Latin America and the Caribbean is on its way to becoming an “aged” region. United Nations population projections leave no room for doubt: in the coming decades, the region will face a scenario of low birth rates and increasing longevity, which will put pension systems at risk. By 2050, the region’s population structure will no longer be shaped like a pyramid but like a column, and around 2060, the low fertility rate will cause the population to stop growing and even decline.
As is already happening in other regions of the world, the process of population aging will put the region’s pension systems in check. The increase in longevity will alter the balance between the capacity of pension systems to provide decent pensions for large segments of the population, as well as the possibility of maintaining that capacity over time. In some cases, pension amounts may decline from their current levels, or contribution rates may have to rise to levels that would make it difficult to create formal employment. What will happen then? How can our region prepare to transform aging into a valuable opportunity?
Although it is true that Latin America and the Caribbean currently have very different realities from those of countries with more advanced aging processes such as Japan, Denmark, New Zealand, Sweden or Singapore, we can learn from their experience and adapt those lessons to our own reality.
Pensions in Japan represent a public expenditure equivalent to 10.2% of its Gross Domestic Product (GDP)
Japan, the world’s most aged country
Japan is in the midst of the most remarkable aging process in human history. According to official government projections, its population is expected to decline by 44 million between 2008 and 2100, due to lower fertility and insufficient compensatory migration. At the same time, Japan boasts the highest life expectancy in the world – 85 years projected life expectancy at birth – and its citizens enjoy the longest retirement period, almost 25 years on average.
These trends pose a significant challenge to the sustainability of Japan’s pension system. Although the pensions granted are relatively modest and need to be supplemented by private savings, they already represent a public expenditure equivalent to 10.2% of the country’s Gross Domestic Product (GDP). It is estimated that the aging of the population could generate an additional increase in social spending of approximately 5 percentage points of GDP between 2020 and 2060.
In response, Japan has implemented several reforms to maintain the financial solvency of its pension system:
- In 2004, it lowered contributions to pensions across the board, and incorporated an adjustment factor according to the evolution of the dependency ratio. In addition, it initiated a progressive increase in the retirement age from 60 to 65. Currently, there are discussions to increase the retirement age to 70.
- In 2006, the possibility of combining receiving a pension with income from paid employment was introduced, provided that a set limit is not exceeded, beyond which the pension is reduced.
- In 2015, the pension payment was enabled as of 10 years of contributions, but in order to collect the maximum pension, 40 years of contributions are required. Additionally, early retirement has a penalty of 6% per year, while postponing retirement has a bonus of 8.4% per year.
Pensions are not yet fully sustainable
Despite these efforts, the latest official government report in 2019 stated that an additional 30% cut in the basic pension is needed to achieve financial sustainability by 2050. Given this situation, the International Monetary Fund has emphasized the need to implement reforms as soon as possible in response to aging, particularly in sensitive areas such as retirement, health and long-term care.
These are some of the International Monetary Fund’s recommendations:
- Change social security financing, migrating from payroll tax to consumption tax.
- Implement reforms aimed at making the labor market more flexible.
- Introduce an Earned Income Tax Credit (EITC) scheme to encourage retirement savings and provide support for low-income retirees.
- Further boosting productivity growth
- Adopt active aging strategies to promote opportunities and quality of life for the aging population.
We don’t stop playing because we get older, we get older because we stop playing.George Bernard Shaw
How do Sweden, the Netherlands and Denmark ensure a balanced pension system?
Sweden is recognized for its pioneering pension reforms. Its current system combines notional accounts – virtual accounts that record all of a worker’s social security contributions over the course of his or her life, which are then taken into account when calculating the pension – and individual capitalization, with pensions based on contributions and life expectancy at retirement.
These mechanisms have proven to be financially sustainable. In 2010 and 2011, a 3.4% reduction in pensions was observed, and in 2014, a 2.7% decrease was recorded. Although these reductions are relatively moderate, they generated an important debate about the pension system in Sweden. Going forward, the increase in longevity is expected to decrease pensions, leading to an increase in the retirement age and a partial indexation to life expectancy.
The Netherlands maintained the retirement age at 64 between 1957 and 2012. Thereafter, it decreed that the age will increase year by year, until it reaches 66 in 2024. Then, from 2025, the increase will be recalculated based on life expectancy at age 65 and will be announced five years before its entry into force, so that each generation will have a similar 20-year decumulation phase (i.e., payment of pensions accumulated during the productive stage).
Denmark, for its part, was one of the first countries to legislate an increase in the retirement age and its indexation to life expectancy; the objective was to maintain a constant retirement period of 14.5 years. Changes in the retirement age in that country are announced 15 years before they occur and can be neither less than 6 months nor more than 1 year in each 5-year period. The first increase was defined in 2015, and will be implemented in 2030, bringing the retirement age from 67 to 68. The indexation mechanism directly incorporates a gender factor (unisex mortality tables). To address socioeconomic differences, it was chosen to incorporate an early retirement scheme that compensates for differences in longevity.
The Danish system, where the retirement age increases slowly and steadily, helps reduce resistance to change, allows for proper planning and ensures a smoother transition to a longer working life. Denmark has implemented a set of complementary measures to ensure social acceptance of this policy, such as providing flexibility in the transition from full-time to part-time employment (and towards full retirement), and offering alternatives for those who are unable to continue working for health reasons. This strategy has ensured that the increase in the retirement age is seen not only as necessary, but also as equitable and feasible. This contrasts, for example, with the recent case of France.
Singapore’s integrated approach
Singapore is one of the fastest aging high-income societies. In fact, population growth is expected to be negative between 2030 and 2035 and the dependency ratio (the number of people dependent on the economically active population) is expected to increase from 12% in 2020 to 61% in 2050.
Singaporeans enjoy a long-life expectancy both at birth (84.8 years) and at retirement at age 65: on average, they draw a pension for almost 21 years.
It is a public policy benchmark because it has not limited itself to pension, labor market and health aspects, but has adopted a broad integrated approach that encompasses housing policies, infrastructure and long-term care, technology, and an inclusive business environment for the elderly:
- The value of pensions is adjusted to respond to the increase in life expectancy. In addition, it was decided to increase the retirement age to 70 in 2030.
- There are complementary programs to invest in job skills and human capital, in infrastructure (with age-appropriate housing, healthcare and technology), and in organizational capital through the promotion of age-appropriate social service networks.
- There is a wide range of digital services and financial technologies tailored to older adults.
- Pension contributions were recently increased. However, contribution subsidies were approved for lower-income households and mechanisms are being introduced to encourage voluntary savings.
- Measures are being implemented to facilitate longer working lives through the reemployment program and the redesign of health insurance plans.
What about Latin America and the Caribbean?
It is clear that no pension system is immune to the effects of increased longevity. Pension expenditure will account for an increasing proportion of public spending, so the region must push for far-reaching reforms as soon as possible to cope with the impacts of the impending demographic change.
From the region we can take note of international experiences and anticipate measures to adjust the retirement age to changes in life expectancy, promote dignified work for the elderly, and prepare the ground for this change to take place with high levels of social acceptance.
Using the words of George Bernard Shaw, how can Latin America and the Caribbean “keep the game going” for older adults? Find out in the new edition of our series The Future of Work in Latin America and the Caribbean.