1551. Sequencing Social Security, Pension, and Insurance Reform

Dimitri Vittas
(December 1995)

The full benefits of social security reform will not be realized until social pension systems are restructured and downsized, contribution rates lowered, and the scope for private pension funds (voluntary or mandatory) increased. Reform of the insurance sector is also essential because of the close links between pensions and life, disability, and annuity insurance.

For both economic and regulatory reasons, most developing countries have underdeveloped pension funds and insurance sectors, and their social security systems face many financial and organizational problems. Wide-ranging reform would produce considerable economic and social benefits.

A restructured social security system would avoid financial insolvency and be better able to meet its objectives of redistribution. The development of pension funds and insurance business would generate long-term financial resources that could stimulate the growth of capital markets and might help provide adequate, affordable long-term benefits to members and policyholders.

The main objectives of an ambitious reform program should be to:

• Prevent the insolvency of the social security system (a longer run problem for developing countries with young populations) and thus ensure adequate but affordable, sustainable pension benefits.
• Remove incentives that encourage the strategic manipulation, and hamper the efficient functioning, of labor markets.
• Control the occurrence of perverse, capricious redistribution by removing the many design faults that afflict security systems in most developing countries.
• Generate long-term financial savings that can help stimulate the modernization and growth of capital markets, finance long-term investments, and facilitate privatization.

Although there is no single optimal way to sequence and pace a reform program, the full benefits of reform will not be realized until social pension systems are restructured and downsized, contribution rates lowered, and the scope for private pension funds (whether voluntary or mandatory) increased.

One often-ignored imperative is to defer indexing the pension system until its many design flaws are corrected.

Finally, reform of the insurance sector is essential for the whole program to succeed, because of the close links between pension reform and the provision of life, disability, and annuity insurance services.

This paper --- a product of the Financial Sector Development Department --- is part of a larger effort in the department to study pension systems and contractual savings. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Priscilla Infante, room G8-115, telephone 202-473-7642, fax 202-522-3199, Internet address pinfante@worldbank. org. (28 pages)

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