The Challenge of Pension Systems in LAC: What s next for reforms?

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized The Challenge of Pension Systems in LAC: What s next for reforms? Mariano Bosch Labor Markets and Social Security Unit Inter-American Development Bank *Opinions are my own, and not necessarily coincide with opinions of IDB or its board of directors. This presentation benefits from the work of a number of IDB colleagues: Solange Berstein, Mariano Bosch, Santiago Levy and Angel Melguizo as well as Elodie Bataille, Maria Eugenia de Diego, Angel Muñoz, Laura Oliveri, and Juan Miguel Villa. It also benefits from our joint work with colleagues at WB, IZA Institute for Labor and OECD. d

Initial thoughts Many pensions systems in Latin America and the Caribbean underwent extensive reforms in the 90s yet, often, such reforms did not fulfill the expectations. Today, pensions systems in many countries continue being affected by problems of low coverage, inadequate pensions, regressivity, fiscal unsustainability, adverse incentives for formal job creation, and weak institutions. As countries are considering avenues to move forward, they are discovering there are unpleasant tradeoffs. This presentation presents these challenges and tradeoffs and argues that reforms need to be rooted in a deeper understanding of how labor markets work. It also argues that moving forward is urgent: the demographic bonus will not last long. Unless comprehensive reforms take place, most countries will not be able to sustain the future consumption of their older populations.

The context Dependency ratios: Regions of the world 1950-2100

Three messages 1) Pension systems in LAC are impacted with problems of low coverage, inadequate pensions, fiscal unsustainability, regressivity, adverse incentives and weak institutions. Many of these problems arise due to poorly functioning labor markets. Others are in the system design Reforms in the 90s to move from DB to DC systems did not ameliorate these problems. And created a few problems of their own. 2) Beyond fiscal, social security systems may affect economic growth and redistribution. 3) Substantive reforms are needed.

The next wave of reforms We believe reforms need to focus on: Rethinking the design of the systems with special emphasis on the fundamental parameters and the implicit redistribution Increasing contribution density (formality). Reforming and/or expanding non-contributory pensions in ways that are incentive-compatible and fiscally sound. Creating stronger institutions. Dealing with the political economy of pension reform

This presentation borrows from 3 recent IDB publications Better Pensions, Better Jobs, 2013 Social Insurance, Informality and Labor Markets, 2015 Pensions at a Glance, 2014

THE CHALLENGE OF PENSION SYSTEMS IN LAC: WHAT S NEXT FOR REFORMS? 1. Social security challenges in LAC 1.1 Low coverage 1.2 Inadequate pensions 1.3 Regressivity 1.4 Rising expenditure 1.5 Incentives to informality 1.6 Weak institutions 2. Avenues for reform

HND SLV GTM PRY DOM NIC BOL COL ECU MEX PER JAM PAN CRI BRA* VEN CHL ARG* URY* Only 4 out of 10 people 65+ in the region get a contributive pension 90% Percentage of persons 65 and older with a contributive pension, 2013 80% 70% 60% 50% 40% LAC-19: 39.6% 30% 20% 10% 0% Source: IDB, Labor Markets and Social Security Indicators, based on household surveys. * Administrative data was used to estimate coverage in these countries.

And less than half of workers workers contribute to a pension Percentage of contributors out of total employed, 2013 Source: IDB, Labor Markets and Social Security Indicators

Percentage of contributors Percentage of contributors Contributions are low for those with low income, non salaried and in small companies Percentage of contributors out of total employed, by income decile in LAC, 2010 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 Salaried Non-salaried Small (2-5) Medium (6-50) Large (50 +) Source: Bosh, Melguizo, Pages (2013)

URY CHL BRA CRI PAN ARG ECU SLV DOM COL VEN PRY JAM NIC HND MEX PER GTM BOL Percentage of 65+ without an adequate contributory pension We estimate that coverage will also be low in the future 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Ranges of the percentage of adults 65+ without an adequate contributory pension in 2050 IDB estimates Outside estimates Source: Bosch, Melguizo, Pages (2013)

Contributory pension coverage population > 65 years of age Replacement rates may be too low in DC systems and too high in DB Net replacement rate of pension systems in LAC at average years of contribution 100 Coverage for population over 65 on contributory systems and replacement rates for average salary worker 80 USA URU BRA ARG 60 CHL Defined contributions Mixed system; 40 LAC19 PAN CRI VEN Defined benefits; 20 0 PER MEX COL BOL DOM SLV JAM PER Source: Pensions at a Glance: Latin America and the Caribbean, 2013 COL GTM HND ECU NIC 0 20 40 60 80 100 Replacement rates - average wage PRY

Those with low income receive a lump sum payment, often at a discount, which defeats the purpose Flow of workers reaching de-accumulation stage Pension 35% RPM Return of contributions (without interest) 65% Pension 17% RAIS Return of contributions (with interest) 82% Minimum pension guarantee fund 1% Note: Refers to affiliates who reached pension age during 2013. Source: Bosch, Berstein, Oliveri and Villa, 2015.

Millions of pesos Another example: Colombia Subsides in the RPM (NPV of the amount the contributor gets from the system minus what she contributes capitalized at 4%) Transferences from affiliates not receiving a pension to pensioners <1% 4% 65% Of affiliates 30% Transferences from all Colombians to high income affiliates who retire Contribute per MW RPM during 10 years Contribute per MW RPM during 20 years Contribute per MW RPM during 26 years Contribute for 5 MW RPM during 26 years Contribute for 25 MW RPM during 26 years Married Single Married Single Source: IDB, 2015

Because low coverage and population youth, public expenditure today is still low but will grow in future Public expenditure in pensions in % of GDP and Demographics Source: Pensions at a Glance: Latin America and the Caribbean, 2013 * Government pension expenditure without contributions.

Costs of social security and other labor mandates are high in the region Wage and non-wage costs relative to GDP per worker vs Share of salaried workers Source: The Age of Productivity, IDB, 2010

Policy makers are faced with two objectives Increase coverage today Secure coverage in the future Non-contributory Pensions Increasing contributions

HND GTM DOM SLV NIC PER PRY JAM VEN COL MEX CRI ECU PAN BRA* CHL URY* ARG* BOL Pension coverage 65+ 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Non contributive pensions are spreading quickly Percentage of people older than 65 that get a pension, 2013 LAC-19 Total. 65.8% LAC-19 Contributive. 39.6% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0% Non - contributive Contributive Source: IDB Labor Markets and Social Security Indicators * Administrative data was used to estimate coverage in these countries.

Non-contributory pensions as one of the major innovations

1990 1992 1993 1995 1996 1997 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008 2009 2011 2012 Non-contributory pensions can be extremely effective in reducing poverty in old age Poverty in Rural Brazil ($2.5 day): 1990-2012 100 80 1991: Expansions of rural pensions <10 60 Average 40 20 65+ 0 rural Menor_10 Mayor_65

Design is important

Comlombian Tax Reform Share of workers contributing to pensions (13 metropolitan areas) 2007-2015 Growth rate 2013-2015: 4.11% anual Growth rate 2007-2012: 4.45% anual

Behavioral interventions Behavioural interventions Default Options Forcing active decisions Comitment devices Simplification Matching contributions Loteries Reminders Microinsurance Enforcement Financial Education Fuente: Bosch et al (2015) Self-employed Salaried Non Contributors Contributors Non Contributors Contributors

The MEI program in Brazil Large proportion of labor force are self-employed: (20%) 17M self employed In 2009 the MEI started to cover those self employed at ta reduced cost. Today 5% MW offering a pension that is 100% of the MW Today: 5 Affiliates, only 50% contributes at a given time.

The MEI program in Brazil Increase in contributions with respect to previous month Fuente: Bosch et al (2015)

The MEI program in Brazil Increase in contributions with respect to previous month April Fuente: Bosch et al (2015)

The MEI program in Brazil Increase in contributions with respect to previous month May Fuente: Bosch et al (2015)

The MEI program in Brazil Increase in contributions with respect to previous month June Fuente: Bosch et al (2015)

The MEI program in Brazil Prices vs Reminders

What direction for reforms? Coverage & Adequacy Make sure that the expansion of non-contributory pensions occurs in a sustainable & incentivecompatible way. Trade offs possible: Targeting--Less costly, but incentives?; Universal--less incentive problems, but more costly. Need to integrate non-contributory pensions into overall system.

What direction for reforms? It is imperative to rethink the overall design of the systems otherwise, high future costs. Reexamine fundamental parameters and in a way that is compatible with the political economy Finance social security with sources of income other than labor taxes. Use more thoroughly behavioral economics (defaults, reminders, particularly for the selfemployed) Increase enforcement Increase the value of social security for workers --- financial education, information, etc.

What direction for reforms? Redistribution Understand and redesign implicit redistribution Reinforce institutions. Better policy design, regulation, supervision and fund management. Improve accountability

Lastly, need to establish a road map Need to define vision with final end, but to get there a series of reforms needed: The political economy is tricky

THANK YOU! @Carmen_Pages @BID_Trabajo blogs.iadb.org/trabajo

Dominican Republic Mexico Haiti Suriname Trinidad and Tobago Bolivia El Salvador Chile Bahamas Brazil Nicaragua LAC26 Barbados Honduras OECD Guatemala Belize Colombia Jamaica Guyana Panama Peru Costa Rica Argentina Nicaragua Venezuela Ecuador Paraguay Theoretical replacement ratios in the region are not low, particularly in DB systems 120 100 80 60 40 20 0 Net replacement rate of pension systems in LAC Average earners Mixed DC DB Source: Pensions at a Glance: Latin America and the Caribbean, 2013

Theoretical rates fall short: very few people contribute all their lives, due to high rotation Net replacement rate* of pension systems in LAC by average years of contribution 120% 120% 100% 80% 60% 40% 20% 0% 100% 80% 60% 40% 20% 0% 100% contribution 60% contribution 30% contribution Mixed DC DB Source: Pensions at a Glance: Latin America and the Caribbean, 2013 *Calculated based on average income. LAC non-weighted average

Turnover is high: workers are sometimes in the system and sometimes not Probability of moving between formal and informal work during one year 25 20 19.1 16.7 17.3 20.6 15 10 5 9.6 13.3 11.4 10.9 8.5 11.9 12.7 7.4 7 9.3 5.7 5.3 0 BRA COL VEN ARG MEX ECU PRY PER formal --> informal informal ---> formal On average 13% of formal workers today will be informal in a year, and 10% of informal will be formal in a year. It is more appropriate to talk about people when they are formal, and when they are informal. Source: IDB, based on household surveys of the region

Years of contribution 30 Turnover is particularly high for those with lower earnings Average years of contribution, People aged between 25-55 years, 2012 28 25 20 15 10 11 14 17 18 20 17 22 18 5 5 0 Until 1 MW 1-2 MW 2-3 MW 3-4 MW 4 and more MW Colombia El Salvador Source: ELPS, 2012

Percentage Low income people tend not to reach the minimum years of contribution and not to qualify for pensions Average of people who contribute less than 20 years (Colombia-El Salvador) People aged between 50-55 years 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 91% 81% 64% 64% 55% 51% 41% 40% 37% 13% Until 1 MW 1-2 MW 2-3 MW 3-4 MW 4 and more MW Colombia El Salvador Source: Estimation based on ELPS, 2012

Social security systems differentiate by job category Citizens workers salaried non-salaried registered in SS no registered (The world of formality) (The world of informality) no workers

Many workers in other categories: is this exogenous? 50% 45% Percentage of self employed workers, 2013 40% 35% 30% LAC-19: 29% 25% 20% 15% 10% 5% 0% Source: IDB, Labor Markets and Social Security Indicators.

Institutions for non-contributory pensions have not been established yet 2002 Program begins only for Mexico City Mexico, evolution of non-contributory pensions 2007 Program begins at federal level but only for cities <500 and adults>70 2008 Program expands to cities < 20,000 2009 Program expands to cities <30,000 In parallel, 18 state governments created additional programs 2012 Program expands across the country 2013 Retirement age decreased from 70 to 65 years old 2014 A law was proposed to duplicate pension amount

Non Contributory pensions in LAC Country Name Benefit adjustment Argentina Programa de Pensiones No Contributivas (Vejez) mp (d) Bolivia Renta Universal de Vejez "Renta Dignidad" d Brazil Benefício de Prestação Continuada mw Brazil Previdência Rural mw Chile Pensión Básica Solidaria de Vejez i Colombia Programa de Protección Social al Adulto Mayor d Costa Rica Régimen No Contributivo de Pensiones por Monto Básico d / mp Ecuador Pensión para Adultos Mayores d El Salvador Nuestros Mayores Derechos d Guatemala Programa de aporte económico del Adulto Mayor dw Mexico Pensión para Adultos Mayores d Panama Asistencia Económica para Adultos Mayores de 70 y más d Paraguay Pensión Alimentaria para Adultos Mayores en pobreza d / mw Peru Programa Nacional de Asistencia Solidaria "Pensión 65" d Uruguay Pensión No Contributiva por Vejez e Invalidez d Venezuela Gran Misión Amor Mayor d d: discresional mp: minimum pension i: inflation mw: minimum wage Source: IDB, 2015

HND GTM NIC BOL PRY COL VEN DOM PER ECU MEX CRI ALC-19 PAN SLV BRA JAM CHL ARG URY Cost as a percentage of GDP How non-contributory pensions are adjusted has large consequences on costs 2.5 Cost of providing a 10% of GDP per capita pensions (as a percentage of GDP) 2.0 1.5 1.0 0.5 0.0 Cost in 2010 Cost in 2050 (inflation-indexed) Cost in 2050 (GDP per capita-indexed) Source: Bosch, Melguizo, Pages, 2013

Fragmentation Fragmented institutions each ones sees only a part. Absence of one single institution supervising the system as a whole. The required information to monitor, evaluate and correct the system is not easily accessible and it is disperse among several institutions. Lack of accountability

Potential problems Room to gain operational efficiency Low diversification of investments & low returns Under development of local capital markets limiting investment opportunities High administration costs Increased dispersion of functions and lack of a comprehensive view of Pension Systems Potential governance fragility of institutions In some cases weakness or lack of technical supervision