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Interview with Guillermo Arthur ERRAZURIZ, President of FIAP

The International Federation of Pension Funds Administrators (FIAP) brings together most associations of pension funds from the states with a multi-pillar pension system, providing global representation of their interests, as well as experience sharing, for the benefit of all its members. Present in Romania in order to invite APAPR, the Romanian association of the private pensions industry, to accede to FIAP, the President of the Federation, Guillermo Arthur ERRAZURIZ, gave PRIMM Insurance&Pensions magazine an exclusive interview.

Interview with
Guillermo Arthur ERRAZURIZ
President of the International Federation of Pension Funds Administrators (FIAP)

PRIMM: The International Federation of Pension Funds Administrators (FIAP) is a strong organization, representing globally the private pension systems created according to the World Bank's model. What is the organization's main current purpose?

Guillermo Arthur ERRAZURIZ: FIAP brings together the associations of the pension administrators from the multi-pillar systems, with a mandatory component (Pillar II), fully-funded (financed through contributions) and based on personal saving accounts. Our purpose is to share the experience of all these states that applied such reforms after the model launched in Chile in 1979 and to promote the need to reform the "pay-as-you-go" public pension system worldwide. We plan to turn the experience gained so far by these states into an example and help improve and streamline the multi-pillar private pension systems throughout the world.

Also, our main objective is to foster the liberalization of legislation on investments of the private pension funds from these systems in order to allow more diverse investments, both in terms of financial instruments and in terms of cross-border investments.

PRIMM: FIAP currently has 21 members, each one from a different country. Most if them are Latin-American states, although pension funds associations from Poland, Bulgaria, Russia and Ukraine have recently joined the Federation. What role does Central and Eastern Europe play in FIAP?

G.A.E.: We are highly interested in strengthening our relations and representation in the Central and Eastern European states. Actually, the pension systems from here and the ones from Latin America are mainly based on the same philosophy. Poland, Bulgaria, Russia and Ukraine are only the first states from this region that joined our organization, but we are interested to see other countries from here become FIAP member, such as Romania, the Czech Republic and others. In fact, this is why I am here, in Romania - this is my first visit here.

PRIMM: Tell us more about the potential affiliation of the Romanian private pension industry to FIAP. What could be the effects of such affiliation?

G.A.E.: Actually, I met with Crinu ANDANUT, President of APAPR (the Association for Privately Administered Pensions from Romania) and with Bram BOON, former president of this institution. They seemed to be highly interested in the affiliation of the Romanian private pension market to our organization, which would bring the advantage of sharing our common experiences, as well as global representation, together with the other member states, for the local private pension industry. We launched the invitation for APAPR to become a FIAP member, an invitation which is actually open to all similar associations from the states in this region that have such pension systems. As we all have private pension systems that are more or less similar, it is obviously useful to learn from each other, and for countries like Romania it proves to be useful to look at the experience of other markets that already went through various maturing stages.

PRIMM: How would you describe the relation between FIAP and various regulatory and supervisory bodies in the private pension field worldwide?

G.A.E.: The private pension systems we applied are strictly regulated, and our activities depend largely on the regulatory and supervisory bodies. We have the best possible relation with these bodies, whose representatives we invite to all our meetings and conferences to present the industry's point of view and find solutions to emerging problems.

PRIMM: What are the guidelines of the multi-pillar private pension systems, both in Latin America and in Central and Eastern Europe? What are the objectives they need to follow, first and foremost?

G.A.E.: Once these systems are launched, the investments component of the pension funds becomes the most important one. And the only targets to consider in the investment strategy are two: profitability and investment safety. This is what an efficient private pension system is all about: profitability and safety. The legislation for these systems must be tailored in line with these goals and must be as flexible and liberal as possible, allowing for investments in as many financial instruments as possible, to capitalize on the opportunities, as well as freedom of investing on markets other than the domestic market, thus providing geographical diversification of the investment risk.

For instance, a legislation that clearly restricts investments in shares makes the respective private pension system non-profitable. Meanwhile, a legislation banning cross-border investments limits the system's safety by not allowing risk diversification. Concentrating the investments of the pension funds on a single financial market, namely the domestic one, is never a wise decision.

Another issue concerns the investments in state securities... The investments in state securities are not the most efficient tools and do not provide the system with the necessary profitability. The legislation must encourage efficient investments, in shares and similar instruments, with strong growth potential on the long term.

PRIMM: What other solutions are there to help streamline the private pension systems and increase their profitability, for the benefit of the participants?

G.A.E.: The multi-fund strategy is a very good solution, for instance. More and more states allow a pension company to manage more that one fund, even two or three or more pension funds, with different investment strategies and risk profiles, to cater to more needs of the different participants to the system, according to their age, risk appetite and suitability. It makes sense that young people subscribing today to such mandatory private pension funds are able to benefit from larger investments in shares made by the funds - even more as it is practically proven that investments in the capital market yield the highest return on long term. At the opposite end, we have the participants to these funds who are maybe closer to their retirement age and want to preserve the value of the savings they already made - we must be able to offer them funds with higher investments in fixed-income financial instruments.

In Chile, for instance, each pension company offers five such funds, their investments going from 100% in fixed-income instruments to the other extreme - investments made entirely in shares. Multi-funds are thus better adjusted to the needs of the participants to the private pension funds.

PRIMM: Are the current levels of contributions to the Pillar II mandatory pension systems sufficient? Romania starts from a contribution of only 2% of the participant's gross income, to reach 6% in 2016.

G.A.E.: Considering all the demographics involved, but especially the increase in life expectancy, the contributions should be higher than current levels. Even 6% is quite low... we estimate that a minimum contribution to the mandatory system should be around 10%, to which we must add the savings in a voluntary third pillar fund, for a higher income replacement rate during the active period. The problem with Pillar III of voluntary private pensions is the same everywhere: the saving incentives in these pension plans are always of fiscal nature, and they particularly benefit participants with high to very high income. But the challenge consists of identifying the solutions that encourage those with medium to low income to save in this system.

PRIMM: The guarantees of the private pension systems are a highly debated topic in the region, but especially in Romania - whether we talk about matching fund returns with the inflation rate or about other types of guarantees. How would you describe FIAP's vision in this area?

G.A.E.: Guaranteeing returns above the inflation rate for the pension funds sounds like a very good idea, in theory, but it is very dangerous when put into practice. Such a provision would make pension funds adopt too prudent investment strategies, which would go against the system's need for profitability that we mentioned previously. The widely spread practice in the multi-pillar system is the minimum guaranteed return, namely the market relative guarantee - just like in Chile, in Poland and in Romania. It's true, this provision clearly leads to a similarity of the private pensions' portfolios - a consequence that I honestly cannot say if it's good or bad. In the market relative guarantee system it is very important that the margin compared to the benchmark is as flexible as possible in order to allow diversification of the funds' investing strategies and not hinder competition between funds.

PRIMM: Another topic for debate, highly relevant on the Romanian market, concerns the outsourcing of the investments by the pension funds. What is the common practice in multi-pillar systems: should or should not pension funds be allowed to outsource the investment of their assets?

G.A.E.: In most states, the investment decision belongs to the pension company. But when that pension company is part of a large international financial group, it is normal to allow certain ways of know-how transfer and consulting intended to capitalize on the group's investment experience, for the benefit of the participants to the fund. However, the responsibility for the investment results must always stay with the pension company.

PRIMM: We are all familiar with the experience of Chile, which introduced the multi-pillar private pension system for the first time in the world. However, the Chilean model has recently suffered several image problems, caused by certain studies claiming that the Chilean state must now pay the pensions for many participants to the multi-pillar system, and stating that the private system was inefficient. What is your reply to these arguments?

G. A. E.: Given that Chile was the first state to apply this reform, many enemies of the multi-pillar system thought of attacking the very Chilean example and destroy the system's credibility. As a result, the Government established a commission to look into the system's current status, and the main conclusions of the research were twofold: 1) the fact that the system pays, to those who contributed for a long time and constantly, pensions that are close to the average salary they had, and 2) the fact that the pension funds and the accumulation of assets in the funds helped foster economic growth and the country's financial markets. The funds got so big, with assets of more than 120 billion USD today, namely an amount almost similar to the GDP of Chile, that they can finance infrastructure activities and even the construction of dwellings, through investments they make in mortgage bonds.

The Chilean system of mandatory pensions started making its first payments approximately ten years ago - what we call the entry into the payout phase. At the moment, the system has four million active and constant contributors, as well as seven million "affiliates", namely participants who only paid some contributions, because of various reasons. Indeed, the state must compensate up to a certain level the pensions for many of these affiliates and for the people with low income, but this is not due to any flaws or to the inefficiency of the multi-pillar private system, but to the low volume of contributions of many participants to the system.

PRIMM: Since you mentioned the payout phase, how is this regulated in Chile?

G.A.E.: The participants to the pension funds have a wide variety of possible solutions, from a simple lump sum, to complex combinations of lump and life annuities that can meet both the need to have available, at some point, a substantial amount, and the need to have a constant income throughout one's lifetime.  

PRIMM: What message did you give the current and former president of APAPR when you invited them to join FIAP?

G.A.E.: I told them not to worry if the current legislation on the private pension market in Romania seems too restrictive now, this is a normal stage occurring after the launch of the system. The experience of similar systems indicates that all of them started off with a restrictive legislation that became more flexible and liberal afterwards, allowing the market to become more efficient.


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