SP DISCUSSION PAPER NO.0015 23089 The Pension System in Argentina Six Years After the Reform Rafael Rofman June 2000 swi~on A80R MARKETS, PENSIONS, SOCIAL ASSISTANCE T H E W O R L D B A N K The pension system in Argentina six years after the reform Rafael Rofman* Buenos Aires, June 2000 The author is Vice President of NACION AFJP and advisor to the Ministry of Economy, Buenos Aires, Argentina. The findings, interpretations and conclusions expressed in this paper are entirely those of the author and do not reflect in any way the official position of his employers. 1 Abstract In a context of a serious financial and legal crisis, Argentina reformed its Pension System in 1994, when a multipillar model with a funded scheme was introduced and first pillar parameters, as minimum age and vesting requirements were tightened. The new system has a significant first pillar (which offers a flat benefit currently valued at 28% of average wage to all retirees) and a second pillar that should provide a similar amount, once the transition is completed. The new system has developed rapidly and most formal workers have joined the new funded scheme. However, there are some problems that must be resolved. In the first pillar, the reform balanced long term finances, but it will also reduce coverage very rapidly, as a consequence of the combined effect of low formality in the labor market and stricter contribution requirements. The most serious problems in the funded pillar are the administration costs and the need to improve regulation and supervision of insurance companies, that provide disability and survivors coverage and annuities to beneficiaries. While these problems are important, their consequences can be avoided if adequate policies are developed by the Government. In this sense, the experience of the pension reform in Argentina is an excellent lesson for other countries that are considering a reform in their own systems. 2 TABLE OF CONTENTS 1. INTRODUCTION ......................................4 2. THE BASIC STRUCTURE OF THE SIJP .5 2.1 THE NEW SYSTEM . . . 5 2.1.1. The Multipilllar Scheme ............................5 2.1.2. Legal Coverage .6 2.1.3. Contnbutions .6 2.1.4. Benefits .7 2.2 THE STATUS OF THE NEW SYSTEM ............................................................................ 10 2.2.1. Membership and Coverage .10 2.2.2. Transfers .12 2.2.3. Fees and Insurance Costs .13 2.2.4. Investment Restrnctions and Performance ......................................................... 14 3. THE PROBLEMS OF THE NEW PENSION SYSTEM ..................................... 18 3.1 COVERAGE ........................................................... 18 3.2 THE FINANCIAL FEASIBILITY OF THE PUBLIC SOCIAL SECURITY SYSTEM .. 21 3.3 BENEFIT UNCERTAINTY ........................................................... 23 3.4 THE COST-EFFECTIVENESS OF THE FUNDED REGIME ............................................... 24 3.4.1. The magnitude of the costs ofAFJPs ......................................................... 24 3.4.2. Regulation alternatives to increase the efficiency: The problem of volatility ........... 27 3.5 THE INSURANCE INDUSTRY AND ITS RELATION WITH THE PENSION SYSTEM .. 28 3.5.1. The disability and death insurance ......................................................... 28 3.5.2. The benefits in thefunded scheme ......................................................... 29 4. CONCLUSIONS ........................................................... 31 5. REFERENCES ....................................................................................................33 STATISTICAL APPENDIX ..35 3 The Pension System in Argentina six years after the Reform 1. INTRODUCTION This document presents a description of the Pension System in Argentina, assessing its performance six years after the major reform that introduced a multipillar scheme. We particularly concentrate our attention on those aspects that are problematic and require further refinement. The Argentine Pension System includes a national system, the SIJP (Sistema Integrado de Jubilaciones y Pensiones - Integrated System of Retirement and Pensions), as well as smaller governmental provincial systems, provincial-level professionalfunds and some special systems that cover the military and security forces. The legal coverage of the SIJP is almost universal, since it includes public and private employees as well as self employed. The provincial systems cover government employees of the provinces or municipalities that have not yet joined the SIJP (approximately one half of all provinces) and there are a large number of professional funds -mainly provincial employers funds (for instance, the Bank of the Province of Buenos Aires) and special systems (like the Military and the Federal Police). Out of the approximately 13 million active, employed workers in Argentina, 4.7 million contribute to the SIJP, around a million contribute to provincial regimes and 500,000 to the other schemes. Roughly 6.8 million workers do not contribute to any system (most of them should belong to the SIJP) and, therefore, may not have adequate retirement savings. This analysis is focused on the SIJP, because it is the system with the widest scope and it is slowly absorbing the other schemes. Nevertheless, it is important to mention than the problems ofprovincial and sectoral regimes should be carefully addressed, because they appear in some cases to be financially unsustainable. The second section describes the basic framework of the new system. Next, the third section presents information on the evolution of the system in itsfirstfive years of operations. Section four discusses the performance of the new system and its success in providing adequate social insurance coverage. Finally, section five presents the main lessons of tbe Argentinean experience with pension reform. 4 2. THE BASIC STRUCTURE OF THE SIJP 2.1 The New System Argentina's new pension system, established in 1994, is made up of a Public PAYG Regime and an Individual Funded Regime. In this section, we briefly describe the operation of this new system, including the multipillar scheme, its coverage, contribution rates, benefits, and the Government role in the operation of SIJP. The structure of the new system is somewhat complex, and a diagram describing the main institutions and characteristics is included at the end of the section. 2.1.1. The Multipillar Scheme The national pension system in Argentina (SIJP) is designed according to a model known in the literature as "multipillar". The system has three pillars; one, run by the government, that is mostly compulsory and offers a basic benefit; the second, run by the government and private managers, is also compulsory and pays benefits in relation to past contributions. The third pillar, of voluntary participation, is run by private managers and is very small. The first pillar is run as a pay-as-you-go scheme, by the National Social Security Administration (ANSeS). It is financed by employers' contributions (16% of gross taxable income, according to the law) and the main benefit from this pillar is a Ulniversal Basic Benefit (PBU, a monthly flat amount of approximately 28% of average wages, that can be claimed by any worker with 30 years of contributions and that has reached the minimum eligibility age. The second pillar, financed by employees contributions (11% of gross taxable income), consists of two alternative regimes: a pay-as-you-go regime, managed by ANSeS and a Funded Regime, managed by privately owned Pension Fund Managing Companies (AFJP).' Disability and survivors benefits are financed by the second pillar, depending on the option (funded or pay-as-you-go) the worker has chosen, while survivor benefits due to death of a retiree are financed in the same way as the retirement payment. Besides the elements already described, the SIJP has a transitional benefit, aimed at providing benefits to workers that contributed to the old system. All workers with contributions before the reform and retiring after 1994 will receive a Compensatory Benefit (PC), proportional to the pre-retirement income and the number of years with 1 Assuming that a worker contributes 35 years in a row, with a commission of 3.5% of his salary, a wage increase of 2% annually and 5% annual earnings, he will receive approximately 30% of his last wage as a pension for life. 5 contributions to the old system.2 In addition, workers retired before the reform will continue to receive their benefits. The administration of the new first pillar, the PAYG second pillar, the benefits paid out under the old system and transitional benefits is concentrated in one scheme, called the "Public Pension Regime" (RPP), that is managed by a government agency, the National Administration of Social Security (ANSeS). Additionally, the RPP covers part of the cost of annuities for disability and survivors benefits in the funded regime. 2.1.2. Legal Coverage Participation in the SIJP is compulsory for wage earners in the private sector, employees of the National Government and of Provincial or Municipal Governments that have joined the system and for self employed workers. Some special groups, as directors and partners of companies, members of administration councils, clergymen, housewives and others may join the system on a voluntary basis. Members of the military and security forces and other small groups are excluded. When workers enter the labor force they are automatically included in the first pillar scheme, and must choose between the PAYG and the funded regimes for their earnings related scheme. If they choose the PAYG, they can switch to the funded scheme at any time. If they chose funded, they cannot go back to PAYG. The default option (applied if the worker does not make and explicit choice) is the funded scheme.3 2.1.3. Contributions Contributions to the SIJP are compulsory, and workers in the funded scheme can also make additional voluntary contributions. Employees and employers are required to contribute 11% and 16%4 of taxable income, respectively. The self-employed must contribute 27% of a pre-defined taxable income. Voluntary contributions can be made by workers (called "imposiciones voluntarias") or by employers (called "depositos convenidos"). The law defined a minimum taxable income, equivalent to approximately 33% of average wages, and a maximum, of about 6 times the average wage. Employers' contributions, and 16 of the 27 percentage points of the self- employed, are transferred to ANSeS and used to finance the RPP. To complement these contributions, some earmarked taxes are also directed to the ANSeS, and any remaining deficit is covered by the National Treasury. 2 This method for dealing with the benefits accrued in a PAYG scheme contrasts with the recognition bond method used in other countries such as Chile. 3 Workers in the labor force at the time of the reform were given a five month period to choose which regime they prefer, the default option being the funded scheme. 4 As mentioned before, the employers contribution rate can be reduced by decree. Since 1994 a complex scheme of reductions by location and industry is in place, generating an actual contribution rate of approximately 8% as of the end of 1999. 6 Employees' contributions, and 11 of the 27 points of the self employed, are transferred to ANSeS and used to finance the RPP if workers choose that regime, or transferred to a pension fund (after AFJP fees are deducted) if workers choose the funded regime. In this case, the AFJPs withdraw their commissions from the employee contributions, resulting in a smaller net contribution of around 7.5% of taxable income. If workers do not make an explicit choice, they are assigned to an AFJP. 2.1.4. Benefits The public pension regime pays separate benefits to pensioners under the old system, and to affiliates of the new system. The benefits for the new system are the (a) Basic Universal Benefit (PBU); (b) Compensatory Benefit (PC); (c) Additional Benefit for Permanence (PAP); (d) survivorship and disability benefits. In addition, the funded regime offers (e) Ordinary Retirement (RO); and (f) survivorship and disability benefits to those who choose this scheme. (a) Basic Universal Benefit (PBU) is a redistributive, flat benefit. Retirees of the SIJP who have contributed to the system (either the new or the old one) for 30 years or more are eligible at 60/65 years old (females/males). The benefit level is approximately 28% of average wage. (b) Compensatory Benefit (PC) is a benefit for individuals who meet the criteria for the PBU for age and years of contributions and have contributed to the old system. They receive 1.5% of pre-retirement income per year of contributions to the old system. Thus, a worker with 35 years of contributions retiring immediately after the reform would have receive a PC of 52.5% of his/her previous salary, while young workers entering the labor force after the reform will not receive any PC. (c) Additional Benefit for Permanence (PAP) is a benefit for workers who meet the criteria for the PBU and decided to join the second pillar PAYG scheme. They receive 0.85% of pre-retirement income per year of contributions to the new second pillar PAYG scheme. Thus, a worker with 35 years of contributions to this scheme will receive a PAP of 29.75% of his/her pre-retirement income, while somebody who retired immediately after the reform (or who chose the funded second pillar regime) will not receive any PAP. (d) Survivors and Disability Benefits are benefits for survivors of contributing workers in the second pillar PAYG scheme (limited to spouse and young children of active contributors) or the workers, if they become disabled. Benefits are pre-defined. Disabled workers receive 70% of their salary before the disability and survivors receive between 50% and 70%, depending on the family structure. Benefits are reduced and even denied if compliance has been too low5. 5 The "regularity" rule establishes that only workers with contributions in more than 29 of the last 36 months receive full benefits, those with less than 30 but more that 17 months receive reduced benefits (by 5/7) and those with less than 18 months receive no benefits. 7 (e) Ordinary Retirement (RO) is a benefit received by affiliates of an AFJP once they retire. This benefit is paid in addition to any other from the RPP that the workers have accrued rights, such as PBU and PC. Benefits are paid in the form of annuities, scheduled withdrawals or fragmentary withdrawals. In the first case, the beneficiary buys an annuity from a retirement insurance company (CSR), and the balance of the account is transferred to this CSR. Annuity contracts are highly regulated and only life annuities that include survivors' benefits are allowed. The basic parameters used to calculate the benefits (life tables and interest rates) are established by the Supervisory Agencies. Alternatively, beneficiaries can leave their balance in the pension fund, and agree with the AFJP to withdraw a monthly amount that cannot exceed what they would get from an annuity. Every year the agreement is reconsidered and amounts are adjusted, with a reduction unless returns were high enough to compensate for the aging process. At any time, the beneficiary may use his balance to buy a regular annuity. In the event of the death of the main beneficiary, the balance of the account is used to finance the survivors benefits (either as an annuity or a scheduled withdrawal, depending on the desire of the survivors) and, if there are no beneficiaries, the balance becomes part of the deceased's estate. The third option, the scheduled withdrawal, consists of a monthly withdrawal from the individual account that exceeds what the beneficiary would get from an annuity, but is less than 50% of the maximum PBU. (f) Survivors and Disability Benefits are benefits for survivors of contributing workers in the second pillar funded scheme (limited to spouse and young children of active contributors) or the workers, if they become disabled. Benefits are calculated with the same criteria as in the PAYG scheme (including the rules on regularity), but the financial arrangement is different. Once the right to a benefit is established and the monthly amount is calculated, the AFJP must calculate how much capital is necessary to acquire an annuity that would cover such benefit. Then, the AFJP, drawing from the disability and survivors insurance, must complement the balance of the account to reach this amount. Once the money is deposited, the beneficiaries may choose to buy an annuity or agree on a scheduled withdrawal, according to their own preferences. During the transitional years, part of the complementary capital is paid by ANSeS6 6 The decree 55/94 established that the National Government participates in the constitution of the Complementary Capital with a sum proportional to the age of the workers in 1994. 8 Figure 1. Scheme of the Integrated Pension System (SIJP) REVENUES IE1 F OWN 16/ Payroll Tax from employers Old System (may be reduced by decree) Benefits 16% Payroll Tax from self- Universal Flat employees Benefit (PBU) 11% Contributions of employees affiliated to this regime Copnsatory Benefit (P) | GENERAL REVENUE TAXES Pay-As-You-Go _ -cI Value Added Tax I Pernnence I Income Tax BRegm _ senefit (PAP)j Wealthi Tax Gas Tax Fup.rwvors Renefit Others 30% Of PERixatization Disability Benefit1 30°/c of Privati7afionsll Advanced Age Integrated Pension Benefit System OWN I I%Personal Contributions of employees affiliated to this regime Capitalization 1 1% Personal Contributions of Regime self-employees affiliated to this reginmer Commnission to Accumiulatio | Ordinary| thle AFJP . Z Win Individual Retirement Life Accounts I _ ~ | Annuities Disability l Sheduled _ Benefit f ~Withdrawall | AFJP Life anid _ |Expenses . Disability _ [Fragmen