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5 November, 2021

The individually funded versus the PAYGO pension systems in Latin America

The Chairman of Asofondos de Colombia, Santiago Montenegro, said that several Latin American countries are adopting policies that are undermining the individually funded systems, such as early withdrawals and the full or partial return to PAYGO systems in other countries.

In his presentation, the economist argued that PAYGO systems are unsustainable for several reasons: demographic changes, giving rise to a larger number of retirees than contributors; labor informality and the increasing digitization of society, which is replacing active workers with robots, algorithms and the internet of things.

“The individually funded systems are superior to the PAYGO systems because their returns are higher. The returns of the individually funded systems are the returns on capital, which have tended to drop in developed countries. However, the returns of the PAYGO systems are equal to the growth of the working population plus productivity per worker,” he explained.

According to the International Federation of Pension Fund Administrators (FIAP) data, the total number of countries that have adopted this system, in its different modalities, has practically tripled since 1999.

It is true that population aging has also affected the individually funded systems, but even under these conditions they are superior, particularly in the replacement rates they provide.

On the other hand, and given the high levels of informality, the economist recommends that individuals who are unable to save enough to finance a pension should receive a guaranteed minimum income that covers the poverty line.

Regarding the political repercussions and the consequences of ending the individually funded system, Montenegro explains that, in addition to a negative impact on savings and economic growth, it would negatively affect the capital market and the allocation of resources in the economy, while also increasing unemployment.

For the system to function correctly and efficiently, there must be competition between different public fund managers subject to the same rules, he explained. Furthermore, as the expert pointed out, there should be a solidarity pillar funded from the national budget, and a contributory pillar that pays contributions into individual accounts rather than a PAYGO system. Savings and individually funded accounts should be basic components against risks in old age.

“In any country, the design of the pension system must consider sustainability as one of the most important pillars. The sustainability of a pension system will be achieved to the extent that pensions can be paid with the contributions of workers plus the return on their savings,” said Montenegro.

The presentation can be viewed on the seminar’s website (https://seminariofiap.strim.cl/).


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