PensionReforms' summary and comments
Generally, public retirement income systems in Latin America are moving away from PAYG, Defined Benefit to pre-funded, Defined Contribution pensions.  In the IMF's view, this is a good thing.  The shift was intended to deepen and improve financial markets, enhance fiscal sustainability, and improve signals sent by markets to savers.

Unfortunately, the transition from PAYG to pre-funded hasn't been as smooth as might have been preferred.  The report looks at "... macroeconomic aspects, focusing on financial market stability and fiscal sustainability."

The report suggests that pension reforms in Latin America:
"...have had a positive effect on macroeconomic performance and capital market development.  Moreover, these reforms have established a much stronger multi-pillar framework for pension systems in the region."

So, according to the report, what seems to be wrong with what's happened so far?  Quite a lot actually:
. Concentration of pension fund portfolios in government bonds remains high.
. The lack of new investment alternatives has distorted asset prices.  Apparently, most analysts attribute the 30% p.a. increase in Chilean share prices between 1985-93 largely to the relaxation in investment restrictions on AFPs and the demand for shares.
. Countries have gradually freed up investments abroad, but "remain wary of the impact on foreign currency markets".
. The fiscal costs of the transition to funded systems have been higher than expected, and have contributed to high debt levels and "...and at times compromised macroeconomic stability".

The report has quite a long list of recommendations.  It suggests that countries:
. "... could strengthen the first and third pillars, that is the safety net aspects of the system (including minimum pensions) and the complementary/voluntary savings components."  The safety net seems still to be needed partly because of relatively low participation rates in the 'compulsory' schemes but also because of expected reductions in the pension replacement rates after retirement.
. "The mandatory second pillar, could also be made more efficient through a number of measures, including some targeted to improve cost effectiveness and competition among private pension funds."
. "Portfolio investment limits should continue to be relaxed in a gradual manner, and this ought to be coordinated with sovereign debt management activities, as well as with legislation and regulation on capital markets."
. "Better legislation on corporate governance would also help funds broaden the set of corporate bonds they can safely invest in, insofar that the laws are not unduly restrictive and distinguish between bond and equity issues."
. "Excessive concentration of pension funds' portfolios should be kept in check, not just to avoid the risk of default, but also to avoid the temptation to exploit the otherwise captive demand for government bonds from the pension funds."
. "Limits on pension funds investments abroad should be relaxed gradually, and regulations on foreign assets and currency exposure should be dictated by the diversification needs and risk-adjusted return opportunities available to the pension funds-rather than [foreign exchange] market considerations."
. "Also, some pension fund regulations, such as industry-related minimum performance requirements, could be relaxed to reduce herding behavior."
. "Furthermore, raising the disclosure and transparency requirements of other financial intermediaries closer to the high levels required for pension funds would remove the excessive focus on funds as drivers of most trends in asset prices, including the exchange rate."

The report suggests that countries have tended to underestimate the significant transition costs:
"Political economy constraints during the debate and/or implementation of reforms have reversed or made insufficient the originally envisaged parametric changes to the old PAYG regimes.  This has in some cases added 2 percentage points of GDP to the transitional fiscal deficit, which if added to a likely one percent more under a cyclical down turn, could constrain fiscal policy and prompt calls for a reversal of pension reforms.  Public debt has risen by more than 10 percentage points of GDP in some pension reformers, and this has raised issues of debt sustainability and increased the sovereign funding costs-since market participants seem to give more weight to explicit than implicit pension debt."

These transition issues could be improved, according to the report by not rushing reform but instead " ...building fiscal space before the pension reforms is highly desirable".

Also, more and better information about the long-term demographic costs " ...would strengthen the fiscal policy framework and facilitate the discussion of contingent policy measures before deviations become too costly."

PensionReforms suggests that this report should give any country pause for thought before adopting anything like the Chilean model for its retirement income policy.  A number of things struck PensionReforms about the report's conclusions:
. Governance is a significant issue for both public and private pensions, no matter what their design.  Governance assumes much greater importance when governments are forcing citizens to save in particular ways at particular times and for a particular purpose (when citizens might reasonably have other ideas about that).
. Governments should have very clear ideas about what change is expected to achieve and, having identified those objectives, should be held to account transparently for their achievements and failures.
. Whether pension systems are public or private; Defined Benefit or Defined Contribution; pre-funded or PAYG are less important than the strength of the economy that has the obligation to convert claims to consumption (the ultimate purpose of any retirement income system).  It seems unclear to PensionReforms how the Latin American changes have added to saving (in the macroeconomic sense) and/or to growth.
. Compulsory Tier 2 systems that end up lending most of their assets back to the government (in the shape of bonds) have changed the names of the owners of the economic claims on the economy but not their substance.  Government bonds comprise 46% of Latin American Tier 2 schemes' assets in 2005.
. Most Latin American systems amount, in effect, to the partial privatisation of a former government pension obligation.  If that happens without a proper examination of the government's welfare obligation, the change has started from part way down the road.  That will put inevitable pressures on the achievement of the reform's objectives.
. Governments still have the implied obligation that has been partially privatised so is reasonably concerned to ensure the Tier 2 arrangements 'work'.  Partial privatisation also necessarily involves intricate regulation that is costly to administer and often produces unintended consequences.
. Tier 1 still seems important (in fact, needs "strengthening" according to the report) despite the fact that Latin American reforms, by making the contributory Tier 2 more attractive to workers, was intended to reduce drastically the need for Tier 1 social assistance pensions.

PensionReforms suggests that the Latin American reform score card can still be marked as 'not achieved'.  (File size 417 KB)  233