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Private pension changes essential to secure a prosperous future

Interview - July 9, 2015

A large proportion of Peru’s workforce is in the informal sector and therefore not included in the current pension system. This will spell problems in the future for Peru to support an ageing population that has not paid into the system. Therefore fund managers are calling for a greater push to bring everyone into the private pensions system, to tap the huge potential market, and provide incentives that encourage more workers to contribute to a more secure future. Renzo Ricci Cocchella, CEO of Prima AFP, discusses the gaps and opportunities in the market, the changes already made, and the reforms still needed. 


The World Bank and the IMF are confirming the economic progress of Peru over the past decade, a growth that is undoubtedly completely different from that of the rest of the region. This growth cannot be understood without the work made by institutions such as the AFPs (Pension Fund Administrators) in the country. How have the AFPs, and Prima in particular, contributed to this economic growth that has led Peru to where it is today?

We should first contextualize the importance of AFPs in Peru. As a system, today we are close to $40 billion, about 20% of the GDP, and represent the main source of savings in the country.

This has been extremely positive, because it's also a fund for individual accounts, not a distribution system.

Therefore it's the actual savings of the more than 5.7 million Peruvians who are in the AFP system.

When we invest, we invest a part in the local market and another in the global market.

We believe that while we are leverage for the country's growth, and our goal is to be profitable and get better pensions for our customers, the fund should be increasing its share of global investment.

In fact, we have made progress in that regard, we started with 10% and we are currently at 42% of investment abroad.

But that doesn't mean that we're not investing in Peru. Most of our portfolio is local; we are very interested in long-term projects, such as infrastructure or private equity.

In that sense we have also been leverage for growth, the AFPs have participated in a number of infrastructure investments that represent about 10% of the portfolio and they are increasing, because in 2012 there was a reform in the pension system which basically sought a much more efficient investment model, with new investment instruments, and among the changes made there was a considerable increase in the limits for investment in alternative funds.

We have three types of funds: low risk, medium risk, and high risk. In the medium risk we can invest up to 15% in hedge funds, and the high risk, which is the one with more variable income, about 20%. Only in hedge funds, which in turn are invested in infrastructure. Thus, the potential for the AFP system to continue to invest in infrastructure and be leverage for growth in the country is certainly very important.

We not only contribute through infrastructure, but also through investment in various companies in the country, which means that we are also leverage for the growth of various businesses.

According to a study, approximately 0.5% of the annual GDP is related to the AFPs.

We are also a major player in the capital market, which is both good and bad. It's good, because we are an important capital market player, but it's such a small and liquid company, that when we invest we are left with long-term instruments and therefore we influence in the capital market being not so liquid.

So there are certain measures to take on how to further develop the local capital market.

Overall, the AFPs have been a determining factor for the growth of the capital market, and an important leverage in infrastructure and other sectors.

In a recent interview, you said that citizens should be better informed about how their pension fund is being invested in a particular infrastructure project, which is contributing to the development of a sector of their own country, in order to have more affiliates, and make people leave informality and join a pension fund. Do you that the general public knows about the output of their pension funds in the society?

In fact, although the system is already 22 years old and there have been a number of efforts to communicate its benefits, I think we have not been effective in this regard.

There are many questions, many myths going around about the AFP system. I think there is still a long way to fill this gap of information with our customers.

We developed a very aggressive communication campaign to destroy those myths, by radio, by press, and social networks.

Our employees have become spokespeople in this task, and I believe we'll be able to spread the word about the advantages of this system.

In a recent market study we noticed something very interesting: in general, AFP members have good information and a good perception of the system, while those who have a poor perception of the system are those not affiliated to it.

So, we must not only make an effort regarding our affiliates, but we also have to make an effort with the general population, to fight against the myths and lies spread about the AFP. This is a big challenge.

This journey began in 1992 with a law passed by former President Fujimori, with the model of Chile in mind. However, the ratio of affiliates in Peru is lower than the average of the region. The demographic curve indicates that there is a huge potential, which can contribute to long-term growth. What is in your opinion the path to follow?

In Peru, while there are 5.7 million members in the AFP system, and about 2.5 million in the national system, the ones actually listed are about half those figures, around 2.5 [million] in the private system and just over 1.5 [million] in the national system.

That is about 4 million people contributing overall (out of an economically active population of 16 million).

That means only 25% of those who could contribute to a pension system are covered, but the other 75% are not.

That's a risk for the country, because the future governments will have a significant portion of the population without any coverage on the risk of longevity.

Why do we have this high percentage of the population outside the pension system? Mainly because of informal work.

That's the difference between countries like Chile, Colombia and Mexico, where the AFP system has much more coverage.

The question, then, should be whether it is the AFP system that is responsible for the formalization of the economy, which I think is not.

That role goes beyond the AFPs; it requires a government project. Also, having such a high rate of informality creates a barrier for sustainable GDP growth.

Of course, that doesn't mean that at the AFP we should stay idle, we must also make an effort to communicate the benefits to the segments of the population that are not affiliated yet.

Today, the AFPs are basically focused on salaried workers, but they lack the self-employed, such as doctors or lawyers. With the reform, there was an intention to make affiliation mandatory for this sector, but in the end this was rejected in parliament.

Still, something must be done about these sectors, because if we make the projection for 2070, the population will cease to be demographically as a pyramid but it will become something like a cylinder, we will have more and more adults without coverage, and the adult-youth ratio will begin to change, so that there will be fewer young workers and more adults without coverage.

If a decision is not taken today, in 55 years we will have a very serious problem, and some future government will be forced to provide coverage for the people who need it. That decision must be made today.

There are currently four AFPs operating in Peru, with a total of $40 billion in the private pension system. Since your arrival, this company has seen significant growth. What is your strategy to continue growing and differentiate it from competitors while looking ahead?

In 2012 many things changed in the private pension system. Among them, the market is no longer a free and open market, but a closed, monopoly market where new affiliates are incorporated into the AFP that wins a bidding process based primarily on price.

We believe that this system generates some bad incentives, and we also believe in free market.

We have spoken with the regulator and we have conveyed that we believe there should not be any more tenders.

Recently there was a second tender which means the monopoly will go on until May 2017, and I hope that from June 2017 the market will be free again.

If that happens, Prima will have a comprehensive value proposal because customers, when choosing an AFP, choose not only the price, which is the only driver of tenders.

An AFP is also chosen for profitability, which is undoubtedly one of the most important factors, because it is what has the biggest impact on the pension.

It is chosen for support, because this is a long-term business – nobody wants to put their money in a company that is not reliable.

It is chosen because of consultancy and information, because people want to know how their capital is invested, or about the pension arrangements; they want us to be close to the customers.

I'm not saying that price is not relevant to be competitive, but it's really a combination.

We are the market leader, and it's not me who says so, they say so in market studies. We work so that our proposal is the best on the market, and in doing so we expect to gain a significant portion of the future free market.

If the market remains closed, the sources for growth wouldn't be through our affiliates but by other businesses.

These may be, for example, voluntary contributions, which may be with or without pension purposes.

When they have no pension purposes, then they are like a mutual fund, simply to monetize a surplus; they have nothing to do with a pension.

If you have surplus and savings, you invest in the same fund of your pension, and can withdraw it at any given time. This is a line of business that's growing significantly.

Then we have the transfers, clients who are in another AFP, who prefer our proposal and who eventually join Prima.

Those are the three main drivers for growth. The other growth driver is efficiency. Our spending on income ratio has improved substantially; in a few years it has gone from 50% to 42%.

To make our proposal more competitive, this efficiency can be transferred in part to the price.

Actually, the main leverage to transfer our efficiency to price is the extension of coverage, because the more coverage we have, the more we dilute our fixed costs over more customers, and therefore we become more competitive and we can be more aggressive in the price offered to the market.

So we believe in the free market, because in a free market all AFPs can expand their base, become more competitive, and transfer a part of their efficiency to the final price.

You've mentioned that the AFPs have enough money to continue investing, but they need the government to raise the limit for investment abroad. Is this because it is less risky to invest outside of Peru, is it to diversify the investment portfolio, or is it to have a synergy with the ways in which the AFPs are investing at a global scale?

In portfolio management, the golden formula is diversification. We can use a specific example.

The system was created with less than 10% of investment abroad, we are now at 42% and we would like this percentage to continue rising.

Today the Central Bank can increase it up to 50%, and if we want it to be higher than the 50% then it should be approved by the parliament.

In Chile it is up to 80%. This doesn't mean that actually the 80% is invested abroad – that is just the limit – but they have the flexibility to decide whether to use that completely or not.

For this reason, diversification is critical to generate good returns with less volatility. Also, if you are forced to stay too local, you end up investing in some liquid papers and in a small market, which greatly increases the volatility of the fund.

Extending the limit of investment abroad doesn't mean that we will not invest in Peru, but it allows us to invest in both markets, because the liquidity received by the AFP system every year is huge, including contributions, dividends and bond coupons.

We must be close to $4 billion annually in the entire system. This is the equivalent of the construction of a whole gas pipeline every two years.

The investment portfolio of Prima AFP alone is around 33% of those $40 billion.

You've also said that it is important to mention that in 2014 there were new projects at a global level, more in line with the big players. What do you mean by this?

Years ago we used to invest a lot in the local market, at fixed income or variable income, categories such as "plain vanilla," something not very complex.

As time went by we have become more global, and we have new investment categories such as hedge funds or derivatives.

We have evolved in our investment team and our risk team, not only in our professional quality but we have also increased the size of it.

We changed its structure to adapt to this new reality, and we have changed our systems. We are using the Bloomberg systems in portfolio management, we have made alliances with BlackRock in consultancy, under a model of strategic location.

We have changed the incentives for our investment team to be more long-term, and we have changed our processes.

All this has meant a huge change in the structure, equipment and systems for investment and risk, with a model that ensures a greater system performance under a limited risk.

Where are you investing, internationally speaking?

We're not staying in one particular region. We have a monthly investment committee that evaluates global conditions and the situation in Europe, Asia, and the United States – emerging versus developed, fixed income versus equities, etcetera.

Several perspectives are analyzed for decision-making and what to do with the portfolio. We are now working in the United States, Europe, Japan, India, and China.

But there is more uncertainty now than a decade ago, so the decision-making process is more complex.

Peru has a direct or indirect relationship with the United States. Credicorp has been listed in the New York Stock Exchange for over 20 years now. You have brought Oliver Wyman to improve your system efficiency, and the new technologies in the sector are coming from the United States. What does the US represent for the core business of Prima AFP?

The United States is without a question an extremely attractive market in fixed income, in equities, also even in alternative funds.

Furthermore, the performance of equities in the US has been excellent, especially last year, so it is always a country that we consider as an investment opportunity.

As for alliances or suppliers, it's true that there are very important companies for consultancy or potential partnerships.

We've had an excellent experience with Oliver Wyman regarding investment advice. It's a country you always have to keep in mind because it’s a very important global player.

Finally, what are the three things related to the AFPs that you would like to change?

The first is that there should be a single system in Peru in which the systems are complementary – with the AFPs managing individual accounts under the mandatory pillar, the government contributing to the solidarity pillar to ensure and complement the AFPs, ensuring a minimum pension, and a third pillar being the voluntary contributions, in which the customer who wants to further improve their pension can do it.

That would be my first wish list regarding how I'd like to see the Peruvian pension system.

Secondly, and specifically about AFP Prima, although this company is very close to its customers, it could be even closer through technology, so that our customers have more transparent access to all the information they need about their portfolio or any other issues related to the AFP.

That's a wish list that we can control, which involves strategic decisions.

And thirdly, the government should be actively involved in solving and offering initiatives to expand coverage. I'm talking specifically about the challenge of how to turn that large portion of informal work into the formal economy.

I think this is extremely important, not only for the AFP system, but for the country as a whole.