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September 2009


Calvin Jackson and Katy Bennett discuss executive pay practices globally in a two-part article, the second part to be published next month. In Part 1 they concentrate on corporate governance practices around the world with an emphasis on 11 countries (Belgium, Brazil, France, Germany, Hong Kong, the Republic of Ireland, Italy, Japan, the Netherlands, the UK and the USA), with Russia added in where it makes sense to do so.

The challenges of Brazil's pensions industry, especially in the context of interest rate and mortality assumptions, are described by Eder da Costa e Silva_ He is clear that these challenges are not a result of the global financial crisis and global recession; rather, they stem from the many reforms in the Brazilian economy, no! least the dramatic lowering of inflation in the last decade.

Tim HoUy and Joe Wolcott examine the US company practice of introducing furlough programmes as a means of surviving' tough economic conditions without laying off large numbers of employees They explain what can and cannot be done legally in this area, giving warnings of where the dangers lie in adopting' such an approach.

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Pension Industry Challenges in Brazil:

Interest Rate & Mortality Assumptions

Eder da Costa e Silva

Eder da Costa e Silva has a Master's degree in Professional Administration from FGV in Sao Paulo and is a graduate in Actuarial Science of the Rio de Janeiro Federal University (UFRJ), He is a member of the Brazilian Institute of Actuaries, to whose board he was elected from 2000 to 2004,

In addition, he is an Independent Board Member of the Brazilian Institute of Corporate Governance (lBGe) , Before establishing OTBX with three partners, Mr da Costa held senior management positions in pension funds (TRW and HSBC) , an insurance company (Unibanco AIG) and a number of global consulting firms (Mercer, Watson Wyatt and Hewitt),

The first piece of legislation in Brazil to regulate the private pensions sector, Law No. 6435, was published in July 1977, three years after ERISA * was enacted in the USA. The Brazilian pension law was created at a time when the defined benefit plan was the predominant approach to pension benefits.

After 24 years, the legislation became outdated, as it failed to recognize, with the same speed, all the developments occurring in private pension plans. Technology, investment and advances driven by consultants are fast moving and cause significant changes.

Law No. 109 replaced Law No. 6435 in May 2001. The new legislation and its subsequent ruling brought defined contribution plans out of the shadows, set rules for variable contribution approaches and requirements for pension governance, introduced vesting rules and a new disclosure framework, established incentives for participants' education, and was behind the discussion of many other topics, including a set of actuarial standards for funding calculations.

In parallel with this, the Brazilian economy faced many positive changes. Inflation, after its March 1994 peak of 8496 in a single month, is now under control and forecast to be around-t.S's for the entire year of2009.

Interest rates on government bonds dropped from 45% (nominal terms) in 1999 to a one-figure rate of 8.75% in July 2009 (see FIGURE 1 opposite). The interest rate is expected to drop even further, reaching around 8.25% even before the end of 2009, as indicated by the COPOM - Comite de Politico Monet6ria, a Committee of the Brazilian Central Bank for setting interest rates.

Although the world is facing a global economic crisis, as incredible as it might seem, the topics I am to discuss in this article were not triggered by the crisis but, rather, by the positive state of the Brazilian economy during the first years of this century - after many decades of poor performance.


The pension fund industry in Brazil has experienced significant growth in the last 10 years. As of December 2008, pension fund assets totaled R$416 billion t, over

US$200 billion. Those assets were invested in fixed income alternatives (66.2%), such as government bonds; variable income (28%) represented by company stock; real estate (3.1 %); and other minor asset classes, such as loans to plan participants.

The Brazilian pension fund system is said to be the eighth largest in the world, consisting of 372 pension funds; 1,037 different retirement plans; and 2.5 million participants, retirees and other pensioners. Now, the whole private pensions industry in Brazil might be affected by the low interest rate level, the lowest in the country's recent history.

The growth experienced by private pensions during the past decade followed a period of financial engineering that was supported by much higher interest rates. In the last 13 years returns 011 assets of the Brazilian pension fund were 1,08696, nearly double the investment return required by the actuarial assumptions adopted for funding calculations, equivalent to 550% in the same period.

Not surprisingly, due to the economic CriSIS, pension assets in Brazil decreased by 1.6% last year while foreign pension funds faced an average loss of 19% according to the OECO*. The majority of pension assets in Brazil are concentrated in fixed income investments, mainly federal government bonds. In a scenario of high interest rates, that type of investment guaranteed pretty good returns without exposing pension funds to any investment risks.

That is not expected to happen any more. It is safe to say that those days are gone. Funds are now being forced to review their investment return assumptions adopted for funding calculations, which

;I; Employee Retiremenllncome Security Act

t £1 = R$3.02; €1 = R$2.63; US$1 = R$1,84 as at 21 August 2009

* Organisation jar Economic Co-operation and Development

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used to be 6% p.a, on top of an inflation index. In a scenario of real interest rates of 4-5% p.a., such an assumption may not sound conservative, as it would be desirable. The discount rate adopted on accounting valuations will also need to be reviewed, with unfavorable impacts all the balance sheets of publicly traded companies.

An interest rate slightly under 10% p.a., regardless of the fact that it represents a high interest rate in any country in the world, is bound to have many local consequences. One possible consequence may be a lack of incentive for people to save, in a country where individuals do not already habitually save.

However, excluding what can happen with future retirement savings, the government is introducing many measures to try to soften the impact of a lower interest rate environment on the accumulated pension fund assets.

The government is considering easing the current rules set for pension investments, since limits on the various asset classes are beginning to affect investment results.

A main concern is with defined benefit plans where a 1% drop in the interest rate can represent, on average, as much of an increase in cost as 15-2096. By contrast, with defined contribution plans, a slowing down on investment returns means either participants having more time to save for retirement or accepting a lower benefit.

Among the changes being considered are the following:

• Pension funds may be allowed to invest part of their assets abroad. Currently, the Brazilian private pension entities can invest outside the country only through the so-called "multi-market funds" where the limit is 3%. The authorities are considering raising that limit to 10%, allowing direct investments and not only those through investment funds.

• There is talk of increasing the limit for investments in real estate. Today, no more than 8% of total assets

can be invested in such a market, including real estate investment funds. The 8% limit would be kept the same, but real estate funds would have a specific rule with a separate 10% limit.

• Raising the 50% limit for investments in variable income is being contemplated. Currently, only stocks of companies with the most rigorous corporate governance are considered. The limit would be raised to 7096 of a pension fund's total assets.

During a recent presentation to the sales team of the largest insurance company that markets retirement products in Brazil, many positive things were said about the country having obtained an Investment Grade economy; However. when the drop in the interest rate and its impact on the pension sector was discussed, the Chief Financial Officer grabbed the microphone and said:

" ... for each percentage point drop we experience in our investment returns, we lose half a billion Brazilian reais - over a quarter billion US dollars - in our assets. We have to be ready to reduce our administrative expenses and optimize our costs."

The average asset management fee charged by insured retirement plans to individuals in Brazil is equivalent to 3% p.a. applied over total assets. Considering a 4-5% p.a. interest rate, those fees need certainly to be revised by insurance companies.

The insurance sector will have to pursue better operational results. The leverage once given by investment returns will diminish and actuaries will become more important to the insurance industry than ever before.

In summary, the lowering of the interest rate will affect participants' behaviors, the structures behind the administration and asset management charges. the funding and accounting actuarial valuations, company balance sheets and pension fund strategies. All those are already under discussion and should produce the main changes beginning in 2010. The

Interest Rate Movements

19 Feb 2003 Rate: 26.5%

<, __ A ~~ 10Sep2008

\/~ 18:;:200~ __ / Rate: "13,7%

Rate: 18% r~

---- "<,

10 Jul2009

Rate: 8,75%

1996 4 Mar 1999 Rate: 45%

17 Dec 1997 Rate: 38%






2002 Year









Benefits & Compensation International. SEPTEMBER 2009. 11 _

problems caused by the new era of the single-figure interest rate in Brazil can be viewed positively. However, we should not lose sight of the fact that those pro ble rns were not generated by the global crisis, but by the many changes and reforms the Brazilian economy was subjected to in the last 20 years and is an achievement of Brazilian society.


Prior to 2002, the Brazilian authorities did not impose any minimum mortality assumptions for the actuarial funding valuations. However, in August 2002, through Resolution No. 1 I, the Brazilian private pensions agency, known as SPC - Secretaria de Previdencio Complementar, established for the first time a rule to be adopted by actuaries when conducting annual valuations. The minimum life expectancies to be allowed from that point on were those set through AT-49 (Annu ity Tabl e 1949).

In that first step, the government did not impose a deadline or grace period for pension funds to comply with the AT-49. Some exceptions in the adoption of the new standard were even accepted, as long as they were backed by actuarial statements. The minimum mortality assumption was no big deal for pension plans sponsored by multinational companies, which tended to be more conservative. Few multinationals, if any, were adopting less conservative assumptions than the AT-49 in their funding actuarial valuations.

In March 2006, the bar was raised. The government issued Resolution No. 18, requiring the AT-83 (Annuity Table 1983) to be the reference for the mi nimu m life expectancy. Pension funds were then required to fully comply with the new standard within two years.

Again, little or no impact on defined benefit reserves, liabilities or costing was felt by multinationals. However, possible effects are coming closer, It took slightly less than four years for the minimum acceptable mortality table to shift towards a more conservative position.


Even before the global economic crisis hit us all, there were discussions within the Brazilian private pensions agency about raising the standard of the mortal i ty ta ble once more. The minimum life expectancy foreseen and even observed in government talks is probably the AT-2000 (Annuity Table 2000).

It is difficult to guess when the change will occur, but it is certainly on its way. Looking at the experience curve, on the assumption that it will take the same four-year period as last time, and given that the last change occurred in 2006, the AT-2000 will be in the frame ... sometime during the year 2010.

Today we are facing a global economic crisis; a credit crisis where "cash is king". A conservative mortality table, as in the case of the AT-2000, will probably affect many multinationals' plans with defined benefit components. Company cash flows can potentially be affected and a contribution increase may come to be required in many cases.

To make the change more palatable, the government will most certainly stipulate a reasonable period oftime for compliance by the pension funds.


There is an old Brazilian saying that:

"For those who don't know where they are headed, all winds blow in the opposite direction."

To avoid this fate, foreign companies offering local employees in Brazil a retirement benefit with a defined benefit component might want to consider, during their 2009 actuarial funding and accounting valuations, conducting some scenario analysis regarding interest rate, discount rate and mortality assumptions.

Sponsoring companies need to be on the front foot, reviewing business strategies, redesigning their private retirement benefits and anticipating the changes ahead. Q

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_ 12 Benefits & (ompensationlnternational • SEPTEMBER 2009 •