth separation: AFP and Pension Funds - Role of the State: Administrator- Role of the State:  Supervisory  Subsidiary - Benefits: Old age, disability and- Benefits: Old age, disability and survivorship pensions survivorship pensions Disability and survivorship insurance: collective and mutually supportive II. Bases of the Pension System

6. Characteristics of the New Pension Systems: Latin America COUNTRIES SingleIntegrated MixedMixed in Competition LATIN AMERICA(Individual Cap.)(PAYG and Indiv. Cap.) Argentina  Bolivia  Colombia  Costa Rica  Chile  Ecuador  El Salvador  Mexico  Nicaragua  Peru  Dominican Rep.  Uruguay  INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM

7. Characteristics of the New Pension Systems: Europe and Asia COUNTRIES SingleIntegrated MixedMixed in Competition EUROPE AND ASIA (Individual Cap.)(PAYG and Indiv. Cap.) Bulgaria  Croatia  Estonia  Hungary  Kazakhstan  Latvia  Macedonia  Poland  INDIVIDUAL SAVING AND CAPITALIZATION SYSTEM

8. 0255075100 Mexico Chile El Salvador Colombia Dominican R Argentina Uruguay Costa Rica Proportion of the pension financed by the PAYG system New Pension Systems Source: Palacios (2003)

9. 1.- Return of the Funds The rates of return of the funds exceed the growth of real wages and per capita income 1.- Return of the Funds The rates of return of the funds exceed the growth of real wages and per capita income. Source: Palacios (2003) Country Return of Funds Growth of Real Wages Difference Return Funds- Growth Wages Ratio Maximum Returns to Minimum Returns Growth Real income per capita Difference Return Funds- Growth Income per capita Argentina 11.70%-0,80%12,50%1,17-0,40%12,10% Bolivia 16,20%8,80%7,60%n.d.0,40%15,80% Colombia 11,80%1,40%10,40%1,13-0,30%12,10% Chile 10,50%1,80%8,70%1,054,50%6,00% El Salvador 11,30%-0,20%11,50%1,30,50%10,80% Mexico 10,60%0,00%10,60%n.d.2,80%7,80% Peru 5,70%1,80%3,90%1,062,40%3,30% Uruguay 9,50%3,60%5,90%1,06-0,30%9,80% III. Results of the Reforms

10. PENSION FUNDS IN LATIN AMERICA Chile Argentina Mexico Uruguay Bolivia C. Rica Colombia Peru El Salvador Total (30.06.2003): MM US$ 106.018 MM US$ Jun’ 03 2.- Rapid growth of the funds

11. Pension Funds and GDP (June 2003) Source: FIAP CountryFundGDPFund/GDP (MM US$) Latin America Argentina (2)15,328236,6314.82% Bolivia1,2588,16015.42% Colombia6,40371,2978.98% Costa Rica (1)21815,7811.38% Chile (1)39,67267,23659.00% El Salvador (1)1,28914,0009.20% Mexico (2)35,405584,1476.06% Peru5,29630,59217.31% Uruguay1,14912,3219.33% Europe and Asia Bulgaria11315,5630.73% Kazakhstan1,4326,98720.49% Poland9,486343,9342.76% (1) GDP as of 31.12.2001 (2) GDP as of 30.09.2002

12. MEMBERSHIP IN LATIN AMERICA Chile Mexico Argentina Colombia Peru Bolivia C. Rica El Salvador Total (30.06.2003) : 58.747.165 Jun’ 03 3.- Rapid growth of membership

13. 4.- Economic Effects of the Reforms QUALITATIVE EFFECTS: It offers investors the possibility of combining risk (better combination of risk return and diversification). It reduces intermediation costs. It encourages the creation of innovative long-term financial instruments. It improves transparency and corporate governance. It boosts the industry in custodial services, risk assessment, etc.

14. SOME EXAMPLES - Corporate Bonds SOME EXAMPLES - Corporate Bonds CHILEPERUMEXICO Note for Chile: Average life of bonds in the first five years of the 1990s: between 10 and 15 years. Currently between 15 and 20 years. They have been issued at 30 years.

15. - Equities - Equities PERUCHILE

16. - Mortgage-Backed Securities and Bank Bonds - Mortgage-Backed Securities and Bank Bonds CHILE Stock of Housing Financed with MBS

17. - Investment Fund Shares - Investment Fund Shares CHILE

18. 5.- Projection of the Fiscal Deficit of the Reform: Chilean Case % GDP

19. 6.- Coverage When the costs of the formal sector decrease Employment in this sector increases. A strong link is formed between contributions paid and benefits received. Incentives are created for both workers and employers to pay contributions into the pension system: lowering of contribution rates, increasing credibility in the system. GREATER COVERAGE HOWEVER, THERE IS STILL MUCH TO BE DONE TO ENLARGE THE FORMAL SECTOR IN THE ECONOMY

20. IV. Political Economics of the Individual Capitalization Systems IV. Political Economics of the Individual Capitalization Systems Relative political risk: - Capitalization - Pay-as-you-go Government pressures: - Fiscal - Redistributive Resistance of the Individual Capitalization system: - Individual “defined contribution” accounts - Visibility of redistributions - Redistribution of stocks and not flows - Redistribution produces greater impact - Ownership Rights - Private management Two examples: Chile and Argentina Political economics of adjustment: - Market versus political system - Visibility

21. V. Final Remarks In addition to making a significant contribution towards solving the problem of pensions, this reform has positive economic effects. The macroeconomic, labour market and capital market reforms contribute to increasing the positive effects of the pension reform on the economy. Although the capitalization system has suffered considerable political threats, it is still stronger than the pay-as-you-go system when it comes to facing up to “political risk”.

22. Latin America: Investment Diversification (2002) Source: Palacios (2003) Country State instruments Local Investment Foreign Investment Cash and Time Deposits Fixed IncomeEquities Argentina78%11%9%2%90%10% Bolivia69%14%1%16%100%0% Chile30%32%17%21%75%25% Colombia49%34%5%12%93%7% Costa Rica67%19%0%14%100%0% El Salvador85%1%0%14%99%1% Mexico83%15%0%2%100%0% Peru15%53%7%25%71%29% Uruguay64%6%0%30%100%0% The effects on the pension funds of the economic crisis of the past few years would have been less if their investment portfolios had been better diversified. V. Final Remarks

23. The inadequate diversification is explained by the combined effect of limited development in some local capital markets and regulations. V. Final Remarks State and Bank Deposits 0%50%100%150%200%250% Costa Rica Colombia Uruguay Nicaragua Dominican Rep. Peru El Salvador Bolivia Argentina Chile Private Investments and Mutual Funds Source: Palacios (2003) Latin America: Differences in Investment Limits

24. Fortunately there is evidence that regulation may move in this direction in the near future, and in some cases that is has already done so: CHILE: - Multifunds - Increase in limit for investment abroad MEXICO: - Multifunds (Reform to SAR Law) - Investment allowed in foreign securities ARGENTINA: - Possibility for the AFJPs to buy dollars without limits (Project) PERU: - Multifund - Increase in limit for investment abroad V. Final Remarks

25. Chile : Results of the Multifunds (October 2003) FUNDS (Millions US$) % YIELD (Jan. – Oct. 03) Fund A 1.912,88 4,09 24,7% Fund B 6.590,38 14,09 14,9% Fund C31.426,23 67,20 10,0% Fund D 4.779,30 10,22 8,3% Fund E 2.057,03 4,40 3,1% TOTAL46.765,82 100,00 The Funds are differentiated by their minimum and maximum proportion of equities.