‘Brazil grows in the dark while the politicians sleep” – so runs the Brazilian expression from the turn of the 20th century that documented an unparalleled boom in the country’s economy, set incongruously against a backdrop of political ineptitude.
Its resonance at the turn of the 21st century is no less striking – albeit for conflicting reasons.
Brazil’s social security terrain has long been blighted by financial problems, which have mushroomed ominously while the government floundered. The growth talked about today is into the red. Debt levels – attributable principally to the anarchic state of Brazil’s civil service pension arrangements – stand in excess of R$60bn (e38bn).
However, a new legislative dawn appears to be illuminating the dark shadows around Brazil’s retirement pillars.
As a result a whole host of new issues are springing up, which in themselves suggest Brazil’s politicians may have finally woken up to the reality of long- term retirement provision and its place in the economic structure as a whole.
This is not to say that Brazil’s ills will be cured overnight.
The country’s basic social security system, INSS (Instituto National de Securidade Sociale), while deemed to be universal, still only covers around half of the country’s official working population (18m out of 37m) and this excludes almost the same number again entrenched in a burgeoning black economy.
Social cover is still relatively low, with most retirees receiving between one and two minimum wages in pension payment.
The second tier of the Brazilian basic system – an autonomous hotchpotch of plans for civil servants and liberal professions – has no affiliation with INSS.
And as Paulo Kliass, secretary for supplementary saving at the ministry of social affairs in Brasilia, points out, herein lies much of the country’s pension debt: “The liberal professions have had autonomy at the local level, which is certainly one of the reasons why there has been such confusion and mismanagement. There are 5,000 states in Brazil, each with their own individual arrangements. If you look at the 1998 figures the debt came to R42bn. From this amount R35bn of the debt was caused by the regional and civil service benefit levels and only R7bn was caused by the INSS system. Therefore, reform of the INSS system was not really the major problem.”
Reform of the country’s supplementary pensions system is the order of the day though. A radical overhaul of the present pensions law – in place since 1977 – is having a profound knock-on effect for Brazil’s supplementary pensions pillar.
In marked contrast to its Latin American neighbours, which have, for the most part, abandoned their social security systems in favour of individualised savings plans managed by private entities, Brazil’s occupational pillar retains a very European flavour.
Corporate pension funds – some of the continent’s oldest – and private plans act predominantly as a top-up to social security rather than a replacement.
The Brazilian closed pension fund system represented assets worth R$115bn by February 2000 – equivalent to around 11.4% of GDP. The country’s open pension plans recorded asset levels of approximately 1% of GDP. Yet it is the latter which is growing at the expense of its more paternalistic counterpart.
Since 1994 the private market has actually risen by about 40% a year. This is in part due to a shift from internally administered (but not necessarily managed) DB arrangements to more flexible and increasingly outsourced DC plans in many of the major corporations, resulting from the extensive privatisation of formerly monolithic public entities.
Carlos de Melo, president of Unibanco AIG Previdencia, has strong views on the market shift: “I don’t feel that in the future we need to have closed pension funds because of the costs involved. If you talk to private companies then they are looking to move towards open entities. Growth is strongest here and the numbers in closed funds are shrinking.”
The other major upheaval in Brazilian pension law is a redefinition of pension fund structure towards a set of legal procedures aimed at ensuring transparency and professionalism – known domestically as laws eight, nine and 10.
Such mainstays as the necessity of a clear split between fund and sponsor – a ‘grey’ relationship that in the past led to numerous scandals – and the need for asset liability models to ensure a sufficient match for the liabilities are for the first time entering law. Pension portability and vesting rights are also included in the comprehensive system makeover.
Law ‘number 8’ covering the custody split passed through parliament this summer with a clear majority. “This law ensures that pension funds hold their assets with an independent custodian,” says Kliass. “We don’t want to have any doubt that there is a split here, to ensure that there is no use of pensions money by the company.”
The law also limits contributions to a match between employer and employee, as well as providing clarity on the legally permitted form of a pension fund. “The old law only mentioned DB, but the new article is very clear that companies can do both DB and DC, taking into account whatever actuarial science is available in the market,” he adds.
The fundamental aspect of the new reform though will be the direct integration of civil servants/unions/liberal professions into the supplementary pensions system in a bid to stem the spiralling debt of the public system. Previously, it had only been possible for a corporation to instigate a complementary plan.
The importance here in terms of fiscal policy is that while participants’ rights will not be lowered, they will be subject to funding within a clear, transparent framework.
Nevertheless, the enormous potential of such asset flows into the market has provoked competitive salvos from both the closed funds seeking to consolidate their dwindling sector and the open funds bidding for a greater slice of the pensions action.
Carlos Duarte Caldas, head of ABRAPP, the Brazilian closed pension funds association, with membership of around 300 pension funds, puts forward the view that it is “economically sensible” for individuals to be part of a large group for pension cover. “In the discussions about the new projects of law we made suggestions – along with the other interested parties – to the deputies in Brasilia about the creation of public pension funds for civil servants and liberal professions. These were accepted and the project was approved.”
Caldas believes the modernisation of the system can only be beneficial. “The creation of specific pension institutes with portability, vesting rights and proper funding will lead to enormous growth potential.” ABRAPP studies show that there are assets of R$130bn in the present system but that in five to seven years there could be R$300bn under the new reforms.
But Fuad Noman, director president of BrasilPrev, and soon to take over the chairmanship of ANAP, the association for open funds, which represents the 40 largest groups, disagrees: “We are very concerned about the new legislation and believe the new rules have to limit the unions in offering these products because such an offering could contaminate the system. One suggestion is that they might not be allowed to oversee the management of the assets.”
Noman points out that associations can already go to open funds for this kind of group arrangement. “We have already had experience of closed-end funds in this area and the result was a disaster. With open funds the performance figures are in the newspaper and you can compare and decide for yourself.”
Nevertheless, in other Latin American markets there has been a degree of criticism levelled at the aggressive marketing of open funds.
And in Brazil, many closed pension funds appear to be acquitting themselves well and adopting the highest professional standards (see boxes).
The debate is also being spiced up by a legacy of taxation uncertainty on capital gains (see page 42) which at present favours the open funds.
As a result, the closed schemes are wrangling in the Brazilian supreme-court with the government for clarification of fiscal exemption.
The open funds have their own issues to contend with.
Brazil’s unparalleled inflationary past meant that individual savings contracts would often wear an attractive nominal interest rate tag covered by the high interest rates available on government bonds. Their real value was debatable.
As the government cuts interest rates, companies are replacing the old guaranteed products with a wholesale 401k type product – known as the PGBL.
However, many are caught between a rock and a hard place. Brazilians still demand the high return rates of yesterday, and fearing a loss of customer base, some open funds are dragging their heels in abandoning the guarantees. Furthermore, competition is fierce in both the institutional and private investment management markets.
Of the 55 open fund entities operating in Brazil, just five dominate the field, with between 80–90% of assets.
New overseas competition arrives incessantly – recognising the market potential – and consequently fees are being driven ever lower. Consolidation is inevitable as distribution becomes key and the development of new investment products intensifies.
The interest rate issue is equally pressing for the closed funds, which can invest up to 60% in domestic shares.
While seeking to boost returns through greater equity exposure, funds are faced with the reality of a relatively small stock market and liquidity squeeze prompted by increasing numbers of company share buy-backs. Brazilian law does not permit overseas investment and the search is on for vehicles to circumvent this impasse.
Private equity is touted as one possibility and funds can invest up to 20% in one company but no more than 5% of overall pension assets.
Activist equity funds are also being promoted as another possibility – part of an attempt to improve overall levels of corporate governance in the market (see page 40).
The call is being made for the relaxation of investment rules though. “In the long term I believe that restrictions on overseas investment should be changed because we are now part of a global capital system,” says Caldas of ABRAPP. “I don’t believe this will happen very soon – although there may be some relaxation concerning Mercosul countries – but in my opinion it will be needed to save pension funds from any future crisis.”
Kliass of the government is more cautious: “We are creating the foundations for economic stability and growth with the possibility to give better contributions, reduce unemployment, and encourage investment in certain economic sectors. Consequently, funds should not be too risky in terms of asset management. One important addition we have made is that pension funds can invest in derivatives and we could see changes to have more private equity or commercial paper activity. The risk management side is essential though.”
On international investment, however, Kliass says the idea is to create the optimum domestic resources to assist enterprises and help build the conditions to develop the market. “Today the stock market is not so large or open, but this does not mean we have to go international. On the contrary we need savings to be invested in Brazil. We don’t have the luxury yet to place our savings for this kind of social activity abroad. That is the case now. Maybe in some years this will change – but we have a long social agenda to follow.”
Undoubtedly the path ahead for Brazil’s social security and pensions system will be strewn with potential pitfalls – it is almost a part of the fabric of the nation.
As Franciso Oliveira, of the Institute of Applied Economics, who worked as an adviser on the reforms, points out: “Every time we have had funds in the reach of the government they have been ruined. I hope that I am wrong this time.”
Oliveira worries about how far fiduciary responsibility has really come in Brazil. “There are still problems here including the idea of reinsurance plans for pension funds, which can create a moral vacuum. One fundamental problem is that there is no Portuguese word for enforce and in Brazil we make laws to see if they work – not vice versa. I want to know that the government will enforce any law against pension fraud etc, because if the incentives are significant no law will hold people back. I believe this country will not grow without a safe, transparent pension fund industry and there is some way to go yet.”
One aspect of this could be whether the closed or open funds win out in the long pensions battle.
Wayne Wride, a senior consultant at Towers Perrin in São Paolo, comments: “My gut feeling is that companies will look to cash balance plans in the future. Clearly, for the first time Brazil feels that it has turned a corner and companies realise that to be a player in the market and attract the right staff you have to have a pension plan. For the most part though, I think the large companies will go towards the more cost-effective PGBL open fund system.”

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