SeLFIES: Uma simples inovação para melhorar a segurança na reforma

The reason why Brazil thought about creating a sovereign supplementary pension fund to be offered directly to individuals as an investment is the high proportion of self-employed workers. In addition to official public pensions, there is a relevant private market for complementary pensions in Brazil (around 26% of GDP), but it does not fully serve low- and middle-income workers, especially the self-employed.

Thus, by 2022, there is an expectation that a complementary pension fund will be implemented in Brazil. Inspired by the Standard of Living Indexed, Forward-starting, Income-only Securities (known by the acronym SeLFIES, which can be translated as "standard of living indexed, amortization-only and future income)"), with an innovative and simple approach, it aims to facilitate and democratize supplementary pension income for many Brazilians. This product can even serve as a gateway and education for supplementary retirement income planning.

With just two pieces of data - the desired income and the expected retirement date - the saver can plan their supplementary retirement, and will be able to know that they need to purchase a certain amount of securities until retirement begins, simply by tracking the evolution of the amount purchased over time.

The main attributes of SeLFIES are:

- It is a long-term government bond with a yield linked to the change in inflation for the period, plus interest set at the time of purchase..;

- This bond combines the accumulation and income phases in a single instrument. There is a long period of accumulation of resources in this instrument, which from a certain date starts paying monthly amortizations for 20 years, thus imitating a retirement income; and

- This sovereign wealth fund can be bought directly by individuals, ensuring low transaction costs.

Brazil will be a pioneer in the world in offering this type of social welfare planning instrument to its citizens. Two pre-existing conditions favoured the adoption of this public policy:

(i) Brazil is one of the pioneers in issuing inflation-indexed bonds; and

(ii) Since 2002, Brazil has had a program called Tesouro Direto, which sells federal government bonds to individuals 100% online.

Two challenges to offering SeLFIES in Brazil can be cited. The first relates to communicating to citizens about the role of this instrument and making it clear that this instrument has the function of complementing, not replacing, public pension provision. This is especially important because public pension provision has a much more comprehensive range of protections and at a lower cost to the insured compared to any alternative market solution. The second challenge is to place the focus of communication with SWF investors on the income to be received in retirement, rather than the accumulated balance or the return earned at any one time. This is extremely important from a financial education point of view, especially as the price volatility of this bond tends to be high due to the long term. But as we have seen, in terms of inflation-adjusted income, this bond will be quite stable, and this is the most important variable for a citizen planning his retirement.

I believe that this kind of complementary savings instrument for retirement could be useful for many countries.

Considering in particular the demographic and labour market trends and the low level of financial and welfare education, there is a perceived need for nation states to provide the population with complementary and easily understandable means for better retirement income planning.

All these factors show that the population needs to be increasingly aware of the need to take responsibility for retirement planning with different sources of income: public pensions, private pensions, income from work, etc. The public pension system will remain the main source of retirement income for the majority of the population, but it will be increasingly important for workers to seek to supplement their retirement income with other instruments, for the reasons explained above.

On a theoretical point of view SelFIES seems to me a great solution to face financial challenges of longevity rise and for funding complementary guaranteed income to state pensions provisions during retirement. In my opinion SeLFIES should be considered by Spanish and Portugal Governments but taking in account all the barriers and difficulties for their development, working in a shock measured plan to face those barriers. Some of those difficulties are not currently faced al all-in regard to complementary saving and retirement complementary personal and occupational pension provision.

From a point of view of the incomes generation a part of the fiscal policy, SelFIES would be an efficient way of obtain cash flow to infrastructure project, making it more attractive to investors/saves due to less default and credit risk.

SeLFIES are also an attractive complementary tool for insurance company to compensate or balance the longevity risk of the lifetime payments on their annuities’ s portfolio.

Also, it´s a good point to use SeLFIES in pensions fund and insurance portfolios in order to enhance diversification, reduce volatility, and decrease investment and longevity risk.

For some long-term retail savers to get a defined benefit structure with a guarantee, mitigating or removing investment risk and longevity risk, could me make SelFIES very attractive as unique complementary saving tool for retirement or as a part of their whole retirement assets portfolio.

But anyway, I don´t visualize Selfies as a main or unique type of asset in a long-term strategy for savers, due to the limitation in terms of guarantee rates, coupons, and the difficulties to beat inflation with guaranteed structures. 

¿Which are the potential barriers to SelFIES in Spain and how to face these challenges? 

Most of them are not directly related to the SelFIES product features.

A majority Spanish mid class workers don´t have saving habits. They don´t save in financial products, but when the save most of them don´t save in currently available financial asset, mutual funds, pension funds, insurance product.  ¿Why the diagnosis and the results would be different for SeLFIES?.

• State pensions in Spain provide a high replacement rate (near 80%). That net replacement rate probably will rise in the future thanks to last pension reform which will improve the pensions benefits. Actually, current Government policies are prioritizing generosity to sustainability and to the future income/benefit balance. An average wage employee could be asking himself: ¿ why should I generate a complementary pot/annuity if Government state pension will provide me what I need. The worries about future risk of sustainability (and sensibility to the need of adaptation future benefits – or extending retirement age- to longevity increases and dependency ratio) are not present among most of society, just among a small group of expert, pensions professional, insurers…

• Saving asset composition in Spain, and type of assets, with a majority of real state asset (77% of Spanish family wealthy). People save in houses non in financial products. This is grounded in the basics of our society and our DNA.

• Among financial assets, a huge part of the saving, even for long term saving, is placed in bank accounts and deposits, a consequence of lack of financial education.

• Individuals saving on a personal voluntary basis are insufficient. But the diagnosis is even worse in occupational pensions, although it´s expected than the new legislation (Ley 12/2024 de regulación para el  impulso de los planes de pensiones de empleo)  will increase the savings (AUM) of employees in workplace pensions.

¿Why the Spaniards are going to save purchasing SeFIES, even accepting SelFIES are easy to understand to them and a safe solution for them? For being successful is this objective, we need to have a look and work much better applying the same measures that those, than pensions industry always discusses about, in order to fight against the lack of long term complementary savings (both DB and DC). Some of that measures never have been implemented in Spain and others haven´t been set up in a proper way.

However, for individuals and institutional investors (pension funds and insurance companies) in other countries of UE and OCED could be an attractive option to purchase Spanish and Portuguese Governments SelFIES . In many of those others OCDE counties, workers asset in long term savings are much higher than the Spaniards keep, more than 100% of GDP in some cases ( i.e Netherlands 210%, UK 118%, Switzerland 149%-) vs less than 3% in Spain . 

Reasons for this much higher private and occupational pensions savings are:

• A deeper financial education among those countries’ nationals.

• But mainly a need to complement, with annuities benefits providing buy occupational and personal pensions plan, a low amount and low replacement rate state pensions, which in some cases are just safety networks against poverty (based in residency and not in salaries/contributions). Some countries accounts high levels of occupational pensions assets because it´s mandatory (by law or by collective bargaining) to employees and their employers (ie.  CH by law or many of Netherland collective agreement) or just to the employer (UK by law) to enroll employees and to make contributions to the pension’s schemes.

So SELFIES issued by Spanish Government could find in the future a market of purchasers in others OCDE countries (and as well outside OCDE), as an alternative for individual savers or for institutional investors, like occupational pension funds, to better leverage their portfolio asset allocations and diversification.

But as first purpose, Spanish and Portuguese Governments should close the circle and try to use SeLFIES to “help” to improve the pensions complementary payments of their nationals during their retirement, not just to obtain international financing. Including SeLFIES within those Governments debt emissions “product mix”, explaining easily the benefits of using this type of bond, not only to the institutional investor but also the benefits to individuals for their retirement financial safety (guarantees, grading and credit risk contention, easy to account by the individual what he/she will perceive). “Marketing” and communication will be critical.

¿Why not a institutional campaign (tv and media, social networks, Spanish Tax Agency communications when annual personal income tax presentation, etc.) focusing about the benefits for the retail investor purchases?

SelFIES should be emitted just by Spain (and Portugal) Governments, no on regional basis (Comunidades Autonomas) neither other public entities. 

Tax incentives would help in the SelFIES

To support building up a massive interest to subscribe of SeLFIES among Spanish and Portuguese individuals (among those who currently are saving and those who doesn´t have savings), it would be very convenient a deferred tax scheme, a EET (Exemption, Exemption, Taxed).

Subscription/purchasing of SELFIES should be deductible in personal income tax up to a limit. That limit or allowance could be fix as the same amount that the apply to pensions plan contributions. I mean, same limit than the general limit of contributions to pension plan (excluding additional limit for occupational pensiones).  It´s true that current limit is very low and need to me improved to permit higher contributions to personal pension schemes.  Alternatively, it could be set up a specific limit for SELFIES higher than the one applies to personal pensions plan, in order to incentive more the use of SELFIES. Or, why nor a segregated and independent limit just for SeLFIES? 

So, amount in purchasing the SeLFIES bonds would be deductible in the year of acquisition and, in consequence, benefits of SelFIES (lifetime annuity or alternative the deaccumulation way), including accumulated profits, would be subjected to tax.

In order to avoid fixing limitations in SelFIES purchasing, for those individuals who would want to buy SelFIES in an total nominal amount over the deductible limit, ideally the excess could be taxable but the tranche of benefit corresponding to a subscription excess subjected to tax when was bought would be taxed just in the return (coupons). Also, should be considering the option to deduct SelFIES non deducted one fiscal year (because overcome the limits) in the next 4-5 fiscal years.

In my opinion, Tax incentives are not enough at all for promoting long-term saving and to develop a significant SELFIES market among Spanish workers, but it should be a must to introduce them to support that objective.

In summary, about SelFIES (Standard-of-Living indexed, Forward-starting, Income-only Securities)

Non only SELFIES but YES also to SELFIES for Spaniards retirement complementary payments.

In my opinion this type of structure has an extraordinary design, take in account all types of Risk and mitigate some of them, consider as well Sustainability (ESG) features. It probably would be easy to understand by a retail purchaser (mid class Spaniard or Portuguese) if it´s explained to them in a proper way, including the small wording. But lot of work in financial education (“to understand better is to buy more probably”), public diffusion, Government commitment in promote that type of public debt, and other complementary measures (deferred tax incentives).

Despite a clear recent -and expected future- decline of retirement income provided by Social Security and a nearly non-existence of corporate pension plans, individual retirement savings in Portugal are very limited: less than 11% of GDP, covering only 16% of the working population. (See Hernández-Pacheco et al., 2022*). These savings should at some point start growing exponentially, but no inflection point is foreseen in the short term.

This limits the opportunity for the issuance of SeLFIES or any other product intended to invest retirement assets.

It is true, though, that SeLFIES do pose interesting features both for the issuer (limiting debt growth during challenging economic periods) and for the individual investor (having a guaranteed income as a share of future economic activity).

SeLFIES would need to compete with other investment products which produce more fees to financial intermediaries and would need to be well explained to a not very financially literate public.

An important challenge for the adoption of SeLFIES in general, is that payments could be reduced from one year to the other in case of a negative growth in economic activity. People may in principle understand it but be “surprised” when it indeed happens.

It is also important to note that SeLFIES would need to be complemented by deferred annuities, for which currently there’s a very limited market (if existent at all).

In summary: despite its advantages for both issuer and individual investor, the small size of retirement assets, poor financial literacy and competing interest for a small pool of assets pose a big challenge for a successful launch of SeLFIES in Portugal at this time.

*Hernández-Pacheco A., Carcache R., Ramos A., Saving for Retirement Through Consumption; An Application for Portugal.