Guillermo Larrain Rios Superintendent of Pension Funds Administrators, Chile President of AIOS

1. Comments onOld-Age Income Support in the 21st Century: An International Perspective on Pension Systems and Reformsby R. Holzmann and R. Hinzplus several colleagues Guillermo Larrain Rios Superintendent of Pension Funds Administrators, Chile President of AIOS Cartagena de Indias, May 20th, 2005

2. General View • Multipillar pension systems are new. Excluding Chile, none has more than 12 year old (Peru). • It is one of the few socio-economic institutions created in developing countries and being adopted by developed ones: Sweden, ¿US? • Implication: no OECD country is an example in this, there are no international standards (ie, no public good of good governance: Basle Accords, IOSCO, etc…) • We, developing countries, must take this challenge in our hands and proceed to reflect, to model and to make funded pension systems coherent with the principles of social security. We are not making the appropriate effort We rely on the kind help from the… World Bank Therefore, the clarification of official World Bank policies concerning pension reform is welcomed

3. This Policy Report • Not a research paper. The report describes well the criteria used by the WB in pension reform issues. • It is not as easy to read as a paper, there are few data, but it is relevant to understand how the Bank articulates its reflection and policy suggestions in this topic. • The WB approach is much more complex and nuanced than what is often perceived from outside. • There is no unilateral argument in favour of capitalization systems, that is: • the P2 may constitute per se the main component of the pension system, • that P0 and/or P1 are residuals • There is a sense that countries are different and deserve a unique combination within the multipillar approach. This is a serious approach.

4. This Policy Report • It starts increasing the number of pillars originally included in “Averting the Old Age Crisis”, giving therefore reason to those who think that coverage issues are relevant and require a treatment outside Pillar 2. • But then, it reflects on how to improve Pillar 2 from various perspectives, giving reason to those who think that the system can be improved significantly from its current situation. • One particular aspect of this is that there is no policy criteria suggesting that P1 should be strengthen at the expense of P2.

5. Six disordered and contradictory questions for the WB and for you • WB has a general emphasis on poverty prevention. For the sake of pension systems, isn´t it too much? • Maybe the WB has devoted less resources to promote a better P1, but have we made all relevant progresses in improving P2? • As enjoying a pension is a question of spending the money, have we devoted enough resources to improve the disbursement phase? Where are the LICs?

6. Six disordered and contradictory questions for the WB and for you • In moving towards a funded system people supposedly should be responsible for their future. Are they capable of managing those risks? And the other actors, State + AFPs? • Have we dealt appropriately with transitional problems? Is the political economy worse due to unresolved transitional problems? • The claim for more competition is also derived from the fact that pension savings are mandatory. Have we looked for a relevant and sustainable solution to competition? One implication: can we ask Parliaments for subsidies to strengthen P3, if we agree that there are IO problems in P2?

7. The discussion of pillar weight: Too much emphasis in poverty prevention? • Poverty incidence at old-age • Myopia • Inertia

8. Relationship between different pillars. There is a meaningful opportunity cost of alleviating poverty at old age: poverty when young • Incidence of Poverty is lower at old age. • Proposal for a universal pension looses ground in a context where fiscal budget is limited

9. Objectives of a Pension System: Old-Age Poverty Alleviation and Consumption Smoothing Question: At what age do you think you will die? • Strong evidence in favor of myopia. • Too much focus on poverty alleviation may leave out policies directed to smooth consumption. • People under-estimate their Life Expectancy and correct these estimation too late. Expectativa de vida según tablas de 1985

10. Coverage increases with Planning horizon Question: How far do you organise your expenditures? People who plan further in advance are more likely to contribute in the pension system. Source: EPS(2002)

11. 2) Have we cared enough about complementary reforms? • Financial markets • Labour Markets • Women • Informality

12. In Financial Markets: why diversification is so poor? Are you incompetent?

13. In Chile, the achievement of diversification has been progressive

14. Some institutional prerequisites for asset diversification • Macro stability (inflation, shocks,…) • Growth: investment opportunities • Contract´ stability • Quality of regulation • Elimination of tax distortions • Risk classification • Custodians … etc • Fixed Income: • Mortage Credit • Corporate Bonds • Variable Income • Corporate culture, accountability, transparency • Corporate governance • Minority shareholder´s rights The reform agenda besides pension reform is large. It needs effort, persistence and patience… Because several interest groups (within the financial sector as well) will certainly try to block it

15. Labor Markets. Female Labor Force Participation is still low in Latin America • What explains low female participation rates? • Some Chilean thoughts: • Lack of appropriate labor contracts for women • Child care • … machismo

16. Labor Markets. Informality is high in Latin America. Do we know what to do? Do we know where to start doing something?

17. Informality is important because it is stronger among poorer people… Source: CASEN Survey 2003

18. … and youngsters. Fuente: Encuesta CASEN 2000

19. 3) Pension reform is not only about savings accumulation, but also about spending the bucks! • Disbursement phase

20. 6% 2,01 % Big Focus on Accumulation Phase, but what happens in Disbursement Phase? • Effect of SCOMP on Annuities Fees • New Mortality Tables, updated to take into account higher Life Expectancy levels

21. Another challenge: Early retirement Average early retirement age: 56 (men) and 54 (women)

22. 4) Who bears which risks? • Individuals • Firms (AFP) • State

23. Risk in the Individual Accumulation Pension System • Which is the relevant concept of risk? • How to measure this risk? • How is it assigned among the system participants? • The most relevant risk is the risk of Poverty at Old-Age. • Neither the own affiliates, nor the Government or the Managers seem to be covering this risk appropriately.

24. Individuals have limited knowledge: how can we expect them to know about and manage risk ? What serious effort the government has made to improve information, to teach people how the system works? Why could you expect this to happen with IO problems?

25. Minimum pension growth 2% Yield 5% State: coverage of Minimum Pensions seem fairly low, should we strengthen P0 and P1? Base scenario Only 10% of retirees will receive minimum pension benefit while almost 50% of them will obtain self-financed pensions below the minimum pension level Source: Berstein, Larrain and Pino (2005)

26. Yield 7% Reachable scenario The definition of P1 is poor Source: Berstein, Larrain and Pino (2005) Minimum Pension growth 2%

27. AFP: Managers are more worried about risk of falling below Minimum Return • Returns tend to be very similar across different Managers. Evidence of Herd Behavior. Is it due to minimum return guarantee? • More investment flexibility cannot imply that affiliates absorb the marginal risk. Who and how deals with it?

28. 6) Transitional issues • Recognition bonds • Past macroeconomic events • Fiscal adjustment

29. There are also Transition Issues • Recognition Bonds: calculated over an inconvenient base because unemployment was too high between 1975 and 1979 • Previsional Damage • High Unemployment in 80s y 00s These unresolved issues bias political economy against the reform

30. Sistema de Pensiones y Finanzas Públicas Fuente: Dirección de Presupuestos

31. 7) Industrial Organization issues

32. Demand: Mandatory “Consumption” Limited Knowledge Low Sensibility towards Management Fees Supply: Important Economies of Scale Quasi- Natural Monopoly Few providers and High Concentration Competition based on Sales Forces and Spurious Incentives (gifts) Industrial Organization Issues

33. Comments onOld-Age Income Support in the 21st Century: An International Perspective on Pension Systems and Reformsby R. Holzmann and R. Hinzplus several colleagues Guillermo Larrain Rios Superintendent of Pension Funds Administrators, Chile President of AIOS Cartagena de Indias, May 20th, 2005