January 27, 2005—Over the last two decades, 12 Latin American countries have reformed their national retirement plans by shifting the mainstay of pensions from social to individual responsibility. These governments have downsized the public pay-as-you-go (PAYG) component and introduced private ones, such as mandatory individual private savings accounts and voluntary private pension plans, thereby creating a multi-pillar pension system. "As longevity increases around the world and more retirees live longer, simple economics show that retirement income increasingly should come from individual savings,” explains Indermit Gill, World Bank Economic Adviser in the Poverty Reduction and Economic Management Network and a co-author of Keeping the Promise of Social Security in Latin America, a new book that examines the region's experience with these reforms. Although PAYG systems typically become unsustainable when due to a demographic shift which increases the ratio of pensioners to workers, Latin America's public pension systems became strained while the population was still relatively young. "Some argue that the old public pensions systems got in trouble sooner than expected, not just because of the changing demographics, but because governments didn't manage them well," Gill says. By changing the government's role from a managerial to a regulatory one, the reforms were expected to shelter pension funds from direct government intervention. Chile was at the forefront of these reforms in the region when it introduced individual retirement accounts in 1981. Other countries followed suit in the early 1990s, first Peru, then Argentina and Colombia. Although each country modified the changes to fit its circumstances, these structural reforms had some core goals in common: - Make the national pension system financially sustainable
- Make public pension payout more equitable
- Diversify sources of retirement income, reducing workers’ reliance on the government to honor pension promises
- Improve incentives for more workers to contribute more and for longer to increase coverage of social security systems
Reform proponents expected the changes to yield other benefits, such as deepening domestic capital markets that would help develop the countries’ financial sectors. Instituting private pension accounts would create a new domestic source of long-term investment in capital markets that lacked such instruments. This in turn was expected to help develop the financial sector, since managing these long-term accounts required better regulation, transparency and supervision. Lessons Learned At first, it seemed that the new pension systems worked well. These countries were growing and the privatized pension funds were earning high rates of return. But upon closer scrutiny, several concerns became obvious. 1. The overall pension coverage hadn’t increased. "It was too expensive for some people, especially those with lower earnings, to contribute to these private accounts,” says Gill. “Contribution rates, as well as administrative and insurance fees, were high.” They invested money in other ways they considered cheaper, safer and better suited to their needs. "Workers in Chile and Peru, who aren’t contributing to the private pension plans, often invest in their own homes, purchase other property, or fund their kids' education," says Gill. 2. Transition costs -- that arise from the diversion of worker contributions from government coffers to private savings accounts -- of moving to the new system were sometimes higher than expected. This severely strained government finances in countries that hadn’t prepared adequately to account for these costs. 3. Finally, the funds were not as “government proof” as was expected. "Since investors perceived most of these countries as risky bets, they lent money at high rates," explains Gill. "Pension funds, in turn, predominately held government bonds, which yielded high rates of return." In the long run, this lack of asset diversification left the funds dangerously exposed to the governments' fiscal problems. In Argentina nearly 50 percent of the privately managed assets were invested in government bonds in 1994. This percentage eventually rose to above 70. When the country defaulted on its government debt in the late 2001, it also defaulted on its pensioners. "Maybe we overestimated how good these systems were in shielding pensioners from the government," Gill concedes. Chile leads the way In existence for more than two decades, Chile’s pension system is the most mature. Unlike some other countries, Chile successfully pulled off this conversion because the government buttressed the reforms with fiscal discipline and had lowered payroll taxes to help attract people to the new system. But now the government is finding out that people contribute to private pension accounts up to a point, and then invest money in other assets. Often, workers pay in for 20 years -- the period required to qualify for a government-guaranteed minimum pension. Going forward, this could mean that the government’s role will be more significant than originally thought. “The government may have to help many more people than originally anticipated through the minimum pension guarantee," says Gill. Next Steps While the reforms were a step in the right direction, these countries must do more to ensure all retirees are taken care of, including: Ensure that privately administered pension plans are efficient and well diversified Continue increasing coverage by getting more workers to contribute to the plans Focus on covering the poor elderly to ensure they don’t fall into poverty
|
RSS