Peru: Reforming private pensions
A mixed commission of Peru’s financial sector regulatory bodies has finished its work on a private pension fund reform proposal and will soon be presenting its ideas to the Ministry of Economy and Finance (MEF). Proposed reforms include increasing coverage and lowering the commissions that private pension funds currently charge affiliates.
In a statement to local press, Luis Miguel Castilla, the minister of economy and finance, recently announced that the “mixed commission”, comprised of the Central Reserve Bank; the Superintendent of Banking, Insurance, and Pension Funds (SBS); and the MEF, could have the proposal ready for review by the Council of Ministers and Congress by the end of June.
At present, Peru’s private pension fund affiliates pay an average commission of 1.92% of monthly salary. While this rate has decreased steadily from an average of 2.4% in the early 2000s, it is still among the highest in Latin America. The average commission charged by Chilean pension funds, for example, is 1.47%.
Lawmakers believe higher commissions are the result of a lack of competition in the sector. Indeed, there are only four private pension funds (known locally by their Spanish acronym, AFPs) in the country, two of which hold 60% of the market – Prima AFP and AFP Integra. Initiatives aimed at increasing competition in the sector are likely to play an important role in reform.
In terms of attracting new AFPs, Aldo Ferrini, the chief investment officer of AFP Integra, said this would be a difficult task, given the nature of the local market. According to Ferrini, “A new participant will start with no affiliates and this is a big business; it requires a lot of infrastructure. You need to have nationwide coverage and, most importantly, a value proposition that convinces affiliates of your ability to manage their money professionally. The companies in our market have a track record of 18-20 years. This will be difficult to compete with.”
In June 2011, the former administration proposed a plan to encourage Peru’s current AFPs to compete more aggressively amongst themselves. This allows AFPs to compete for the contributions of new affiliates as part of a tendering offer. There is no word on whether or not a similar programme will be included in the soon-to-be-revealed pension fund reform proposal.
Apart from proposals to lower commissions through competition, some lawmakers believe the practice of charging commissions based on salaries should be abandoned entirely. Alternatively, commissions could be charged on retirement account balances or earnings. Those in favour of this proposal believe that it aligns the interest of AFPs with affiliates. Under this system, AFPs wishing to increase their bottom line would have to work to increase the value of their customers’ accounts.
Regardless of the method proposed, the prevailing logic is that lowering commissions will attract new affiliates to the sector, thereby expanding coverage. In reality, potential new affiliates might require a stronger nudge.
To this end, lawmakers seem intent on developing a way to attract more independent workers into the private pension fund system. Proposals in this direction include requiring independent workers make a minimum pension fund contribution and providing incentives for them to do so.
A related issue is the lack of pension fund contributions from employees of small and medium-sized enterprises (SMEs). While they account for 80% of Peru’s labour market, they are among the smallest contributors to private pension funds.
Critics argue that under the current system, AFPs have little interest in reaching out to SMEs, instead choosing to concentrate their energy on developing relationships with large corporate clients. If the combined economic strength of Peru’s SMEs is not motivation enough, it appears other incentives will have to be employed to influence AFPs to increase coverage of these workers. Perhaps the previously mentioned tender offering for new affiliates could be a solution.
While all of these reform proposals apply strictly to the private pension fund system, it is worth noting that only 16.2% of Peru’s economically active population contributes to AFPs. Any reform that hopes to be effective in the long run will have to seek some form of cooperation between the public and private pension fund systems in an effort to increase coverage. This will be the only way to ensure that all Peruvians have some form of financial support in their old age.