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Appendix I: A Brief International Comparison
Appendix II: Concepts and Measurement of Contribution Densities
There is no unique and consistent definition of contribution densities in the literature.
Most authors agree that it measures the intensity of contributions in a given time period. Differences occur, however, regarding the definition of “intensity” and “time period”.
Most studies measure the intensity in time units. In other words, it is asked how much time a participant paid contributions relative to some total time. Some authors measure the frequency of contributions in months (e.g. De Mesa et al, 2004), others in quarters (e.g. Braham and Marouni, 2016) or even in contribution years (e.g. Melguizo et al., 2017). Usually, these differences are explained by data limitations of the respective studies. Contribution time is generally related to the “total potential periods of contributions” (Mc Gillivrary, 2003, p. 321), or put differently to the “total months or years potentially active” (Rofman et al. 2015, p. 7).
Other authors propose to measure contribution densities in monetary units, such as Valdes-Prieto (2008) who defines contribution density “as the share of (the present value of) earnings in the active phase of life on which the individual contributes to some contributory pension system”. Also, Mc Gillivrary (2003, p. 321) proposes to use such a monetary indicator in addition to a time-based contribution density metric. Additionally, the period over which contribution densities are measured differs across studies. In the case of theoretical models, a very long-time span is often considered, e.g. the entire working career of 40 and more years (OECD, 2014 or IMF, 2018a). Empirical estimates of contribution densities, on the contrary, cover often much shorter periods due to data limitations.
In this paper we apply the relatively common time-based contribution density metric. It measures the total contribution months accrued relative to the maximum possible months to be accrued. We refer to this indicator as “contributions at the intensive margin” (CIM) – following comparable terms in labor economics.
Appendix III: Considerations for a Non-Contributory Pillar and Options for Increasing Contributory Coverage1
We would like to thank Hillman Farfan Ruiz (Oficina de Normalización Previsional – ONP) and Jorge Mogrovejo Gonzales and Elio Sánchez (Superintendencia de Banca, Seguros y AFP – SBS) for excellent collaboration throughout this project and for kindly sharing the administrative pension data with us. We would also like to acknowledge useful discussions and clarifications from Ravi Balakrishnan (IMF), Noelia Bernal (Universidad del Pacifico), Lorenzo Figliuoli (IMF), Asta Zviniene (World Bank), and seminar participants at the Central Bank of Peru and the IMF. Czaba Feher (IMF) and staff of the SBS, ONP, Central Bank and Ministry of Economy and Finance of Peru provided detailed written comments which significantly improved the paper. Adrian Robles provided excellent research assistance.
Replacement rates are a standard metric in pension system evaluation and capture the ratio of pension to labor income of an affiliate. We calculate gross replacement rates since calculating net rates would require additional assumptions and information on the tax system and its development.
The net real rate of return is the gross real rate of return adjusted for fees. There are two reasons that reducing asset-based fees does not have the same effect as increasing the gross real of return. First, a significant fraction of affiliates currently still operates under the contribution-based fee model and are thus not affected by changes in asset-based fees. Second, no asset-based fees are charged during retirement. If all affiliates paid asset-based fees and these were charged during both the accumulation phase and retirement, then a change in the gross real rate of return and a change in fees would be exactly equivalent and have the exact same impact on the net real rate of return.
The SNP is the oldest pension system in Peru having been created in 1972. SNP pensions are administered by the Oficina de Normalización Previsional (ONP). The SPP was created in 1992, following the Chilean model and is supervised by the Superintendencia de Banca, Seguros y AFP (SBS).
The minimum pension is currently S/. 415 per payment and the maximum pension is S/. 857.36. The maximum and minimum pension amounts have occasionally been adjusted but there is no explicit indexation mechanism. As a reference point, the current legal minimum wage is S/ 930.
Age, number of contributions, and birth cohort are among the criteria determining eligibility for a minimum pension in the SPP. The detailed criteria are set out in laws 27617 and 28991.
Numbers are calculated based on the 2017 Peruvian household survey (ENAHO, INEI).
The 2017 IMF Staff Report for Peru notes that labor market regulations are an important contributor to informality in Peru and “education levels, the tax regime, access to public services, and enforcement of laws have also played a role”.
Current replacement rates are defined as first pension over average income over the past decade while our simulations in the next section are for first pension over final income. In practice, this does not make a significant difference since we assume in our simulations that all affiliates have the same annual wage growth and thus remain in the relative average earnings position observed over the last years 2010–2017.
Both the median and mean contribution density of current retirees was 0.38, very close to the 0.4 mean contribution density for current affiliates which will be discussed in section III.
The SPP allows for early retirement if the individual savings account has sufficient resources to finance a pension which is higher than 40 percent of the average salary over the past 120 months. It has been observed that workers who do not satisfy this requirement start making contributions on a lower income level, thereby reducing average earnings and enabling them to satisfy the replacement rate criterion. A similar mechanism can be observed in the case of early retirement due to unemployment.
Alternatively, contribution densities could be measured only for the length of affiliation. For example, a worker aged 40 who enters the SPP for the first time in 2016 and contributes for the full 12 months has a contribution density of 20 percent over 2012–16 (=12 out of 60 potential months) using one methodology but a contribution density of 100 percent under the alternative methodology. Overall contribution densities are about 4 percentage points higher when using the alternative methodology.
It is worth pointing out that average earnings of affiliates are higher in the SPP than in the SNP. The average monthly wage in the SPP was 2700 Soles in 2016 (age groups 20–64) while it was 1300 soles in the SNP. One likely explanation is that the maximum pension in the SNP leads higher earnings groups to join the SPP.
It should be noted that the relatively low contribution densities may to some extent be explained by the elimination of obligatory contributions for groups of self-employed.
Since earnings data is not available for all affiliates, contribution density estimates for earnings quintiles are not strictly comparable to overall averages. The sample size used to calculate quintiles is smaller than the overall sample used for averages.
This figure may underestimate the share of SNP affiliates who are unlikely to reach the 20-year threshold because it is based on contribution histories of only those affiliates who made at least one month of contribution in the period 2012–2016. In other words, fully inactive SNP affiliates (about 27 percent of the sample) are disregarded.
In line with the data, contribution densities are assumed to rise between ages 20 and 30.
The earnings position is measured based on average earnings in 2012–16. Earnings prior to 2016 are indexed with general wage growth to 2016.
Public sector employees who usually experience steep earnings careers are to a significant degree not captured by our data – given older age groups are affiliated with the now closed cedula viva special regime. This aspect likely contributes to the relatively flat earnings profile observed.
It should be noted that SNP pensioners additionally receive some bonuses established by law which are neglected in our calculations. One of these bonuses is paid for advanced age, so called Bonificaciones de Edad Avanzada. They are granted to pensioners who are 80 years or older and equal 25 percent of the pension. Under a consideration of this additional SNP benefits the replacement rate in the SNP would be somewhat higher.
The contribution density applied for the projection is measured by dividing the total contribution months accrued in a given time span by the overall months in this time span. If an affiliate entered the SPP during the observation period, the denominator reflects the total months from the affiliation start date until the end of the observation period.
A longer reference period is chosen here compared to SNP due to the fact that earnings information for SPP is sparser and provided only for one month in a given year.
The simulations do not consider voluntary contributions.
Assuming constant asset-based fees over the forecast horizon is a relatively conservative assumption given the recent downward trend.
The contingent probability to survive from retirement age r in year t until a future age f is estimated as follows:
The value of ax is an additional information provided in the SPP-S-2017 mortality tables.
Note that while the simulation assumes that all pensioners in the SPP choose an annuity, other retirement options exists in Peru.
It is worth noting that women account for significantly less than half of total affiliates in both the SNP and SPP. Moreover, it should be noted that gender-specific earnings differences, generally, do not affect replacement rates as they are considered both in the nominator and denominator of replacement rates.
The Peruvian Social Protection Commission (2017) presents empirical replacement rates, too. Unfortunately, the published report lacks details on the projection assumptions. Thus, they are omitted in Table 3.
All else equal, moving from commissions based on the flow of contributions (so that total contributions are 10 percent of gross earnings plus 1–2 percent for commissions) to a system where fees are charged on the stock of contributions (so that total contributions are 10 percent and commissions are later deducted from the stock of assets) reduces replacement rates. Having said that, there are many valid reasons for changing from a flow to stock commissions system (see further below).
One consideration could be to make the added contributions employer-contributions. Peru is an outlier in having the full contributions on the employee side at the moment. Higher employer contributions could still be borne by employees over the long-term, however (see Melguizo and Gonzalez-Paramo. 2013 and Saez et al., 2012 for a discussion). For certain groups which are more likely to react to contribution rate changes by lower/higher formal labour supply, such as the young, a subsidy covering (part) of the employer contribution could be considered. As mentioned in the body of the text, there might exist a trade-off between higher labor informality and higher replacement rates for those who are in the formal sector.
According to Inter-American Development Bank data, over half of all workers in Peru receive less than or equal to the minimum wage, highlighting the difficulty of saving sufficiently for retirement.
Early retirement before 65 is also possible under certain conditions. In the SNP, at age 55 with at least 30 years of contributions (men) or age 50 with at least 25 years of contributions (women); age 55 (men) or age 50 (women) with at least 20 years of contributions in the event of a collective lay-off from employment. In the SPP, retirement is possible at any age if the individual account has accumulated assets that will replace at least 40 percent of average indexed earnings in the last 120 months. The cut-off used to be 50 percent but was changed in 2012.
To avoid double-charging people who had already been paying fees on the flow, a complicated structure was introduced. First, all contributors who had been members prior to 2013 could choose whether to migrate to the new fee set-up or stay with the old one. If they chose to migrate to the new one, a 10-year transition window was created where “mixed commissions” are charged – a weighted average between flow and asset-based fees (asset-based fees only on the amount accumulated since 2013), with the weight on the stock slowly increasing over time.
See Bernal and Olivera (2019) for a detailed discussion of the impact of the change in the fee structure on affiliates.
The 2017 report by the Peruvian Social Protection Commission contains a detailed discussion of pension fund fees and commissions in Peru, including some regional comparisons. They conclude that at the time of writing they were relatively high in Peru.
Reducing commissions is a difficult task with many factors potentially influencing this equilibrium price. Market size appears to be a key factor and it is largely outside the scope of policy makers (see Carranza and others, 2017).
With the remaining 4.5 percent going to health insurance.
It is concerning that most withdrawals are to pay down existing mortgage debt rather than for down payments. Down payments involve the acquisition of new assets so it could more easily be defended as a valid alternative way of old-age savings even though the absence of reverse mortgage markets limits the cash flow which can be generated by the asset.
As of 2016 there were 6 insurance companies which offered annuities in Peru.
If we consider a scenario where the minimum and maximum pension increase with wage growth, replacement rates would be around 26 percent in 2045.
The calculations assume that the microdata we have are representative for each cohort individually and not only for the system as a whole (not necessarily true but perhaps a reasonable approximation). The net cost might be somewhat lower if it implies that less people would receive Pension65. On the other hand, the calculations do not consider the likely negative impact on SNP revenues (e.g. affiliates choosing to stop contributing earlier than they would have otherwise) which would imply a higher net fiscal cost.
Additionally, long vesting periods to receive a pension annuity play a role. For instance, in Uruguay, no pension is paid out if fewer than 30 years of contributions have been accrued.
In Colombia, high adequacy is due to defined benefit (DB) entitlements. It is assumed that future new contributors, who have the choice between DB and DC, opt for the more generous DB scheme. Individuals with a low contribution density of 50 percent, however, do not fulfill the vesting period (1150 weeks) for DB annuities and therefore end up with significantly lower (DC) replacement rates in Colombia.
It is assumed that the agent chooses at the start of his career the system which provides the highest replacement rates for a given contribution density. As a result, the lower contribution density scenario (50 percent) in the figure above reflects an SNP affiliate, while the 75 percent and 100 scenarios represent an SPP affiliate.
Options to increase coverage of the contributory pillar and the design of the non-contributory pillar are complex topics. This appendix merely lays out some thoughts, without the presumption of completeness. Future work should look more carefully at detailed policy design issues for Peru.
The beneficial effects of Pension 65 are very similar to the impact of the non-contributory pension (Adultos Mayores) found in Mexico (Galiani and others, 2014). Lopez Garcia and Otero (2017), on the other hand, only find limited effects of the Chilean non-contributory pension.
The claw-back rate (not smaller than 0 and not larger than 1) is the rate at which the non-contributory pension decreases with contributory pension savings. See Valdes-Prieto (2008) for an insightful theoretical discussion of the challenges of non-contributory pension design. Galiani and other (2014) find no negative anticipation effects of the non-contributory pension in Mexico but other studies have found an adverse impact on labor formality. See also World Bank (2008) for an extensive discussion.
Indexing eligibility to life expectancy implies that by 2050, Peruvians over 69 would be eligible. Keeping the eligibility age constant at 65 would add another 0.1 percent of GDP in annual costs by 2050. Low income is particularly acute for those aged above 70.
In Peru, legislation which calls for matching contribution for workers in firms with less than 10 employees exists, but it has so far not been implemented.
Bernal and others are currently running a field experiment in Peru which will evaluate the impact of a 50 percent and a 100 percent matching contribution.
No explicit reform scenario for matching contributions is estimated in the main body of the paper given that there currently still exists high uncertainty regarding the behavioral response of contributors with respect to matching contributions in a country with high informality.