Brazil's Pension Reform: A Golden Goose If It Will Fly

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Brazil's Pension Reform

A Golden Goose If It Will Fly

By Gerald Jeffris

Dow Jones Newspaper, May 12, 2003

Brasilia - As Brazil's controversial social security reform proposal gets kicked around in Congress, it may look like an unwelcome political liability for the new government.

But if it ever gets off the ground, the reform may bring more-than-hoped-for gains for the economy of Latin America's largest country.

Aside from shrinking a chronic public sector deficit, analysts say the reform could help bring valuable funds into local markets by boosting investment in the local pension fund industry by 7-10% annually over the coming years.

"The discussion on the social security reform brought people a concern about retirement, which is something they didn't have earlier and this made people seek out retirement plans," explained Osvaldo do Nascimento, executive director of pension fund giant Itau Previdencia y Seguros. "The great advance that the reform is bringing interest in long term investment."

Domestic savings through pension plans represent about 13-14% of gross domestic product in Brazil, compared to about 50% in more developed economies. After the pension reform, Nascimento, who also serves as president of the National Association of Private Pension Plans, expects this figure could reach 30-40%. And according to Brazilian law, all money put into pension funds must be directed to investments in the local economy, thereby helping lift the value of local assets.

The reform as it was submitted to congress is mostly aimed at shoring up public sector accounts, which have bled the budget and threaten to continue doing so in coming years.

The social security system for public sector workers registered a deficit of 54 billion reals ($1=BRL2.875) last year and the publicly administered INSS system for private sector workers produced a deficit of BRL17 billion.

Together the systems produced a deficit last year of 5.5% of gross domestic product, which surpassed the entire nominal public sector deficit of BRL61 billion or 4.4% of GDP.

The social security gap, meanwhile, is projected to reach BRL80 billion in 2003.

The proposed reforms wouldn't wipe out that deficit immediately. According to official projections, the impact of the reforms would be BRL4 billion in the year following the reform's approval and BRL56 billion over the next 30 years.

"The public system is so unbalanced that even with these changes it won't be balanced," said Social Security Minister Ricardo Berzoini. "The changes we are proposing are to help free up more budget funds for investment in social programs."

Would Boost Local Pension

 Funds Industry

Among the main points of the reform are increases in minimum retirement ages to 60 years for men and 55 for women from 53 and 48 years, respectively. In addition, active and inactive public sector workers would be required to contribute 11% of their earnings above BRL1056 per month. Benefits, meanwhile, would be limited to net earnings after the 11% contribution.

Also as part of the reform, state-administered social security benefits would be limited to a maximum of BRL2400 per month. All benefits higher than that amount could only be paid through complementary private pension funds.

This change in particular could offer a catalyst for the pension fund industry to expand dramatically over the coming years.

Currently, about 8 million of the country's 170 million inhabitants have private pension plans.

The social security reform, meanwhile, could add a significant portion of 5 million active public sector workers and 3 million inactive workers to that group.

According to Itau's Nascimento, the industry has grown at about 35% annually over the last 8 years, but this growth rate could expand to 42-45% after the pension reform.

Meanwhile, local funds have been preparing themselves for that possibility. Bradesco Vida and Previdencia is the heavyweight in the pension market, with about a 46% share. Bradesco is followed by ItauPrev, and Unibanco AIG Previdencia with 12% and 11% of the market, respectively. State-controlled banks Banco do Brasil and Caixa Economica together hold about 15% of the market.

But along with these, foreign players, including Santander Seguros, HSBC Vida and Previdencia, Canada Life, Hartford, and Nationwide Maritime have been expanding operations in the country in hopes of nabbing a bigger portion of the budding market.

The big opportunity for fund administrators will be in the so-called PGBL and VBGL open pension funds.

In 1998, the congress changed private pension plan rules to allow for these portable, tax deductible plans, which operate on a similar basis to 401ks and Roth IRAs in the U.S. Through the plans, Brazil's government permits personal income tax deductions of up to 12% annually on contributions, or deferral of tax payments until the period of withdrawal.

Since the new rules were put in place, investment in local open pension funds has grown to nearly BRL32 billion last year from about BRL8 billion previously.

Tough Road Ahead For Reform Proposal

While the pension fund industry is keeping its fingers crossed for the reforms, the government is bound to face a difficult time in getting its reform agenda through congress.

Labor organizations in opposition to the reform are taking special exception to the required 11% contribution from inactive public sector workers and are questioning the possibility of moving to a defined contribution system from one of defined benefits.

They say, moreover, that the government doesn't need to change the public system but simply apply more budget funds to maintaining it.

"The government doesn't explain where all the money went over the last 30 to 40 years when it collected funds that went to public works projects," noted Milton Almeida, a workers advocate affiliated with labor union umbrella group CUT.

Workers complain that the government used contributions for the social security system on massive investments over the past several decades for projects such as the Itaipu hydroelectric complex, the Transamazon highway, the now-privatized steel company Companhia Siderurgica Nacional SA (SID), and the construction of Brasilia.

Opponents of the reform argue that that the federal government itself diverted as much as BRL100 billion from the system and companies in the private sector owe as much as BRL75 billion in welfare contributions to the government.

They also note that taxes such as the Cofins and the CPMF, which together collect BRL70 billion per year, could be used to cover a portion of the deficit.

In the meantime, arguments such as those have begun to sway government allies and members of the opposition against the reform, which was defeated at least three times during the previous government of Fernando Henrique Cardoso.

Recent surveys indicate as many as half of the 594 lawmakers in congress, including members of the government's own coalition, plan to vote against the government's social security reform proposal. The government will need a three-fifths majority in both houses to approve the changes.

President Luiz Inacio Lula da Silva hopes for completion of the reform by the end of the year.