Chile established its private individually funded system in 1981 and was the example followed by Peru, Mexico and Colombia years later. The four models are now being studied in the rest of the world, so Guillermo Arthur and Luis Validivieso, the chairman and vice-chairman of the International Federation of Pension Fund Administrators (FIAP), who are also the chairmen of the Associations of Pension Fund Administrators (AFP) of Chile and Peru, respectively, visited Madrid, Spain, in representation of FIAP.
The event was organized by INVERCO (Association of Collective Investment Agencies and Pension Funds, in Spain), and was attended by the European Federation of Pension Funds (Europe Pensions). Its leading authority, Joanne Segars, explained that although the model is different in each country, the majority of systems on both sides of the Atlantic share several similarities and challenges, such as the coverage of the population and the provision of safe pensions for workers that are sustainable over time.

The chairman of FIAP, which represents the trade associations of 18 countries, 13 of which are Latin American, stressed in his speech that: “We have to save more because we are living longer,” since life expectancy has increased due to the economic development of the region.

He also emphasized the good yields in real terms accumulated in the system. In its almost 23 years of existence in Chile, the model has averaged a real annual return of 8.5% and has only had four years of losses. Nonetheless, “we must still acknowledge that we face significant challenges,” said Guillermo Arthur. “Despite the high rate of return of the pension funds, the replacement rates generated by the system are not expected to be sufficient,” he added.

“The growth of real wages is very high, 4% in Chile and above 5% in Peru, but contributions are based on a lower wage,” said both Arthur and Valdivieso. They also pointed out that Latin America had to work on reducing the informal economy.

This is one of the reasons why the comparisons between the average return rates of individually funded and PAYGO systems are not correct, since in the former the contributing worker is entitled to a pension regardless of what he has earned, whereas in the latter case, people who have contributed to the system for less than the minimum number of years of contributions required, are not entitled to a pension, and this is not taken into account in the calculations.

Contribution to growth

The FIAP speakers cited the study promoted by the SURA group “Contribution of the private pension system to the economic development of Latin America; experiences of Colombia, Mexico, Chile and Peru.” They pointed out that the academics in charge of the research estimated that the contribution of the individually funded systems to the annual average growth of the GDP is: (i) 0.37 percentage points (pp) in the Chilean case (i.e. the reform explains 8% of economic growth); (ii) 0.58 pp in Colombia (i.e. the reform explains 13% of economic growth); (iii) 0.33 pp in Peru (i.e. the reform explains 6% of economic growth); and (iv) 0.31 pp in Mexico (i.e. the reform explains 6% of economic growth).

“When the reforms were introduced in Latin American, capital markets were only just beginning to emerge and hardly existed.” Along with the pension reforms, other reforms had to be introduced for the investment of the pension funds, since they had huge resources and the market did not have the necessary financial instruments. They had to be adapted for the new institutional investors,” said Guillermo Arthur. This stimulated the development of the capital market and contributed to the development of the economy.

The investments of the AFPs are also another positive factor in countries with the individually funded model, argued Arthur in conclusion, especially in cases where it is difficult to find investors to put up resources: “There are certain instruments that are especially attractive to the pension funds, which need to invest with a long-term horizon, and there are also instruments requiring long-term financing. “For example, mortgage bonds issued by the banks in housing, or infrastructure bonds.”

Chile established its private individually funded system in 1981 and was the example followed by Peru, Mexico and Colombia years later. The four models are now being studied in the rest of the world, so Guillermo Arthur and Luis Validivieso, the chairman and vice-chairman of the International Federation of Pension Fund Administrators (FIAP), who are also the chairmen of the Associations of Pension Fund Administrators (AFP) of Chile and Peru, respectively, visited Madrid, Spain, in representation of FIAP.
The event was organized by INVERCO (Association of Collective Investment Agencies and Pension Funds, in Spain), and was attended by the European Federation of Pension Funds (Europe Pensions). Its leading authority, Joanne Segars, explained that although the model is different in each country, the majority of systems on both sides of the Atlantic share several similarities and challenges, such as the coverage of the population and the provision of safe pensions for workers that are sustainable over time.

The chairman of FIAP, which represents the trade associations of 18 countries, 13 of which are Latin American, stressed in his speech that: “We have to save more because we are living longer,” since life expectancy has increased due to the economic development of the region.

He also emphasized the good yields in real terms accumulated in the system. In its almost 23 years of existence in Chile, the model has averaged a real annual return of 8.5% and has only had four years of losses. Nonetheless, “we must still acknowledge that we face significant challenges,” said Guillermo Arthur. “Despite the high rate of return of the pension funds, the replacement rates generated by the system are not expected to be sufficient,” he added.

“The growth of real wages is very high, 4% in Chile and above 5% in Peru, but contributions are based on a lower wage,” said both Arthur and Valdivieso. They also pointed out that Latin America had to work on reducing the informal economy.

This is one of the reasons why the comparisons between the average return rates of individually funded and PAYGO systems are not correct, since in the former the contributing worker is entitled to a pension regardless of what he has earned, whereas in the latter case, people who have contributed to the system for less than the minimum number of years of contributions required, are not entitled to a pension, and this is not taken into account in the calculations.

Contribution to growth

The FIAP speakers cited the study promoted by the SURA group “Contribution of the private pension system to the economic development of Latin America; experiences of Colombia, Mexico, Chile and Peru.” They pointed out that the academics in charge of the research estimated that the contribution of the individually funded systems to the annual average growth of the GDP is: (i) 0.37 percentage points (pp) in the Chilean case (i.e. the reform explains 8% of economic growth); (ii) 0.58 pp in Colombia (i.e. the reform explains 13% of economic growth); (iii) 0.33 pp in Peru (i.e. the reform explains 6% of economic growth); and (iv) 0.31 pp in Mexico (i.e. the reform explains 6% of economic growth).

“When the reforms were introduced in Latin American, capital markets were only just beginning to emerge and hardly existed.” Along with the pension reforms, other reforms had to be introduced for the investment of the pension funds, since they had huge resources and the market did not have the necessary financial instruments. They had to be adapted for the new institutional investors,” said Guillermo Arthur. This stimulated the development of the capital market and contributed to the development of the economy.

The investments of the AFPs are also another positive factor in countries with the individually funded model, argued Arthur in conclusion, especially in cases where it is difficult to find investors to put up resources: “There are certain instruments that are especially attractive to the pension funds, which need to invest with a long-term horizon, and there are also instruments requiring long-term financing. “For example, mortgage bonds issued by the banks in housing, or infrastructure bonds.”