Contents. xix 1 RETHINKING SOCIAL SECURITY PRIORITIES IN LATIN AMERICA 1

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1 Contents Foreword Acknowledgments xvii xix 1 RETHINKING SOCIAL SECURITY PRIORITIES IN LATIN AMERICA 1 PART I. RETROSPECTIVE: FISCAL, FINANCIAL, AND SOCIAL BENEFITS FROM PENSION REFORM 17 2 STRUCTURAL REFORMS TO SOCIAL SECURITY IN LATIN AMERICA 19 3 THE FISCAL SUSTAINABILITY OF PUBLIC PENSION PROMISES IN LATIN AMERICA 39 4 THE FINANCIAL BENEFITS OF PENSION REFORM 57 5 SOCIAL GAINS FROM PENSION REFORMS IN LATIN AMERICA 89 PART II. ANALYTICAL: HOW GOVERNMENTS CAN HELP INDIVIDUALS DEAL WITH RETIREMENT HOW INDIVIDUALS VIEW SOCIAL SECURITY HOW WELL HAS THE SAVINGS COMPONENT PERFORMED FROM THE INDIVIDUAL S PERSPECTIVE? THE PREFERENCES THAT INDIVIDUALS REVEAL 165 ix

2 x CONTENTS PART III. PROSPECTIVE: THE FUTURE OF SOCIAL SECURITY IN LATIN AMERICA PREVENTING POVERTY IN OLD AGE: IMPROVING THE POOLING COMPONENT FACILITATING CONSUMPTION SMOOTHING: IMPROVING THE SAVINGS COMPONENT THE WAY FORWARD 267 Technical Annex. Assumptions of PROST Simulations 283 Appendix. Background Papers for Keeping the Promise 291 Bibliography 293 Index 321 BOXES 1.1 Three Central Dilemmas of Pension Privatization Bolivia s Pension Reform: A Transition Considerably More Costly Than Expected Virtuous and Vicious Fiscal Circles: The Cases of Chile and Argentina The Importance of Concomitant Reforms in the Financial System Inflation-Indexed Securities in Latin America Defining the Coverage Problem: What Is It and Why Do We Care? Was Increasing Coverage an Objective of Pension Reform? The Welfare State as a Piggy Bank to Reduce Old-Age Income Insecurity A Theory of Comprehensive Insurance The Four Fundamental Risks in Retirement Income Security Systems Comparing Notional Defined Contribution Systems and Pension Funds Invested in Inflation- and Wage-Indexed Government Bonds Argentina s System in Crisis: Do Private Accounts Protect Workers from Policy Risk? Points to Keep in Mind When Comparing Risks in Pension Fund Portfolios in Latin America 137

3 CONTENTS xi 8.1 PRIESO: Social Risk Management Surveys in Chile and Peru Peru s Reformed Pension System: Multipillar in Name Only The Cuota Social: Preventing Poverty among Elderly Men and Women in Mexico BONOSOL: Bolivia s Universal Pension Program The Big-Bang Approach to Voluntary Pension Savings Reform in Chile The Role of the Financial System in Brazil s Voluntary Pension Savings Plans The Role of the Second Pillar 278 FIGURES 1.1 Pension Systems Cover between 10 and 60 Percent of the Economically Active Population in Latin American Countries Between One-Tenth and Two-Thirds of the Aged Populations Receive Pensions in Latin American Countries Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure PAYG Pension Systems Destination of Mandatory Pension Contributions Simulated Implicit Pension Debts (IPDs) with and without Structural Reforms Total Pension Debt (Explicit) Accumulated after 2001, with and without Structural Reforms 43 3B.1 Cash Flow Gap in Bolivia 45 3B.2a Chile Was Fiscally Strong prior to Reform; 3B.2b Argentina Was Not 47 Pension System Deficits Contributed Significantly to Deteriorating Fiscal Balance in Argentina There Is No Indication That Pension Reform Increased Mexico s Country Risk Pension Funds Are Major Investors in Government Debt Interest Rate Spreads Have Declined in Peru and Bolivia Since the Reforms ( ) Stock Market Turnover Ratios in Selected Latin American Countries ( ) Structural Reforms Are Likely to Improve Equity by Lowering Regressive Transfers and Returns 91

4 xii CONTENTS 5.2 Structural Reforms Make the New Systems More Gender Neutral, but Women s Average Benefits Can Be Significantly Lowered by the Use of Gender-Specific Mortality Tables Pension Income Increases Inequity Relative to Earned Income from Labor Has Participation Increased? There Is No Clear Pattern in Data on Contribution to National Pension Systems Pension Funds Invest Mainly in Government Bonds and Instruments Issued by Financial Institutions The Standard Trade-Off between Risk and Return Has Not Materialized in Latin America (Returns from Inception to December 2000) In Chile Intercohort Differences in Returns Have Been Large Returns on Deposits in Chile Have Been Lower but More Stable Than Pension Fund Returns Brady Bonds Would Have Been a Better Investment Than Domestic Equities for Peruvian Pension Funds Variable Commission Rates Have Risen as a Result of Declines in Contribution Rates in Argentina and Peru Half of the Pension Contributions of the Average Chilean Worker Who Retired in 2000 Went to Fees Participation in the Second Pillar Is Costlier for Poorer Workers in Chile Annuities Have Yielded Varying Levels of Retirement Benefits in Chile Chile s Pension Funds Did Not Do a Good Job of Educating Participants: Fondo 2 Had Few Takers Despite Earning Higher Returns Chilean Workers Choices in the New Multifund System Largely Correspond with the Default Options Choices Are Similar for Different Income Groups in Chile If Controlling for Age Chile: Reported Contribution Density There Is No Difference in Risk Preferences between Employees and Self-Employed Workers Who Responded to the PRIESO Survey in Chile Self-Employed Workers Who Contribute to the AFP System in Chile Have a Greater Tolerance for Risk 183

5 CONTENTS xiii 8.4 Peru: Reported Contribution Density There Is No Difference in Risk Preferences between Employees and Self-Employed Workers in Peru Self-Employed People in the AFP System in Peru Are More Risk Averse Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure Pooling Pension Systems Accumulated Wealth Increases with Age and Is Greatest among Old People Relative Generosity and Cost of Alternative Public Poverty Pension Arrangements in Selected Countries Average Noncontributory Pensions Are between 30 Percent and 60 Percent of Average Contributory Pensions In Peru, Fees Remain Persistently High, Despite Increasing Returns and Declining Administrative Costs Savings Products Offered by Insurers Are More Popular Than the AFPs Liquid Cuenta Mutual Funds Have Grown Significantly Only in Brazil, Where Pension Funds Are Voluntary Fees for Equity Mutual Funds in Chile Have Remained Stubbornly High Economies of Scale in Fund Management Kick in at Low Asset Levels Insurance Company Bankruptcy Is a Threat to Policyholders Coverage Can Vary at Similar Stages of Economic Development 274 TABLES 1.1 Instruments of Old-Age Income Security Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1980s and 1990s Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1990s and 2000s Contribution Rates and Earnings Ceilings in the Mandatory Funded Systems Voluntary Funded Pillars in Latin America 35

6 xiv CONTENTS 3.1 Current Pension Deficits (Benefit Expenditures Less Contribution Revenue) Financed by Government Transfers Portfolio Ceilings by Main Asset Classes (December 2002) Portfolio Floors by Country Assets Held by Pension Funds Have Doubled as a Percentage of GDP (December 1998 December 2002) Pension Funds Invest Mainly in Debt of Governments and Financial Institutions (December 2002) For the Average Latin American Country, the Two Largest Institutions Control Two-Thirds of the Pension Funds (December 2002) There Is Evidence That Pension Reforms Positively Affect Incentives Participation Rates and Incidence of Benefits Show a Regressive Pattern of Coverage by Formal Pension Systems Justifying a Government-Imposed Mandate to Save for Old Age Microeconomic Reasons Justifying a Government-Imposed Mandate to Save for Old-Age Macroeconomic Reasons Gross, Real Returns to Pension Funds Have Been High Asset Allocation and Portfolio Limits Workers Still Pay High Commissions in Some Countries (December 2002) The Form of Benefits Is Usually Inconsistent with an Assumption of Retiree Irrationality with Respect to Saving The Five New Funds in Chile Vary by Proportion of Equity Investment Probability That Workers Contribute to Social Security Is Determined by Individual, Household, and Labor Market Factors Reformed Pension Systems in Chile and Peru Are Similar, but There Are Important Differences Poverty among Elderly People Is as Frequent as among Other Age Groups When Measured by Current Income Expenditure on Noncontributory Pension Programs Noncontributory, Poverty Prevention Pensions Cover a Significant Portion of Pension Recipients 216

7 CONTENTS xv 9.4 As a Share of Average Wages, Minimum Wages Are Relatively High in Chile, Colombia, and Some Other Latin American Countries Cost of Providing and Guaranteeing a Public Pension Equal to the Minimum Wage Reform Options to Reduce the Operational Expenses of the New Private Second Pillar Reform Options to Ensure That Savings Are Passed on to Affiliates as Lower Commissions Reform Options to Improve Investment and Longevity Risk Management 243 TA.1 Assumptions Common to All Country Cases 283 TA.2 Country-Specific Details, Assumptions, and Sources of Data 284 TA.3 Assumed Profiles of Representative Affiliated Men and Women 289