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This review assesses the Peruvian pension system in its entirety, looking at both public and private, pay-as-you-go (PAYG) financed and funded pension provisions. It draws on international best practices and the specificities of the Peruvian pension system to propose a set of policy options to improve its functioning and ability to deliver adequate and secure retirement income.

These policy proposals should be implemented as a package. All the components work together to balance the different trade-offs. Implementing them separately in a piecemeal manner will break the balance and could jeopardise the whole reform. Nevertheless, implementation could be gradual taking into account fiscal capacity, institutional capability and labour market developments.

The review provides policy options to help tackle old-age poverty; establish a solid framework for the contributory pension system to meet its objectives; improve the coverage and level of pensions; and, optimise the design and improve the regulation of the funded private pension component. These proposals also aim to improve trust that the pension system and its institutions will work in the best interests of the population to provide a secure retirement income.

Tackle old-age poverty by establishing a non-contributory pension that provides a safety net for all Peruvians in old age

The safety-net programme Pensión 65 that provides a flat benefit payment for the elderly in extreme poverty has largely been a success. However, coverage could improve.

  • Benefit levels (currently around 9% of average wages) should increase and should grow, at least, with inflation to maintain purchasing power.

  • Publicity campaigns could increase people’s awareness of the programme and the programme’s eligibility criteria could reach a larger population.

  • With the expansion of coverage, Pensión 65 benefits may need to change from a flat-rate to a top-up payment.

Establish a solid framework for the contributory pension system to meet its objectives

The PAYG public and funded private pension components currently operate in parallel, competing against each other rather than building on complementarity. Strict eligibility requirements for the public system mean that many contributors will not be eligible for benefits. Furthermore, a lack of coordination among public institutions overseeing the whole pension system has led to pensioners losing contributions.

The public PAYG and the funded private pension should complement each other. One main recommendation is to retain both, and require that everyone contribute to and receive pensions from both components.

  • Apply the new rules to all new contributions to the system immediately after the reform while protecting past entitlements.

  • Adjust the public system benefit formula to ensure financial sustainability. Introduce automatic mechanisms to adjust the parameters and benefit levels to the macroeconomic and demographic realities.

  • Reduce the minimum number of years required to contribute to the PAYG system before being eligible for benefits.

  • Establish a minimum level of pension that increases with the number of years of contributions so that individuals can see merit in continuing to contribute. Coordinate the minimum pension benefit with the increased safety-net Pensión 65.

  • Create a centralised platform to collect contributions and manage information collection for the entire system.

Improve the coverage of the system and the level of pensions

Coverage of the contributory pension system is low by international standards, at around 55% of the working age population. High levels of informal employment, relatively low contributions, low contribution densities, and the possibility of retiring before the legal retirement age, explain the low levels of pension benefits, which are around 35-40% of final salary.

  • Subsidise the social security contributions of low-income workers. This would reduce the costs for informal workers, the majority of whom have low income, to become formal.

  • Provide incentives for informal workers to save for retirement. Matching contributions can be an effective incentive to contribute, particularly for low-income groups. Incentives could also be linked to contribution density to encourage more frequent contributions.

  • Nudge individuals to save for retirement in addition to the other measures by, for example, introducing automatic enrolment, and using other insights from behavioural economics such as simplification of the processes and improved communication.

  • Consider reintroducing the requirement that independent workers contribute to the system, while allowing for a flexible contribution schedule and innovative collection mechanisms such as through utility bills.

  • Increase the mandatory contribution rate. This increase could be gradual and linked to wage increases to prevent an immediate reduction in nominal wages. However, during the transition period, there will be people with different contribution rates. Alternatively, or in parallel, additional contributions could come from the employer.

  • Limit the early withdrawal of assets from pension accounts. Early withdrawals for the purchase of a home could be limited to voluntary contributions.

  • Make early retirement more restrictive. Eliminate the gender disparity in early retirement ages, impose minimum income requirements, and adjust benefits downward in an actuarially neutral way to reflect the longer expected time in retirement.

Optimise the design and improve the regulation of the private funded system

Recent measures have generated cost reductions and competition, but further improvements are necessary to promote better investment outcomes for individuals and to ensure that their best interests are of paramount importance.

  • Adapt default investment strategy to provide a more optimal lifecycle approach.

  • Introduce independent investment benchmarks to assess the performance of the AFPs and improve comparability.

  • Align fees with costs and promote competition. Improving the disclosure and reporting on AFPs’ cost and fees would encourage better cost control. Implementing a performance based fee structure would better align the incentives of the AFPs with the interests of their members and would facilitate aligning the fees charged on mandatory contributions with those for voluntary contributions. Limiting how often individuals can change funds and providers would help to avoid cost increases related to unnecessarily frequent switching.

  • Eliminate the minimum guaranteed return.

The option to take 95.5% of assets as a lump sum at retirement has undermined the role of the pension system to provide a regular stream of income in retirement. Short of removing this option, policy makers should implement measures to encourage people to have a pension in retirement.

  • Require a minimum level of income in retirement to be able to take a lump sum.

  • Maintain tax incentives and matching contributions (when introduced) aimed at encouraging saving for retirement only when people buy into a regular stream of income at retirement. People taking lump sums should be able to take only their contributions and returns, but not the incentives received.

  • Continue to simplify and standardise the pay-out options.

  • Ensure the continued security of benefits by regularly reviewing assumptions (e.g. mortality tables) and establishing a procedure to protect annuitants in the case of insolvency of the insurer.

Address the lack of trust and confidence in the pension system

There is a lack of trust in the pension system. The population does not fully understand how the pension system works and how contributing to the system will benefit them financially in old age. In addition, there is a perception that the public and private institutions involved do not operate in people’s best interest.

  • Promote knowledge of how the pension system works.

  • Improve confidence in the financial institutions of the pension system by establishing a centralised platform as the main point of contact for affiliates.

  • Establish an independent committee of experts that will be responsible for the implementation of the reform. They should ensure that the pension reform achieves its long-term view of creating a sustainable pension system in a gradual manner and free of short-term political pressures, and avoiding winners and losers.

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Executive summary