By Paola Vásquez, Leandro Ramos and Ivette Ccellccascca
A pension system guarantees that contributors can have sufficient monetary resources to support themselves for the rest of their life after retirement. In Peru, the pension system is mixed made up of one public system and private one that coexist since 1992. Thus, dependent workers are obliged to choose whether their contributions would be destined to the Pension Standardization Office or to a Private Pension Fund (ONP and AFP by its acronyms in Spanish, respectively). For independent workers, membership is voluntary.
During 2020, this system has been questioned for a sector of the country that requests the release of part of its funds in the pandemic context, as well as the comprehensive reform that guarantees a decent pension for all regardless of their employment status or income. Because of it, these requests have been collected by two branches of the state, the Executive and the Legislative, clearly from very divergent approaches. In this article we will describe the main characteristics of the Peruvian pension system, the impact of the economic measures promoted this year in the context of the Covid-19 pandemic and finally, the status of the comprehensive reform project that was approved this year.
The National Pension System (ONP)
The distribution model used by the ONP covers old-age risks, disability and survivor pensions for the insured's family, likewise, it accepts dependent workers and voluntary contributors. It should be noted that the pension that contributors receive does not depend solely on their individual contribution and there is a minimum and maximum pension that ranges from S / 500 to S / 893. The pension depends on the years and amounts contributed and the retirement age is 65 years. Nowadays, it is the 13% of the salary that must be contributed for a minimum of 20 years, less than this time they won't receive pension. It should be noted that according to the International Monetary Fund, by 2019, 60% of the contributors do not meet this period, one of the main problems of this system.
The pensions granted by the ONP are not provided solely with contributions from contributors, rather they receive aid from the Public Treasury and the Consolidated Pension Reserve Fund (FCR), with contributors being the main source of financing in recent years.
Due to demographic changes such as the increase in life expectancy and the reduction in the fertility rate in Peru, there are more people who pass the barrier of 65. This represents a challenge, since it means that in the next few years there will be more beneficiaries than taxpayers, so the contributions will be used to pay the beneficiaries without saving for the workers.
The Private Pension System (AFP)
The AFPs are private financial institutions that manage pension funds through the individual account system and are regulated by the Superintendency of Banking, Insurance and AFPs (SBS). Therefore, the amount a person receives upon retirement depends solely on their own contributions and the additional product of the profitability they generate. The pension will be calculated based on the total accumulated fund and contributors can retire before they reach the age of 65 under certain requirements. Currently there are 4 AFPs: Integra, Hábitat, Profuturo and Prima AFP, Habitat is the last to join in 2014 due to the departure of Horizonte; Prima and Integra are the ones with the highest volume of contributions, as can be seen in the following graph:
One of the important factors when deciding which AFP to join is the commission rate they charge and the returns they generate. However, since there are only 4 companies competing to attract the largest number of affiliates, these values are close, as follows:
Commission charged by entity at 2020
Source: AFP Integra
In summary, the main difference between the two systems is that the ONP operates under the modality of distribution called a common fund, that is, the current contributions will be paid to today's retirees who meet the requirements. On the other hand, the AFPs do so through an individual capitalization system, that is, the money deposited is invested with the aim of making it profitable.
Now, there is much disagreement about how the pension system is managed and regulated because the contributors do not get to collect 100% of their contributions at the end of their life and they cannot receive the generated benefits. Thus, most require that it be delivered in its entirety at the time of retirement as is the case with the Australian pension system. It should be taken into account that, beyond the deficiencies in the design of our pension system, the problem is aggravated by the poor Peruvian savings culture.
In addition, 2020 that has affected the entire national economic and social system, has also had significant repercussions on the AFPs due 2 reasons: Emergency Decree 038-2020 in April that authorized the withdrawal until 25% of total funds for amounts greater than 2000 soles (the withdrawal could be total for less amounts) and Law No. 31068 currently proposed (December 2020) that authorizes a withdrawal of pension savings of up to S / 17,200 and could be possible before January 9, 2021. The economic implications of both bills approved by Congress and the reaction of these particular entities are detailed below.
Economic implications of bills during a pandemic
a) Refund of contributions to Decree Law 19990
The Congress promulgated on Friday, December 4 of this year, the law that establishes, in an exceptional manner and for the only time, the return of contributions to active and inactive contributors of the Office of Social Security Normalization (ONP), for the withdrawal of funds for up to 4,300 soles (1 UIT).
Active and inactive contributors to the national pension system may benefit from the return of their contributions established in this law, during the 90 business days after the publication of this rule in the Official Gazette “El Peruano”.
According to a Benites, Vargas and Ugaz study, the return of contributions is not constitutional for three reasons: the intangibility of the funds, the principle of financial sustainability, and the right to access a pension.
The first one, the intangibility of the funds, refers to the fact that the national pension system is based on a distribution system on the principle of solidarity. The solidarity of current contributors finance current pensioners, so once contributions are made to the fund, ownership of said contribution is lost.
The second reason is that the law violates the principle of financial sustainability since the national pension system must ensure its own efficiency, sustainability and possibilities of existence. The return to current contributors and pensioners would not only come from solidarity funds but also from the public treasury.
Finally, the lack of financing for a solidarity distribution system would threaten current taxpayers to access a pension in the future, since the pension plan would not be sustainable.
b) Withdrawal of funds for beneficiaries AFP, Law 31068
In early April, the Executive promulgated the Emergency Decree 034-2020 that establishes the extraordinary withdrawal of the pension fund in the Private Pension System to mitigate the economic effects of mandatory social isolation. The beneficiaries of this measure were the affiliates who, in the last 6 consecutive months until March of this year have not contributed to their individual capitalization account (CIC) and who could withdraw up to S / 2,000.
After 8 months following the decree, there was speculation about a second withdrawal of pension funds. Julio Velarde, the president of the Central Reserve Bank (BCR), announced that a second massive withdrawal of pension funds would increase country risk and interest rates, especially those for long-term debt such as mortgages. Velarde emphasized that this measure to withdraw pension funds puts macroeconomic stability and the ongoing economic reactivation process at risk. During the first withdrawal, one of the BCR's measures was the purchase of dollars to mitigate the impact of the exchange rate and thus assure the AFPs had the necessary liquidity for the delivery of pension funds.
Finally, the Congress of the Republic promulgated on Wednesday, November 18, Law No. 31068 which authorizes the extraordinary withdrawal of the pension fund in the Private Pension System. The beneficiaries of this measure were the affiliates who, in the last 12 consecutive months until October 31 of this year, have not contributed to their individual capitalization account (CIC), and therefore could withdraw up to S / 17,200 (4 UIT). Given this, Velarde pointed out that the measure taken during the transitional government of Manuel Merino was inadequate and irresponsible not only for the aforementioned reasons but also because of the troubled political situation.
Economic implications of bills for the comprehensive reform of the pension system
On 04-29-2020 the Law Project 05095/2020-PE “Law for the Comprehensive Reform of Pension Systems” was presented to the Congress of the Republic, the objective of which was the creation of a Mixed Commission in charge of formulating a reform proposal comprehensive of the National and Private System of the country's Pension Funds.
This Commission is made up of representatives of the Legislative Power, the Executive Power (Ministry of Economy and Finance, Ministry of Labor and Employment Promotion and the Social Security Standardization Office), as well as representatives of autonomous bodies such as the Central Reserve Bank and the Superintendency of Banking, Insurance and AFPs.
According to the presentations made by that commission, the main objective of the comprehensive reform of the Social Security System is to guarantee a universal pension to the population to prevent poverty in old age. To achieve this, the following key elements should be considered:
Expand pension coverage: According to data from ENAHO 2018, around 68% of the Economically Active Population (EAP) is not affiliated to any type of Pension System.
Improve financial information and education: Raise public awareness about the importance of saving for old age.
Reduce costs for the benefit of the affiliate: The oligopolistic market of AFPs prevents the reduction of costs that imply lower commissions for affiliates, for this reason the entry of new actors such as banks is being considered.
Improve benefits: higher incentives that allow voluntary savings.
The preliminary proposal presented by the Commission for the reform of the pension system comprises 4 pillars:
The non-contributory and semi-contributed pillar would be aimed at the most vulnerable population, which includes the beneficiaries of Pension 65 and low-income workers. This pillar would be constituted by a collective fund, without individual property and would be administered by the State. The contributory pillar would consist of individual accounts self-financed by the workers, a scheme similar to that of the current Private System. Lastly, the fourth pillar of voluntary savings would seek to provide facilities for voluntary contributions, through innovative mechanisms such as contributions through the collection of IGV (Value Added Tax in Spanish), consumption contributions, among others.
Although the reform seeks to solve the current problems of our Pension System for the benefit of the general population, this proposal is not free from defects and criticism. Thus, the Peruvian Association of AFPs questioned the creation of a state entity called the Public Pension Agency (OPP) approved by the Reform Commission. Said entity would be in charge of the affiliation, raisings, collection, supervision and definition of the investment policy of the new Peruvian pension system. In this regard, the AFP Association expressed in a statement its concern about the role of the State, since experience has shown that the private system would be much more efficient.
After 28 years, the debate about the comprehensive reform of the pension system is open and there is still a long way to go. There isn't magic solution to all the problems in the current system. Along these lines, the IDB, in its report called Diagnosis of the Peruvian Pension System and Reform Avenues, pointed out that “there is no single method that can solve all the problems of the pension system, nor a specific adjustment speed for each of the reforms that are going to be proposed”. Both pension systems have great challenges to solve. In the case of the public system, the great challenge is to guarantee inter- and intra-generational equity as well as fiscal sustainability, and in the case of the private system, the adequacy of pensions.
These points have been addressed in the comprehensive reform, and for its success, it is necessary that the members of the Reform Commission evaluate all the possibilities and make decisions safeguarding the interests of the population and all those involved. Even we as citizens can make our opinions known and make inquiries through the Congress website. Likewise, the Pension System Reform Commission has a Facebook page where the Work Tables on the reform have been broadcast live.
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