Risk of Disability, Old-age and Death: Pension Sustainability in Colombia

Sergio Clavijo,Ekaterina Cuéllar,Andrea Ríos,Laura Clavijo,Nelson Vera,David Malagón,Alejandro Vera

doi:10.5539/jms.v7n1p103

Abstract

This paper concludes that the sustainability of the public “pay-as-you-go” pension regime in Colombia (RPM) looks fragile and is threatened by massive transfers from the private “defined contributions” regime (RAIS) to the RPM. The fiscal deficit of the RPM could be rising from 140% of GDP (in NPV) to 228% of GDP during the next three decades on account of the migration of close to nine million retirees moving to the RPM. Pressure to the fiscal budget will increase towards 90% of GDP (in NPV) as a result of the pension shortfall, making it very difficult to comply with a fiscal target of 4% of GDP per year. In addition, the life annuities’ market is quite shallow in Colombia due to: i) the State guarantee of a pension equivalent to 100% of a legal-minimum-wage (1 LMW); which in turn is fully indexed to annual inflation; and ii) the risk of assuming longer periods of pension enjoyment via judicial sentences (elevating the current expectations of 20-25 year period of enjoyment). Limiting the pension guarantee to 50-75% of a LMW, allowing for life-annuities recalculation, and decreasing the cost-margin of insurance companies would help place the Colombian life annuities market in a more financially sustainable path.

Highlights

The period 2014-2015 has been characterized by macro-financial tension, especially for emerging economies (EM)
The decreasing price of oil has had negative effects, mainly: i) intensifying the twin deficits, reaching 6% of GDP in the current account and a 3%-4% of GDP fiscal deficit; ii) 35% depreciation against the dollar during 2015, resulting in higher inflation due to exchange rate pass-through effect (+5.8% end-2015), requiring the Central Bank (BR) to increase its interest rate to 5.25% at the end of 2015; and iii) losses worth 0.5% of potential economic growth, due to the inability to reactivate key sectors such as agriculture and the manufacturing industry
The first set of estimations aim at determining the Net Present Value (NPV) of the pension system, from the RAIS-RPM migration phenomenon, which has been spurred by the “unfair” competition that Law 100 de 1993 enabled by facing RAIS private-savings to RPM government subsidies

Summary

Introduction

The period 2014-2015 has been characterized by macro-financial tension, especially for emerging economies (EM). The decreasing price of oil has had negative effects, mainly: i) intensifying the twin deficits, reaching 6% of GDP in the current account (vs 4.3% historically) and a 3%-4% of GDP fiscal deficit (vs 2.4% for 2013-2014); ii) 35% depreciation against the dollar during 2015, resulting in higher inflation due to exchange rate pass-through effect (+5.8% end-2015), requiring the Central Bank (BR) to increase its interest rate to 5.25% at the end of 2015 (vs 4.5% in 2014); and iii) losses worth 0.5% of potential economic growth (leading a historical 4.5% growth rate to fall towards the 3.5%-4% range), due to the inability to reactivate key sectors such as agriculture and the manufacturing industry These events have exposed structural weaknesses of the Colombian economy, unveiling the consequences of having missed the opportunity that the 2004-2014 boom represented in terms of advancing with structural reforms. This paper addresses many of the pension challenges to be faced, with special attention to the pension accumulation cycle as well as the de-accumulation phase

Methods

Results

Conclusion