ANNUITIES IN LATIN AMERICA
A NNUITIES IN L ATIN A MERICA
J O N A TH A N C A L L U N D
Callund y Compañia Ltda, Chile
INTRODUCTION These are the most relevant ones and provide
a broad range of variations on a similar theme.
I have been asked to talk about my experience I will also be touching, although only briefly,
in the annuity markets in the Region and in on the conditions in Colombia and Brazil.
particular four specific discussion points:
I gave an earlier version of this paper at
- What has been the evolution of the annuity another World Bank conference on annuities
markets in recent years? in Mexico City in 1997. That event has since
allowed me to follow the development of the
- The pros and cons of obliging members to Mexican AFORE system and the dynamic
purchase an annuity mandatory?
annuity market that has come into being there
- What has been the degree of member over the last two years.
Now for some background on me and my
- How do the systems of annuities compare
firm. I have been in Chile since 1993 and
have followed the development of the annuity
market there from a number of different
This is tall order in an hour, especially given
that I am the only one talking about Latin
America and, there is a lot of basic material to
- In carrying out feasibility studies and
cover before we can get round to addressing
actuarial work for foreign investors, my firm
these issues. However, given that the
has been involved in setting up a number of
presentations yesterday covered many of
concepts and in some depth, I will be
spending a good deal of my time explaining - As employee benefits consultants, we advise
the background to the AFP system in Chile employers on how best to make use of the
and the practical issues of annuity market AFP system and assist them in setting up
there. This will assist us in understanding the pension plans to supplement the mandatory
conditions of the other markets. contributions, especially for executives.
- As financial planning consultants, we
I will then look at each of the other selected
counsel individuals on the way to save for old
markets, comparing them with Chile, before
age and how best to arrange for a pension in
moving on to the two policy questions, the AFP system, whether as programmed
namely whether or not it is a good idea to give
withdrawal or an annuity.
the pensioner an alternative to the annuity and
what has been the effect of these young
We have also worked in Argentina and Peru,
systems in terms of benefits to the consumer. assisting the government in developing the
I would then plan to leave around 10 minutes regulations, medical commissions and
insurance market conditions for the survivors
and disability pension systems.
I will be looking at four annuity markets,
namely; Chile, Argentina, Peru and Mexico.
ANNUITIES IN LATIN AMERICA
This group insurance product is probably the million were making regular contributions.
most important area for the development of an This compares with only 530,000 members
annuity market in the early days of an AFP- (less than 3%) who currently draw pensioners.
type system, as old age pensions do not Around 80% of these pensioners are in Chile.
develop until at least 10 years after the system According to the same source, the total funds
has begun. This is because the seniors, let’s under management at the end of 1998 were
say the over 45 year-olds, in the working US$52 billion.
population, will tend to remain in the pay-as-
you-go system – there is simply not the time According to a recent SOLOMON BROTHERS
necessary for these individuals to develop the study, the total funds in the Region are
capital sum to purchase an annuity. projected to grow to US$360 billion by the
PENSION REFORMS IN THE REGION
This is a considerable amount of money and is
Excluding Brazil and Venezuela, all the large a very good starting point for the development
countries and many of the smaller ones in of an annuity industry in the Region.
Latin America have implemented a Chilean-
style, non-State pension fund system. As we all know, the basic premise of a
capitalization system of the type that has now
Chile started the ball rolling with the launch been implemented throughout the sub-
of the AFP System on May Day, 1981. It continent (and many other parts of the world –
then took over twelve years for the next most recently in Poland where a new system
country, Peru, to follow suit. That was in mid started only two months ago), is that there are
1993. Colombia and Argentina followed in two distinct stages:
1994 and then Uruguay in April 1996. In
1997, both Bolivia and Mexico initiated their Two Stages of a Capitalization System
own modifications of the system and as
recently as April last year, El Salvador joined
the fold. - The accumulation period, during which the
employees place their State-mandated (and
Statistics on the Reformed Regional voluntary) savings for old age with an AFP,
Pension Systems AFJP, AFAP, AFORE, or what ever the
private sector fund manager happens to be
Table 8: Regional Pension System Data called, with a view to them being invested in
(December 1998) the capital markets, generating real returns, so
( ) as to create a sufficient funds with which to
Country Start Date Members Pensioners Funds (US$ m) retire.
CHILE May-81 5,950,694 419,613 31,029
PERU Jun-93 1,965,136 13,842 1,786
- And, at that moment the second stage, the
COLOMBIA Apr-94 2,702,257 2,787 1,767
pay-out period or “decumulation” (as Dimitri
ARGENTINA Jul-94 7,067,123 37,813 11,526
Vitas referred to it in a recent paper in Chile)
URUGUAY Apr-96 506,517 n/a 374 begins. This, then, is primarily where the
BOLIVIA May-97 416,267 n/a 276 annuity comes into its own, although, as we
MEXICO Jul-97 13,827,674 24,955 5,508 shall see a significant number of annuities will
EL SALVADOR Apr-98 569,972 n/a n/a be bought before normal retirement age, i.e. in
TOTAL 33,005,640 499,010 52,267 the case of disability and death.
Source: PrimAmérica Consultores
For obvious reasons, the “new” systems in the
According to the latest statistics produced by Region have all but focused exclusively on
my friends at PRIMAMÉRICA CONSULTORES, in the accumulation period, i.e. assuring the
March 1999 these nine systems accounted for efficiency of the fund managers, optimizing
over 34 million members, of which around 21 the return-to-risk function of the investments,
ANNUITIES IN LATIN AMERICA
ensuring the correct collection of Annuities in Argentina
contributions, controlling the commercial In Argentina, in March 1999 there were
practices of the agents and fund managers 42,000 pensioners, of which only half of the
and, in general, minimizing costs. Few of the 28,100 survivors pensioners were drawing an
systems have matured sufficiently to generate annuity – the rest are drawing programmed
any significant concerns over annuities, i.e. withdrawals.
the vast majority of members are still active
contributors and there are few pensioners. By Figure 16: Pensions in Argentina
all accounts, then, this is an issue that has yet (March 1999)
to be looked at (and is clearly the prime Old age Total of 42,051
reason for an event like this conference). 19%
Figure 14: Private Pensions in the Region
(March 1999) 14%
Peru Mexico Colombia
Argentina 3% 6% 1% As for the 6,000 disabled pensioners, all of
these are still in the 3-year transition period
prior to confirmation of their disability by the
MEDICAL COMMISSION. These members
currently receive pensions from the
specialized insurance company providing the
group disability and survivors’ pension
insurance cover to the AFJP. As regards the
By all accounts, the only AFP-type system old age pensioners, there are a few – some
where there are pensioners in any number is 8,000, but only 50 of these have opted to
Chile. purchase an annuity, the rest are drawing
Figure 15: Pensions in Chile
Pensions in Mexico
In Mexico, after only 24 months, or so, there
Total of 446,364 Survivors
are 30,000 pensioners in the AFORE system,
all of which are drawing annuities.
Figure 17: Pensions in Mexico
Old age Disabled (March 1999)
Total of 29,864
By March 1999, there were around 450,000 Survivors
pensioners; 280,000 old-age pensioners, 44%
113,000 survivors’ pensioners and around
57,000 disability pensioners. Of these, only Disabled
around 60% - are paid as assured annuities,
while the balance is being drawn down from
the AFP system as programmed withdrawals. In addition, there are around 4,000 pensioners
under the workers’ compensation system,
This compares with the annuities in bringing the total to nearly 34,000. The
Argentina. distribution between disability and survivor’s
pensioners is about half-and-half.
ANNUITIES IN LATIN AMERICA
Pensions in Peru Programmed Withdrawal as an alternative to
A total of 15,200 pensioners in Peru (March the annuity.
1999), of which 2,400 were old age pensions.
Figure 18: Pensions in Peru In Chile, in addition to the US$32 billion
(March 1999) (May 1999) in pension funds managed by the
AFPs, the life insurance companies have
Total of 15,166
16% already amassed over US$10 billion, or a
5% third of the AFP funds in technical reserves
on the books of the 23 annuity companies.
THE CHILEAN ANNUITIES MARKET
I will now spend around 20 minutes outlining
Most of these (80%) are survivor’s some of the basic conditions of the AFP
pensioners. What’s more, there are less than system that the affect the structure and
800 cases of disability (after over 5 years!). dynamics of the annuity market. It will be
The vast majority of these cases are in receipt seen that many of the same concepts have
of annuities under the special group disability been adopted in the other countries. This will
and survivors’ pension insurance cover. help us when we come to compare the
conditions and look at the specific issues I
Types of Pensions in the Region have been asked to cover.
The fact that there are still so few pensioners
is, in fact, good news, as the development of a The Pension Methods
sophisticated and solvent annuity market
requires time and considerable preparation. The Chilean system provides for disability,
The Chilean experience certainly shows this old-age and survivor’s pensions, offering the
and, as with many other facets of the member or his surviving dependants’ a choice
movement towards mandatory capitalized of three pension methods:
pension savings, Chile can provide other - Retiro Programado - Programmed
countries with a number of general lessons. Withdrawals – also referred to as Systematic
Withdrawals in the US or Income Draw-
Figure 19: Types of Pensions in Latin America Down in the UK,
- Renta Vitalicia Inmediata - Immediate
Total of 536,236 Annuities,
- Renta Vitalicia Diferido con Renta
Temporal - Deferred Annuities with
In the Chilean AFP system, the annuity is an
Returning to the projections of the $360
billion in pension funds by the end of the next - Programmed Withdrawal, under the
decade, this figure is more an indication of the programmed withdrawal (PW) method, the
projections of the annuity market, as the vast funds are retained in the member’s AFP
majority of these savings will, by definition, account. It is the AFP which assesses the
end up being transferred to annuity level pension (in indexed units of account -
companies. Mind you, not all of the funds Unidades de Fomento) each year as an
will be converted to an annuity, given actuarial function of the member and
considerations of State Minimum Pensions dependants’ ages and sexes, such that the fund
and the existence of the option of a
ANNUITIES IN LATIN AMERICA
will be completely drawn down over the
expected remaining life-time. During this A profit-sharing endorsement was approved
period the fund continues to accrue the full in 1988, but it was subsequently withdrawn.
returns generated by the AFP (less any
It is important to note that the annuity option
expenses, if the AFP makes a charge). At any
may only be taken by those members who are
time, the member, or in the case of his death,
able to contract an annuity which is greater
his dependants’ may opt for one of the other
than or equal to 110% of the State guaranteed
minimum old age pension. This accounts for
- Annuity, The immediate annuity is a a large number of low-income members or
pension method whereby the member agrees those with a poor contribution record, being
to transfer the balance of his pension savings obliged to draw a PW.
account as a lump-sum premium to one of the Table 9: Comparison of Programmed
life insurance companies in return for a life- Withdrawal with annuity
long guaranteed monthly payment (in this
case indexed in Unidades de Fomento) from
the moment of signing the contract and the
Member may change Irrevocable contract.
subsequent payment of the survivors’ AFP or switch to an
pensions, if applicable. This insurance annuity.
contract is irrevocable and is based on a Pensions are Pension is fixed at
standard policy conditions, approved by the recalculated annually. the outset.
SUPERINTENDENT OF INSURANCE. The rate or return is not The rate of return is
- Deferred Annuity, the deferred annuity No longevity insurance. Life-long payment of
with temporary withdrawal method entails pensions.
member contracting to receive a guaranteed Managed by an AFP. Managed by an
annuity from a date in the future, as insurance company.
determined in the policy and retaining Gives rise to inheritance No rights to
sufficient funds in his pension savings on death inheritance.
account to receive a temporary income from Pensions tend to fall in Pensions are constant
the AFP to cover the period from the date of time. in real terms.
opting for this method and the date on which
annuity payments begin. There one important In addition to the above conditions, the PW in
of condition to this hybrid arrangement - the Chile differs from the annuity in the following
deferred annuity may not be greater than 50%, aspects:
nor less than 100% of the first temporary
income payment. - In determining the value of the PW, the AFP
makes no consideration for the cost of the
In addition to the basic conditions, the contingent funeral grant (UF15 or around
SUPERINTENDENCY has since approved a US$450), payable on the member's death.
number of annuity riders: - The rate of interest applied is based in part
(80%) on the returns made by the AFPs on the
- A guaranteed minimum period of payment, pension funds over the last 10 years and the
say 5 or 10 years, average annuity rate in the previous calendar
- Repayment of the initial capital – know as year (20%) – the rate used this year is around
the “Refund” option in the US, and 6% p.a. This compares with the prevailing
market annuity rates of around 5% p.a.
- the possibility of improving the contingent
survivor’s pensions above the legal 60% up to - No consideration is given to expense
a maximum of 100% of the policyholder’s margins, e.g. administration costs, brokers’
pension. commissions and profit margins – these
ANNUITIES IN LATIN AMERICA
currently amount to around 1.5% in the balance. The annuity rates will also work
annuity market. against him as times goes by, i.e. the
“Mortality Drag” to which David Blake
Furthermore, other than the technical aspects,
the convenience of the PW include:
Early Retirement and the Bonos de
- The attraction of earning a better return in
the short term on the balance of the individual
account than that offered by the life office in These are two issues in Chile, which are not
the long term – the unit value of the pension so relevant in the other markets.
funds has risen by over 10% in real terms so
far this year. Early retirement in the Chilean annuity
market is of great importance. These
- The attraction of retaining control of the annuities have come to represent over two
balance of the member's account, in the case thirds of all annuities sold.
of early death - the balance up to UF4,000
(around US$120,000) is tax free when Annuity Sales by Type of Pensioner
transferred as part of the member's estate. The possibility of retiring before the “legal”
- The attraction of not having to draw down retirement age is a legal and financial quirk.
the full amount of the pension, something A male member may retire before age 65 if
which is not possible with an annuity. This the balance in his AFP account is sufficient to
benefit offers considerable tax advantages to purchase an annuity equal to 50% of his
members with alternative sources of income, average wage over the previous ten years.
permitting the accumulation of tax sheltered
capital gains until a pension is drawn, or What’s more, if the balance is sufficient to
leaving the balance to be paid over to the purchase an annuity of more that 70% of the
member's estate. average wage, then the law allows the
member to draw down the balance as a lump
- The potential of increasing the level of sum (Excedente de Libre Disposición). An
pension due to a change in the family group. added attraction of this is that it is virtually
For example, premature death of the spouse or tax-free!
the member himself will inevitably lead to a
higher pension for the survivor than any With this, the early retirement option and the
offered an annuity contract. "Libre Diposicion" rule provide the member
with a strong incentive to retire as soon as
In summary, the PW is a very competitive possible (and, most of the time, without
product when compared with the annuity. giving up his job) and so to opt for an early
However, it involves the member retaining retirement annuity – a second source of
both the longevity risk and the investment income.
risk, whereas with the annuity contract both of
these risks are ceded to an insurance Another important structural aspect of the
company. Chilean system is the existence of the Bono
de Reconocimiento and the possibility for the
This means that the AFPs, in Chile at least, member to endorse the bond and sell it in the
are seen as competitors of the insurance secondary market.
The "Bono" represents the periods of
Although at the outset, for a healthy retired contributions registered in the "old system" by
member, the PW may well probably be the those employees who switched to the AFP
best option, the big question is when should System. The Bono is nominative, and is held
the member switch to annuity? The longer he by the AFP as part of the member's individual
leaves the decision the smaller will be his account. Its value is expressed in pesos at the
ANNUITIES IN LATIN AMERICA
date the member joined the AFP System, and Disability Pensions
it accrues a real interest of 4% p.a. The Bono In Chile a member is entitled to a disability
and the interest accrued is payable the day the pension if, after being evaluated by a
member reaches the normal retirement age, or specialized MEDICAL COMMISSION, his is
on death or being declared disabled, and it is found to have suffered a permanent loss of
then paid into the Cuenta de Capitalización more than 50% (partial disability) or 2/3rds
Individual. (total disability) in working capacity.
By trading the Bono in, the member can The approval process is done in two stages,
release a large part (still over 60% in most i.e. all initial assessments are subject to a
cases) of his retirement savings to funds the review after 3 years.
cost of the pension. Without this possibility,
early retirement would be virtually The disability benefit is assessed as 50%
impossible. (partial) and 70% (total) of average pay over
the previous 10 years.
Recent calculations show that the Bonos still
to be paid by the government will add as During the first 3 years, the company that
much as US$12 billion to future retirement underwrote the group D&D policy with the
funding. AFP at the time of the claim pays the pension,
without touching the member’s balance with
The Chilean annuity market has benefited the AFP (or his Bono de Reconocimiento).
significantly from this particular system for
funding the government obligation. Such a Figure 20: Chile - Annuity Sales by Type
situation does not exist under the Argentine (US$ Millions)
and Mexican models. Even in Peru, where 1000
there are Bonos, the values are considerably 800
smaller and they are not expected to have 700
600 Early Retirement
anything like the effect they have had, and 500
will continue to have, in Chile. 300 Disability
Death & Disability Cover (The Group
1991 1992 1993 1994 1995 1996 1997
Source: S.V.S. Annuities Statistics
The system of payment of disability and
survivor’s pensions is complex. However, it At the end of the 3-year period, assuming the
is important, as it is one of the principle Medical Commission confirms that the
sources of potential annuities in all the member permanently disabled, then the same
systems under review. The conditions of the Company pays the Aporte Adicional to the
other three systems are, by and large, member’s AFP account.
modification of the Chilean scheme.
This Aporte Adicional is equal to the
The D&D covers are provided under a special difference between:
group insurance contract, taken out by the
AFP to provide a defined benefit as, a - Capital Necesario - the technical fund
percentage of average pay, to a member required to finance the member's disability
suffering from a disability or to his pension and potential survivors' pensions for
dependants in the case of death before the his beneficiaries, based on the regulated
normal retirement age (Normal retirement in mortality tables and a long-term rate or
Chile is taken to be 65 for men and 60 for interest, and
ANNUITIES IN LATIN AMERICA
- The accumulated balance (including the beneficiaries of an irrevocable insurance
Bono de Reconocimiento) in the member’s contract that is underwritten by a registered
AFP account. life insurance company in Chile.
At this moment, i.e. after 3 years, the member Number of annuities policies Sold
is free to opt between one of the three Pension
Insurance companies in Chile are divided into
Methods and may elect to purchase an annuity
life and non-life companies. However, the
with the new (topped-up) balance in his AFP
life insurance companies need not be
specialised in annuities, i.e. most tend to sell
Survivor’s Pensions other traditional individual and group
On death, the member's dependants have a
right to survivors’ pensions. These are Figure 21: Chile: Number of Policies Sold
determined as a percentage of the member’s
average pay: 23,082
- 42% for a widow without children. 18,754
- 35% for a widow while any children draw a 11,813
- 10.5% for each child to age 18 or 24, if in 2,674
full-time education. 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Source: S.V.S. Annuities Statistics
The amount of the Capital Necesario is
dependent on the actuarial present value of the The benefit of this contract is the life-long
contingent flow of the survivors’ pensions and receipt of indexed pension, denominated in
the company then pays the Aporte Adicional. Unidades de Fomento (UF), which is a legally
recognized unit of account, the value of which
In both cases, the discount rate used in is adjusted daily in line with variations in
calculating of the Capìtal Necesario is the consumer price inflation (CPI). The pension
average market interest rate used by life is payable monthly in advance.
insurance companies for AFP Annuities in the
calendar quarter immediately prior to quarter The premium for this contract is a lump-sum,
in which the claim occurred. comprising the balance of the member’s
The mortality tables have been defined by the account in the AFP, together with the cash
SUPERINTENDENCY, based loosely on Chilean value of the Bono de Reconocimiento. This
experience: sum is paid at the start of the contract.
- MI85 (disabled mortality)
- B85 (beneficiaries’ mortality). Chile – Annuity Premiums
The price of this insurance policy is expressed
The Annuity Product as a capital per monthly unit pension, for
example, 165 units of capital per unit of
Having looked at the basic conditions that pension, which is the average conversion rate
give rise to the benefits under the mandatory at present and which is determined freely in
pension system in Chile, we should now look the market.
at the conditions of the annuity as a financial
product. The market data used in this sections
is taken from a recent study prepared by
Consorcio Nacional de Seguros Vida.
Under an AFP annuity policy, the AFP
member, or his surviving dependants, are the
ANNUITIES IN LATIN AMERICA
Figure 22: Chile - Annuity Sales It is the last of these requirements, which
(US$ millions) creates the significant capital "strains" found
in the annuity business in Chile.
734 In the early years of the annuity business
(prior to 1988), there were few competitors in
the market and all annuities were written
129 using the maximum technical interest rate of
3% p.a. real. Consequently, investment
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
spreads were very large (4% or more). Asset
Source: S.V.S. Annuities Statistics
selection, as a result, was concentrated in
bonds and the capital strain was not a real
The purchase of an annuity can be made concern. In 1988, the INSURANCE
directly by the member or with the assistance SUPERINTENDENCY introduced new technical
of independent brokers or company agents, reserve regulations (Regulaciones de Calce)
giving a right to a commission, the amount of aimed to encourage annuity companies to
which is stated in the policy document – optimize the matching of their asset and
average commissions are currently over 5%. liability flows, by requiring higher risk capital
All pension payments are made directly by the commitments when this did not.
insurance company, i.e. the AFP has no
further dealings with the members once his The regulations allow a company to set up
balance is transferred to the insurance 80% of its technical reserves using the market
company. rate, in so far as the term of the assets and
liabilities are matched. The balance of 20%
The Technical Reserves for Annuities
of the reserves must, under all circumstances
The investment of a lump-sum premium be valued at a conservative rate of 3% p.a. To
received on the sale of an annuity is directly do this, the regulations oblige companies to
affected by the regulations issued by the split all liability and asset flows into 10
Insurance Superintendent (SVS). periods ranging from 0 to 24 months (Range
1) to 29 years and over (Range 10).
These regulations are designed to accomplish
the following risk management functions: In practice, most annuity companies will be
ale to arrange for perfect matching up to 15 or
- Avoid excess exposure to any one asset class 16 years and some of the larger more
(for example, over exposure to mutual established companies may do as well as 18
mortgage units). years. However, given the structure of
investments available in Chile, none will be
- Avoid excess concentrations within any covered for period beyond 21 years, so
single asset class (for example, creating a large degree of reinvestment risk
disproportionate holding in bonds issued by a and obliging the companies to use value the
particular company). reserves conservatively and well below
- Eliminate certain classes of asset, which, due market rates.
to the nature of annuity liabilities, do not
provide similar cash flows or principal In practice, and despite the lack of suitable
protection features (for example, equities). long-term investment instruments, the
matching has permitted companies to
- Ensure proper matching by maturity and establish reserves at rates closer to 4.5% p.a.
cash flows of liabilities generated with real, allowing the companies to offer higher
selected assets. pensions. However, with commercial interest
rates used for pricing annuities at over 5%
ANNUITIES IN LATIN AMERICA
p.a., there are still significant capital - The same can be said for those members
requirements. As a rule, a difference of 1% in who are unwell on retirement, i.e. whose own
the between the commercial and matching projection of their life expectancy is reduced.
rate will signify around 12% in capital cost in These members are likely to opt to stay with a
writing a new policy. programmed withdrawal, so taking this group
out of the risk pool. In this case, without
Following these changes and with the arrival these “good risks”, the average longevity of a
of more and more competitors in the annuity life offices portfolio will tend to be higher
market, the financial spread has been than that projected by the population table.
progressively squeezed, falling from 2.6% in
1990 to 0.9% in 1997. This anti-selection will inevitably be a factor
in the initial stages of any system. However,
Depending on the average term of the pension it is understood that the risk of anti selection
liabilities, the capital strain of the annuity in a portfolio of annuitants reduces over time.
business currently ranges between 4.5% and
10% of the single premium income, before Over the last few year, the Chilean Insurance
payment of commissions and expenses. Association and the Insurance
Superintendency have been working to
Mortality Tables develop a new table based on the 18 years’
The mortality tables used for all pension claims experience of the AFP system. The
calculations in the AFP system are jointly new table - RV98 is expected to be introduced
regulated by the Superintendencies of in the coming months. It is important to note
Insurance and AFPs. As such, these are that, this table will be applied to all new
applied both in the determination by the AFP contracts, i.e. it is not expected to affect the
of the Aporte Adicional in the case of value of the reserves for the existing portfolio
disability or survivors’ pensions as well as by of annuitants.
life insurance company in rating and
establishing the minimum technical reserves What is more, the next project is the
for the annuities. development of a table form rating the
programmed withdrawals – work on this is
To-date all the tables have been non-selective, already well under way. The motivation for
i.e. they are based on national statistics, creating such a new table is to ensure that
without any specific sector adjustments. these calculations are done more precisely, as
However, their application in the AFP system they directly affect the cost of the State in
is selective, as only a part of the population is providing the guaranteed Minimum Pensions.
represented under the AFP system. Commercialisation of Annuities
The application of these tables in determining In traditional life insurance, products are
the minimum reserves for all annuities focused on protection and/or replacement of
involves a potentially high degree of anti- income streams. In practice, few consumers
selection; of these products seek a company directly to
provide these types of cover, hence the
- As indicated before, the better educated and saying, that “insurance is sold, not bought”.
higher socio-economic groups will tend to With this, insurance companies have tended to
consider the PW option more than the lower develop a range of different distribution
paid retiring members. In this case, the channels through which to contact the public
mortality of the lower socio-economic groups, and convince them of the need for such
due to their access to health care facilities, protection. Despite the cost, the majority of
work patterns and diet, will tend to be higher companies involved in these lines of business
than the 'average' projected in the table. have developed a sales force of agents to
place these products, given that this has
ANNUITIES IN LATIN AMERICA
proven to be the most effective means of The commissions have increased considerably
distribution. over the last few years, from around 1.5% of
gross premium in 1988 to well over 5% today.
Figure 23: Chile - Annuity Interest Rates
(Guaranteed Real Annual Returns) Brokers Commissions
This does not reflect a change in the services
provided, but the demand from the pensioner
to get hold of a cash sum on retirement and, in
effect, commute part of pension.
The system does not allow the member to take
part of the balance as a lump sum (unless the
pension exceeds 70% of salary). This being
1991 1992 1993 1994 1995 1996 1997 1998
the case, the broker or agent is encourage to
Source: S.V.S. Annuities Statistics.
pay part of the commission over the to
In the annuities business, however, the pensioner as part of the “deal”.
situation is significantly different. On
reaching retirement age or being declared On the other hand, the best indicator of the
disabled, the potential annuitant is actively level of pensions is the guaranteed interest
encouraged to look for an insurer and, given rate offered at any one moment.
the complexity of the market, most of them As we heard yesterday about the UK market
elect to use a broker or consultant to assist and low rats, the Chilean situation is quite the
them in selecting the best company. The use reverse and despite the degree of reinvestment
of direct sales forces in the Chilean annuity risk, average rates have consistently been in
markets is not common practice, although excess of 4.5% p.a. real, rising to 5.7% at the
some of the larger companies do have them. end of 1998.
The use of independent brokers is further
enhanced in Chile, where the regulations Chile – Annuity Interest Rates
oblige the annuitant to present quotations These rates are guaranteed for an average
from at least three different companies. term of over 15 years
The principle elements determining the sale of The Chilean Annuity Market
an annuity via the brokers in Chile are the
level of commissions and the amount of the Overall, the life insurance market in Chile has
pension offered. Other factors, such as grown consistently since the beginning of the
company size, reputation, solvency, service 1980's, reaching a total premium of US$250
and national origin are of considerably less million by 1988. Since then, the market has
importance. expanded exponentially, largely driven by the
sale of early retirement annuities, which has
Figure 24: Chile - Brokers Commissions accounted for over 70% of all annuity sales in
(% Gross Written Premium)
the last five years. In 1998, the total life
insurance market premium was US$1.6
billion, of which AFP annuities accounted for
4.9% 64% or US$1.1 billion, in new business.
In terms of assets under management, Chilean
annuity companies’ reserves have risen from
US$1.5 billion in 1988 to US$7.7 billion in
December 1998. These are projected to
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 increase at rates well in excess of 10% p.a.,
Source : S.V.S. Annuities Statistics rising to US$37 billion by the year 2010.
ANNUITIES IN LATIN AMERICA
The number of companies participating in the - Those deriving from the special private
annuity market has increased from 9 in 1988 system of Seguros de Retiro, which are made
to 23 at the end of 1998. Similarly, the up of individual and group assured pension
volume of premium has increased by an plans, and
average of 40% p.a. over the period, despite
- Those deriving from the AFJP system.
having fallen for the first time last year. The
heightened competition shows up in the fact
The former was an early attempt to resolve
that the largest five companies now represent
the social security crisis relying almost
a little over 40% of the market, compared
entirely on private initiative and tax incentives
with 98.5% in 1988.
to create supplementary voluntary savings.
The latter, the AFJP system was introduced in
The expected number of potential annuitants
July 1994 and is closely based on the Chilean
has been projected using demographic data of
model, although with some key differences.
members in the AFP system, and recent early
The Sistema de Seguros de Retiro
The Seguros de Retiro came into being in
The projected flow of annuitants over the April 1987, with Superintendency Resolution
period of is as follows: 19.106, which authorized the creation of
companies especially for this new line of
Table 10: Projected Flow of Annuitants
business - Compañías de Seguros de Retiro.
Year Number of Annuities Given the lack any alternative system of long-
1995 22,000 p.a. term saving at the time (i.e. there was no way
2000 25,000 p.a. to supplement the State pay-as-you-go
2005 36,000 p.a.
system), the new system developed rapidly
2010 49,000 p.a.
and there were over 40 providers by the end
On the other hand, the projected annual of the first year.
premium flows are anticipated to grow as
One of the main attractions of the new system
was the tax benefit accruing to the premiums
Table 11: Projected Annual Premium Flows paid to these special insurance companies.
Year Number of Although this benefit was generous at the
Annuities outset, it has been held at its current level of
1995 US$1 billion A$1,892 for many years now, making it now
2000 US$1.9 billion relatively insignificant for most employees in
2005 US$3.3 billion the middle and high income bracket.
2010 US$4.9 billion Despite the enthusiastic start, the economic
and financial conditions towards the end of
Having looked at Chile in some detail, we
the 80’s and the beginning of the 90’s made
now have model with which to compare the
life virtually impossible in the financial sector
conditions in the other three annuity markets,
and, following a spate of M&A activity, by
namely: Argentina, Mexico and Peru.
1992 there were only 26 companies in this
ANNUITIES IN ARGENTINA market. However, from day one, La Estrella,
the largest Compañía de Retiro, has
Argentina is probably the most sophisticated maintained its lead in this market and as at
of all four markets and differs from the others
December 1998 still had around half of all the
in having had a form of private sector pension policies and the mathematical reserves. There
provision prior to their social security reform are now 30 companies in the sector and the
in July 1994. As such, there are two potential
second largest is Siembra Retiro with a further
sources of annuities: 33% of the market.
ANNUITIES IN LATIN AMERICA
The Seguros de Retiro are better understood However, the Renta Vitalicia and Retiro
as deferred annuities in the Continental Programado methods do. They also have a
European sense, where, for the payment of a third option, the Retiro Fraccionado, which is
regular (normally monthly) throughout the obligatory for any member whose fund is
period of the contract, the policy holder insufficient to opt for one of the other
acquires a right to a portion of a future methods, i.e. the member is allowed to draw
pension, as of a date determined at the time down a fixed amount of around $115 until the
the contract is drawn up. The conditions of balance is used up.
the contract, in terms of the unit premium for
Types of Pension
the future pension are freely determined by
the parties, considering the individual’s age - The Retiro Fraccionado is far and away the
and sex, the type of annuity conditions and the most common method for drawing and old
age after which the pension is to be paid. age pension, with over 8,000 cases by March
1999. This compares with 50 cases of old age
This market can be divided into individual annuities.
and group contracts. The former is effectively - As regards disability pensions, the vast
a competitor for voluntary savings to the majority of the 5,800 cases are still in the
AFJP system, whereas the latter is the most transitory period, awaiting confirmation of
tax-effective and flexible vehicle for their permanent disability status. As such the
“traditional” corporate supplementary pension pensions are being paid by the specialist
plans. insurance companies that can only underwrite
the group disability and survivors’ pension
As at December 1998 there were over 80,000 insurance, the COMPAÑÍAS DE SEGUROS DE
individual and 900,000 group policies in VIDA PREVISIONAL. It is these single line
force, representing over US$1 billion in companies, and there are 18 of them
mathematical reserves (This compares with responsible for paying the equivalent of the
the US$11 billion held in the AFJP system). Aportes Adicionales to the member’s account.
Despite an initial slow-down in the market During the 3 year transition period, these
following the introduction of the AFJP companies also pay the temporary pensions to
system, the rate of growth of new contracts the members declared disabled under a 1st
and premiums is now strong again with Ruling of the Medical Commission.
increases of 13% and 25% respectively in - Finally, there were 28,000 survivors’
1998. pensions in payment in March 1999. Of
these, nearly 15,000 had opted for an annuity.
Given that this system has been in operation The average lump sum premium of these
for over 10 years, there is now a growing contacts is in the order of $37,000. The top
stream of annuities. However, the numbers five providers of survivors’ annuities
are still very small. In 1998, 1,189 new represent over 70% of the market premium.
annuity policies were sold, bringing the total
number of policies in force to 5,639, of which Annuity Policy Conditions
only 83 are individual policies. The conditions of the annuity policy differ
from those of the Chilean counterpart. In
AFJP Annuities Argentina, the member is free to contract the
annuity in A$ pesos or US$ dollars (which is
The conditions of the AFJP system and the
now also the case in Peru).
emerging annuity market are similar to those
found in Chile and Peru, in the sense that at
As price indexation is illegal in Argentina,
retirement, whether due to disability, death or
since the passing of the Ley de
old age, there are different pension methods.
Convertabilidad, pensions may only be held
The Chilean option of a deferred annuity with
in nominal (A$ or US$) terms. This problem
temporary withdrawal does not exist.
ANNUITIES IN LATIN AMERICA
is overcome by the use of profit-sharing The Pension Methods
clauses. As in all the cases before, the pension law
The regulatory maximum technical interest allows the member to opt between an annuity
rate is 4% p.a. real. The only way that a or a PW on reaching normal retirement age.
pensioner can increase his pension is by
participating in the returns in excess of this In the case of disability and survivors’
4% rate. The level of profit sharing is written pensions, however, the law obliges the
into the policy and normally means the issue member or his dependants to draw an annuity,
of a supplementary policy, guaranteeing the i.e. the PW is then not an option.
additional life-long pension, when the annual
returns exceed the prescribed level. Recognition of Contributions to the Old
Pay-as you-go System
It is clear, therefore, that the Argentine The Mexican system for recognizing
reserving methodology does not consider the contributions under the prior social security
possibility of a higher discount rate in relation system differs from all the other systems in
to the degree of matching (calce) between the the region. The State does not recognize any
asset and liability flows, which is the basis of amount, such as the Bono de Reconocimiento
competition in the Chilean annuity market. in Chile and Peru. Nor does it guarantee a
Another important difference is in the tables basic pension in respect of these contributions
used in assessing the annuity. In Argentina (as is the case in Argentina). However, it
there is no single table for assessing annuity goes considerably further. In July 1997 all
rates and the corresponding reserves. These employees were obliged to switch to the new
are proposed by the annuity company actuary system. As compensation for this, the State
and then presented to the Superintendency for now treats the rights to the pensions under the
approval as part of the technical basis of the “old” system as an "acquired right". In this
particular policy. In practice, however, given way, if an employee finds that the pension
the significant risks involved, the actuaries in under the new system is inferior to the
the market have all tended to opt for one of pension he would have received, then the
two US tables (GAM 70 or GAM 90), State guarantees the original pension benefit
depending on the type of annuity. in return for the balance in the member’s
AFORE account (but not including the SAR
With this, the basis of competition among the account). Otherwise, member is left to retire
annuity companies is in the levels of profit with the funds in the AFORE account and
participation offered to the client. This is without any further State guarantees.
good news for the insurer, as, by using a
lower discount rate, the company reduces its This is the reason why there are likely to be
reinvestment risk, sharing the returns with the very few old age annuitants in the
annuitant. In practice, it is normal for forthcoming years. All these members will
companies to share up to 80% of the effectively cash-in their AFORE account and
investment spread. receive the original pension directly from the
ANNUITIES IN MEXICO
Despite being the last of the countries to
Unlike in the other three systems, in Mexico
implement an AFP-type arrangement, it is
quite likely that the Mexican annuity market the insurance market does not underwrite the
will soon outstrip all the rest, both in number risk and cost of disability and survivors’
pension claims. This responsibility is retained
of policies and volume of investments.
by the State, and it is the Instituto Mexicano
de Seguridad Social (IMSS) that pays the
equivalent of the Aportes Adicionales –
ANNUITIES IN LATIN AMERICA
known as the Monto Constitutivo. This is - Monthly inflation indexation - the law
financed by a flat contribution of 2.5% of provides for an adjustment in February each
salaries, collected by the IMSS. year.
- Life insurance.
On presentation of a disability or death claim,
the IMSS pays a lump sum into the member’s - Accidental death insurance,
account sufficient to “top-up” the balance to
- Personal accident cover (including medical
equate with the Monto Constitutivo. This
calculation is assessed using specially
constructed mortality tables and a real - Funeral expenses cover for the member.
technical interest rate of 3.5% p.a. The - A predetermined structure of life-long
calculation also considering a one-time increases pension payments.
allowance of 3.5% for expenses.
- Family support
With this, the member or his dependants are - Educational support
obliged to purchase an annuity equal to the
disability or survivors’ pensions defined in the These and other additional benefits are
law. permitted by the CNSF on condition that they
are fully financed by the insurer and that the
13 companies have been approved to operate term of payment is the same as the annuity,
in this annuity market and a 14th is in process i.e. life-long.
of being approved by the Comisión Nacional
de Seguros y Finanzas (CNSF). The effect of these benefits is to ensure a high
degree of consumer satisfaction, since they
The annuity market has only been in operation
invariably receive a better deal than under the
for 24 months. Given the structure of the
system, there are two types of annuities –
those arising as a result of disabilities and As at the end of 1998, the technical cost of the
survivor’s pensions under the AFORE system additional benefits in the market was assessed
and those deriving from accidents at work. at around 4.4% of gross written premiums.
As at March 1999 there were around 34,000 Investments and the Technical Basis of
policies in force, of which 30,000 were the Policy
AFORE pensioners and the balance of 4,000 As of this month (June 1999) all annuity
were workmen’s compensation claimants. reserves must be invested in inflation indexed
The Product instruments. This is a radical change and is
even stricter than in Chile, where there is no
The legislation obliges claimants to select an
obligation to be in Unidades de Fomento –
annuity company to provide the guaranteed
although the vast majority of the companies
benefits. Only in the case of old-age pensions
can a claimant draw a programmed
withdrawal. On receipt of the Monto Constitutivo the
annuity company is obliged to set up a reserve
The companies compete on the basis of
on the same 3.5% basis in which it was
products or services that they offer in addition
assessed. In addition, all the companies are
to the basic pension. These additional
required to create a series of additional
benefits are also regulated by the CNSF and
- A reserve for fluctuations in investment
returns, to be constituted from 15% of
earnings in excess of the 3.5% statutory rate;
ANNUITIES IN LATIN AMERICA
- An additional reserve (de "prevision") of 2% D&D).
of the base reserve, to compensate for any
The average individual annuity in the forecast
adverse mortality experience, and
has a value (single premium) of about
- A special mathematical reserve constituted US$33,000. These values are smaller than the
out of favourable deviation between the actual average single premium in Chile and about a
vs. planned reserves (i.e. a positive deviation third of the average value in Argentina... due
of more than 5%). in part to the lower average wage and in part
to a lower level of benefits per case. The
- In addition to the reserves, the companies
following is the AMIS forecast of the
have to meet the additional marketing and
Mexican annuity market.
administrative expenses leading to both
accounting and financial loss on all new
Table 12: Mexico: Forecast of Annuity Market
YEAR Projected Annuity Sales
Figure 25: Mexico - Technical Reserves (US$ millions)
(Mexican $ Millions) 1997 $600
7,391 2000 2,020
3,097 2002 2,170
Dec-97 Mar-98 Jun-98 Sep-98 Dec-98
Within five years or so it is easy to imagine an
Source: CNSF Pensions Insurance Statistics
industry with over US$10 billion in reserves
Over the last 24 months, the reserves have ANNUITIES IN PERU
grown to $10 billion Mexican pesos.
The Role for Annuities in the Pension
There are around 2,400 approved and The annuity under the Peruvian AFP system is
registered pension advisers (in addition to also an option, i.e. the member may elect a
each company’s sales agents) who act as Programmed Withdrawal on the normal
consultants and brokers in placing the annuity retirement age. However, an important
contracts. These professionals are monitored difference between the Peruvian system and
by the CNSF and obliged to complete at least the others is the way in which survivors’ and
50 hours of formal training each year – much disability pensions are arranged.
like an IFA in the US. In fact, generous
training courses are provided via the annuity As we have seen, in Chile, Argentina and
companies. In addition, all the annuity Mexico, under the group disability and
companies have signed an ethical code of survivors’ pension programme, the member or
practice, to ensure they control their sales his beneficiaries are given the option to elect
force and brokers. an annuity once the Aporte Adicional is paid.
The rates of commission vary, but the market In Peru the assured pension must always be
average in December 1998 was 1.9% of paid directly by the insurer of the group
premiums. policy, i.e. these companies offer two forms
The MEXICAN ASSOCIATION OF INSURANCE - The short-term risk that a member will die or
COMPANIES (AMIS) has prepared a forecast become disabled, and
of the volume of annuities resulting from the - In that case on-going longevity and long-
above two covers (Work Accidents and term financial risk cover throughout the
ANNUITIES IN LATIN AMERICA
annuity payment period. The Annuity in Peru
Under an annuity contract, the member
This was the method used in Chile until reaching retirement and or his surviving
1988. dependants, are the beneficiaries of an
Among other things, this has a significant irrevocable insurance contract that is
impact on the development of annuities in underwritten by a registered insurance
Peru, as all disability and survivors’ company in Peru.
pensioners do not come to market. This
means that the only annuities really available Unlike the case in Chile and Argentina,
are the old age annuities. Insurance companies in Peru are not divided
into life and non-life companies. However,
At present, five different insurance companies the regulations require companies to separate
underwrite the five AFP group D&D their activities and account separately for life
insurance policies. Despite a formal and insurance lines and annuities, including the
public tendering process, over the last few group disability and survivors’ pension
years the owners of these five companies insurance.
happen to be the same as own the respective The benefit of the annuity contract is the life-
AFP. With this, it is unlikely that the annuity long receipt of indexed pension, denominated
market will develop in Peru at anything like in Peruvian Sol. The value of the pension is
the pace of the other three markets. subsequently adjusted every 3 months in line
Pensions in Peru with variations in consumer price inflation in
Lima. However, since the middle of 1998,
The following table shows the development of
companies have also been allowed to issue
the number of pensioners in each year and the
polices in US$ dollars. These policies will
stock of pensioners as at December 1998 and
not need future adjustments. In this way, the
initial vale of the US$ annuity is considerably
Table 13: Number and Stock of Pensioners higher than the equivalent Sol-denominated
Old Survivors Disability System policies – according to David Blake, with
Year similar conditions in the UK, the initial
1993 - 85 - 85 difference may be as much as 30%.
1994 - 891 12 903
1995 27 1.108 38 1.173 The premium for this contract is a lump sum,
1996 225 2.211 88 2.524 comprising the balance of the member’s AFP
1997 432 2.747 159 3.338 account, together with the cash value of the
1998 972 3.252 271 4.495 Bono de Reconocimiento. This sum is paid at
1999 366 861 97 1.324
Dec-99 2.022 11.155 665 13.842
the start of the contract.
Jan-99 102 303 39 444 The selection of the annuity provider is made
Feb-99 110 324 30 464 via the members’ AFP, through a system of
Mar-99 154 234 28 416 electronic pricing. No brokers and agents are
Total 2.388 12.016 762 15.166 involved and there can be no commission paid
Distribution 16% 79% 5% 100%
on the placement of the annuity.
All pension payments are made via the
This shows that nearly the insurance company
members AFP, i.e. the insurance company has
that underwrites the group D&D risk is
no direct contact with the pensioner.
currently paying 85% of all pensions. Of the
2,400 old age pensioners, the majority are
The annuities can be immediate or deferred.
currently drawing programmed withdrawals.
However, the regulations do no allow
companies to offer any minimum guaranteed
periods of payment.
ANNUITIES IN LATIN AMERICA
Early Retirement and the Bonos de matching (calce) and all reserves are assessed
Reconocimiento considering a real technical discount rate of
As in Chile, the Peruvian law allows for a 3% p.a. Furthermore, the tables that are used
member to retire when his balance is are the Chilean tables:
sufficient to acquire an annuity of at least - RV85 (mortality of annuitants),
50% of his average (previous five years) - B85 (mortality of beneficiaries) and
salary. However, these conditions are of no - MI85 (mortality of disabled members).
consequence to the Peruvian annuity market, The annuity calculation formulae are the same
given the relatively small size of the Bono de as those used in Chile, but considering the
Reconocimiento. different reversion factors, as the levels or
spouse, child and parents’ benefits differ from
Even, if the Bono was a consideration, the law those in Chile.
does not permit the member to endorse it over
to the insurance company nor trade it on the COMPARISON OF REGIONAL ANNUITY
secondary market. MARKETS
Having reviewed the numbers and concepts, it
What is more, retirement ages are 65 for men will be clear that these four markets are in fact
and women and there are very few members very different. Although all of them have
within 10 years of this age. implemented an AFP-type system, as with
The Technical Reserves for Annuities most things, the problems and opportunities
The regulations governing annuities in Peru are in understanding the detail and how this is
were issued by the SUPERINTENDENCY OF likely to affect the development of each
BANKS AND INSURANCE when the AFP market.
system was implemented in 1993 and have
not been revised since. The following table compare the principal
variables I have covered.
The terms of the policy are based on those in
Chile prior to 1988, i.e. there is no system of
Table 14: Condition Comparison among Chile, Argentina, Mexico and Peru
CONDITION CHILE ARGENTINA MEXICO PERU
Reserving Rate Matching-related 4% real 3.5% real 3% real
Indexation IPC / daily No IPC / 12 months IPC / 3
(Unidad de months
D&D Cover Annuities Annuities Annuities X
Early Retirement Yes No No No
Bono de Reconocimiento Yes No No Yes
Who pays the pension Insurer Insurer Insurer AFP
Brokers Yes / >5% Yes / >2% Yes / <2% No
D&D Yes Yes No No
Old Age Yes Yes Yes Yes
Basis of Competition Pension % profit sharing Additional Benefits ?