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FIAP proposes a “longevity insurance” for retirees over 85 years of age

13 October, 2015

Individual funding, assistance and greater savings are the pillars

The Chilean lawyer and expert in pension matters, Guillermo Arthur, said that the retirement age should have been increased in Latin America years ago. As the President of the International Federation of Pension Fund Administrators (FIAP), he was commenting a new initiative, namely a “longevity insurance” after retirement.

Source: www.elpais.com.uy

Below is a summary of the interview with the lawyer from the Catholic University of Chile, in Santiago, who specializes in labor and social security matters and chairs the International Federation of Pension Fund Administrators.
– In a little over two decades of existence of the pension fund model in Latin America, there have been constant adjustments…

– It is absolutely normal for the pension systems to be in a constant state of change and evolution, because the scenarios in which they move are subject to constant change.

I will use Chile as an example. A man who retires at age 65 has a life expectancy of another 21 years, and a woman who retires at age 60 has a life expectancy of another 30 years. This is 40% more than the life expectancy at the time the system was created in 1980. On the other hand, interest rates have been falling, and pension amounts are severely affected with every point they fall.

– Have the objectives of the pension systems also changed over time?

– Correct. That is another phenomenon that people have not taken into account, and it is crucial. Pension systems were always intended to replace wages during old age. That was their purpose. However, in Chile, another objective was added to the pension system in the 1990s, based on a proposal by the Central Bank: to mitigate the effects of poverty in old age for all individuals, whether or not they had worked or saved. Hence, pensions must be provided for individuals who did not save. This is what is called non-contributory pensions.

– It is one of the pillars of the system…

– Today we are faced with a system denominated the multipillar system, which comprises a first non-contributory pillar that is paid for with taxes, destined to those who did not contribute during their active lives, or those who did so for a very short period of time. The second contributory pillar can be PAYGO or individually funded. And the third pillar, which is voluntary and must have tax incentives for encouraging workers to save more than what is mandatory. The Latin America pension systems operate within this framework. The problems are others…

– Which ones?

– The contribution rate is 10% in many of the countries of the region, and with that it is impossible to cover a decent retirement, and for more years than were covered before. The pension systems came into being at a time in which people lived to 60. Young people were paying to cover the pensions of the elderly, who were considerably less. So they could be covered with a very small contribution. But due to the fact that there were increasingly fewer young people, as a result of the declining birth rate, and the elderly were increasing due to greater life expectancy, this pyramid began to be turned upside down. So we eventually ended up with fewer young people and more elderly people.

And that is why the PAYGO systems began to founder. There is no ideological issue in discussion here. This is a practical issue. How much young blood do we have to support the pensions of the elderly? Today it is not enough.

– That is the underlying reason for the proposed changes…

– Let’s have a look at what is happening in Europe. There is a clear trend of integration of individual funding mechanisms into the PAYGO systems.

Defending exclusively PAYGO systems nowadays, and blaming the individually funded systems for all their woes, is a Byzantine and absolutely mistaken approach.

– Let’s get back to low contributions. Do you believe that they have to be raised?

– Let’s go back to what is happening in Chile, where President Bachelet appointed a Commission to study the reforms that need to be introduced, because the pensions being paid are too low. Let’s look at the reasons why pensions are low. A woman contributes during 15 years of her active life, on average, in Chile. How much does she contribute during that time? 10% of her income. How long does she live to enjoy that retirement? Another 30 years. Double the time during which she saved; and she collects 70%, when she saved 10%. The figures don’t add up. Given this situation, the only thing the State can do, if that person is poor and qualifies for assistance, is to include him/her in the first non-contributory pillar. This is why the need to raise the contribution rate is being discussed.

– What is the future of the pension systems?

– What lies ahead is a multipillar system, with a robust individually funded core, with a strong voluntary savings system with tax benefits, and a solid pension or non-contributory savings system, whereby the State goes to the aid of the most vulnerable people. That is the best formula, in my opinion.

And there is a proposal that was presented by FIAP some days ago in Montevideo, conceived by a Chilean expert, Solange Bergstein. A proposal for an insurance to cover extreme old age. The logic is: the things that are most likely to occur are financed with savings, the things that are most unlikely to occur, are financed with insurance. What is the idea? The probability that you will still be alive, for example, between 65 and 85 years of age, is high. So spend all your savings in that time. If you live for more than 85 years, which is a less likely period of survival, you will have paid an insurance to cover that stage during your lifetime. And that insurance will be activated when you turn 85. And it would be a very accessible insurance, which would benefit your living contemporaries should you not be around to enjoy it.

The study carried out by FIAP shows that it immediately improves the pension by more than 20%. Today, at age 65, you are being told “Don’t spend all your money, since you could live to be 100.” But with this proposal, you receive more money until you turn 85, and thereafter you start collecting the longevity insurance. It is a proposal that would be very convenient to apply.

– Do you really believe that the individually funded pension systems have been able to improve pensions?

– Yes I do, and even though the contribution rate is only 10%, pensions have improved. For whom? For those who contributed on a regular basis. Those people have good pensions.

– And why are they good, considering the gap between contributions and benefits?
– They are good, first of all, because the returns produced with the savings have been extraordinarily high. Let’s take the examples of Chile, Mexico, Colombia, and Peru. Perhaps not so much in the case of Uruguay, where the diversification of investment has been lower.
Very good returns have been obtained, because one can make riskier investments, and because they are so diversified, that higher risk is diluted. Thus, the investments made with the pension funds have contributed to the economic development of countries.

– You mean, this would be another benefit of the system…

– That is how I understand it. There is a study carried out by FIAP with the support of the Sura group, which estimates that the investments of the pension funds account for approximately 10% of the growth of the GDP in these four countries in the last few years. The funds are also invested in infrastructure, roads, ports and housing. The funds are for paying pensions, but there is a very virtuous relationship between investing well and paying pensions.

We estimate that one million homes were built in Chile due to pension savings. 30-year loans are available in Chile, something not available in many countries, because the pension funds need long-term investments. There is a very important benefit, namely economic growth, the creation of jobs and wealth, and that is due to the individually funded system.
– In Uruguay there is a mixed system; the PAYGO pillar is still in place.
– The PAYGO systems do not accumulate, they receive and pay out. There is a problem with that. You have more people receiving than people saving, because there are more elderly people than young people. I prefer the fully individually funded systems. Mixed systems are PAYGO systems up to a certain level of income. The contribution rate is very high; what would the replacement rate be at the time of retirement if everything were destined to individual funding? We would have to calculate that: always bearing in mind that the people who do not meet the retirement requirements will have to be assisted by the State.

Increases in the retirement age and contributions are imminent in the region.

– The pension funds have three alternatives for balancing the outcomes of the system; increasing the retirement age, reducing the pension amount, or increasing contributions. Which one of them is the fairest and most applicable in your opinion?

– The different options will probably crop up depending on the path chosen by each country. I have no doubt that the retirement age should have been increased a long time ago in Latin America, and it is inevitable. Life expectancy is increasing, and that does not mean that we will be decrepit for longer, but rather that we will be younger for longer, with vitality, capable of working longer. The labor market will benefit from having these accumulated skills over a long period of time.

Contributions must also be increased, gradually. Perhaps another alternative should be sought in Uruguay, where the contribution rate is already high. But there are countries with a very low contribution rate. It is 10% in Chile, and 7% in Mexico. It should increase by 1% per year, so the population does not feel it.
– The non-contributory pillar is essential, regardless of the system…

– When concerning people who are not going to achieve sufficient savings for financing their old age, undoubtedly. But why can the State do that? Because there is a savings system, like the individually funded system, which enabled freeing resources. The State did not have to assist the entire population, and had enough money to destine to the sectors that most needed it, through means testing.

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