Going formal: Brazil's widespread "informal economy" left many citizens outside the tax system but ill-prepared for retirement--until a new product arrived to encourage more saving. (International: Life/Health).

When Brazil was looking for ways to promote private saving for retirement, it faced an environment that called for special incentives. With historical hyperinflation that was tamed only within the past decade, and a tax system that does little to curb a vast off-the-books economy, Brazil's challenge was to design a product that would entice workers to put their money into the formal financial system.

The government's answer, brought to market last March, is by all accounts a resounding success--a product dubbed VGBL, or Vida Gerador Beneficio Livre. Combining life insurance and long-term savings, it offers relative safety, tax-deferred growth and, in the end, a relatively mild tax bite. It appeals to a wide swath of Brazil's middle class, even some of the wealthy, by aligning the product's design with the target buyers' place in the economy.

VGBL is somewhat comparable to universal life in the United States, but it's best understood in contrast to the other major private pension vehicle in Brazill--PGBL, or Piano Gerador de Beneficio Livre, a product with different incentives for a different type of saver, said Uriel de Magalhaes, a consultant based in Rio de Janeiro. Contributions to PGBL plans, many of which are offered through employers, are taxdeductible up to 12% of the worker's earnings. But taking advantage of the tax incentive requires filing a more complex income-tax form, which is of little help to Brazilians who have small professional firms or who work in the country's large "informal economy"--estimated at 25% to 35% of Brazil's gross domestic product. Those people, many of whom are middle class and some of whom could be considered wealthy, file a simplified income tax return on which they claim a standard deduction, de Magalhaes explained.

The VGBL is built up with after-tax dollars, the first such product in Brazil, and interest and capital gains accrue tax free until the product reaches the payout phase. At that point, the saver pays a capital-gains tax, but no tax on the principal. PGBL savers get the up-front tax write-off during the accumulation phase, but the trade-off for that benefit is taxation of the entire payout when the contract matures.

Insureds may transfer funds among different VGBL plans--but not to other types of products--and a 7% tax imposed on life insurance products has been waived for the VGBL. But the product carries higher fees, with loads as high as 5%, to cover the insurance risk that is added to the investment risk, in contrast to the PGBL.

Insurers Enter the Market

Banks have largely ruled the market for the PGBL, said J. Brad Wilson, product officer at Nationwide Global, but VGBL is open for distribution through a variety of channels. While banks have seen success with VGBL, a handful of large insurers, some of them foreign-owned, also have gained from the new product's arrival.

"The product is pretty much taking the market by storm," Wilson said, explaining that the market shifted dramatically away from the PGBL to the VGBL, Nationwide entered the fray in August and has been encouraged by government moves to refine the regulations, allowing for new product designs, he said. The PGBL, Wilson said, is far too restrictive in comparison with the VGBL.

"You can't control the money long enough to make any money on it," Wilson said.

The growing presence of foreign insurers, which account for about one-third of the insurance market's capital, has brought with it improved technology and sophistication in designing products, which has been applied to VGBL, de Magalhaes said.

Both PGBL, introduced in 1998, and VGBL, created through legislation passed late last year, were designed to replace older pension products. Those plans offered impractical, high guaranteed returns of 6% a year, said Antonio Penteado Mendonca, a Sao Paulo-based lawyer who consulted with regulators in designing the VGBL and now works extensively with the product. The VGBL's returns depend on the level of risk selected by the customer, which can range from conservative to aggressive, he said.

Broadly, VGBL products fall into three categories--soberano, which is invested solely in government bonds; renda fixa, which is invested fully in bonds but can have as little as 20% in government instruments; and composto, which can have as much as 49% in stocks but still must have at least 20% in government bonds. In all cases, there is no guarantee of a fixed income, and the contract isn't indexed to inflation.

The principal target customers are the vast numbers of Brazilians who work in the "informal economy"--many of them street vendors or other operators of all-cash, unregistered, retail businesses. These workers pay little or nothing in taxes, as the country's tax-collection system lacks the resources for aggressive enforcement, and stricter taxation would be politically perilous. But if that money can be drawn into the financial system, it can eventually yield tax revenues when VGBL plans reach the payout phase.

Another target market is professionals who run small firms and pay most of their taxes through those firms, leaving their personal income largely exempt from income tax, and small entrepreneurs whose income flows principally from distributed profits, de Magalhaes said. Other potential customers include those who might already have a work-based PGBL plan but want to save still more, beyond the 12% limit of deductibility afforded by PGBL, he said.

Growth Potential

A surprising number of VGBL customers fall into the latter category, said Raphael de Carvalho, head of sales at Nationwide Maritima. Players in the market assumed that VGBL would attract people from a lower income bracket than PGBL, but in practice, average contributions to each product have been very close to each other, de Carvalho said. Indications are that people who already had a PGBL product are buying VGBL as well. "It was something the marketplace was not expecting," he said.

The insurance industry as a whole has plenty of room for growth in Brazil, because until 1994, insurance was hard to sell in the face of a history of hyperinflation in the nation's economy. But with monetary reforms, inflation has been held to annual rates in the single digits ever since, and insurance has seen explosive growth--led by complementary pension products with a nominal growth rate of 40% a year. Insurance hovered for years at less than 1% of Brazil's GDP, but more recently it has risen to more than 3% of GDP, de Magalhaes said.

The marketplace as a whole has expanded about 40% since VGBL was launched, even as PGBL has seen sales drop, de Carvalho said. This suggests that PGBL was the wrong product for many customers--even though many were buying it, he said.

Nationwide Maritima, which had total sales of 55 million reals in 2001, sold about 600,000 reals (about $167,000) of VGBL products in September and October of this year. Nationwide Brazil has about 500,000 customers, which it reaches through some 5,000 brokers and 75 branch offices. By law, all insurance products in Brazil must be sold through brokers.

Itau Previdencia e Seguros, an affiliate of the Itau bank, reported selling 36,000 of its Flexprev VGBL plans in the first two months it was on the market, with second-quarter revenues of 91 million reals (about $25 million) from the new product. The company's overall revenues from contributions to insurance and pension plans increased 74% in the second quarter, largely driven by VGBL sales.

Overall, sales of VGBL through September were estimated at about 1.3 billion reals (about $361 million), out of a total insurance market of more than 17 billion reals, while PGBL contributions totaled about 2 billion reals, according to figures from the Superintendency of Private Insurance, the national insurance regulator.

Today, as much as 90% of reserves for complementary pensions are in 'closed-end' plans such as those offered through employers or other organizations, de Magalhaes said. The remainder is in open-end plans such as PGBL and VGBL, which are relatively new to the market. But they are getting a big boost from foreign entrants to the market, which bring capital, technology and expertise with products.

The potential market for VGBL encompasses about 10% of the Brazilian population, de Magalhaes said. But it could take the next five to seven years to penetrate the first 5%, he predicted, with any further growth depending on broad economic and social factors.

Part of the challenge in designing the VGBL was to change Brazilians mind-set about life insurance, which was achieved by making the product more of an investment vehicle, attorney Mendonca said. He described it as "the best refuge for the middle class's money," calling the product a "safe harbor" amid uncertainty. Real estate and stocks are other investment alternatives, but "no one knows what will happen" with those, Mendonca said.

Another element of uncertainty is political, with a left-wing government set to take office next year after the October election of Luiz Inacio Lula da Silva as president under the banner of the Workers Party. But the advantages of VGBL are relatively safe from political tampering, at least for the next year, because the new government isn't expected to have control of Brazil's Congress, Mendonca said.

VGBL Premium Sold From March to September 2002

Several companies with foreign participation are among the top 12
providers of VGBL polices to Brazilians. Premiums listed are in
Brazilian reals.


* AGF Brasil Seguros S.A.                   3,615,770
Bradesco Vida E Previdencia S.A.        1,044,572,679
Brasilprev Seguros E Previdencia S.A.         420,000
* Caixa Vida E Previdencia S.A.            25,738,085
* Canada Life Previdencia E Seguros         2,240,154
Cia. Seguros Minas-Brasil                   4,363,543
* ICATU Hartford Seguros S.A.                       0
ITAU Previdencia E Seguros S.A.           218,421,693
* Nationwide Maritima Vida E Prev S.A.        225,486
* Real Previdencia E Seguros S.A.           2,150,318
* Unibanco AIG Previdencia S.A.            10,120,391
* Unibanco AIG Seguros S.A.                 8,284,445

* Companies with foreign participation (US$1 = 3.58 Brazilian reals as
of 11/5/2002)

Source: Superintendency of Private Insurance-Ministry of Treasury/
Finance

RELATED ARTICLE: At a Glance: Brazil

* Largest country in South America

* Population: 176 million (66% in 15 to 64 age group)

* Labor force: 79 million (1999 estimated)

* Major industries: Textiles, shoes, chemicals, lumber, iron ore, steel

* Labor force by occupation: Services 53%, agriculture 23%, industry 24%

* President: Luiz Inacio Lula da Silva from the Workers Party

* Overall insurance premium volume in U.S. dollars in 2000: $6.6 billion

Sources: CIA Factbook and Superintendency of Private Insurance