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Uruguay: “Extensive debate on pensions”

15 October, 2013

Source: FIAP based on www.lr21.com.uy; www.elpais.com.uy; www.elobservador.com.uy; and Semanario Busqueda.

Almost 20 years after the implementation of the Individually Funded Savings System in Uruguay (beginning in 1996), the recent bill of law submitted to Congress by the Executive proposing modifications to the Uruguayan Social Security system has given rise to much concern within the sector, since the adoption of some of the proposed measures could entail a weakening of the initial objectives put forward when the individually funded system was created, namely to complement public systems, diversify the risks faced by members in the provision of pensions and improve the benefits they receive.

Bill of Law submitted on October 1, 2013

The most important modifications set out in this Bill of Law involve:

  • Creating a two-fund system, in order to establish a “less risky Fund” to provide greater safety to members who are close to retirement. The bill of law provides for a gradual transition of the individual savings of workers from an “accumulation” sub-fund to another “retirement” sub-fund (safer) after they turn 55.
  • Revoking the option for the Mixed System: workers who were over 40 on April 1, 1996, could opt out of enrollment in the mixed system.
  • Voluntary opting out of the Pension Savings Fund Managers (AFAPs) for workers between 40 and 50 years of age. In order to determine in which cases it would be advisable to revoke this article, the BPS will mandatorily provide advisory services upon request, taking into account the work history and the retirement possibilities that the mixed system would provide the worker.
  • Make it mandatory for members to process transfers before the AFAP they are enrolled in and not the target AFAP, as currently occurs.
  • Promote the reduction of the commissions charged by the AFAPs by automatically assigning members, (those obligated to enroll but who do not choose an AFAP), to the fund managers with the lowest commissions. Members are currently assigned on the basis of the number of members enrolled in each AFAP, and with the proposed change they will be assigned to the two fund managers that charge the lowest commission in the market.
  • Allow retirees who return to formal employment to contribute only to the BPS, continuing to collect their pensions from the AFAPs.

The Pension System in Uruguay
The current mixed Multipillar type system in Uruguay comprises a contributory defined benefits system, a mandatory defined-contribution individual savings system and derived benefits in which the Intergenerational Solidarity Retirement Regime (the public PAYGO system) is integrated with the Individually Funded Savings System (private). Voluntary contributions can also be paid into the Voluntary Savings System. The amount of contributions destined by the worker to each system (public or individually funded) depends on his wage bracket and the option chosen:

  • First level: includes taxable income up to USD 1,447 per month. At this level, workers must contribute 15% of their income to the public PAYGO system. However, members may choose to contribute 50% of their personal contributions to the individually funded system, and the other 50% to the public PAYGO system.
  • Second level: Includes workers who fall within a taxable income bracket of USD 1,447 to USD 2,170 per month. In this case, workers contribute 15% of their salary up to USD 1,447 to the PAYGO system, and 15% of what exceeds USD 1,447, and up to USD 2,170, to the individually funded system. Alternatively, up to a salary of $ 1,447, they can pay 50% of their contribution (15%) to the individually funded system and the entire remaining amount to the PAYGO system.
  • Third level: Workers who are in the taxable income bracket between USD 2,170 and USD 4,341 (maximum taxable wage base for the individually funded system). In this case, they must contribute to the PAYGO system on income up to USD 1,447 and to the individually funded system on the rest of their income.

Fund, Enrollment and Return Figures as of September, 2013

After 20 years, the system has 1,193,554 members, showing an increase of 5.7% in one year, according to official figures published by the Central Bank of Uruguay (BCU). The Pension Savings Fund (FAP), in turn, amounts to UYU 217,001 million (approx. USD $ 9,847 million), which implies an annual increase of 13.4%. The real annual return of the system, to September 2013, measured in indexed units (UI, adjusted for inflation) amounted to 2.51%.

1. Financial sustainability of the individually funded systems

It is surprising that some of the proposals focus, for example, on revoking the option for the mixed system (workers over the age of 40 on April 1, 1996), as well as the possibility of workers between 40 and 50 being able to voluntarily opt out of the AFAPs and contribute only to the PAYGO system.

The international evidence shows that, due to the drop in fertility rates, the increase in life expectancy and the increasing incidence of pension expenses in the total public budget, social security systems worldwide have increasingly been forced to mandatorily incorporate the mechanisms of the individually funded system in order to improve the sustainability and adequacy of their pension systems. The PAYGO systems that have not carried out reforms based on the individually funded savings system have been forced to make considerable “parametric adjustments” to prevent the financial collapse of the social security systems, and in some cases have simply had to freeze pension benefits. In the last 18 years, between 1995 and 2013 (data to September 2013), 65 countries increased the contribution rate in their PAYGO programs to reduce fiscal costs (e.g.: Germany, Armenia, Curacao, France, Lithuania, Nicaragua, Romania); 35 increased the retirement age (e.g.: Germany, Austria, Curacao, Slovenia, Spain, France, Greece, Kazakhstan, Malaysia); and 35 adjusted the benefits formula (e.g.: Armenia, Austria, Curacao, Spain, France, Hungary, Latvia).

2. Pensions and the diversification of members’ risks

One of the purposes of the creation of the individually funded system in Uruguay was to complement the public PAYGO system, thus diversifying the risks faced by members in the provision of pensions and improving the benefits they receive. The stimulus to opt out of the AFAPs at age 40, proposed by the Government, conspires against the ability of workers to accumulate a significant amount in their savings accounts, capitalized in such a way as to be able to access a pension directly proportional to their salaries at the time of retirement. At the age of 40, workers still have 20 years of contribution ahead of them and the history of past contributions is short, given the fact that the AFAP system has not been in place that long.

On the other hand, the individually funded systems are increasingly implementing pension Multifunds and designing specific lower-risk funds for workers close to retirement and pensioners. In fact, the trend is to set up life cycle funds and gradual processes of transferring accumulated balances from higher risk to lower risk funds as members get older and their retirement date approaches. In this regard, the government’s proposal to create a two-fund system with a “less risky fund” to provide greater security to members who are close to retirement is a step in the right direction.

3. Positive impact on the economy

The financial balance of the pension system could be affected by the loss of the macroeconomic benefits inherent in the operation of an individually funded system in which workers’ contributions are invested in financial instruments of the capital market. Existing international evidence shows that the creation of these systems has a positive impact on the growth rate of the Gross Domestic Product (GDP), through increased savings and investment, employment and the productivity of factors (see the Sura Study “Contribution of the private pension system to the economic development of Latin America; experiences of Colombia, Mexico, Chile and Peru“).

The empirical evidence from pension reforms in different countries worldwide shows that the individually funded systems have indeed been beneficial for the financial sustainability of the pension systems, to the extent that day replace actuarially underfinanced systems with an actuarially neutral system that establishes property rights and a direct relationship between the contributions paid in and the benefits received by workers. In some countries, the role assumed by the individually funded system has been greater than in others, but there is no doubt that in all of them it has resulted in a smaller share of the public PAYGO systems or partial accumulation in the financing of pensions, which has improved the long-term sustainability of the pension system as a whole as well as the fiscal financial situation, since actuarially bankrupt systems have been replaced. Thus, the creation of the individually funded systems has been fully consistent with the objectives of the reforms and the control of fiscal deficits, and in practice, their effects have not been neutral due to the decline they have generated in the present value of such deficits. Hence, revoking the option for the mixed system in Uruguay constitutes a setback in the achievement of the aforementioned objectives that could cause serious damage to members and the economy.

Opinions of the industry regarding the proposed reform

With regard to the proposals, the AFAPs are asking Congress to make adjustments to the text proposed by the Government, such as the age at which such option can be exercised and the term for implementing a safer savings fund. The AFAPs do not support the 40 to 50 age bracket, since in the Social Security Dialogue they had proposed that the worker should have only one year – on reaching 50.

The Chairman of República AFAP (the state AFAP), Luis Costa, told the El Pais newspaper that no agreement on the opting-out age had been reached in the Dialogue, but the Executive did define it in “a subsequent agreement with the PIT-CNT (Trade Union Confederation of Uruguay).” Members who were 40 or more in 1996 will also be able to opt out. The fund managers’ proposal made between 10,000 and 20,000 workers per year eligible, which would allow for “good counseling.” Making workers eligible between 40 and 50 years of age “accumulates a number of people” (about 500,000 today), that it is “difficult to attend to,” said Costa. It has therefore been proposed that workers should be able to opt out of the mixed system only when they turn 50. This would make between 10,000 and 20,000 workers per year eligible.

Luis Costa also pointed out that another aspect that requires modification is the effective date of the two-fund system: one accumulation fund (like the existing one) and another retirement fund (safer, which receives contributions in the last years of working life). The bill of law establishes the effective date as the first business day of the month following the completion of 90 days of the law having been approved. The AFAP considered that 270 days will be required, since “the entire operating system” and the account statements have to be created.

The General Manager of Union Capital (one of the private AFAPs), María Dolores Benavente, told El Pais that the AFAPs had already asked to be received by the Committee on Labor and Social Security Matters and made it clear that the bill of law had not emanated from a consensus in the Dialogue, but rather reflected the position of some of the representatives of the workers. According to an analysis by UnionCapital (see attachment at the bottom of this page), the most important aspects requiring modification in the text of the bill of law have to do with the following:

Age: Members must be older than 50-55 (agreement between the four existing AFAPs).
Transfers: No return to the transfers “war.” Transfers must continue to be made in the AFAP the worker has opted out of or such AFAP and the target AFAP (agreement between the three private AFAPs).
An initial voluntary fund with more return and risk should be allowed (agreement between the four existing AFAPs).
The more conservative fund should not be mandatory at age 55 if the member decides that he does not want to transfer as yet (agreement of the four existing AFAPs).
That the BPS should not be the only party providing counseling to members, since it is judge and jury (it receives the funds of those who opt out and is a shareholder in one of the AFAPs) (agreement of the three private AFAPs).

Several opinion columns have appeared in the media criticizing the government’s proposed reform. At the bottom of this page you can download two columns (in Spanish version) published recently, one by Semanario Busqueda and the other one by the El Observador newspaper.

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