Privatizing Social Security in Latin America

Policy Reports | Social Security

No. 221
Friday, January 01, 1999
by Luis Larrain

Executive Summary

Chile, the first nation in the Western Hemisphere to establish a social security system, was the first nation in the world to privatize its system. Since Chile instituted a privatized system in 1981, seven other Latin American countries - Peru in 1993, followed by Argentina, Colombia, Uruguay, Bolivia, Mexico and El Salvador - have adopted the Chilean model to some degree. The new Mexican system, launched in February 1997, already is the largest in Latin America. Most other Latin American countries are considering such a move.

Although the mechanics of the privatized systems vary from country to country, certain features are common to all:

  • Workers are required to contribute to individual retirement accounts, managed by private investment funds.
  • The private investment funds are required to invest conservatively in a diversified portfolio of assets.

In all but one of the privatized systems, the private fund also provides disability and survivors insurance. The exception is Mexico, where the government continues to provide disability and survivors benefits.

Bolivia requires workers to buy an annuity when they retire. All the other countries give the retiree three options: (1) purchase an annuity, (2) make monthly withdrawals from their accounts based on life expectancy, or (3) withdraw funds on a schedule until annuity payments begin at a future time.

Chile, Bolivia, Mexico and El Salvador require all workers entering the labor force for the first time to join the private system, whereas Peru, Argentina, Colombia and Uruguay give them an option. For example, Colombia allows workers to switch back and forth between the public and private systems throughout their work lives. In some of the countries, political opposition has made complete privatization impossible.

Workers in privatized systems fund their own pensions, unlike government systems that use current tax revenues to pay benefits to current retirees. Privatization is expected to bring workers higher benefits than they would receive in a pay-as-you-go system and to increase economic growth by providing new investment capital.

In Chile, the only nation with long-term experience with a privatized system, the average annual real return on assets has been 10.7 percent, and retirement benefits are 19.6 percent higher than under the old system. Private disability pensions are 30.9 percent higher, and survivors benefits are 17.8 percent higher for widows, although they currently are only 75 percent of those under the old system for orphan children. The reformed pension system also has bolstered Chile's economy.

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