Welfare, inequality and financial consequences of a multi-pillar pension system. A reform in Peru

Peru created the Private Pension system (SPP) in 1993, without dismantling its old defined benefit system (the National Pension System, SNP).  However, members of the SPP (those who previously belonged to the SNP) realised that the expected or already received benefits in the SPP were lower than those in the SNP.  In order to correct this effects, there have been many costly adjustments in the pension system

The author presents a proposal to create a multi-pillar pension system in Peru by merging the SNP and SPP:

• the number of years contributed to any system up to the reform date must be accounted for the evaluation of the entitlement of a minimum pension. Additionally, the insured of the SPP are allowed to keep their pension balance
• in the new system each insured has to contribute a rate (a) from his wage to his individual account and a rate (b) to the solidarity fund. The aim of this fund is financing the minimum pension scheme
• the requisites to obtain a minimum pension are the same as in the SNP: i) 20 years of contributions (to SNP and/or SPP), and ii) the wage used to calculate the contribution must be, at least, equal to the minimum wage
• at retirement age, the pension is computed with the pension balance. If the pension is lower than the minimum pension, then additional resources are added from the solidarity fund until the pension equals the minimum pension value
• the creation of a third pillar is another mean for promoting competition among administrate pension funds (AFP). therefore the reform proposal may also be thought of as an opportunity to bring down administrative fees

The paper argues that the proposal has three important effects:

• pension inequality is notably reduced, which breaks the transmission of inequality from labour income to pensions
• the reform is welfare enhancing, although it depends on the value of the contribution rate chosen for the individual account
• pension debt is reduced

The reform is intended to reduce actuarial deficiency, which in turn may improve fiscal spending allocation. But the State has to assign significant resources to pay pension obligations, which might otherwise be used for other social programmes.