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 107 6 HOW INDIVIDUALS VIEW SOCIAL SECURITY 109 7 HOW WELL HAS THE SAVINGS COMPONENT PERFORMED FROM THE INDIVIDUAL S PERSPECTIVE? 125 8 THE PREFERENCES THAT INDIVIDUALS REVEAL 165 ix
x CONTENTS PART III. PROSPECTIVE: THE FUTURE OF SOCIAL SECURITY IN LATIN AMERICA 197 9 PREVENTING POVERTY IN OLD AGE: IMPROVING THE POOLING COMPONENT 199 10 FACILITATING CONSUMPTION SMOOTHING: IMPROVING THE SAVINGS COMPONENT 227 11 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 3 3.1 Bolivia s Pension Reform: A Transition Considerably More Costly Than Expected 45 3.2 Virtuous and Vicious Fiscal Circles: The Cases of Chile and Argentina 47 4.1 The Importance of Concomitant Reforms in the Financial System 64 4.2 Inflation-Indexed Securities in Latin America 74 5.1 Defining the Coverage Problem: What Is It and Why Do We Care? 95 5.2 Was Increasing Coverage an Objective of Pension Reform? 97 6.1 The Welfare State as a Piggy Bank to Reduce Old-Age Income Insecurity 110 6.2 A Theory of Comprehensive Insurance 113 7.1 The Four Fundamental Risks in Retirement Income Security Systems 127 7.2 Comparing Notional Defined Contribution Systems and Pension Funds Invested in Inflation- and Wage-Indexed Government Bonds 128 7.3 Argentina s System in Crisis: Do Private Accounts Protect Workers from Policy Risk? 133 7.4 Points to Keep in Mind When Comparing Risks in Pension Fund Portfolios in Latin America 137
CONTENTS xi 8.1 PRIESO: Social Risk Management Surveys in Chile and Peru 176 8.2 Peru s Reformed Pension System: Multipillar in Name Only 179 9.1 The Cuota Social: Preventing Poverty among Elderly Men and Women in Mexico 208 9.2 BONOSOL: Bolivia s Universal Pension Program 210 10.1 The Big-Bang Approach to Voluntary Pension Savings Reform in Chile 248 10.2 The Role of the Financial System in Brazil s Voluntary Pension Savings Plans 250 11.1 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 6 1.2 Between One-Tenth and Two-Thirds of the Aged Populations Receive Pensions in Latin American Countries 7 2.1 Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure PAYG Pension Systems 20 2.2 Destination of Mandatory Pension Contributions 29 3.1 Simulated Implicit Pension Debts (IPDs) with and without Structural Reforms 40 3.2 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 48 3.3 There Is No Indication That Pension Reform Increased Mexico s Country Risk 52 4.1 Pension Funds Are Major Investors in Government Debt 63 4.2 Interest Rate Spreads Have Declined in Peru and Bolivia Since the Reforms (1993 2002) 79 4.3 Stock Market Turnover Ratios in Selected Latin American Countries (1990 2001) 81 5.1 Structural Reforms Are Likely to Improve Equity by Lowering Regressive Transfers and Returns 91
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 92 5.3 Pension Income Increases Inequity Relative to Earned Income from Labor 94 5.4 Has Participation Increased? There Is No Clear Pattern in Data on Contribution to National Pension Systems 100 7.1 Pension Funds Invest Mainly in Government Bonds and Instruments Issued by Financial Institutions 132 7.2 The Standard Trade-Off between Risk and Return Has Not Materialized in Latin America (Returns from Inception to December 2000) 136 7.3 In Chile Intercohort Differences in Returns Have Been Large 139 7.4 Returns on Deposits in Chile Have Been Lower but More Stable Than Pension Fund Returns 140 7.5 Brady Bonds Would Have Been a Better Investment Than Domestic Equities for Peruvian Pension Funds 141 7.6 Variable Commission Rates Have Risen as a Result of Declines in Contribution Rates in Argentina and Peru 147 7.7 Half of the Pension Contributions of the Average Chilean Worker Who Retired in 2000 Went to Fees 148 7.8 Participation in the Second Pillar Is Costlier for Poorer Workers in Chile 149 7.9 Annuities Have Yielded Varying Levels of Retirement Benefits in Chile 154 7.10 Chile s Pension Funds Did Not Do a Good Job of Educating Participants: Fondo 2 Had Few Takers Despite Earning Higher Returns 156 7.11 Chilean Workers Choices in the New Multifund System Largely Correspond with the Default Options 158 7.12 Choices Are Similar for Different Income Groups in Chile If Controlling for Age 159 8.1 Chile: Reported Contribution Density 180 8.2 There Is No Difference in Risk Preferences between Employees and Self-Employed Workers Who Responded to the PRIESO Survey in Chile 182 8.3 Self-Employed Workers Who Contribute to the AFP System in Chile Have a Greater Tolerance for Risk 183
CONTENTS xiii 8.4 Peru: Reported Contribution Density 184 8.5 There Is No Difference in Risk Preferences between Employees and Self-Employed Workers in Peru 187 8.6 Self-Employed People in the AFP System in Peru Are More Risk Averse 188 9.1 Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure Pooling Pension Systems 200 9.2 Accumulated Wealth Increases with Age and Is Greatest among Old People 204 9.3 Relative Generosity and Cost of Alternative Public Poverty Pension Arrangements in Selected Countries 212 9.4 Average Noncontributory Pensions Are between 30 Percent and 60 Percent of Average Contributory Pensions 217 10.1 In Peru, Fees Remain Persistently High, Despite Increasing Returns and Declining Administrative Costs 234 10.2 Savings Products Offered by Insurers Are More Popular Than the AFPs Liquid Cuenta 2 249 10.3 Mutual Funds Have Grown Significantly Only in Brazil, Where Pension Funds Are Voluntary 252 10.4 Fees for Equity Mutual Funds in Chile Have Remained Stubbornly High 255 10.5 Economies of Scale in Fund Management Kick in at Low Asset Levels 256 10.6 Insurance Company Bankruptcy Is a Threat to Policyholders 258 11.1 Coverage Can Vary at Similar Stages of Economic Development 274 TABLES 1.1 Instruments of Old-Age Income Security 10 2.1 Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1980s and 1990s 23 2.2 Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1990s and 2000s 26 2.3 Contribution Rates and Earnings Ceilings in the Mandatory Funded Systems 32 2.4 Voluntary Funded Pillars in Latin America 35
xiv CONTENTS 3.1 Current Pension Deficits (Benefit Expenditures Less Contribution Revenue) Financed by Government Transfers 42 4.1 Portfolio Ceilings by Main Asset Classes (December 2002) 61 4.2 Portfolio Floors by Country 62 4.3 Assets Held by Pension Funds Have Doubled as a Percentage of GDP (December 1998 December 2002) 62 4.4 Pension Funds Invest Mainly in Debt of Governments and Financial Institutions (December 2002) 67 4.5 For the Average Latin American Country, the Two Largest Institutions Control Two-Thirds of the Pension Funds (December 2002) 68 5.1 There Is Evidence That Pension Reforms Positively Affect Incentives 102 5.2 Participation Rates and Incidence of Benefits Show a Regressive Pattern of Coverage by Formal Pension Systems 104 6.1 Justifying a Government-Imposed Mandate to Save for Old Age Microeconomic Reasons 117 6.2 Justifying a Government-Imposed Mandate to Save for Old-Age Macroeconomic Reasons 120 7.1 Gross, Real Returns to Pension Funds Have Been High 130 7.2 Asset Allocation and Portfolio Limits 142 7.3 Workers Still Pay High Commissions in Some Countries (December 2002) 145 7.4 The Form of Benefits Is Usually Inconsistent with an Assumption of Retiree Irrationality with Respect to Saving 151 7.5 The Five New Funds in Chile Vary by Proportion of Equity Investment 157 8.1 Probability That Workers Contribute to Social Security Is Determined by Individual, Household, and Labor Market Factors 171 8.2 Reformed Pension Systems in Chile and Peru Are Similar, but There Are Important Differences 178 9.1 Poverty among Elderly People Is as Frequent as among Other Age Groups When Measured by Current Income 202 9.2 Expenditure on Noncontributory Pension Programs 215 9.3 Noncontributory, Poverty Prevention Pensions Cover a Significant Portion of Pension Recipients 216
CONTENTS xv 9.4 As a Share of Average Wages, Minimum Wages Are Relatively High in Chile, Colombia, and Some Other Latin American Countries 218 9.5 Cost of Providing and Guaranteeing a Public Pension Equal to the Minimum Wage 220 10.1 Reform Options to Reduce the Operational Expenses of the New Private Second Pillar 235 10.2 Reform Options to Ensure That Savings Are Passed on to Affiliates as Lower Commissions 240 10.3 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