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  Number 226 | Mayo 2000
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Pensions System Reforms: Three in One

Nicaragua’s pension system has been subjected to three reforms: adjustment of its parameters, privatization of its administration and a thoroughgoing replacement of the model under which it operated. Solidarity is out and inequity, the basic problem, was worsened. But all this could change with a new government.

José Luis Rocha

The complete replacement of Nicaragua’s state pension scheme with a private one has caused a huge commotion in the country from the moment the reforms were announced, through their subsequent parliamentary approval and right up to their initial implementation. And it’s not over yet. Anyone could be excused for wondering why Nicaragua, with a per-capita income of under US$500 a year, the shakiest financial system in Central America and one of the lowest social insurance coverages in all of Latin America, has opted for cutting-edge reforms only previously implemented in this form in four other Latin American countries—Chile (1981), Mexico (1997), Bolivia (1997) and El Salvador (1997).

Whether out of urgent need, external pressure, internal whim or the voracity of new financial groups eager to exploit a new market, the change was pushed through with very little reflection or dialogue. Despite the million dollars provided by the World Bank to the Nicaraguan Social Security Institute (INSS) to finance the pro-reform publicity campaign, most of the reading public is still trying to puzzle out the insipid articles INSS published to convince Nicaraguan citizens of the new system’s advantages. In November 1999, a CID-Gallup poll revealed that just 29% of those interviewed knew about the reform, and 76% of those were against it. It is a bad omen indeed if you cannot generate an initial consensus around a process that will last for decades, involve several governments and have us all paying the transition costs for years to come.

The reform was sealed by the pact

At least six serious studies were done over the last ten years with the aim of improving the services INSS offered. Only the one done by the Nicaraguan Pension Reform Commission (CEPREN), coordinated by INSS vice-president Alejandro Vogel Delgadillo himself, recommended the reforms that will now be applied, brushing aside the warnings of the other studies. When the issue was debated in the National Assembly, the representatives opposed to the reforms did not back up their objections with the technical arguments the other studies provided, but instead concentrated on confusing the public or showing off with demagogic broadsides. Ignorance thus turned out to be the executive’s best ally when it came to passing the reforms.

Unionists took to the streets uncertain of the facts but totally convinced that the reforms would not benefit them. The National Association of the Insured (ANASE), the Union of Businesspeople and Executives for National Development (UNYD), the National Association of Nicaraguan Educators (ANDEN), the Sandinista Workers’ Confederation (CST), the National Workers Front (FNT) and the health workers’ union (FETSALUD) all came out against the reforms. But their opposition came to nought; the fate of INSS had already been sealed by the pact. The Pensions Savings System Law, Law No. 340, was pushed through with only 45 out of 93 parliamentarians in favor and 7 against; the remainder, most of them from the Sandinista bench, avoided embarrassment by simply staying away. Those who voted, and even those who didn’t by complicit boycott, were simply rubberstamping a bill obviously based on the INSS study; the only change to come out of the floor debate had been to insist on the old retirement age of 60 rather than raise it to 65.

In the pre-vote lobbying and protesting, the business community was the only winner. It got the employers’ contribution reduced from the 8% in CEPREN’s original proposal to 6.5%. This reduction in employer costs, however, will also diminish the workers’ benefits. Those in the private enterprise umbrella organization known as COSEP knew how to negotiate, while the unions not only failed to notice the goal being scored against them but also won no reductions in the workers’ own contributions.

Everything was set up in advance. For example, the reform clashes with articles of the Constitution stipulating that the state is responsible for administrating social security. But that was dodged using the same legal subterfuge that permits private banks to exist when the Constitution only contemplates a state banking system: the creation of a superintendent’s office to regulate certain aspects of the private system’s administration.

The nuts and bolts of the law

The Nicaraguan social security system consists of three branches: 1) professional risks, 2) illness and maternity, and 3) coverage for disability, old age and death. The new law exclusively affects the latter, which claimed 5.5% of workers’ salaries under the old system. The illness and maternity branch was virtually privatized in 1993 when INSS transferred workers’ contributions and responsibility for providing their health care to newly created Social Security Medical Centers.

The new law came into force following its appearance in the official government publication La Gaceta on April 11 and 12, but still needs enabling regulatory legislation. Its hardest-fought debate was over the harsher legal requirements that must now be met to qualify for a pension. For example, retirement age remains 60, but the minimum number of years that a person must contribute to be eligible has doubled from 15 to 30. In addition, the contributions of both employee and employer have increased while the state’s has disappeared altogether. The new contribution is set at 10.5%, 6.5% of which corresponds to the employer and 4% to the employee. The previous rate was 5.5%, with 1.75% contributed by the worker, 3.5% by the employer and 0.25% by the state. Total disability pensions have increased from 56.3% to 70% of the average salary earned, but that salary is now calculated for the last 10 years rather than the last 5.

The system itself has changed from simple distribution to individual capitalization. Under the original system, the contributions collected and resources accumulated in the technical reserve were simply distributed among the pensioners. This model is also known as pay as you go because contributors pay from their salaries while they work and then receive money from those who are contributing after they retire. It effectively reproduces the shared liability scheme of a family, in which today’s children will look after their parents when they grow old. The new individual capitalization system differs in that the contributions accumulate and are treated the same as any bank account. The money paid out to the pensioner will depend on the profitability of the investments made by the institution responsible for administering the contributions. The hope is that a level of profitability will be achieved that enables the institution to pay the equivalent of 70% of the original salary. Workers’ contributions will be recorded to their personal savings accounts, known as individual capitalization accounts. Once the worker retires, the pensions he or she receives will be directly proportional to the contribution made.

The law establishes that all workers under the age of 43 must contribute according to the new model. The institution responsible for depositing and administering their contributions will no longer be the state-run INSS, but one of a number of new private institutions known as Pension Fund Administrators (AFPs). Thus, not only has the form of managing the pensions changed, so has the depositary. Starting now, INSS will stop accepting new contributors and will only be responsible for those currently over 43.

The new form of administration

The Pension Fund Administrators will be corporations with the exclusive role of administering the pensions and investing the money received in a diversified way to obtain the greatest profitability with the greatest security. To guarantee this, they will be overseen by a Pensions Superintendent’s Office to be established in a law that has yet to be presented to the National Assembly plenary.

To provide greater security, the resources accumulated in the individual pension accounts will be the exclusive property of the contributors and will be separated from the administrative institution’s own holdings. Contributors can select their own AFP and transfer their funds from one to another to ensure maximum profitability and security.

A maximum—and we can safely guess a minimum—of 3% of the contributions will go to the AFP as commission. When the new law enters its third year, the maximum commission will be reduced to 2.5%. When employees meet all of the new legal requirements for qualifying for a pension, they can choose to receive the balance of their individual pension savings account in one of three ways.

1) Programmed income: the AFP will provide them a monthly sum determined by the contributions they made, the profitability obtained, interest rates and the contributor’s estimated life expectancy;
2) Life annuity: on reaching retirement age, members transfer their savings from the AFP to an insurance company which pays them a life annuity;
3) Programmed income with deferred life annuity: this is a combination of the two previous models in which contributors divide their balance, keeping part in the AFP, which gives them the right to a programmed income, while contracting the services of an insurance company with the rest, which gives them the right to a life annuity to be claimed when the AFP’s programmed income runs out.

INSS role shrunken

INSS will play a considerably reduced role in this scheme, collecting the contributions and distributing them to the AFPs. It will also provide the necessary resources when a contributor does not have enough funds in the AFP to ensure that he or she receives the legally established minimum pension. Such a situation should not normally occur, as the law does not allow access to the system to people earning less than the minimum wage, but the state’s commitment to guarantee this minimum is the insured workers’ only safety net if the financial system crashes, due to war for example. INSS will also still provide funeral subsidies and the small pensions for those still covered by the old public system and will therefore be responsible for a minority of contributors and all of those currently receiving pensions. In addition it will be responsible for the "transferal certificates"—also known as "recognition bonds"—that state how much the contributors paid in before transferring to the AFP of their choice. INSS will deposit this certificate in the relevant AFP once all the requirements for receiving a pension have been met. The law does not specify the expected returns on these funds while they remain in INSS.

The new model... in theory

This new social security model that Nicaragua has adopted is being heaped with praise and attributed with multiple advantages. It will supposedly free the state from the possible fiscal deficits generated by providing social security, although the deficits that changing from one model to another will generate are less frequently mentioned.

The new system will supposedly result in the greater profitability of the funds and workers will see a direct relation between what they pay in and the pension they receive. The hope is that the contributions will thus be viewed more as forced savings than as a tax, encouraging them not to dodge the system. It is also supposed that the new system will stimulate our country’s weak capital market, enabling resources to flow towards more profitable activities. In turn, the various projects financed by the pension funds, as well as the jobs and long-term investments generated by these flows, will presumably improve the efficiency of the national economy as a whole. A synergy will thus be produced between the financial system and the pension system, in which they mutually satisfy each other’s needs: social security on the one side and capital on the other. CEPREN calculates that some $44 million will flow from the contributors to the national financial system in the first year alone, and that the figure should total $1 billion by the end of the first ten years.

The new law implies three big changes: privatization, adjustment of the parameters and the transition from a simple distribution system to one of individual capitalization. It is worth looking at them separately because the government has tried to make us swallow all three pills together, as though some of the changes were necessarily linked with others, or the three constituted some kind of monolithic joint package. In fact, however, any of the three changes could have been made without the other two.

The privatization of pension administration

The first big change ushered in by the reforms is the privatization of the system. Nicaragua could have opted to introduce reforms while keeping the system public, as happened in Costa Rica. It is possible for the state to administer the funds under an individual capitalization system or to opt for a mixed system in which a certain percentage of the contribution goes to INSS and the remainder to the AFPs. It is also possible to establish a parallel system in which workers can decide whether to sign up with the state or a private company. Adjusting the parameters and changing the system do not necessarily imply privatization.

To justify privatizing the system, its proponents have fallen back on the old argument that the state is a bad administrator. According to this logic, contributors will now become clients rather than beneficiaries, a metamorphosis that will enable them to demand better services or contract another company if their demands are not met.

A scandal with a moral

Although delving back in time may be one of the most uncomfortable cerebral functions, history continually provides us with valuable lessons. Just a couple of years ago, for example, Haroldo Montealegre sued current INSS director Martín Aguado for his earlier involvement in the suspect administration of millions of dollars as manager of Montealegre’s Banco Mercantil. The Aguado affair was front-page news for some time and both parties invested considerable amounts of money to attack each other in full-page newspaper advertisements.

Exactly how this quarrel was resolved—was some out of court settlement reached or is the suit on ice until Aguado loses his ministerial post and the immunity that comes with it?—is not relevant here. What is relevant is that it came out in the crossfire that once head of INSS, Aguado had deposited millions of dollars worth of his institution’s funds in the Banco Mercantil then withdrew them in reprisal when the dispute blew up. In other words, pension funds were placed in the Banco Mercantil to indulge a former boss and later withdrawn to punish him. Neither move was made in the interest of obtaining maximum profitability for the funds, but rather obeyed another logic. Aguado’s actions in both the private and the public sphere were severely questioned. So what is the moral here? It is that we will always be exposed to corrupt and inefficient officials and will not rid ourselves of the problem by transferring them from the public to the private sector. The ubiquity of corrupt officials is insurmountable. Adequate controls and a real determination to stamp out the impunity of corrupt officials should be prioritized in both the public and the private sectors. All this raises another burning question: how can we expect the state, which was incapable of transparently administrating INSS, to be effective and honest in the Pensions Superintendent’s Office? Is there any guard for the hen house that is not a fox?

The adjustment of the parameters

Various parameters can be toyed with to modify the flow of funds to the INSS vaults and from there to contributors. These include the size of the contributions, the minimum retirement age, the minimum number of years contributed to qualify for a pension, the number of years employed to calculate the average salary and the percentage of the average salary that will make up the pension. Increasing the first four parameters and reducing the last one inevitably improves the financial position of INSS or of any other pension administration institution. The main interest behind adjusting parameters is grounded in an indisputable reality: as they currently stand, the parameters cannot guarantee the majority of contributors a dignified pension. All studies done over the last decade claimed that the parameters had to be adjusted if INSS was to be saved from imminent bankruptcy.

Historical background

That threat of bankruptcy is rooted in INSS’ own institutional history. INSS was created between 1955 and 1957, and its subsequent development has gone hand in hand with the development of its deficit. When the FSLN came to power in 1979, INSS was the fifth least developed institution of its type in Latin America. Part of its technical reserve, built up during an era in which there were a lot more contributors than pensioners due to low life expectancy, had been invested in health infrastructure installations that reduced the costs of the illness and maternity and professional risks branches, whose accounts were not separated from old-age insurance. When this infrastructure was finally transferred to the Ministry of Health, INSS received no compensation whatsoever.

Although the real value of pensions fell rapidly during the 1980s due to skyrocketing inflation, INSS beneficiaries were compensated with certain benefits the like of which they will surely never see again: a monthly food packet, free travel vouchers for city buses and a discount on the purchase of eyeglasses. During the revolutionary years, INSSBI, as it was called then adding welfare to its acronym, also provided social welfare functions to vulnerable sectors such as children, the disabled, the destitute, the elderly and families with serious economic problems that had never paid in to the system. INSSBI was also weighted down with pensions for former FSLN fighters and war victims, a list to which former resistance members and their relatives were added in 1990. The government also discretionally granted pensions in recognition of "services to the homeland." In 1990, this whole non-contributing sector represented 54.8% of the total pensions, but by 1995, under the new government, it had been whittled down to 50%. Although technical studies had suggested that the state treasury should finance these pensions, an administrative decision assigned them to the disabled, old age and death pensions branch of the INSS system, which only served to increase its deficit.

The hyperinflation of the 1980s and first years of the 1990s evaporated the returns on the investments made by INSS. Over a third of its investments had been in national treasury bonds and another part in certificates of deposit in córdobas, two instruments that had sub-inflation interest rates and were not indexed to the dollar so did not retain their value. With certain differences, the same pattern emerged with some of the investments made during the 1990s. Furthermore, debts owed to INSS were not indexed to the dollar either, so rapidly decreased in real terms. To top it all, state companies that owed contributions to INSS and were privatized in the 1990s took advantage of their changed status to ignore their obligations to the institution.

The bad bookkeeping that led INSS to continue invoicing inactive or nonexistent companies and heaping fines and surcharges on top of the fictitious charges helped mask the seriousness of the deficit to some extent until various studies revealed the crisis.

Corruption also needs to be added to the list of problems. One of the most recent scandals involved the issuing of generous scholarships by INSS’ administration to relatives of governing PLC officials. Another scandal involved the investment of the equivalent of US$5 million of INSS’ technical reserves in the renovation of its own deluxe nine-floor administrative building. The official argument was that it was essential "to provide the social security reform with a psychological symbol emanating confidence and solidity," though many saw it as yet another example of the government’s love of opulence.

Why the parameters had to be changed

According to the CEPREN study, INSS has a deficit of over 182 million córdobas [1 córdoba = US$12.5], equivalent to 0.81% of Nicaragua’s Gross Domestic Product. It is estimated that by 2027 the deficit will represent 3.84% of the GDP.

But such a massive deficit is not the only problem. The current contributions rate is not enough to cover the benefits owed to current contributors in any case. The average old-age pensions alone, for example, equal 39.4% of the average salary of INSS contributors. Meanwhile, independent studies considered 60 a low retirement age. They recommended that retirement age be determined according to life expectancy not at birth (66) but at retirement age (76), since if workers retire at 60 they will be drawing a pension an average 10 years longer than was calculated.

With respect to the old 15-year minimum contribution period for eligibility, the problem has been that Nicaraguan workers only contribute 20 years on average, which is lower than the average in many Latin America countries. A number of reasons have contributed to this, among them the growth of unemployment and massive movement into the informal sector, and interruptions in work due to emigration, war, health problems and the like.

The parameters thus had to be adjusted because the system’s future operation was at risk. The studies showed that as far as improving the system’s finances was concerned, the priority was to increase contributions, followed in order of importance by increasing the retirement age and, finally, increasing the minimum contribution period required.
The law did not touch on retirement age because the demagogic campaign of its detractors mainly concentrated on this single parameter. But maintaining this age limit in the new system effectively means that contributors will have accumulated fewer funds by the time they retire. Meanwhile, contributions were raised from 5.5% to 10.5% and the minimum contribution period from 15 to 30 years. Even so, Nicaragua is far from having the highest contribution rates: in Uruguay they are 27.5%, in Argentina 27%, in El Salvador 13.5% and in Bolivia 12%. All of the above-mentioned countries have reformed their pensions system in some way.

Adjusting parameters has its limits. In Nicaragua, a greater increase in contributions would have an obviously adverse effect on the competitiveness of national companies and on the family economy. The government argues that if it had only adjusted parameters it would have simply postponed INSS’s inevitable bankruptcy, and that only a complete change of the system could save it. Certainly, had the reform just involved successive increases in contributions the system would have fallen prey to the problem known as inter-generational burden, in which future generations have to make increasingly higher contributions in order to receive at best the same benefits as previous generations. Although all of this appears very reasonable, most studies suggested a gradual and staggered increase in contributions, rather than the abrupt hike being imposed. The justification for this sudden jump could lie in the need to relieve the state of the costs of changing from the old system to the new one.

The transition to an individual capitalization system

The third great change is the transition from a simple distribution system to a system of individual capitalization. Why was this change made? In the simple distribution system there is no reserve to cover future costs so the system’s payment obligations to pensioners depend directly on the income provided by contributors. The "distribution" consists of dividing among the pensioners the available income from the contributors. The potential risk is that if the reserve drops, the insured will not necessarily receive pensions proportional to their contributions. This system could be seen as a social contract between generations: today’s workers assume the responsibility of supporting today’s pensioners with the understanding that the workers of tomorrow will in turn assume the cost of supporting them.

If the parameters are not adjusted, however, the financial ability to pay the pensions decreases over time as the number of pensioners transcends the number of contributors. In Nicaragua, the simple distribution system apparently worked well at the beginning, when the number of contributors was far higher than the number of pensioners. But over time, the system has increasingly lost its viability.

The population pyramid has evolved in Nicaragua as everywhere else. Life expectancy rose from 57.6 years in 1976 to 66.2 years in 1995. In the coming years the population will have an ever higher percentage of elderly people. If official projections turn out to be true, the current system’s deficit would skyrocket, with spending increasing from the current 0.81% of the GDP to 3.84% in 2027. This same problem is even more acute in the other Latin American countries that pioneered the application of pension schemes, such as Chile, Uruguay, Argentina, Cuba and Brazil. The monumental deficits they have experienced are the result of providing a considerable number of pensions that cannot be covered by decreasing contributions.

In Nicaragua the situation is deteriorating not only due to the country’s demographic evolution, but also because of the weight of the informal sector in the national economy, where 60% of the economically active population (EAP) "works." Extensive public sector streamlining has not been compensated by new jobs in private enterprise and over 50% of the EAP is either openly unemployed or underemployed in the informal sector. Virtually no one in the informal sector has a fixed salary and therefore nobody contributes to INSS, while many businesses that do provide wage-paying jobs are not registered to avoid paying taxes, and thus fall within the "informal" category as well.

The population covered by INSS is more like an inverted population pyramid, where there will soon be more pensioners than contributors. According to a study by Julio Bustamente, Chile’s Pensions Superintendent, the payment of pensions in Nicaragua has been 1.5 times greater than the growth of income over the last three years. The ratio of insured contributors to pensioners dropped from an average of 15:1 in the period 1980-84 to 4:8 in 1994. Faced with so many figures that did not add up, the government’s conclusion was simple: it was not enough to change the parameters, the whole system had to be changed so that those contributing could receive a pension directly proportional to their contributions.

"Photocopying" the Chilean model

The government opted to "photocopy" much of the Chilean model and present it as the perfect example. But Chile’s model has yet to pass the acid test, and it is showing ominous symptoms even though the mass of Chilean pensioners has still not peaked out. During the first 14 years of Chile’s new system, the funds were very profitable indeed, with an average growth of 14%. But in 1995 profitability plummeted to 2.5% and was still under 3.3% in 1966. And as happens where the market rules, when profits fall so do pensions. The AFP commissions did not fall, however, because the system does not punish bad administrators, only helpless pensioners.

Another problem with the Chilean system is that the transition costs are proving to be a problem and will continue to be for many years. The recognition bonds will cost $15 billion, which represents almost a third of Chile’s GDP. Based on this and the low profitability of the investments, the International Labor Organization estimated that 65% of Chilean workers in the new scheme would receive pensions below the legal minimum. Furthermore, it has been demonstrated in practice that the AFPs have the legal mechanisms to dump contributors suffering from chronic and terminal diseases. In Chile most of the contributors are concentrated in a very limited number of AFPs, not because they provide the greatest returns, but because of the impact of their publicity campaigns. The three largest AFPs in Chile account for 69% of the contributors, while in Peru they account for 73%, in Colombia for 58% and in Argentina for 40%. Nicaragua’s importation of an unadapted prescription is a cause for real concern. The study done on Nicaragua by Chile’s Julio Bustamente concluded that it did not have the right conditions to imitate the Chilean model. It recommended implementing a mixed system in which stipulated percentages would simultaneously be contributed to both the state and a private pension administrator. That way the state could guarantee a minimum pension with the private administrator offering individual capitalization. Such a model would have left Nicaragua facing much lower transition costs. According to both Bustamente and Carmelo Meza Lago, who did a study for the Friedrich Ebert Foundation, Nicaragua’s low social security coverage and the weakness of its financial market meant that a mixed system was the most appropriate model for Nicaragua. But the government was determined to clone the Chilean model come hell or high water, ignoring the warnings of both experts, one of whom oversees the very model being imitated.

The Holy Week curve ball

The first application of the model was riddled with obstacles. The reform law was published just before Holy Week in mid-April, but everyone assumed the increase in the contributions would not go into effect until the AFPs began to operate, and there wasn’t even a law for their Superintendence yet. Nonetheless, the INSS board of directors decided to start charging the increase in May so as to pull in some 250 million córdobas to improve INSS’ financial situation.
The notices about the new measure appeared in the media during Holy Week—largely vacation days—to keep the protests to a minimum. It was a real curve ball to both workers and employers. Private enterprise charged that the government had broken the "gentlemen’s agreement" supposedly sealed during the negotiations prior to the law’s approval and threatened massive worker layoffs to compensate for the costs implied in the higher contributions.

According to Article 114 of the Constitution, only the National Assembly is empowered to create or modify taxes. A debate was thus unleashed by the INSS decision: was the increase put forward by the INSS a tax or was it not? Julio Francisco Báez and his brother Theódulo, Nicaragua’s best-known tax law experts, supported by a mountain of supporting documents, brilliantly and unequivocally demonstrated in a televised debate that it was indeed a tax, one known as "special contribution." Meanwhile, the team of INNS lawyers insisted that it was a genre of contribution that the INSS had the authority to modify. It is now up to the Supreme Court to issue a decision.

We will all pay, and dearly

Some have opposed the increase on the grounds that these funds will be used to finance the PLC’s election campaign. If that were the real issue, the proper response would be to fight for honest administration of the funds, not necessarily oppose the measure itself. It is true that the increase is unconstitutional for not having passed through the National Assembly, but there the appropriate response is to get the Assembly’s approval before the AFPs begin to operate. If the funds are used for their intended purpose, they would help defray the costs of the transition to the new model. As part of these transition costs, the government must assume the pensions of the insured who are 43 or older, the minimum pension guarantees and the recognition bonds. It is said that this whole package would cost some US$750 million. Whatever its amount, it would increase the state debt, and thus mean new commitments for all contributors, including those who are not eligible for any pension.
The fewer who are insured, the more unjust it is to burden the entire citizenry with a state subsidy that benefits a minority. All contributors, beneficiaries or not, will pay for the transition. A "forced solidarity" with this relatively privileged insured minority will also be imposed on the 86% of the economically active population that is uninsured. The adoption of some other model, such as the mixed one, would have had fewer transition costs, but having once embarked on the road to the Chilean model, it is unfair to charge those who will not benefit. It is thus better to pay the increase starting now, to lighten the load on the many contributors who get nothing out of social security.

It doesn’t scratch where the itch is

The three changes—privatization, the changed system and the parameter adjustments—do not solve the main problem that social security faces in Nicaragua. With some 250,000 affiliates, the current system only covers 14.3% of the country’s economically active population, or just 5.25% of the whole population, according to official figures. That makes Nicaragua one of the four countries with the lowest coverage in Latin America, and it is undoubtedly even lower in practice than the official figures indicate, since INSS has still not cleaned its records of businesses that are not even open any more. Looking at the new law in light of these data, one feels inclined to repeat the words of an indigenous chief after he was regaled with the benefits of converting to the Catholic religion: "All that scratches, and it scratches well, but it doesn’t scratch where it itches." The reform just doesn’t get to the root of the problem.
The crudest dimensions of the problem show up when we analyze the coverage by economic sector and geographic region: the three most urban departments (Managua, Chinandega and León) hog 95.5% of the total number of insured. Their three capital cities plus Matagalpa’s absorb 74%. Meanwhile, only 3.8% of the total are engaged in agriculture, hunting, fishing and silviculture.

The surest insurance

The new system makes it harder to extend the coverage, especially given the increase in contributions. Any new system should promote the incorporation of new affiliates and expand the coverage to spread the costs out more, but the new law does not oblige the AFPs to offer facilities that would incorporate new affiliates.
In Chile, where the AFPs have been functioning for 18 years and a very high percentage of the population is covered, barely 11% of self-employed workers have been insured. And of those, 4% are professionals working in the formal sector. What will happen in Nicaragua, where over half of all workers are self-employed and most of those underemployed, where 60% of the economically active population is in the informal sector and where 48% of the population lives in rural areas? Article 16 of the new law reads: "The base income for calculating the contributions of independent workers will be the monthly income that they declare to the Administrating Institution, which in no case will be below the minimum monthly wage in effect." Self-employed workers can voluntarily sign on to the system, but how many of them enjoy a wage or other income that is not below the legal minimum?
What about the many peasants who live outside of the money-based economy, whose income is expressed basically in kind since their local economic trade is carried out in barter? Even those freelance workers whose income exceeds the minimum wage will be hard to convince of the benefits of the new system.
It is foreseeable that the real pension insurance for most retirement-age people in Nicaragua will continue to be the contributions they get, if they are lucky, from their children and grandchildren, although even that is in danger from the already massive and growing unemployment.

Solidarity the big missing ingredient

A social security system should fulfill two objectives, the first of which is to prepare for old age. For the lack of a savings culture, the lack of anything to save after meeting immediate consumption needs and so many other reasons pertaining to a culture of day-to-day survival, the majority of Nicaraguans cannot or do not provide for their own retirement. That is why forced savings to have something available for old age is a first basic objective. The second is that the system should provide a redistribution function. Since the elderly are the most vulnerable of a mainly poor population, society should redistribute income toward them, guaranteeing them a minimum pension so they can live decently. Social security is an expression of community solidarity. But during the changeover from a distributive system to one of individual capitalization, solidarity disappears. The objective is financial: the new system does not channel funds toward solidarity redistribution, but toward profit-making investments, presumably in productive activities that create jobs.
The new law is lacking in solidarity. It has done away with the transfer of resources from citizens with greater incomes to those with smaller incomes. In the previous law, if the contributor’s wage was smaller than two minimum wages, he or she had the right to collect 45% of that wage on retirement, plus 1.591% for each year in which contributions were paid in after the first three years. A worker whose wage was more than two minimum wages could only collect 40% plus 1.365%. This equity norm has disappeared and the pension now depends only on how much was contributed. Thus the new system will clearly only increase the social inequalities that were already strangulating Nicaraguan society.

Even keeping the bulk of reforms, dispositions could be designed that would reintroduce solidarity. There is some solidarity, some equity in the Social Security Medical Centers. One makes use of their resources depending on one’s illnesses. Those who get sick more do not pay more, meaning that there is still solidarity in all the contributions toward the contributors who are the sickest, because they have access to more of the system’s benefits. If some solidarity mechanism is not included into the new pension system, we will have a law subjected to pure, hard-nosed market reality: benefits depend strictly on money, on the amount of one’s own contributions, and on the monetary profitability of the investments the AFPs make.

By law, the new system seeks "a direct relation between personal effort and benefits obtained." This presupposes that personal effort is equal to wage remuneration and time of contribution, when we all know that this is simply untrue, that Nicaragua has no shortage of factors that prevent personal effort, however huge it may be, from being awarded a decent remuneration.

AFPs: a risky "duopoly"

The reform paid no attention whatever to the multiple warnings that Nicaragua does not have the right conditions for the AFPs to develop appropriately. Their investment performance will depend on our barely developed financial market, with the further aggravation that, unlike other countries using the same model, Nicaraguan law does not impose a minimum profit rate. The investment yields have not been very high in other countries applying the reform: only 6.7% in Colombia and 7% in Peru. In all of Latin America, Argentina has the highest rate—16.2%—and it uses a mixed system.
In contrast, the 3% commission that the AFPs will receive in Nicaragua is the highest in Latin America. INSS director Martín Aguado has only mentioned two AFPs. With Nicaragua’s limited coverage, there is no room for more, but this "duopoly"—two administrators monopolizing the service—will not make for a better supply of services, even if the commission is lowered or profitability rises. It will also impede the competition that, in theory, guarantees some of the system’s benefits. Bolivia also has a duopoly, and there are problems with it even though the insured population is 70% larger than Nicaragua’s. What can we expect here, with only 250,000 insured, of which a high percentage are already on their pensions? The same thing could happen with the AFPs that is already happening with the Social Security Medical Centers: there about 30, but only 3 of them have cornered two-thirds of the insured and two-thirds of the services provided.

In the interest of improving the performance of the funds, measures should be taken to correct these possible distortions. The law prevents the AFPs from having any other function than administrating the pensions. If other financial institutions not dedicated exclusively to this activity were to be permitted to move into pension management, it would allow greater participation and greater competition, which would reduce the risks of the duopoly, allow agents with proven technical and administrative capacity to participate and reduce the commissions.
The multiplicity of services would also distribute the costs among a larger number of clients and operations. Consideration could even be given to creating non-profit AFPs, which would be a challenge for the NGO community.

More equity and efficiency

Many mechanisms could be introduced to improve the new system’s application. The architects of the reform made a choice, but not always the best one. Some of the mechanisms in other countries where reforms were applied to install the individual capitalization system could improve the equity and efficiency of the model applied in Nicaragua.

In Chile, for example, the AFPs, not the state, assume the costs of the Superintendence of Pensions, which is more reasonable there because the Chilean state guarantees a minimum investment yield. It also guarantees the pensions in case the AFPs go bankrupt. In Mexico, the minimum pension is equivalent to the minimum wage, adjusted annually to the price index. The Mexican state also guarantees a pension at least similar to what the pensioners would have obtained in the previous system. And finally, one of the AFPs in Mexico bases its commission rate at least in part on its investment yield, which obliges it to be more efficient in seeking the greatest earnings. In some countries a solidarity fund has been created with 1% of the medium and high wages to benefit lower-income pensioners, and in various countries, the AFPs were selected based on bids.

The die is not cast

It was essential to reform the INSS. One of the many existing models is definitely going to be applied in Nicaragua. Others could have been applied just as easily, among them the mixed model, which has proven that it reduces the transition costs and has demonstrated better performance with the funds. Nicaragua’s previous system has only been replaced by the individual capitalization model, and even then without including some of its benefits. Things clearly could have been much better, but the die is not yet cast. It can be hoped that with the changes that Nicaragua demands, this law could take several new tacks, introducing more equity, more coverage and more efficiency. If in the upcoming elections we vote for better informed legislators with a more ethical turn of mind, we will be able to provide this law with the many adjustments it still needs.

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