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Keeping the Promise of Social Security in Latin America

; Truman G. Packard ; Juan Yermo

Empirical analysis of two decades of pioneering pension and social security reform in Latin America and the Caribbean shows that much has been achieved, but that critical challenges remain. In tackling this unfinished agenda, a great deal can be learned from the reform experience of countries in the region. Les mer
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Empirical analysis of two decades of pioneering pension and social security reform in Latin America and the Caribbean shows that much has been achieved, but that critical challenges remain. In tackling this unfinished agenda, a great deal can be learned from the reform experience of countries in the region. Keeping the Promise, produced by the chief economist's office in the Latin America and Caribbean Region at the World Bank, evaluates policy reforms in 12 countries, points to successes and shortcomings, and proposes priorities and options for future reform. ""Keeping the Promise provides a timely assessment of two decades of pension reform experience-with a wealth of new data, and empirical evaluation of reformed social security systems. Many economists and policymakers will not be persuaded by some of the main conclusions and recommendations-such as the supposed failure to increase coverage, and the call for strengthening a pay-as-you-go defined-benefit scheme for poverty prevention-but they will welcome the book's critical appraisal. This is required reading for pension specialists and policymakers in Latin America and beyond.""-Klaus Schmidt-Hebbel, Chief of Economic Research, Central Bank of Chile ""A heavyweight analysis of the Latin American pension revolution which raises important questions about the optimal scale of compulsory saving when redesigning pension systems. "" -Paul Wallace, The Economist

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Forewordxvii
Acknowledgmentsxix




Rethinking Social Security Priorities in Latin America

1(16)




PART I. RETROSPECTIVE: FISCAL, FINANCIAL, AND SOCIAL BENEFITS FROM PENSION REFORM

17(90)




Structural Reforms to Social Security in Latin America

19(20)




The Fiscal Sustainability of Public Pension Promises in Latin America

39(18)




The Financial Benefits of Pension Reform

57(32)




Social Gains from Pension Reforms in Latin America

89(18)




PART II. ANALYTICAL: HOW GOVERNMENTS CAN HELP INDIVIDUALS DEAL WITH RETIREMENT

107(90)




How Individuals View Social Security

109(16)




How Well Has the ``Savings'' Component Performed from the Individual's Perspective?

125(40)




The Preferences That Individuals Reveal

165(32)




PART III. PROSPECTIVE: THE FUTURE OF SOCIAL SECURITY IN LATIN AMERICA

197(86)




Preventing Poverty in Old Age: Improving the Pooling Component

199(28)




Facilitating Consumption Smoothing: Improving the Savings Component

227(40)




The Way Forward

267(16)




Technical Annex. Assumptions of PROST Simulations

283(8)




Appendix. Background Papers for Keeping the Promise

291(2)
Bibliography293(28)
Index321




Boxes





Three Central Dilemmas of Pension Privatization

3(42)




Bolivia's Pension Reform: A Transition Considerably More Costly Than Expected

45(2)




Virtuous and Vicious Fiscal Circles: The Cases of Chile and Argentina

47(17)




The Importance of Concomitant Reforms in the Financial System

64(10)




Inflation-Indexed Securities in Latin America

74(21)




Defining the Coverage Problem: What Is It and Why Do We Care?

95(2)




Was Increasing Coverage an Objective of Pension Reform?

97(13)




The Welfare State as a Piggy Bank to Reduce Old-Age Income Insecurity

110(3)




A Theory of ``Comprehensive Insurance''

113(14)




The Four Fundamental Risks in Retirement Income Security Systems

127(1)




Comparing Notional Defined Contribution Systems and Pension Funds Invested in Inflation- and Wage-Indexed Government Bonds

128(5)




Argentina's System in Crisis: Do Private Accounts Protect Workers from Policy Risk?

133(4)




Points to Keep in Mind When Comparing Risks in Pension Fund Portfolios in Latin America

137(39)




PRIESO: Social Risk Management Surveys in Chile and Peru

176(3)




Peru's Reformed Pension System: Multipillar in Name Only

179(29)




The Cuota Social: Preventing Poverty among Elderly Men and Women in Mexico

208(2)




BONOSOL: Bolivia's Universal Pension Program

210(38)




The Big-Bang Approach to Voluntary Pension Savings Reform in Chile

248(2)




The Role of the Financial System in Brazil's Voluntary Pension Savings Plans

250(28)




The Role of the Second Pillar

278




Figures





Pension Systems Cover between 10 and 60 Percent of the Economically Active Population in Latin American Countries

6(1)




Between One-Tenth and Two-Thirds of the Aged Populations Receive Pensions in Latin American Countries

7(13)




Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure PAYG Pension Systems

20(9)




Destination of Mandatory Pension Contributions

29(11)




Simulated Implicit Pension Debts (IPDs) with and without Structural Reforms

40(3)




Total Pension Debt (Explicit) Accumulated after 2001, with and without Structural Reforms

43(2)




Cash Flow Gap in Bolivia

45(2)




Chile Was Fiscally Strong prior to Reform; Argentina Was Not

47(1)




Pension System Deficits Contributed Significantly to Deteriorating Fiscal Balance in Argentina

48(4)




There Is No Indication That Pension Reform Increased Mexico's Country Risk

52(11)




Pension Funds Are Major Investors in Government Debt

63(16)




Interest Rate Spreads Have Declined in Peru and Bolivia Since the Reforms (1993--2002)

79(2)




Stock Market Turnover Ratios in Selected Latin American Countries (1990--2001)

81(10)




Structural Reforms Are Likely to Improve Equity by Lowering Regressive Transfers and Returns

91(1)




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(2)




Pension Income Increases Inequity Relative to Earned Income from Labor

94(6)




Has Participation Increased? There Is No Clear Pattern in Data on Contribution to National Pension Systems

100(32)




Pension Funds Invest Mainly in Government Bonds and Instruments Issued by Financial Institutions

132(4)




The Standard Trade-Off between Risk and Return Has Not Materialized in Latin America (Returns from Inception to December 2000)

136(3)




In Chile Intercohort Differences in Returns Have Been Large

139(1)




Returns on Deposits in Chile Have Been Lower but More Stable Than Pension Fund Returns

140(1)




Brady Bonds Would Have Been a Better Investment Than Domestic Equities for Peruvian Pension Funds

141(6)




Variable Commission Rates Have Risen as a Result of Declines in Contribution Rates in Argentina and Peru

147(1)




Half of the Pension Contributions of the Average Chilean Worker Who Retired in 2000 Went to Fees

148(1)




Participation in the Second Pillar Is Costlier for Poorer Workers in Chile

149(5)




Annuities Have Yielded Varying Levels of Retirement Benefits in Chile

154(2)




Chile's Pension Funds Did Not Do a Good Job of Educating Participants: Fondo 2 Had Few Takers Despite Earning Higher Returns

156(2)




Chilean Workers' Choices in the New Multifund System Largely Correspond with the Default Options

158(1)




Choices Are Similar for Different Income Groups in Chile If Controlling for Age

159(21)




Chile: Reported Contribution Density

180(2)




There Is No Difference in Risk Preferences between Employees and Self-Employed Workers Who Responded to the PRIESO Survey in Chile

182(1)




Self-Employed Workers Who Contribute to the AFP System in Chile Have a Greater Tolerance for Risk

183(1)




Peru: Reported Contribution Density

184(3)




There Is No Difference in Risk Preferences between Employees and Self-Employed Workers in Peru

187(1)




Self-Employed People in the AFP System in Peru Are More Risk Averse

188(12)




Rising Life Expectancy Increases the Share of Elderly People in the Population and Upsets the Balance of Pure Pooling Pension Systems

200(4)




Accumulated Wealth Increases with Age and Is Greatest among Old People

204(8)




Relative Generosity and Cost of Alternative Public Poverty Pension Arrangements in Selected Countries

212(5)




Average Noncontributory Pensions Are between 30 Percent and 60 Percent of Average Contributory Pensions

217(17)




In Peru, Fees Remain Persistently High, Despite Increasing Returns and Declining Administrative Costs

234(15)




Savings Products Offered by Insurers Are More Popular Than the AFPs' Liquid Cuenta 2

249(3)




Mutual Funds Have Grown Significantly Only in Brazil, Where Pension Funds Are Voluntary

252(3)




Fees for Equity Mutual Funds in Chile Have Remained Stubbornly High

255(1)




Economies of Scale in Fund Management Kick in at Low Asset Levels

256(2)




Insurance Company Bankruptcy Is a Threat to Policyholders

258(16)




Coverage Can Vary at Similar Stages of Economic Development

274




Tables





Instruments of Old-Age Income Security

10(13)




Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1980s and 1990s

23(3)




Principal Features of Structural Reforms to Social Security Systems (Old-Age Disability and Death) in Latin America during the 1990s and 2000s

26(6)




Contribution Rates and Earnings Ceilings in the Mandatory Funded Systems

32(3)




Voluntary Funded Pillars in Latin America

35(7)




Current Pension Deficits (Benefit Expenditures Less Contribution Revenue) Financed by Government Transfers

42(19)




Portfolio Ceilings by Main Asset Classes (December 2002)

61(1)




Portfolio Floors by Country

62(1)




Assets Held by Pension Funds Have Doubled as a Percentage of GDP (December 1998--December 2002)

62(5)




Pension Funds Invest Mainly in Debt of Governments and Financial Institutions (December 2002)

67(1)




For the Average Latin American Country, the Two Largest Institutions Control Two-Thirds of the Pension Funds (December 2002)

68(34)




There Is Evidence That Pension Reforms Positively Affect Incentives

102(2)




Participation Rates and Incidence of Benefits Show a Regressive Pattern of Coverage by Formal Pension Systems

104(13)




Justifying a Government-Imposed Mandate to Save for Old Age---Microeconomic Reasons

117(3)




Justifying a Government-Imposed Mandate to Save for Old-Age---Macroeconomic Reasons

120(10)




Gross, Real Returns to Pension Funds Have Been High

130(12)




Asset Allocation and Portfolio Limits

142(3)




Workers Still Pay High Commissions in Some Countries (December 2002)

145(6)




The Form of Benefits Is Usually Inconsistent with an Assumption of Retiree Irrationality with Respect to Saving

151(6)




The Five New Funds in Chile Vary by Proportion of Equity Investment

157(14)




Probability That Workers Contribute to Social Security Is Determined by Individual, Household, and Labor Market Factors

171(7)




Reformed Pension Systems in Chile and Peru Are Similar, but There Are Important Differences

178(24)




Poverty among Elderly People Is as Frequent as among Other Age Groups When Measured by Current Income

202(13)




Expenditure on Noncontributory Pension Programs

215(1)




Noncontributory, Poverty Prevention Pensions Cover a Significant Portion of Pension Recipients

216(2)




As a Share of Average Wages, Minimum Wages Are Relatively High in Chile, Colombia, and Some Other Latin American Countries

218(2)




Cost of Providing and Guaranteeing a Public Pension Equal to the Minimum Wage

220(15)




Reform Options to Reduce the Operational Expenses of the New Private Second Pillar

235(5)




Reform Options to Ensure That Savings Are Passed on to Affiliates as Lower Commissions

240(3)




Reform Options to Improve Investment and Longevity Risk Management

243(40)




Assumptions Common to All Country Cases

283(1)




Country-Specific Details, Assumptions, and Sources of Data

284(5)




Assumed Profiles of Representative Affiliated Men and Women

289