Panama: Selected Issues and Statistical Appendix
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This Selected Issues paper on Panama explores the current situation and trends of the Caja del Seguro Social (CSS) in Panama. The autonomy is embedded in its Organic Law, which also provides the agency with the right to have separate funds from the central government. The slowdown in economic activity and employment has led to a decline in the coverage of the social security system. The Panamanian pension levels are generous, despite the lack of indexation, even by the high standard of advanced European countries, and among the highest in Latin America.

Abstract

This Selected Issues paper on Panama explores the current situation and trends of the Caja del Seguro Social (CSS) in Panama. The autonomy is embedded in its Organic Law, which also provides the agency with the right to have separate funds from the central government. The slowdown in economic activity and employment has led to a decline in the coverage of the social security system. The Panamanian pension levels are generous, despite the lack of indexation, even by the high standard of advanced European countries, and among the highest in Latin America.

Panama: Basic Data

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Sources: Panamanian authorities; and Fund staff estimates.

In percent of initial stock of liabilities to the private sector.

I. The Social Security System—A Pending Reform1

Summary

  • There is a broad public agreement that: (i) the social security agency (CSS) is facing a severe financial crisis; and (ii) urgent measures are needed to ensure its sustainability.

  • This chapter explores the current situation and trends of the CSS in Panama, and the options put forward by the members of the national dialogue on social security reform to address the financial crisis.

  • The cornerstone of the problem is the imbalance between pension benefits and contributions to the pay-as-you-go system. The liability to current pensioners is estimated at US$2.7 billion (21 percent of GDP). The total unfunded obligations, taking into account the claims of current contributors, was estimated at 56 percent of GDP in a 1998 ILO study. On current trends, the financial reserves would be depleted during the next decade.

  • The UNDP is assisting as a facilitator of the national debate and a compiler of the proposals presented by the government, employers, workers, and the civil society. Consensus has been reached on some key components of the CSS programs, but the task force on pensions (IVM) has reached no conclusions.

  • Proposals tabled have included higher contribution rates, a longer minimum contribution period, changes in retirement age (employers), and the preservation of existing benefits (workers). Because no single measure would solve the problem, there is a need for a combination of the different proposals put forward by the IVM task force, and an important element of a comprehensive reform would be a reduction in the costs of administration of the social security system.

  • The current authorities in coordination with the forthcoming administration (presidential elections are scheduled for May 4, 2004) will face the challenge of taking actions needed to attain the financial viability of the CSS, and ensure that it will remain financially viable over the long term.

A. Overview of the Social Security System

Basic characteristics of the system

1. The social security system is administered by the Caja del Seguro Social (CSS), a public agency with substantial administrative and financial autonomy.2 The autonomy is embedded in its Organic Law, which also provides the agency with the right to have separate funds from the central government. To provide comprehensive social protection, according to the constitutional mandate,3 the CSS is organized in four independent programs: (i) disability, old age, and death benefits (IVM); (ii) health and maternity care (HM); (iii) professional risks (PR); and administration (AD). The administration program encompasses the operational and administrative activities of the CSS. The pension program (IVM), a pay-as-you-go system, accounts for more than half of the total CSS revenue and expenditure.

2. The slowdown in economic activity and employment has led to a recent decline in the coverage of the social security system. The coverage of the CSS, defined by the sum of its affiliates and dependent beneficiaries, in relation to the population, reached 67 percent by end-2002.4 About 56 percent of the economically active population (EAP) contributes to the CSS, but the coverage rate has decreased slightly in the last few years (Figure I.1). The number of active contributors also has decreased in the last three years, possibly because of evasion.

Figure I.1
Figure I.1

Economic Cris is and Labor Markets have Negatively Impacted Coverage of the System

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

3. The Panamanian pension levels are generous, despite the lack of indexation, even by the high standard of advanced European countries, and among the highest in Latin America (Tables I.1 and I.2). The pensionable base or the reference wage is the average wage over the best seven years of a worker’s wage history. For a minimum contribution period of 15 years, a worker receives a pension of 60 percent of the reference wage (minimum replacement rate), and for every additional year of contribution, 1¼ percentage points are added, up to 100 percent. A ceiling on the monthly pension of US$1,500 is not binding for most pensioners, since the average monthly wage is below US$450. The retirement age is 62 years for men and 57 years for women.

Table I.1

Panama: Latin America—Comparison of Retirement Ages, Contribution Period, and Replacement Ratesxb

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Source: Mesa-Lago, Betranou (1998).

(a) Not defined for the new system.

(b) Only for minimum pension.

(c) Defined every year.

Table I.2.

Panama: Comparison with Europe’s Contribution Rates, Retirement Age,

Minimum Contribution Period and Replacement Rates

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Source: International Labor Organization.

4. The CSS is under-funded despite a combined contribution rate over 20 percent. The allocation of contributions from employers, workers, and the government is detailed in Table I.3. Self-employed workers contribute 18 percent of their labor income, in the absence of an employer contribution. Surpluses in one program cannot be used to finance deficits in other programs. An additional source of funding is the return on the financial reserves, miscellaneous services fees, and the government contribution (Figure I.2).

Table I.3.

Panama: Allocation of Contributions Among the CSS Programs

(In percentage of gross salaries)

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Source: Social Security Agency (2003).

Average premium. The contribution rate for the Professional Risk program varies between 0.9 and 5.0 percent according to the risk category.

Figure I.2

Social Security Agency—Financing Structure 2002

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

The CSS financial crisis

5. The finances of the CSS have deteriorated markedly in recent years. The balance shifted from a surplus (after government transfers) of US$141 million in 1998 to an estimated deficit of US$60 million in 2003. Interest income from financial reserves helped ensure an overall surplus in earlier years. However, this income source is on a declining path, since reserves started to decline in 2002 to cover the remaining deficit after government transfers. The deficit is projected to widen progressively in the absence of reform (Table I.4).

Table I. 4.

Panama: CSS Income Statement (In millions of U.S. dollars)

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Source: Social Security Agency.

6. The financial imbalances in the CSS have been exacerbated by a sharp increase in operating costs, stagnant government contributions, and a marked decline in other income. In the last seven years, personnel expenditure has grown 52 percent, well above the growth in contributions; while other operating expenditure grew 32 percent in the same period. In the period 1999–2002, total expenditure grew 24 percent, while total contributions rose only 6 percent. The relatively poor performance in contributions is associated with arrears of the public and private sectors, and probably also an increase in evasion and informal economic activity. At end-June 2003 the arrears amounted to US$162 million, or 1.3 percent of GDP. Additionally, financial income from the reserves has been sharply reduced due to the lower international rates and a conservative portfolio management strategy. Added cost pressures result from automatic wage increases (Leyes Especiales) for several groups of CSS workers (Figure I.3).

Figure I.3
Figure I.3

Social Security Agency—Income and Revenue Performance

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

7. The reserves of the CSS fall short of the legal requirement by 21 percent of GDP (Figure I.4).5 The actuarial deficit is defined as the difference between the reserves required by the CSS Organic Law and the available reserves. The CSS projects that, on current trends, the reserves could be depleted by 2013 (Figure I.5). This date is even earlier than indicated in the study made by the International Labor Organization (ILO),6 which had forecast that reserves would continue until 2018. This study also estimated the total unfunded pension liabilities, including obligations to current contributors to the IVM, at US$7.1 billion in NPV terms, equivalent to 59 percent of GDP. Large future pension deficits reflect a rising dependency ratio, which is projected to increase from 11 percent in 2001 to 43 percent by 2050.7

Figure I.4
Figure I.4

IVM Actuarial Deficit and Reserves

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

Figure I.5
Figure I.5

IVM Reserves 1995–2020

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

8. The financial deterioration is rooted in several structural factors. In addition to the aging of the population, the current pension contribution rate of 9.5 percent is low relative to the size of pension benefits. The CSS imbalances are compounded by the recent rapid growth in personnel in the social security sector, which may not be easily reversed. The 2001 ILO study had forecast that reserves would begin to be drawn down to cover the pension deficit starting in 2005; however, as noted above, this began in 2002. The problem of unsustainable CSS finances has become larger and more urgent than before.

B. National Dialogue on Social Security Reform

The political process and the task forces

9. In Panama, as in any country, social security reform is a sensitive political issue. The government’s strategy is to build a strong consensus for reform that leads to ownership across broad segments of society.8 In 1991, a pension reform increased the retirement age by two years and eliminated the option of early retirement. These measures intended to maintain a positive overall balance until 2020, so that reserves would not need to be drawn down. However, despite the high political cost paid by the administration at that time, by 1994 it was clear that these changes were insufficient.

10. The National Dialogue on social security reform achieved consensus on key issues, but it has been unable to agree on reform of the most important program, the pension scheme. In March 2001, President Moscoso called for a National Dialogue on the CSS and asked the UNDP to facilitate the debate. Workers, pensioners, employers, academics, and representatives of civil society were invited to participate in the dialogue. The UNDP organized several seminars for all Dialogue participants on the characteristics of the CSS and its current and prospective financial situation, and it supported the development of an actuarial model to evaluate proposals for reform.

11. The National Dialogue created four task forces in August 2001, one for each of the programs administered by the CSS. By November 2002, only the task forces on the health care and maternity program and the CSS administration program had reached full consensus. The task force on the workmen’s compensation program drafted a revised law, but not all aspects of it had been agreed with the workers representatives. The pension task force has found the question of burden sharing in the design of pension reform to be intractable. Its deliberations have concentrated on the estimation of unfunded pension obligations (i.e., the size of the actuarial deficit), on the basis of which different proposals would be assessed. Various proposals have been presented to the task force, including higher contribution rates, a longer minimum contribution period, changes in retirement age (employers), and the preservation of existing benefits (workers). The actuarial model was being validated by the CSS in early 2004, after which it may be made available to National Dialogue participants. It would provide updated projections of unfunded (direct and contingent) liabilities of the pension system and could be used to quantify the impact of proposals for pension reform (Table I.5).

Table I.5.

Panama: Main Consensus Reached by the Task Forces

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The government proposal

12. President Moscoso presented a proposal to the National Dialogue on social security reform that called for burden sharing between the public and private sectors. The government would contribute an income stream to the IVM reserves from a trust fund that would receive the remaining shares of privatized enterprises. This equity is valued at an estimated US$700 million. The proposal also included recommendations for:

  • increasing the pension contribution rate by 2 to 3 percentage points, to be distributed between workers and employers, with an estimated NPV of US$1.4–2.2 billion; and

  • improving the return on the financial reserves by investing in higher yielding financial assets such as the Panamanian global bonds.

The combined effect of the proposed measures would be to delay the need to draw from the financial reserves until about 2040.9 A deficit would eventually emerge, based on the demographics and economic assumptions, since the projections assumed no change in the requirements and benefits provided by the IVM program (Figure I.6).

Figure I.6
Figure I.6

IVM Reserves Government Proposal

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

Source: Ministry of Economy and Finance.

C. Looking Ahead

13. A political decision would need to be taken in light of the low probability of reaching consensus on the financing of the actuarial deficit by the members of the task force. Final approval of the actuarial model by the CSS does not guarantee that the results will be accepted by all members, particularly labor union representatives. Even if an agreement is reached on the size of the actuarial gap and, the quantitative impact of the proposals, the pension task force would still face the difficult task of agreeing on the burden sharing to be embedded in a comprehensive pension reform that could achieve the long-term financial viability of the pension program (Figure I.7).

Figure I.7
Figure I.7

Social Security Agency—Return on the IVM Reserves

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

14. The work of the National Dialogue can provide a basis for social security reform. Until now, the government and the UNDP, as facilitator of the Dialogue, have maintained the objective of attaining full consensus. As a result, the validation of the actuarial model has not been finalized, a step that is required before evaluating alternative reform proposals. In principle, once the model has been validated, the authorities could decide to make it available to all National Dialogue participants, and invite them to present reform proposals and quantify their impact. Future decisions on the design of pension reform could be based on the results of these assessments.

15. The authorities have taken steps to improve the finances of the CSS, including by allowing greater flexibility in the management of the pension reserves. In line with the strategy announced by the current administration in 2003, the CSS was authorized to utilize private sector financial intermediaries to help manage the financial reserves, a task that had been assigned exclusively to the National Bank of Panama (BNP). The aim is to increase the return on the reserves, which averaged 4.6 percent in August 2003 by investing in Panamanian global bonds, which currently yield 8 percent (Table I.6). This investment is authorized by the CSS Organic Law and has the potential to substantially increase the overall rate of return10.

Table I.6.

Panama: CSS Financial Assets and Average Return

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Source: Social Security Agency (2003).

16. The National Dialogue has set the stage for a comprehensive social security reform. Progress has been made through the National Dialogue in achieving consensus on reform of some of the CSS programs, and a model is nearly ready that could be used to evaluate proposals for pension reform. The increased public awareness of the need for social security reform helps establish the feasibility of the needed reforms.

References

  • Caja de Seguro Social, 2003, Compendio Estadístico y Financiero de la Caja de Seguro Social, Panamá. Dirección Nacional de Planificación.

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  • International Labor Organization, 2001, Valuación Financiera y Actuarial de la Caja del Seguro Social (CSS), Panamá.

  • International Labor Organization, 1998, “Panama: Valuación Financiera y Actuarial Integral de la Caja del Seguro Social y Elaboración de un Modelo de Cuentas Sociales,” Informe, Panamá.

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  • International Monetary Fund, 2000, “Social Security System, Current Trends and Directions for Reform in Panama,” Selected Issues and Statistical Appendix. IMF Staff Country Report No. 00/44, International Monetary Fund, Washington, D.C.

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  • Mesa-Lago, C. and F. Bertranou, 1998, Manual de Economía de la Seguridad Social, Montevideo: Centro Latinoamericano de Economía Humana.

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  • Ministerio de Economía y Finanzas, 2002, “Program de Invalidez, Vejez y Muerte,” Propuesta del Gobierno Nacional. Caja del Seguro Social (CSS), Panamá.

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  • Simone A., 2003, Panama’s Social Security System (Mimeo), International Monetary Fund, Washington D.C.

1

Prepared by Oscar A. Hendrick (WHD)

2

Created by Law 23 in March 1941.

3

Political Constitution, Article 109 and 110.

4

This included some 640,000 active contributors, 140,000 pensioners, and 1.2 million dependents.

5

The CSS Organic Law requires the CSS to maintain a level of capital reserves equal to the present value of all obligations to current pensioners (Articles 34 and 34a).

6

The 2001 ILO study updated a 1998 study, which projected the depletion of reserves in 2023. The assumptions in the ILO studies, which preceded the growth slowdown of 2001–02, were more optimistic than in subsequent projections.

7

Defined as the ratio of pensioners to contributors to the pension scheme.

8

The current administration has a slim majority in the Assembly.

9

“Programa de Invalidez, Vejez y Muerte: Propuesta del Gobierno Nacional, Caja del Seguro Social”;. Presentation by the Vice Minister of Finance, MEF, June 2002.

10

The fiscal impact of increasing the yield of reserves would be partly offset by a reduction in NBP profits, hence in dividends paid to the government, since the CSS deposits with the NBP (equivalent to 7 percent of the GDP) are a low-cost source of funding for the BNP.

Annex: Testing the Stability of Panama’s Banking System: Two Episodes

Panama’s experience in avoiding or coping with banking crisis and liquidity shortages includes two episodes that stressed the banking system and tested the stability of the financial sector. Both arise from exogenous shocks, namely the political crisis during the Noriega period and the shock created by the global slowdown and the unsettled financial markets in South America in 2001–02.

A. Noriega Period

Panama went through a period of political instability and sharp economic contraction during 1988–89, posing a severe test to the stability of the banking system. Political instability and external sanctions led to a deep banking crisis in Panama, and a cumulative decline in real GDP of 15 percent. In March 1988 the U.S. government froze official Panamanian deposits in the United States, suspended the clearing arrangement between the BNP and the Federal Reserve, and withheld payments for use of the Panama Canal.

Banking activity was curtailed by a bank holiday that began in March 1988. The National Banking Commission declared the holiday in order to halt capital flight, and extended it for nine weeks (Box). The payments system was seriously disrupted. All general license (onshore) banks were closed, but those with significant international transactions were allowed to request an international license to continue their offshore operations. Restrictions on interbank balances were partially removed after four months.

Large deposit withdrawals led to liquidity shortages and a contraction of banking system operations. Bank deposits fell by a cumulative 30 percent (11 percent of GDP) during 1988–89, resulting in a 25 percent reduction in credit to the private sector, a sharp decline in foreign assets, and a 40 percent loss of bank capital. Liquidity constraints gave rise to a secondary market in restricted deposits,1 as banks issued certificates of deposit (CEDIs) in exchange for restricted deposits.2 However, during the freeze, deposit interest accrued normally, and as a result no depositors lost money beyond the artificial reduction in interest rates.3

Operations of the BNP were seriously affected during the political crisis. Private sector deposits decreased by half, and private nonperforming loans reached more than 50 percent of the loan portfolio. The BNP stopped servicing its external obligations. Regulatory forbearance allowed the BNP to continue operations, since it was the only bank that provided services throughout the country through an extensive branch network.

The banking system recovered in 1990–91 without major bank failures or large fiscal costs. A new administration took office in December 1989 and adopted a set of measures to foster confidence, and bank liquidity improved markedly in 1990–91 following the U.S. release of Panamanian government funds and sizable foreign capital inflows. Private sector deposits at end-1990 were larger than the pre-banking crisis peak in 1986. The recovery of credit to the private sector started slowly in 1990 and picked up significantly in 1991, as economic activity rebounded.

A number of points emerge from the Noriega episode:

  • Three bank closures led to depositor losses but did not precipitate a crisis of confidence in the banking system.

  • The banking crisis did not have direct fiscal costs.

  • The BNP is no stronger than the government finances backing the institution. Private banks, on the other hand, were able to tap international support to service their obligations.

B. Regional Financial Market Turbulence and Banking System Stress

The banking system weathered the global economic slowdown and the unsettled financial markets in South America in 2001–02. Concern about the exposure of the Panamanian banking system to Argentina and Brazil led to an 18 percent drop in deposits and other funding sources over the two years to December 2003. Most of the drop was in deposits from nonresidents, as foreign interbank deposits decreased by 36 percent during the period (Figure II.1). In response, banks reduced credit to nonresidents (mainly in Argentina and Brazil) by 43 percent over the same period. Such a large contraction was possible because a significant share of the credit granted by Panamanian banks is short-term financing.

Figure II.1
Figure II.1

Panama: Credit and Deposits in the Panamanian Banking System, 1998–2003

(In millions of U.S . dollars)

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

Source: Superintendency of Banks.

Balance-sheet downsizing was concentrated in foreign-owned banks, which are specialized in foreign lending; foreign operations of domestic banks are a minor component of their loan portfolio (Figure II.1). The bank with the largest exposure in South America is Bladex, a supranational commercial bank specializing in trade finance to the region. To cope with its problems in Argentina, Bladex sold most of its assets in that country and raised its equity by more than 60 percent or US$147 million in June 2003. Its unweighted capital-asset ratio rose from 9 percent at end-2001 to 22 percent at end-September 2003.

The shock to the banking system arising from South America had a limited effect on bank performance indicators (Annex Tables II.1–II.4). Banks are now well capitalized with a risk-weighted capital adequacy ratio of more than 17 percent on average. Banking system liquidity decreased in 2001–02 but as of end-November 2003 the liquid assets-to-deposits ratio averaged 28 percent, and the liquidity ratio that includes marketable securities exceeded 40 percent for both foreign and domestic banks.

Annex Table II.1.

Panama: Financial Soundness Indicators of Private Panamanian Banks under General License

(Percentages, end of period)

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Source: Superintendency of Banks.

Liabilities comprise deposits and other liabilities, including debentures.

Annex Table II.2.

Panama: Financial Soundness Indicators of Foreign Owned Banks under General License

(Percentages, end of period)

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Source: Superintendency of Banks.

Liabilities comprise deposits and other liabilities, including debentures.

Annex Table II.3.

Panama: Financial Soundness Indicators of Public Banks

(Percentages, end of period)

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Source: Superintendency of Banks

Liabilities comprise deposits and other liabilities including debentures.

Annex Table II.4.

Panama: Financial Soundness Indicators of International License Banks

(Percentages, end of period)

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Source: Superintendency of Banks.

Liabilities comprise deposits and other liabilities, including debentures.

Domestic deposit interest rates trended downward following the interest rate path in the major financial centers since 2000 (Figure II.2). Foreign banks lowered deposit interest rates faster than private Panamanian banks up to mid 2002 when Bladex’s exposure in South America became known. After the re-capitalization of Bladex in mid-2003 the foreign banks spread over Libor diminished significantly.

Figure II.2
Figure II.2

Panama: Deposit Rates, 1997–2003

(In percent)

Citation: IMF Staff Country Reports 2006, 026; 10.5089/9781451830866.002.A001

Sources: Superintendency of Banks.

The banking system’s resilience to recent external shocks reflects a strong institutional framework and sound management of the banks. The upgrade in the regulatory system since 1999 strengthened the banking system to withstand external financial turmoil without a major disruption. Ample bank liquidity at the onset of the shock also helped maintain confidence. This favorable setting was aided by a downward trend in international interest rates that enabled banks to increase profit margins. Combined with administrative cost reductions and an increase in non-interest income the return on assets and equity in Panamanian banks rose above their 2000 level. The business specialization helped limit the transmission of the external shock to the domestic system as banks with large exposures in South America had little domestic business.

Major Changes in Banking Legislation During 1988–90

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Appendix: Panama: Summary of the Tax System as of September 30, 2003 1/

Panama: Summary of the Tax System as of September 30, 2003 1/

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Excluding some minor municipal taxes. B = Panamanian balboas.