For Peru, a country that has been enjoying rapid economic growth in recent years, the step in pension reforms is regarded as long overdue. One of the world’s fastest-growing economies, Peru’s pension industry was formed in 1992. An update of these reforms was initiated in 2012, with the intention of improving access for the many citizens that are currently without pensions, as well as aiding the many pension funds in the country, known as AFPs. World Finance spoke to Renzo Ricci, CEO at Prima AFP, one of the country’s leading private pension funds, about the changes to the regulations and how the industry has reacted.
Peru has instituted a series of reforms in the Private Pension System. Why were these reforms made?
The Private Pension System (SPP) celebrated its 20th anniversary in 2013. During its two decades of existence, the system has achieved several important goals, including allowing five million affiliates to set up their own retirement fund; contributing to economic growth through investment; generating internal savings; and developing the Peruvian capital market.
Despite this, improvements were needed to consolidate the SPP to increase coverage, given that a large percentage of the Peruvian population is not affiliated with any pension system, and to boost the efficiency of pension fund administrators to lower costs for clients. In this context, the Peruvian government passed a law to reform the SPP in July 2012, which came into effect at the end of that year.
The reforms have brought down the commissions that the AFPs charge for administration by assigning affiliates through a tender process. Additionally, the insurance premium that is covered for managing the risk of disability, survivorship and burial costs has been reduced from 1.27 percent to 1.23 percent on average due to the process to tender the right to offer a collective insurance policy for all of SPP’s affiliates. In order to align the interests of the affiliates with those of the AFP, a commission on account balances was created so that affiliates can pay a percentage based on their pension fund balance.
[A] large percentage of the Peruvian population is not affiliated with any
In the second semester of 2014, the SPP will extend its coverage by including independent workers under the age of 40. These workers will be required to contribute to the pension system. It is important to mention that a large percentage of workers is not affiliated to any pension system and as such is not saving for retirement. This is due mainly to the informality in the market. Additionally, 75 percent of senior citizens have no pension. This measure will help people have a pension by the time they reach retirement age. In the next 20 years this age bracket will represent 18 percent of Peru’s total population (see Fig. 1).
Is the SPP reform complete or does the government need to take further measures?
The process to implement the SPP reform began at the end of 2012. Although several measures have already been put into place, others are pending, including steps to centralise the processes that will generate efficiencies for the AFP, which will lead to lower costs for affiliates, and the incorporation of independent affiliates into the SPP system.
Finally, we believe that it would be more convenient if the SPP returns to a free market model that will allow the AFPs to include more people and generate more competition. In terms of investments, we believe that a reform is needed in the capital markets to reduce the costs of fund management. If the AFPs have more leeway to invest, risk-adjusted profitability will continue to gradually improve to benefit affiliates. Additionally, the limit for investing abroad should continue to rise. This will give the AFPs more investment alternatives and a greater flexibility in terms of diversifying risks for clients.
Has the new system changed Prima AFP?
All of the AFPs, with the exception of the AFP that won the tender, can no longer compete to affiliate the people that enter the workforce for the first time. After the tender, only one AFP can affiliate new workers, who must stay with this AFP for two years. This situation has led Prima to focus on strengthening its affiliates’ loyalty by permanently improving its value proposition and reaching affiliates through new channels. Prima has also been preparing to defend its client portfolio by improving its sales force, internal processes and commercial strategies.
With the reform, a new commission on account balances was created so that affiliates can pay a percentage based on their pension fund balance. Existing affiliates were given the option to choose this new commission or stay with the old commission, which is based on affiliates’ salaries. The affiliates who choose the new commission must pay a mixed commission for 10 years while they migrate from the fixed commission based on salaries to the commission based on the fund balance. This means that Prima now manages a client portfolio with two different commissions.
For investment management, new regulation is yet to pass aiming to expedite the approval process for new investments, grant more flexibility with derivatives and alternatives, and provide greater transparency of portfolio returns and composition. We think some of these measures will allow higher risk-adjusted returns in the future. To date, however, the reform has not had a material impact on the way the portfolios are managed.
Beyond specific changes in the regulatory chapter for investments, the reform also sought to improve alignment of fund managers by introducing a fee scheme calculated as a percentage of assets, which now coexists with the traditional scheme calculated as a percentage of a clients’ salary. Regardless, we believe that the intense level of competition and our client’s strong preference for and awareness about fund returns, warrants a strong alignment of Prima with its clients. Our motto is “be the best pension fund in Peru”, both in terms of service and investment returns, particularly with a long-term focus.
What changes in investments has the SPP Reform brought?
Several announcements have been made defining the future roadmap of investments’ regulation. These regulations have three concrete objectives: to expedite investment approvals, to provide greater flexibility, and to improve performance analysis and disclosure. Since the inception of the industry, AFPs had to ask the regulator to approve the eligibility of each investment before being able to place an order. The regulator is now planning to pass on the eligibility analysis to the AFPs, therefore expediting the investment approvals and preventing missed opportunities that are associated with very tight timelines.
More important, however, is the greater investment flexibility that the regulator has in the works, particularly referring to the use of derivatives and alternative investments. Gaining exposure to certain assets or hedging financial risks through derivatives is currently largely restricted. But this may change soon as the regulator plans to grant more flexibility.
With regards to alternative investments – private equity, infrastructure, real estate and hedge funds – limits are expected to rise dramatically from where they stand today. This move goes in line with the asset allocation of global players to alternative investments that could range from 20 to 40 percent of assets, compared to a meagre five percent of assets for Peruvian pension plans.
What infrastructure projects is Prima AFP investing in at the moment?
Infrastructure investments have been and remain a top investment priority. They have the scale to meet our investment needs, the long maturities that match well with our long investment horizons, and in many cases returns are linked to inflation, providing an excellent hedge in a market with scarcity of inflation-linked securities.
Peru ranks very well in terms of high economic growth, low inflation and strong fiscal accounts, but doesn’t stack well in infrastructure. According to the last Global Competitiveness Report from the World Bank, Peru ranks globally 111th out of 144 in terms of infrastructure quality, only similar to Uganda or Nicaragua. Therefore, we believe that on a standalone basis, investing in infrastructure has its own merits.
Recently, the government has put in place an ambitious agenda of over $10bn in infrastructure concessions, which we see as a great source for future investment opportunities. More immediately, financing transportation is more likely to take centre-stage. We expect the works in roads that will better interconnect the north, south and east of Lima, as well as granting of a concession this year to build Peru’s first underground train for a total investment of more than $5.6bn.
The so-called “Fideicomiso de Infraestructura”, or Infrastructure Investment Trust, is a vehicle created by all the AFPs to invest in the sector, particularly in what the government calls “priority projects”. Our first trust was put in place in 2010 for a total committed capital of $300m, which was later raised to $400m and virtually fully invested in 2013. Late last year we decided to launch a second trust for a total committed capital of $1bn.
What are Prima AFP’s future projects and how do they compare with competitors?
Over the last eight years, Prima AFP has been faithful to the purpose for which it was created: to lead pension fund management and reach high levels of customer service, advisory service quality and profitability. Additionally, we have strengthened the mission that guides our performance: we work today to obtain the best conditions to ensure that our affiliates have the best pension possible while keeping them permanently up-to-date on their fund’s evolution.
In 2014, we continue to improve our value proposition, to develop our Voluntary Contributions product given that we believe this constitutes a highly attractive market segment, and to strengthen our relations with independent workers under the age of 40 who are already affiliated to our AFP by advising them that they are now obliged by law to contribute to an AFP.
Also, Prima AFP will continue to strengthen its investment strategy and will improve its processes to take advantage of the changes generated by the SPP reform, which include better alternatives for investment and flexibility in terms of the use of derivative instruments. Our goal is to improve profitability for our affiliates while reducing risks to a minimum.