Pension reform and private pension funds in Peru and Colombia

The author examines the performance of the new private pension systems in Peru and Colombia during their first years of existence. Peru and Colombia were the second and third Latin American countries to implement a systemic reform of their pension systems. The reforms experienced difficulties in both countries, partly because of deficiencies in the design of the new systems and partly because of shortcomings in implementation. Both countries, especially Peru, took several additional measures to rectify the design problems of their reform programs. The systems now in place differ in several important respects from the systems initially introduced. This shared experience suggests that athough flawed reform programs incur inefficiencies, the flaws can be removed and the reform programs significantly strengthened--if the authorities have a strong long-term commitment to a successful systemic pension reform. Peru's private pension funds suffered unfair competition with its public pillars, which required lower contribution rates and lower retirement ages. They suffered poor financial results partly because of low salary levels and partly because they were not given permission to defer their high start-up costs, resulting in substantial capital losses. Private pension funds in Peru have become increasingly diversified, with 25 percent of assets invested in equities by the end of 1996. But a big share of investments is in the banking sector and other financial institutions, giving the funds significant exposure to a sector that in most countries is highly leveraged and exposed to financial crises. Those investments should be more diversified sectorally. Development of Colombia's private pension system was also limited because it coexisted with the public system. Competition with the public system was not as unfair as in Peru, but the slow pace of reform in the public system and the disincentives for older workers to join the new system were a significant obstacle to faster growth. Despite using a preexisting fund management infrastructure, Colombia's private pensions funds incurred high start-up costs and suffered heavy losses. Although Colombia's financial sector was far more developed than Peru's when reform started, Colombia's portfolio has been much slower to diversify than Peru's--mostly because of high returns on fixed-income securities in Colombia and low trading in the stock market. The author discusses the public pension systems only in terms of their relationship with and impact on the private systems'functioning.