Monitoring pensions coverage and matching contributions in Latin American countries

1. Monitoring pensions coverage and matching contributions in Latin American countries 2011 OECD/IOPS Global Forum on Private Pensions Cape Town, South Africa, 25-26 October 2011 Santiago Fernandez de Lis │Chief Economist, Financial Systems and Regulation- BBVA Research –

2. Index Section 1 Introduction Section 2 The Coverage Problem in Latam Section 3 The Model Section 4 Some Projections for Chile Section 5 Conclusions

3. Section 1Pension systems in Latin America* Relevant numbers of pensions systems in Latam Source: BBVA, FIAP, WDI Pension schemes in Latin America Source: BBVA, FIAP, WDI • There has been different adoptions of DC schemes in Latam according to idiosyncratic aspects. This situation along with structural factors in each country has generated different results. * In this presentation we refer to the cases of Chile, Colombia, Mexico and Peru

4. Section 1Desired outcomes of pension reform in Latin America • Pensions reforms in Latin America have contributed for the fiscal consolidation in the region • There is evidence that mandatory funded schemes have a positive effect on national savings rates and economic growth • It confirms that the reforms have contributed to the development of capital markets • However, there are still major problems to solve, especially low coverage in some countries Private Savings Financing Infrastructure Projects Fiscal Deficits Pension Funds GDP Coverage Pension reforms in the 90s bring about interesting results thorough different channels. However after almost two decades of implementing structural changes, countries continue struggling to expand social protection

5. Index Section 1 Introduction Section 2 The Coverage Problem in Latam Section 3 The Model Section 4 Some Projections for Chile Section 5 Conclusions

6. Section 2Informality and pension coverage Informality and affiliates by EAP* Source: ILO, FIAP (2007) • Informality poses a tremendous challenge for policymakers in order to enforce a mandatory pension scheme • The complexity of the problem also arises because of mobility between the formal and informal sectors (Jüttint and De la Iglesia, 2009; Maloney, 2010) • The challenge is: • To create a system that includes a large group of workers that do not belong to the formal labor market. • Mandatory requisites to contribute alone, will not be enough. * With available information from different geographies

7. 80 Perú 70 Colombia 60 50 Mexico 40 Chile 30 20 10 0 Latvia Bhutan Gabon Guinea Jordan Yemen Namibia Algeria Belgium Estonia Malawi Angola Ethiopia Lesotho Georgia Slovenia Romania Albania Denmark Malaysia Hungary Germany Norway Tajikistan Uruguay Indonesia Tanzania Honduras El Salvador Cote d'Ivoire Luxembourg Macao. China New Zealand Venezuela, RB Russian Federation Bosnia and Herzegovina Section 2Informality: a phenomenon to take into account • Research has found elements in LAC that affect coverageoutcomes in contrast with developed countries: • Seasonal Employment • Informality • Low income, inequality and poverty • Institutional and political constraints • The informality is a structural problem that is difficult to resolve Informality rate (% of GDP) Source: Schneider et al (2010)

8. Section 2Participation and replacement rate: two faces of the coverage gap Replacement rate: Pension/Average Salary before Retirement Source: BBVA, FIAP, WDI Coverage rate: Contributors/Workforce Source: BBVA, FIAP, WDI • A: collectives with contribution densities close to 100%. • B: collectives with contribution densities close to 70% • C: collectives with contribution densities close to 30% • When Latam is compared to more developed countries, the results of the lack of coverage is even more dramatic. • Another way to see the coverage in the region is the limitation that some groups have in obtaining higher replacement rates. This target depends on the density of contributions and income levels.

9. 100% I 90% 80% 70% II 60% 50% 40% III 30% 20% 10% 0% 2005 2006 2007 2008 2009 Not Affiliated DC-Not Contributing DC-Contributors DB-Not Contributing DB-Contributors Section 2Designing a reform that absorbs a huge share of the population continue to be the pending agenda. Peru: Employed workers according to Pension status Source: Carpio-Salazar (2010) • Some countries have not experienced any relevant improvement in expanding pension coverage. • Looking at the case of Peru, not covered individuals include people who are not making enough contributions (I+II) as well as people who are not saving at all (III). • This imposes a serious social risk

10. Section 2The puzzle of designing a pension system that Works Peru: Collective of workers participating to any pension scheme as a percentage of labor force Source: BBVA Research • There were mild advances during the last four years, but still the problem of coverage remains. • It is necessary to think about the specific characteristics of the different groups • How to manage pension savings of seasonal and low income groups lacking basic coverage on housing, health and education? • Pervasive informal economy makes it impossible to enforce any mandatory scheme, • It is important to count on a detailed pension modelthat let us understand different projected scenarios for workers with different socio economic characteristics, and implement policies to overcome actual limitations of the systems.

11. Index Section 1 Introduction Section 2 The Coverage Problem in Latam Section 3 The Model Section 4 Some Projections for Chile Section 5 Conclusions

12. Section 3A new pension model to assess the reform of 2008 • The evolution of Latin American pension systems challenges us to confront the major challenges, with particular attention to the most vulnerable collectives. • Also, there are strong demographic transitions that can significantly alter the structure of pension systems in the future, such as the transition from education, labor market (especially women), informality, etc. • This model allows to collect these features by increasing the heterogeneity of individual representatives of the model to the maximum permitted level of available information.

13. Section 3General characteristics of the pension model Data Sources 30 Types of Representative Individuals • Demographics: • Population projections from ECLAC • Use of RV2009 to calculate the old age pensions • Calculations using of the ECLAC and Mortality.org for own projections • Institutional and labour markets • Encuesta de Protección Social of Chile • Casen • Application of data mining Provida AFP dataset. • Men and women • Three levels of education: primary or less, secondary, and tertiary • Ten deciles of income for each level of education • Three densities of contribution for each salary level according to its contingency work. • Population age groups ranging from 0 to 100

14. Chile • Peru (in progress) • Colombia (in progress) • Mexico (in progress) Section 3 Main outputs of the pension model Policies and risks that can be evaluated: Outputs Which will be available for • Expand and evaluate the cost of the Solidarity Pillar • Voluntary contributions • Longevity Risk • Labor market policies • Others • Projected Pension Funds • Fiscal Cost • Replacement rates • Coverage rates • Net annual contributions • Income distribution • Macroeconomic and Labor Market effects over the system • Projections of Social Security policies

15. Section 3General characteristics of the pension model Labor market transitions in MAP2 Labor forceSource: BBVA Research Five Labor Contingencies Three possibilities of contributions each with its corresponding density • Employed • Self-employed • Unemployed • Informal • Inactive • Employed • Self-employed • Unemployed The actuarial module allows that different types of pensions be assigned based on historical selection

16. Index Section 1 Introduction Section 2 The Coverage Problem in Latam Section 3 The Model Section 4 Some Projections for Chile Section 5 Conclusions

17. Section 3Evolution of the Chilean pension system in 2008 Creation of the individual capitalization system: Law 3500 of 1980 Source: Report of the Advisory Board of Pension Reform Current System: Law 20255 of 2008 Source: Report of the Advisory Board of Pension Reform Structural Change Creation of the multifunds system: Law 19.795 of 2002 • In 1980, a pension system based on individual capitalization was created • The solidarity of the system is given by the welfare pensions (PASIS) * and the minimum pension guarantee (GEPM) ** • However, a cohort with little savings remain without pensions • * socioeconomic characterization requirement. • ** access subject to a minimum of 240 months of in order to obtain insurance • In 2008, the solidarity pillar was integrated with the contributory pillar • Those unable to save receive the Basic Solidarity Pension (PBS) and those with some ability to save receive the solidarity contribution (APS) • Disadvantaged groups receive other incentives (bonus for kids) • The reform solidifies the voluntary pillar

18. Section 3Changes in the Chilean pension system in 2008 The policies implemented in 2008 aimed to increase the coverage • Creation of a new solidarity pillar (NPS) with old-age benefits, disability and survivors benefits integrated to the contributory pillar. • Access to the benefits of the NPS to all persons who meet specific requirements of socio economic insufficiencies. • Subsidies to employers for hiring young workers belonging to the most vulnerable segment of the population. Potential employees also receives a subsidy. • Creation of the voluntary contributors regime, allows the participation in the pension system of individuals disregarding of its employment situation (informal/formal; active workers/ no active workers) • Bonus for new babies (no income level requirement). • Mandatory contribution for self employees (gradual implementation).

19. In this case study, we assess this new policy included in the 2008 pension reform Some Key points: The irregularity of income and the intermittent nature of employment, make the current monthly contributing model, unattractive to this group. The preference for maintaining liquidity and lack of pension culture discourage the participation of self-employed workers' contributions. Due to these factors, the coverage of independent workers has been low and declining in recent years. In 2005, only 3.9% of independent workers quoted in the pension funds. The evidence also shows that low levels of pension savings are not replaced by another type of savings, showing little use of financial instruments. Along with the extension of rights involving the introduction of the solidarity pillar, pension reform and duties gives incentives to independent workers, enabling them to increase the level and quality of pension coverage. Section 3 The case of mandatory contributions of the informal self-employed: case study

20. The obligation to contribute to the pension system will be implemented gradually, according to the following schedule (dates correspond to 1 January of the year) Implementation Period 2008 -2011 Pension education process 2012 -2014 Obligation to contribute at 40%, 70% and 100% of taxable income, respectively in each year 2015 onwards: Compulsory pension on total taxable income (80% of all gross income taxed by Article 42 No. 2of the Law on Income Tax) 2018 onwards: It includes the obligation to contribute to health Section 3The case of mandatory contributions of the informal self-employed: case study • This raises uncertainty about the ability of regulator to monitor compliance, although they rely on the verified tax culture of Chilean population. • In our scenario, we assume a success rate of 80%

21. Section 3Heterogeneity captured by the new model - Strong heterogeneity in education across generations can change the coverage ratios and replacement rates in the future. Qualification by age Matrix (Women) Source: BBVA Research calculations using CASEN database Qualification by age Matrix (Men) Source: BBVA Research calculations using CASEN database

22. Section 3Heterogeneity captured by the new model • - The highest rates of coverage are observed in the group with higher studies. • - If measures to promote coverage and reducing informality (especially primary education) are not implemented, coverage will remain relatively stable over time. Projections of Pension coverage rates according to education achievement Fuente: Cálculos propios BBVA Research utilizando la CASEN

23. Sección 3Heterogeneity captured by the new model Even within the same level of education, significant differences can be seen in the level of income from contributors Females Source: BBVA Research Males Source: BBVA Research This is seen, for example, in the potential income that could be obtained by cohorts of people with primary school in deciles 1, 5 and 10

24. Section 3Heterogeneity in the informal self-employed • There is a higher percentage of informal self-employed workers in the group of men than of women. • The highest percentage of informal self-employed are concentrated in the group of people with primary studies, followed by secondary and tertiary.

25. Section 3Reform: mandatory contribution in self-employed; women Total coverage women rate/total population 15-64 years Fuente: Cálculos propios BBVA Research utilizando la CASEN Total coverage women rate/workforce Fuente: Cálculos propios BBVA Research utilizando la CASEN • With regard to the workforce, there were no significant changes due to the strong increase in the labor force in the group of women. • The impact of reform could be quantified by 14 percentage points • The coverage rate for women will increase significantly from 27% to 42% by improving their educational level. • The impact of reform could achieve an increase of 7 percentage points

26. Section 3Reform: mandatory contribution in self-employed; men Total men coveraqe rate/total population 15-64 Fuente: Cálculos propios BBVA Research utilizando la CASEN Total men coveraqe rate/workforce Fuente: Cálculos propios BBVA Research utilizando la CASEN • With regard to the workforce, there were no significant changes due to the growth of this variable. • The impact of reform could be quantified by 13.4 percentage points • The coverage ratio with respect to the natural population will grow by improving the educational level from 42% today to 44.5% in 2050. • The impact of reform could be quantified in an increase of 10 percentage points

27. Section 3Reform: mandatory contribution in self-employed; educational attainment Total primary studies coverage rate/pop 15-64 Fuente: Cálculos propios BBVA Research utilizando la CASEN • The impact of the reform would increase the coverage rate by 15.5 percentage points in workers with primary school. • For workers with secondary education coverage would increase by 5 percentage points. • In the collective with tertiary education, coverage would increase by 11 percentage points.

28. Section 3 Reform: mandatory contribution in self-employed; Total impact Total coveraqe rate/pop 15-64 Fuente: Cálculos propios BBVA Research utilizando la CASEN Total coveraqe rate/workforce Fuente: Cálculos propios BBVA Research utilizando la CASEN • The coverage ratio with respect to the population will grow naturally, thanks to improved educational attainment from 35% today to 43% in 2050. • The impact of reform could be quantified in an increase of 14 percentage points • With regard to the workforce, there were no significant changes due to the growth of this variable, especially in the group of women • The impact of this reform could be quantified by 9 percentage points.

29. Section 3Reform: mandatory contribution in self-employed; the impact on informality rates Informality rate/workforce Fuente: Cálculos propios BBVA Research utilizando la CASEN • This reform would decrease informality rate by 13 percentage points

30. Index Section 1 Introduction Section 2 The Coverage Problem in Latam Section 3 The Model Section 4 Some Projections for Chile Section 5 Conclusions

31. Conclusions • The phenomenon of low coverage remains a challenge in the pension systems in Latin America. • Our new pension model can capture sufficient heterogeneity from the representative agents, in order to quantify different measures of pension policies. • In the case of Chile, we performed an initial exercise based on the reform measure that makes mandatory the participation of self-employed. • The collective breakdown shows that Chile will experience major transitions in terms of educational attainment and labor market, which will impact on the structure of the system in the future. • The measure of mandatory contributions for informal self-employed can have huge effects on the Chilean pension system, increasing the coverage rate by 14 percentage points. Page 31

32. Conclusions • This measure affects groups that have traditionally been auto excluded in the pension system. • Given that informal self-employed are overrepresented in the lowest social level of educational attainment this measure will improve their coverage. • On the other hand, coverage increase more in the group of males. However, it shows an important process of "catching up" between genres, given the significant increase coverage experience by females. Page 32

33. Monitoring pensions coverage and matching contributions in Latin American countries 2011 OECD/IOPS Global Forum on Private Pensions Cape Town, South Africa, 25-26 October 2011 Santiago Fernandez de Lis │Chief Economist, Financial Systems and Regulation- BBVA Research –