This Selected Issues paper and Statistical Appendix analyzes economic developments in Colombia during 1996–99. Output growth slowed sharply in 1996 and early 1997, but subsequently rebounded owing to stronger exports, a temporary boom in world coffee prices, and an easing of credit policy. Despite efforts at addressing the fiscal imbalances, the nonfinancial public sector deficit widened further to more than 4 percent of GDP in 1997. Monetary policy during 1996 and most of 1997 was geared toward stimulating domestic demand.


This Selected Issues paper and Statistical Appendix analyzes economic developments in Colombia during 1996–99. Output growth slowed sharply in 1996 and early 1997, but subsequently rebounded owing to stronger exports, a temporary boom in world coffee prices, and an easing of credit policy. Despite efforts at addressing the fiscal imbalances, the nonfinancial public sector deficit widened further to more than 4 percent of GDP in 1997. Monetary policy during 1996 and most of 1997 was geared toward stimulating domestic demand.

V. Pension System Reform25

66. The Colombian congress approved a major pension reform in December 1993 (Law 100 of 1993) to broaden the coverage of the pension system, remove inequities, and provide adequate and sustainable retirement benefits. The main aspect of the reform was the establishment of a defined contribution, fully funded, privately administered pension system, alongside the public pay-as-you-go (PAYG) defined benefit system; contributions to the new system began in April 1994. This chapter reviews the situation with respect to the pension system at the beginning of the 1990s; describes the pension reform; assesses the impact on the fiscal accounts; and presents the main challenges ahead.

A. The Pension System in the Early 1990s

67. At the time of the reform, Colombia’s pension system comprised six broad categories of PAYG defined benefit pension plans: (i) three government sector worker systems (comprising 56 national pension funds and 991 regional pension funds), with about 811,000 affiliates; (ii) several decentralized and public enterprise pension funds, with about 300,000 affiliates; (iii) a mandatory pension scheme for private sector workers administered by the ISS, with 3.4 million affiliates; and (iv) a group of pension plans sponsored by insurance companies for voluntary pension contributions by private and public sector workers and by private firms for their own employees, with 100,000 affiliates. Coverage of the system amounted only to about 30 percent of the labor force compared with an average of 38 percent for Latin America and the Caribbean as a whole.

68. Benefits under the old system varied widely between different regimes but were more favorable to public sector workers. Public sector schemes generally were noncontributory, whereas the contribution rate for workers in the ISS scheme was 6.5 percent of wages; and retirement ages generally were five years lower in the public sector schemes than for the ISS scheme (55 for men and 50 for women). Pension payments were defined relative to average nominal wages two years before retirement and varied from 75 percent for public sector workers to 45-90 percent for private sector workers, subject to a minimum of between 10 and 20 years of pension contributions.

69. By 1993, pension payments for public sector workers were equivalent to 1.4 percent of GDP, almost entirely financed by transfers from central administration and local government budgets; payments to private sector workers in the ISS scheme were equivalent to 0.8 percent of GDP, slightly below contributions of 1 percent of GDP. The financial position of the ISS scheme suffered because reserves were mainly invested in low-yielding government securities and pension contributions subsidized health and other social services provided by the ISS. The poor financial position of the public sector schemes also reflected mismanagement and corruption. The consolidated pension system had reserves equivalent to about 1.6 percent of GDP in 1993 and implicit pension liabilities were estimated at the equivalent of 86 percent of GDP (Clavijo, 1998; Schmidt-Hebbel, 1995); without reform, the gap between implicit PAYG debts and explicit reserves was projected to increase sharply.

B. The 1993 Reform

70. The 1993 reform introduced a fully funded privately administered pension system, closed all but six of the public pension schemes, and restructured pension contribution rates and benefits.26 Affiliates to the schemes that were closed had to choose between joining the ISS scheme or moving to the private sector scheme. Three pension schemes were not reformed: the security services (military and police), teachers, and the state oil company (ECOPETROL). Contribution rates for the ISS and privately funded schemes were set at 8 percent of salary, rising to 13.5 percent by 1996; the minimum number of years of contribution to qualify for a pension was set at 19.2 years for which the pension was set at 65 percent of base salary (computed as the average of declared salaries during the last ten years); and, beginning in 2014, the retirement age for women and men will be raised by two years. The new retirement age applied only to new entrants into the labor force and to existing affiliates aged below 35 years for women and below 40 for men.

71. To broaden coverage of the pension system to low income groups, all workers earning more than four times the minimum wage were required to contribute an additional 1 percent of their income to the solidarity pension fund (SPF). These contributions were to be matched by government transfers to the fund. The SPF would be managed by the government and its resources used to supplement the contributions of wage earners and independent workers to enable them to join the pension system; the workers supported by the subsidy would have the choice of joining either the ISS or the privately funded system.

72. Affiliation to either the ISS or privately managed pension systems is mandatory for dependant public and private sector workers and they may switch back and forth between them every three years. Independent workers may join either system voluntarily, provided their contributions reach a minimum level. Workers already contributing to the ISS system who choose to transfer to the privately managed system receive compensation in the form of a recognition bond calculated to reflect the net present value of pension entitlements accumulated under the old system.

73. The recognition bonds are endorsed to private pension fund administrators (AFPs) who compete for the management of the workers’ individual retirement accounts. Each AFP pools its affiliates’ funds and invests them in equities, bonds, and money market instruments. Upon retirement, workers can use the funds accumulated in their individual accounts to purchase an annuity from an insurance company, start a series of phased withdrawals, or a combination of the two. However, early retirement is possible as soon as the balance in the individual account is sufficient to finance a pension of at least 110 percent of the minimum wage; any excess capital can be withdrawn and used for purposes other than retirement. Affiliation to the private pension system grew from about 1 million affiliates at end-1994 to 2.5 million at end-1997. The early success of the scheme benefited from the similarities in benefit eligibility conditions and contribution rates between the ISS and AFP systems, and the fact that workers were already familiar with the concept of private fund management companies due to the Colombian severance program.27

74. Regarding the investments by the AFPs, the reform established maximum investment limits by instrument and issuer, expressed as a percentage of the total fund. Currently, for each AFP the combined ceiling limit for government securities and other public debt instruments is 70 percent; for equities and mutual fund shares, 30 percent; for foreign bonds and international mutual funds invested in bonds and stock index instruments, 10 percent; financial sector bonds, 50 percent; and mortgage backed securities, 30 percent. At end-March 1998, the total funds under management of the mandatory private pension system amounted to US$1.4 billion (1.6 percent of GDP) for about 2.5 million affiliates. Investment in domestic financial sector and corporate bonds and in time deposits accounted for about 60 percent of the total. The average annual rate of return on AFP funds over the period mid-1995 to end-March 1998 was 30 percent.

C. The Fiscal Cost of the Reform

75. One of the determinants of the cost of the reform is the amount of the entitlement recognized to those who switch to the private pension system. The authorities had to choose between compensating for past contributions to the system, or recognizing the pension rights accumulated under the public pension system. Compensating for past contributions presented three important difficulties: (i) records were inadequate to reconstruct the individual affiliates’ contribution histories; (ii) contributions to the ISS system had been relatively low, such that valuing recognition bonds on this basis would have discouraged transfers by affiliates to the private system; and (iii) it would have been necessary to agree on an implicit rate of return on past contributions, which was complicated by volatile real interest rates. In the event, the authorities chose the more expensive option of compensating workers according to the net present value of the entitlements accumulated under the old system. The face value of the recognition bond is calculated as the amount that should have been saved in the individual account in order to accumulate the necessary capital to finance an annuity equal to the corresponding pension entitlement in the old system.

76. Several recent studies suggest that the pension system will remain a substantial burden on the public finances despite the reforms: the combined balance of the public sector and ISS pension schemes is projected to deteriorate from a surplus of about 1 percent of GDP in 1998 to a deficit of 2.25 percent of GDP by 2025, with a cumulative deficit equivalent to 54.4 percent of GDP.28 Such estimates, however, are highly sensitive to the assumptions made, particularly about the number of workers projected to switch to the private pension system, the value of the recognition bonds issued, and the discount rate. By end-May 1998 about 589,856 recognition bonds had been issued with a value of about US$16.4 billion.

77. The continued heavy burden of the pension system on the public finances reflects: (i) the increase in contribution rates that the government will have to pay as the employer of workers enrolling in the privately administered scheme; (ii) the long transition period over which pension benefits in the ISS scheme are reduced; (iii) the option of affiliation to the privately administered scheme means that the ISS and public sector schemes will gradually lose their contributor bases while continuing payments to their own current and future pensioners; and (iv) the lack of reform to the pension schemes of the security services, teachers, and the state oil company.

D. Problems and Challenges

78. The continued burden of the pension system on the public finances points to the need for additional measures. The two most obvious areas for action are: broadening the pension reform to include the schemes of the security services, teachers, and ECOPETROL; and shortening the reform transition period to the new retirement age in the ISS scheme. These measures would also reduce further the substantial remaining inequities in the system.

79. However, additional reforms are unlikely to eliminate the pensions deficit altogether and the government will need to devise a financing strategy for the PAYG pension system and redemption of recognition bonds in the coming decades. Options under discussion include increased taxation, the use of revenue from oil discoveries and privatization receipts to build up pension reserves, improving the quality of the portfolio of ISS investments, and increased government debt issues (representing the swap of explicit government debt for implicit PAYG debt).

80. There have been problems with the implementation of recognition bonds due to the fragmented pension system for public employees and the fiscal decentralization of the country. In particular, regional governments have been slow to meet their obligations to issue bonds for affiliates switching from regional public sector pension funds to the private system. The option of switching back and forth between public and private systems after three years will further complicate the management of recognition bonds.

81. Difficulties in increasing the coverage of the pension system are likely to persist given the incentive to maintain employment in the informal sector because of the high payroll tax and the quite large element not linked closely to expected benefits at the individual level.29 In order to raise the share of formal sector employment and production, the “pure taxation” component of payroll contributions might be replaced by general taxation.

82. The financial health of the AFPs may be an issue given their high start-up costs and low incomes of affiliated workers. At end-1996 the total capital of the AFP industry was about US$236 million, but net worth amounted to about US$68 million because of large operational losses mainly due to high advertising costs and salaries for the sales force. Since the fees of the AFPs generally are charged as a percentage of affiliates’ salaries, the operating revenue of the AFPs also has been low;30 however, by March 1998, all but one of the nine AFPs had broken even.31


  • Clavijo, S., 1998, “Pension Reform in Colombia: Macroeconomic and Fiscal Effects,” mimeo (Washington: International Monetary Fund).

  • Comisión de Racionalización del Gasto y de las Finanzas Públicas, 1997, “Informe Final - El Saneamiento Fiscal, Un Compromiso de la Sociedad, Tema IV: Sistema de Pensiones-Deuda Publica,” (Colombia: Ministerio de Hacienda y Crédito Público).

    • Search Google Scholar
    • Export Citation
  • Mackenzie, G. et al., 1997, Pension Regimes and Saving, IMF Occasional Paper No. 153 (Washington: International Monetary Fund).

  • Queisser, M., 1997, “Pension Reform and Private Pension Funds in Peru and Colombia,” World Bank Policy Research Paper No. 1853 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Schmidt-Hebbel, K., 1995, “Colombia’s Pension reform, Fiscal and Macroeconomic Effects,” World Bank Discussion Paper No. 314 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation

Prepared by John Thornton.


The public sector schemes deemed insolvent and those relating to single public entities were no longer allowed to collect pension contributions; some continue to administer pension payments (from government transfers) but this activity is gradually being centralized.


Employers are required to provide severance benefits of one month’s salary for each year of employment; since 1990, the severance program has been administered by private mutual funds.


This is the baseline scenario presented by the Comisión de Rationalizatión del Gasto y de las Finanzas Públicas (1997) which assumes that all new affiliates enter the private sector scheme; the deficit is broadly in line with that projected by Clavijo (1998).


Between 7 and 9 percentage points of the payroll tax of 46.3 percent of earnings is not linked closely to expected benefits at the individual level.


Total commissions charged by the AFPs, including the premiums charged for disability and survivors’ insurance, may not exceed 3.5 percent of the contributors base salary.


The AFPs are licensed, regulated and supervised by the pension department of the superintendencia bancaria.