Restructuring Pension Systems in Latin America and the Caribbean

By Isabel Morales

Aging populations are a concern all over the world. However, populations in Latin America and the Caribbean are currently aging faster than eastern nations did in the past. The United Nations estimates that by 2050, most people over the age of 65 will live in developing nations (Shetty, 2012)Though an increase in life expectancy throughout Latin America is a good thing, the longer people live, the more effort is needed to think of ways that guarantee citizens’ welfare once they retire. The pension systems in several Latin American countries are not supporting their aging populations as promised, and governments are failing to present aging as a major public policy concern (Shrestha, 2000)In addition, high levels of informality in the region negatively affect the working population—which is crucial to support pension systems (CAF, 2020)Considering this, it is important to focus on making structural changes to the pension systems in Latin America in the coming years to prevent demographic and economic effects from hindering the welfare and quality of life of older citizens in the region.  

Major Pension Reform in Latin America and the Chilean Model: 1980-2005 

Major pension restructuring in Latin America started with the pension reform in Chile. After Chile restructured its pension system in 1981, ten other Latin American countries followed (Argentina, Bolivia, Colombia, Costa Rica, Dominican Republic, El Salvador, Mexico, Panama, Peru, and Uruguay) (Mesa-Lago & Valero, 2020)The Chilean pension system reform replaced the public pay-as-you-go (PAYG) setup, with a fully funded defined contribution (FF-DC) systemIn a PAYG system, the individual receiving the pension decides how much money they want to contribute to a plan by either having a set amount regularly deducted from their paycheck, or by contributing the desired amount in one single payment (Kagan, 2020). The current pension system in Chile is now an FF-DC based on individual accounts owned by private companies called Administradoras de Fondos de Pensiones (AFP) (Shelton, 2012).  

Chile’s pension system consists of three tiers: a poverty prevention tier, an individual account tier, and a voluntary savings tier. The poverty prevention tier offers a minimum benefit to individuals who did not participate in the pension system and to workers whose monthly pensions financed by individual accounts (second tier) did not meet requirements and were left without an account (Shelton, 2012). Within the second tier, workers contribute 10 percent of their salary to an individual account and choose a private-sector Administradora de Fondos de Pensiones (AFP) to invest their pension contributions in. After the worker retires, they can withdraw the money they have accumulated in their individual account in the form of a regular incomeThe third tier allows retired workers to add tax-benefit savings to their pension income (Shelton, 2012) 

This system introduced in Chile was innovative and viewed as a model for other countries in Latin America and the world. Therefore, several countries adopted the same system or a similar system with a different approach, which is observed in Table I (De la Torre & Rudolph, 2018). For instance, some Latin American and Caribbean countries adopted a pay-as-you-go defined benefit (PAYG-DB) system where the contributions of active workers finance the pensions of currently retired workersSome others adopted the Chilean FF-DC system where contributions are transferred to individual accounts and invested by pension fund management companies (De la Torre & Rudolph, 2018). However, the majority adopted a mixed system that includes both contributory PAYG-DB and FF-DC systemsThese mixed systems can be complementary or competing. In a mixed complementary scheme, PAYG-DB and FF-DC frameworks are implemented togetherIn a mixed competing system, individuals can choose one of the frameworks or switch frequently between thethroughout their lives (De la Torre & Rudolph, 2018). 

Table I. Types of contributory pension systems in Latin America  


Source: De la Torre, A., & Rudolph, H. P. (2018, March). The Troubled State of Pension Systems in Latin America. Brookings Institution. 

Problems with Pensions in Latin America and the Caribbean 

Reforms to the current pension system in Chile took place in 2008. Before these reforms, the system was based on individual savings, and it did not provide coverage for people with low incomes or irregular contribution histories. It is not feasible for those with low incomes to contribute to their pensions regularly when they need that income to subsist. This is one of the issues associated with contributory systems where pension benefits are proportional to contributions (Barr & Diamond, 2016). Therefore, the 2008 reforms introduced a “solidarity pension system” intending to expand participation for lower-income workers. The solidarity system is non-contributory and financed by a governmental solidarity fund (ECLAC, 2008). Being non-contributory, most people are eligible to receive a pension because it does not require regular contributions to an individual account. It includes formal and informal, urban and rural, employed and self-employed workers, and those outside the labor force (Barr & Diamond, 2016). In addition to Chile, more than a dozen Latin American countries currently have some form of non-contributory social pension system because of this low coverage issue (De la Torre & Rudolph, 2018) 

Though the Chilean pension system experienced major improvements after the 2008 reforms, it still did not turn out as well as projected. The Chilean pension system was introduced with the claim that people could retire on 70 percent of their salaries (Heine, 2020). However, retirees are only receiving about 20 to 30 percent of their wages and some 80 percent of pensioners receive less than the minimum wage each month of 326,500 Chilean pesos (over 440 dollars) (Heine, 2020)Some of the reasons behind this issue are due to factors within the FF-DC system that were established to encourage participation: low mandatory contribution rates, big time gaps between contributions, and low retirement ages (De la Torre & Rudolph, 2018).  

Several countries throughout Latin America and the Caribbean also struggle to provide the pension benefits that were initially promised (Heine, 2020)However, because pension systems differ throughout Latin American and Caribbean countries, the issues present within each country’s system are different. For instance, the main challenges countries with contributory pension systems (PAYG-DB and FF-DC) currently face are related to low coverage and insufficient savings accumulation (De la Torre & Rudolph, 2018). These problems are exacerbated by high levels of informality and unemploymentBecause more than 50 percent of the population in the region works in the informal sector, there is not a lot of coverage and savings that go into formal pensions (Runde & Kohan, 2021). Also, there are fewer resources and pension opportunities through contributory pension plans for those in the informal sector, as reflected in Chile. This leaves lower-income groups more at risk for poverty (Runde & Kohan, 2021) 

Aging populations in Latin American and Caribbean countries also put severe pressure on governments fiscal budgets. As the number of people above the age of 65 increases and the working-age population decreases, there will be less of an economic capacity to cover the needs of those who have already retired. The cost of services to support the elderly will also be higher, as more people will be demanding health care services (World Bank Group, 2016)Latin American and Caribbean countries currently spend about 4.3 percent of their GDP on pensions (Runde & Kohan, 2021)This expense in GDP allocated to supporting the aging population will increase in the coming years and governments will need to budget for an expected rise in cost to avoid fiscal difficulties that may threaten their economic stability (Runde & Kohan, 2021) 

Greater problems in Latin American and Caribbean labor markets that are exacerbated by an aging population and economic inequalities show that lack of savings and low pension coverage cannot be solved by pension reforms alone. However, this does not mean that there should not be changes made to pension systems at all. Reforms must be enacted relative to technological advancements and current challenges present in each country that will better support older populations (De la Torre & Rudolph, 2018). This is especially true in countries where levels of aging are higher such as Uruguay and Cuba (Mesa-Lago, 2019)Therefore, governments in Latin America and the Caribbean must be willing to reform their pension and social security systems in the coming years to support their citizens' welfare 




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De la Torre, A., & Rudolph, H. P. (2018, March). The Troubled State of Pension Systems in Latin America. Brookings Institution. 

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