Latin America’s Spoiled Pension Ecosystem

The creation of private pension funds in Chile in the 1980s was hailed as the answer to bankrupt public systems under a free-market economic shift. The model, with worker/employer mandatory allocations as a portion of salaries, was adopted across the region and in more than two dozen other emerging markets.  Fund creation and oversight was guided and paid for by the World Bank, USAID, and other donors. Enthusiasm for the concept was so great that funders even discussed outside guarantees for private systems in countries lacking deep capital markets for investment.

The first country to dismantle its private pension pillar for short-term spending was Hungary in the wake of the GFC in 2010. The dozen year-old system was forced to transfer its USD 13 billion in assets to the state to plug the budget deficit, with the move part of broader populist measures taken then. Soon after, Poland’s system was crippled when the state took over and cancelled all government bonds held by the private funds, wiping out half of their assets, to prevent debt from reaching a constitutional limit.

Today in Latin America, governments are facilitating rather than forcing the end of the private system model to allow savers to survive the Covid-19 pandemic.  Despite an emergency aid package worth 12% of GDP including direct payments to the poor, Peru made the first move. As the country locked down, the government enacted legislation allowing savers to tap up to 25% of accounts. Estimates put withdrawals at some 13% of the USD 50 billion that was under management, as more than half of account holders took payouts.

Pioneer Chile followed, allowing up to 10% withdrawals from Latin America’s largest USD 180 billion, 61.5% of GDP, private pension funds.  The move follows months of protests over poverty and social justice prior to the pandemic’s outbreak, including outcry over lack of a public retirement scheme and high fees/low returns for the private funds. Chile will hold a referendum on re-writing the constitution in October. If approved major pension system changes are likely in proposed amendments. 

Elsewhere in the region, Colombia’s congress is considering a bill to allow the unemployed to withdraw up to 10% of savings from the USD 73 billion managed by private funds. Mexican funds are allowing the jobless to take up to 3 months of their last salary, or 11.5%, of their savings from the USD 191 billion system as the President recently guided a higher future employer contribution formula. A record high USD 823 million was withdrawn in June, according to the regulator. The Senate in the Dominican Republic is debating permitting 30% withdrawals, while Brazil is considering allowing workers to make partial withdrawals under its system’s non-compulsory private pillar.

Early withdrawals will help to mitigate the pandemic-induced devastation for thousands of families in Latin America, but the economic and market impact will be felt for years.  Private pension managers are being forced to sell into weak markets to meet redemption requests. Despite some rebound this summer, stock markets across the region are down between 25-45% in USD terms.  Forced selling of assets is pressuring local bond markets at the same time foreign investors have withdrawn.  In Chile, for example, 20% of funds’ assets are in Treasury instruments and under its emergency program the central bank was only permitted to buy central bank and bank bonds.? As debt and deficits soar, there is rising concern about how governments will find buyers as they borrow record amounts..

Fiscal and institutional investor impacts will be felt into the next decade. The countries which allow international investment by private funds will benefit this year from forced selling. As funds sell overseas holdings, currency pressure will ease and current account gaps narrow, with Chile benefiting as foreign assets stand at more than 40% of portfolios.. Longer-term large chunks of the system may erode or be dismantled with assets transferred to the state to meet the needs of retirees. For countries like Peru with a parallel public pay-as-you-go pension scheme, the government is already considering refunding some worker contributions which could bankrupt the system. Private pension funds have been a standout Latin America success to overcome public retirement scheme weakness and build a solid contractual savings base..  With workers drawing down savings today, their private accounts will be inadequate to meet future needs and the states will have to assume the burden as a proven capital markets catalyst decays. .