pensions

For most Latin Americans, the most effective way to ensure an income in old age is through pension systems. They work differently in each country, but for the average citizen they represent their main source of livelihood in the last stage of their life. However, despite their importance, most people do not know how they work, or because of their design, many of them are at risk of not being sustainable in the long term.

 

"Saving is a very difficult thing. But saving for old age is even more difficult," says Carmen Pagés, head of the Labor Market Division at the IDB.

 

In a recent IDB report, we analyzed 34 pension systems in 27 countries in Latin America and the Caribbean to understand how they are designed; but also, to grasp how to face the challenges that arise from a rapidly aging region and from women having fewer children. The report found that many of the pension systems face deficiencies in coverage, adequacy and sustainability.

 

But it is not only an aging population which calls for a redesign of Latin American pensions. The automation of work throughout the region could significantly impact how these operate.

 

Let's start with the coverage. Many of the pension systems require of people to continuously hold a formal job throughout their working life. However, on average, only 52.8% of the economically active population has a formal job in the countries of Latin America and the Caribbean. Even among these workers, not all work full time or stay in the same job. In the region, there are high levels of wage inequality, high informality and insecurity in employment. The vast majority do not regularly contribute to pensions, and if they do, they probably do so with pauses along their working lives. In most pension systems there are minimum years of contributions which when not fulfilled, the money they saved is not returned to them; in turn, it helps subsidize the pensions of other workers.   

Because of this, many informal workers, independent workers or those who do not have a stable employment, tend to suffer from economic marginalization in old age. One of these highly vulnerable groups are low-income independent workers: it is estimated that only 1 in 10 of them has savings for their non-active living stage.

 

Changes in technology—such as automation and robotization, and platforms such as Uber or Cabify—will make it harder for a person to work in the same job throughout their life. In the future, pension systems will have to adapt to a new reality where there will be many more independent workers who do not earn a fixed monthly income.

 

Another challenge is the way in which pension systems operate. Currently, the vast majority of them subsidize workers who participate continuously in these since their contributions are insufficient to finance the entire pension they were promised. On average, in a type of pension system called Defined Benefit (DB)—where the amount is determined by a pension rule or promise—approximately 44% of what they receive is subsidized. In another system called Defined Contribution (DC), where the pension depends on the amount saved by the worker and its financial performance, the average subsidy is 31%.

 

Thumbnail

 

The challenge with these models is that subsidies, while designed to benefit those with the lowest wages, do not necessarily assist those who are in the most need of help. In the case of the Defined Benefit model, in absolute terms a greater amount is granted to the pensioners who earn the most. In both models, workers who contribute sporadically to pension systems, which in most cases are those with low-paying or unstable jobs, are excluded and in some cases harmed. In the Defined Benefit model, workers who do not meet the minimum years of contributions to the pension lose everything they have payed. In the Defined Contribution system, while they can recover the amount they have saved, if they do not achieve sufficient years they will not be able to access minimum pensions or longevity insurance.

 

The design of pension systems will also generate greater economic pressures for governments in the coming years. The region is aging at an accelerated pace that is unprecedented in the world. In other countries—such as the United Kingdom or France—it took more than 65 years for its population of older adults to increase from 10% to 20% of the total population, while in Latin America and the Caribbean this will happen in only 25 years. 

 

Conclusion? Spending on subsidies for pensions will likely increase in the coming decades.

 

Thumbnail


At the IDB, we are designing innovative solutions to face these challenges through our Retirement Savings Laboratory. We are testing pilot projects in different countries of the region focused on two population groups: low-income independent workers and middle-income workers who are not saving enough for old age.

 

One of these initiatives, for example, is a mechanism for people who work in freelance jobs, such as Cabify or Rappi, to obtain a pension.

 

"The great innovation of social security in the nineteenth century was that it became an automatic mechanism, that is discounted from the payroll and you forget about it," says Carmen Pagés, head of the Labor Market Division of the IDB. "But for freelancers that does not happen. What we are looking for is to reproduce that innovation in the 21st century, in a context where the gig economy and freelance workers are increasing, " she concludes.  

You can download the publication on pensions and learn what is the situation of pensions in your country here or learn more about the Retirement Savings Lab here.

 

Thumbnail