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The Second-Generation Pension Reforms in Latin America

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The Second-Generation Pension Reforms in Latin America Organisation de Coopération et de Développement Economiques AWP 5.4 Eng Organisation for Economic Co-operation and Development ________________________________________________________________________________________ ___ Or. Eng. AGEING WORKING PAPERS Maintaining Prosperity In An Ageing Society: the OECD study on the policy implications of ageing THE SECOND-GENERATION PENSION REFORMS IN LATIN AMERICA WORKING PAPER AWP 5.4 This is one of a series of analytic papers that supported the OECD’s ageing study, a “horizontal”project in the sense that it involved a number of OECD directorates. The results of the entire project are summarised in Maintaining Prosperity in an Ageing Society , OECD 1998. Chapter III of Maintaining Prosperity—on retirement income reforms —drew on this working paper which assesses the lessons that can be learned in the OECD area by reforms in Argentina, Peru, Columbia, Uruguay, Mexico, Bolivia and El Salvador. The study will published under the same title, (OECD 1998). The second-generation pension reforms carried out in Latin America illustrate that a move to more pension funding is feasible in a democratic context and that the transition to a fully or partially funded pension system can be financed in various ways. The study also points out that, given the high operational costs of the Latin American model, countries planning to reform their pension systems should carefully consider the appropriate administrative structure. Finally, the study underlines the importance -- for OECD countries and transition economies as well as developing countries -- of arresting the financial deterioration of the pension systems early, instead of waiting for the systems to collapse. The author is Monika Queisser (e-mail: [email protected]) of the OECD’s Development Centre. This study was carried out under the Development Centre’s research project on “Macroeconomic Interdependence and Capital Flows ”. DEVELOPMENT CENTRE STUDIES THE SECOND-GENERATION PENSION REFORMS IN LATIN AMERICA BY MONIKA QUEISSER 2 Table of Contents Preface Executive Summary Chapter 1 The Crisis of Old Age Security in Latin America Reform Attempts: Failure of the Piecemeal Approach Chapter 2 Adapting the Chilean Model: The Second-Generation Pension Reforms in LAC The Reference Model The Second-Generation Pension Reforms Offering a Private Alternative: Peru and Colombia Putting the Eggs in Two Baskets: Argentina and Uruguay Switching for the Life-Time: Mexico Capitalising for the People: Bolivia Replicating the Reference Model: El Salvador Chapter 3 Financing the Transition towards Funded Systems Coping with Transition Strategies for Transition Financing Debt versus Tax Financing Evidence from Latin American Reform Countries Downsizing the Old Systems Slowing the Speed of Transition Partial Shifts Compensation Mechanisms Sources of Transition Financing Chapter 4 Reform Results and Performance of the New Systems Coverage and Affiliation Management Companies and Market Concentration Fees and Commissions Fund Accumulation and Portfolios Effects on Savings and Growth Benefit Options and Minimum Pensions 3 Chapter 5 Challenges for Pensions Policy in Latin America Affiliation and Effective Coverage Operating Costs of the Private Systems Minimum Rate of Return Guarantees and Portfolio Uniformity Annuities Chapter 6 Lessons for OECD Countries Annex 1: Pension Reform in Peru Annex 2: Pension Reform in Colombia Annex 3: Pension Reform in Argentina Annex 4: Pension Reform in Uruguay Annex 5: Pension Reform in Mexico Annex 6: Pension Reform in Bolivia Annex 7: Pension Reform in El Salvador Bibliography 4 19/6/98 Preface Latin America is becoming a laboratory for social security reforms. More than a decade after Chile's move from a public, pay-as-you-go to a private, funded pension system, seven Latin American countries have reformed their pension systems. This study analyses and evaluates the pension reform experiences of Argentina, Peru, Colombia, Uruguay, Mexico, Bolivia and El Salvador. It provides a detailed description of the second-generation pension reforms carried out in these countries, evaluates the first years of operation of the new systems and outlines the remaining problems and challenges. Analysis of Brazil's important effort to introduce comprehensive pension reform is not included in the study because the system structure had not yet been finalised at the time of writing. The basic, common feature of second-generation pension reforms in Latin America is a greater role for funded, privately-managed pensions. The move towards more funding, under discussion in several OECD countries, is one possible way of confronting the effects of ageing populations on pay-as-you-go pension systems. Therefore, the Latin American reform experience is valuable not only for other developing countries about to embark on pension reform but also for policy makers and pension experts in OECD countries and transition economies. The second-generation pension reforms carried out in Latin America illustrate that a move to more pension funding is feasible in a democratic context and that the transition to a fully or partially funded pension system can be financed in various ways. The study also points out that, given the high operational costs of the Latin American model, countries planning to reform their pension systems should carefully consider the appropriate administrative structure. Finally, the study underlines the importance -- for OECD countries and transition economies as well as developing countries -- of arresting the financial deterioration of the pension systems early, instead of waiting for the systems to collapse. This study was carried out under the Development Centre’s research project on “Macroeconomic Interdependence and Capital Flows”, and serves as an input to the OECD’s Ageing Populations Project. It benefited from close co-operation with and support from policy makers, in particular pension supervisors, as well as pension experts in all of the Latin American second-generation reform countries. Jean Bonvin President OECD Development Centre May 1998 5 Executive Summary Introduction Latin America has proven to be the most dynamic and innovative region in the area of pension reform. More than a decade after Chile moved from a public pay-as-you-go to a private funded pension system, seven more countries in Latin America have reformed their pension systems. No two of these “second generation” pension reforms are alike but their basic common feature is a greater role for funded, privately managed pensions. In the design of their new systems, the individual countries have made different choices depending on their initial conditions such as the pension systems’ financial viability, the fiscal situation as well as the political environment in which pensions were reformed. The varied nature of Latin America’s recent pension reforms and their mixed results hold valuable lessons for OECD and non-OECD countries alike. Reform Models The second-generation countries can be grouped according to the size and maturity of their public pension systems. Apart from Chile, Argentina and Uruguay have the oldest social security systems in the region. In both countries, the age profiles of the population are comparable to those of Western European countries and population growth is low or negative. Thus, by the1990s their pay-as-you-go systems had reached high degrees of maturity. With increasing old-age dependency ratios and a rapidly deteriorating ratio between contributors and affiliates, both countries were faced with growing deficits in their pension system. The debt implicit in the pay-as-you-go system was estimated to be more than twice GDP in Uruguay and thus substantially higher than in most OECD countries. Compared to Chile, pension reform had to be undertaken under much more difficult fiscal circumstances, since neither Argentina nor Uruguay was running budgetary surpluses. Thus, a full transition to a funded system was not a realistic option due to the extremely high costs involved. Further, in both countries the political power of trade unions and pensioners’ associations favoring the preservation of the pay-as-you-go system is strong. The Argentine pension reform was more comprehensive and far-reaching than the Uruguayan reform. Argentina established a true multi-pillar system where all workers must contribute both to a public pay-as-you-go pillar and to a second pillar which can be either a privately managed defined- contribution or a public defined benefit scheme. In Uruguay, only workers above a certain income threshold are required to contribute to the second pillar; since the threshold is set at a relatively high level, only few workers are mandatorily affiliated; nevertheless, the response of workers has been positive and voluntary affiliation to the new system has exceeded expectations. Peru, Colombia and Mexico had relatively young and immature pension systems. Their schemes too were based on social insurance priniciples; originally established as partially funded schemes, the pension systems’ reserves were being drawn down rapidly due to generous benefit eligibility conditions and high non-pension expenditure coupled with high evasion of contributions. The financial pressure, however, was not yet due to ageing populations. Since the systems covered only a small part of the economically active population and real benefit levels had deteriorated as a result of inflation, the implicit debt of these systems was low compared to the Southern Cone countries.
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