Uruguay: Selected Issues

This 2011 Article IV Consultation—Selected Issues paper focuses on estimating potential output and the output gap and spillovers from agriculture in the case of Uruguay. It introduces additional economic information and theory to estimate potential output, shedding some light on the discussion of current monetary and fiscal policies. The objective is to take advantage of economic data to disentangle the most recent economic performance by introducing multivariate techniques. The paper also presents an overview of the labor market and pension system of Uruguay.

Abstract

This 2011 Article IV Consultation—Selected Issues paper focuses on estimating potential output and the output gap and spillovers from agriculture in the case of Uruguay. It introduces additional economic information and theory to estimate potential output, shedding some light on the discussion of current monetary and fiscal policies. The objective is to take advantage of economic data to disentangle the most recent economic performance by introducing multivariate techniques. The paper also presents an overview of the labor market and pension system of Uruguay.

V. Uruguay’s Pension System: Overview1

1. Uruguay is a true pioneer in the introduction of social security systems in Latin America. Many countries in the region introduced social security systems through the XX century—and by the 1960s had established defined benefit or Pay-As-You-Go (PAYGO) systems. Uruguay’s social security system was one of the first and most comprehensive—its origins can be traced back to the 1800s and by 1920 had a significant coverage, which included not only teachers and public sector employees, but also private sector workers (Rothman and Carranza, 2005).

2. The system was established as a defined benefits or Pay-As-You-Go (PAYGO) model and included several pension schemes. In a PAYGO system, active workers pay for the pensions obligations of retired workers. By 1990, Uruguay had several different pension arrangements providing differentiated benefits to their affiliates. The solidarity system was managed by the Banco de Prevision Social (BPS). While it had important positive features in its design (including its comprehensive coverage), the Uruguayan PAYGO system was not exempt of some of the problems that affected other similar systems in the region—including high operational costs, and increasing deficits and long-term imbalances, due in part to the country’s aging population.

3. This paper presents an overview of Uruguay’s pension system and the major reforms that have affected the system since 1996. It describes the main elements of the pension system as a defined benefit/PAYGO system prior to the 1996 reform, which involved the introduction of the defined contribution component with individual capitalization accounts (ICAs). The paper also reviews on the key amendments following the 2007 tax reform and the 2008 law that fosters the access to pension benefits as well as their financial impact.

4. The main findings of the paper are that: a) following the 1996 reform, Uruguay’s already high coverage level by the PAYGO system has been increased further; most of the value pensions lost in the 1980’s has been recovered; and its implicit debt was reduced b) after 15 years in place, the individual capitalization account component is widely accepted; c) the financial impact of the 2007 and 2009 reforms was limited by the combination of changes in contribution rates with a broader tax base, the remarkable formalization process, and the creation of thousands of new jobs as well as a result of the rationalization of the parameters that define the access to pension benefits.

5. The paper is organized as follows: Section A provides a background of the PAYGO system before 1996. Section B describes the 1996 reform in terms of its key objectives: a) increase coverage, b) improve pension levels, and c) reduce the system’s implicit debt. Section C analyzes the main reforms introduced since 2007, namely the tax reform and the law that made the access to pension benefits more flexible. Section D estimates the financial impact of these two reforms. Section E describes briefly the individual capitalization account system in terms of coverage, assets, and investment policies. Section F concludes.

A. Background

6. Uruguay has one of the oldest pension systems among emerging markets and its coverage is among the highest in Latin America. While some of the elements of Uruguay’s social security system can be traced back to 1829—prior to the first Constitution of the Republic, signed in 1830—the first retirement system, which covered teachers only, was introduced in 1896. The system was broadened to all public sector employees in 1904 and to workers from the private sector in 1919. Rofman and Carranza (2005) found that in 1995, Uruguay ranked third in Latin America in terms of coverage rate, measured as the number of contributors to the pension system relative to the economic active population (14 + years old).

7. The system was established as a defined benefits or Pay-As-You-Go (PAYGO) model and included several pension schemes. In Uruguay’s PAYGO system, active workers, employers, and the government pay for the pension obligations of retired workers. By 1990, Uruguay had several different pension arrangements providing differentiated benefits to their affiliates. These other programs included, among others, the military and police pension systems, the lawyers, and the professionals that work at universities in Uruguay. The solidarity system was managed by the Banco de Previsión Social (BPS).

8. The system ran into large deficits which peaked at 3.3 percent of GDP in 1995. These deficits were the result of the generosity of the programs, the aging of the population, the reduction in the rate between active and passive population, evasion of contributions, and other inefficiencies.2.

B. Main Components and Effects of the 1996 Pension Reform

9. In 1996, Uruguay added a second pillar to the solidarity component managed by BPS. The approval of the two pillar system was achieved as a result of the broad dialogue, which included the participation of workers and pensioners as well as on the role that the public sector would continue to play. Under the current system, BPS continues managing the intergenerational or solidarity component and collects the contributions for the whole pension system. The second pillar is managed by private pension funds, which run a defined contributions component with “individual capitalization accounts”, where pensions depend upon the accumulated contributions and their rate of return.

10. The reform aimed to achieve both social and economic objectives. In line with the reforms in the countries that preceded Uruguay’s 1996 reform, the changes to the pension system aimed to maintain and further increase the high coverage level, improve pensions paid, and reduce its increasing deficits.

11. Several parametric changes accompanied the structural pension reform. These included: a) increasing women’s retirement age to 60 years to make it equal to that of men’s; b) increasing the required years of service from 30 to 35; c) increasing the number of years to compute the basic retirement wage; and d) reducing the replacement rates, among others (Table 1).

Table 1.

Uruguay: Main Reforms to the Solidarity Pension System

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Source: IMF staff from official data.

12. The 1996 reform has progressively achieved its objectives. Zviniene and Packard (2004) estimated that, at the end of 2010, what is known as the “implicit debt”3 of the old pension system had been reduced by over 60 percent of GDP down to 146 percent of GDP; a significant portion of these obligations remained in the solidarity system. Coverage, both in terms of total population as well as in terms of the working age population, has increased (Table 2) while pensions, on the other hand, remain below 1996 levels.

Table 2.

Uruguay: Coverage by the Solidarity System

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Sources: Banco de Prevision Social and IMF staff calculations.

Percent of persons 60+ retired under BPS.

13. While the parametric changes reduced the deficit of the solidarity system, other measures also contributed. These included administrative measures that helped to reduce evasion in social security contributions and some moderation in adjusting pension payments. In 2006, revenues reached 5.2 percent of GDP up from 4.2 percent in 2004 while expenditures reached 7.2 percent of GDP in 2008 down from 8 percent of GDP in 2004.

C. Recent Reforms to Foster Accessibility, Equity, and Reduce Employers’ Burden

14. Since 2007, the Frente Amplio governments have introduced important reforms to the new pension system. In tandem with the 2007 tax reform, the government has sought to reduce the burden on employers; it lowered the contribution rates from 12.5 percent to 7.5 percent for the industry, commerce, and domestic service sectors as well as certain public institutions. At the same time, the tax reform increased the contribution rate to the rural sector and eliminated many exemptions.

15. Law 18.395 made the benefits more accessible to future retires. The main amendments, which were derived from the first national dialogue on the pension system4, include: a) reducing the years of service from 35 to 30 years with a 45 percent replacement rate when retiring at age 60; b) making access more flexible to the older retirement age benefit for persons aged 65 + years by opening other gradual possibilities—aside from the traditional one to retire at age70 and 15 years of service. That is, for a 69 year old person applying for the old age pension benefit, the system requires 17 years of service; and c) granting one year of service to women per each child up to five children. The latter reflects the government’s commitment to reduce gender inequality and recognize the role women play in raising a family’s children.

16. In addition, the government allowed the return of more than 5,000 workers to BPS but its impact would be minor while would help to consolidate the two pillar system. While we do not make estimates of the financial impact associated to disaffiliation of over 5,000 contributors from the private pension funds, the impact would be minor as they represent less than 1 percent of the active contributors to both pillars. On the other hand, allowing this group, which otherwise could have received lower pensions than in BPS, has increased the positive perception on the new system.

D. Financial Impact from the 2007 and 2009 Reforms

17. The changes in the tax system and the more flexible conditions to access pension benefits have increased the pressure on the solidarity system. The impact has been limited by the positive impact from a broader tax base and some rationalization in the parameters to define the access to common pensions and the early access to the old age pension benefit. The rationalization of these parameters aims to reign in on any potential abuse from the more favorable conditions to retire.

18. BPS’s strong role in reducing tax evasion has also played a key role in limiting the additional financial needs. BPS’ measures include a set of public policies to increase formalization and reduce evasion. In the last six years, the response from firms and workers have entailed a significant increase in the formal work posts that contribute to social security of the order of 50 percent; over this period evasion was reduced from 40 percent in 2004 to 20 percent in 2010. In addition, the rapid expansion of the economy has also contributed to the creation of thousands of new jobs and thus to improve BPS’s revenues. This has lead to an improvement in the system’s asset-to-liability ratio.

19. Revenues declined by 0.4 percent of GDP while the obligations of the solidarity system increased by 0.5 percent of GDP following the changes introduced by the 2007 and 2009 reforms. The reduction in the employers’ contributions rate lowered BPS revenues by 0.2 percent of GDP in both 2007 and 2008 (Table 3).

Table 3.

Uruguay: Contributions to the Solidarity System

(Percent of GDP)

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Sources: Banco de Prevision Social and IMF staff calculations.

20. From the expenditure side, the reforms increased the solidarity system’s obligations by 0.5 percent of GDP. Table 4 shows the increase in the number of retirees before and after the reform. Before 2008—when workers needed 35 years of service to apply for retirement—the number of retirees was on a declining path. This trend reversed after the reforms. In 2009, there were 13,816 new retirees with women representing near 70 percent of the new retirees.

Figure 1.
Figure 1.

Uruguay: Retirees from the Solidarity System 1993-2009

(Thousands)

Citation: IMF Staff Country Reports 2011, 376; 10.5089/9781463926601.002.A005

Source: Bank of Greece, and staff estimates.
Table 4.

Uruguay: Trend in Number of Retirees

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Source: Banco de Prevision Social and IMF staff calculations.

21. Preliminary estimates suggest that the overall impact from both major reforms equals to 0.9 percent of GDP.5 The analysis that seeks to isolate the effects of the most important reforms suggests that their impact is equivalent to 80 percent of the estimated public sector deficits for the next five years. Figure 2 shows the change in trend in both revenues and expenditures following prior to and after the 1996 reform, as well as after the 2007 and 2009 reforms. Before 1996, the deficit was widening as revenues were declining and expenditures rising. Following the 1996 reform, the deficit was reduced slightly but increased once again as a result of the 2002 financial crisis. Lower spending levels and higher revenues contributed to cut the deficit before 2007, but the trend reversed slightly following the 2007 and 2009 reforms.

Figure 2.
Figure 2.

Uruguay: Performance of the Solidarity System 1993-2009

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 376; 10.5089/9781463926601.002.A005

Source: Bank of Greece, and staff estimates.

E. The Defined Contributions System with Individual Accounts

22. According to Banco Central del Uruguay,6 as of October 2011, there were 1,065,164 individuals affiliated with the private pension system, which had accumulated US$7.9 billion in assets. Since December 2010, the number of new affiliates to the individual account system has increased by 8.5 percent while the assets managed by the private pension funds increased by nearly US$1.1 billion.

23. There are now four private pension funds managing the assets. The individual capitalization accounts, which started with six private managers, have consolidated into four pension funds. República AFAP, the largest of them, has a market share close to 40 percent of the affiliates and manages nearly 57 percent of the assets.

24. The government changed recently the investment limits (Law 18.673). Starting in January 2011, the maximum investment level in public sector securities was reduced from 90 percent to 85 percent. This ceiling will be further reduced by 2.5 percent per year until it reaches 75 percent by 2016. The limit to invest the funds on private sector instruments was raised to 50 percent while the option to investment in highly rated sovereigns (including investment in multilateral papers) was increased to 15 percent. On the other hand, the ceiling to investment in foreign currency denominated assets was set at 30 percent.

25. Most of the US$7.9 billion in assets managed by the private pensions funds are currently invested in public sector debt. The Banco Central del Uruguay reports that as of October 31, 2011, 81 percent of the funds were invested in public sector papers down from the 84 percent at the end of 2010. The remaining assets included: World Bank multilateral notes (6.3 percent), private sector debt (5.8 percent), and loans to individuals affiliated to the pension funds and others (7 percent).

F. Conclusions

26. The 1996 reform has achieved several of its key objectives. Coverage, already high in Uruguay before the 1996 reform, has been further increased. The deficit of the solidarity system was reduced making the system more sustainable in the medium to long-term. Pensions have recovered but still remain below Uruguay’s pre-crisis levels.

27. Preliminary estimates suggest that the 2007 and 2009 reforms may have increased the central government’s burden, although this is moderated by an increase in revenues by BPS, including due to formalization. The administrative measures implemented by BPS, have also contributed to an important formalization of the labor market and a reduction in the evasion of contributions. The additional financial need of the solidarity system is equivalent to nearly 80 percent of the projected public sector deficit for the next five years.

28. Despite a seemingly important concentration of assets and affiliates in the state owned private pension fund, the system is widely accepted. As noted earlier in this paper, the broad participation of pensioners in the debate prior to the introduction of the two pillar system and during 2007 contributed to the large acceptance of the private pension funds.

References

  • Banco Central del Uruguay, 2011, “Principales Variables del Régimen de Jubilación por Ahorro Individual Obligatorio.” Banco Central del Uruguay: http://www3.bcu.gub.uy/a5585.html

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  • Banco de Previsión Social, 2010, “Proyección Financiera del Sistema Previsional Contributivo Administrado por el Banco de Previsión Social: Base Años 2003/2008.” Montevideo.

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  • International Labor Organization, 2005, “Uruguay: Empleo y Protección Social: de la crisis al crecimiento.” Chile.

  • International Labor Organization, 1952, “Convention 102: Social Security (Minimum Standards) Convention.” Geneva.

  • Holzmann, Robert, R. Palacios, and A. Zviniene, 2004, “Implicit Pension Debt: Issues, Measurement and Scope in International Perspective,” Social Protection Discussion Paper Series, No. 0403, World Bank, Washington D.C.

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  • Klaus Schmidt-Hebbel, 1999, “Latin America’s Pension Revolution: A Review of Approaches and Experience,” World Bank, Washington, D.C.

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  • Rofman, Rafael and E. Carranza, 2005, “Social Security Coverage in Latin America.” Social Protection Discussion Paper Series No. 0523, World Bank, Washington D.C.

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  • Zviniene, Asta and T. Packard, 2004, “A Simulation of Social Security Reforms in Latin America: What Has Been Gained?,” Background paper for regional study on social security reform, Office of the Chief Economist, Latin America and Caribbean region, The World Bank, Washington, D.C.

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1

Prepared by Manuel Rosales Torres.

2

Some measures were taken that enlarged the number of beneficiaries. For instance, in some cases, pensions may have been granted without proof of contributions but rather on witness’ evidence.

3

The pension implicit debt is defined as the sum of future obligations, including guarantees of minimum pension, to current workers who are contributing to the pension system. Holzman et al (2005) indicate that “when establishing an unfunded (pay-as-you-go) pension scheme, mandating the payment of contributions to the current generation and promising to pay future pension benefits, the government makes commitment. To make comparable estimates of implicit debt for 35 countries, including Uruguay, Holzman at al make the estimates on the basis of “Accrued-to-date liabilities”, which represent the present value of pensions to be paid in the future on the basis of accrued rights; neither future contributions, nor the accrual of new rights on the basis of these contributions are considered.

4

For approximately nine months in 2007, the government called a national dialogue on social security to assess with the main sectors of the society the performance of the pension system and to draw the inputs for the future adjustments. The dialogue was headed by the Comisión Sectorial de Seguridad Social with the assistance of the United Nations Development Program in Uruguay, the Spanish Agency for Cooperation, and the Universidad de la República. The public sector was represented by the Labor, Economy and Finance, Health, and Social Development Ministries as well as by the Budget Office and BPS.

5

To assess the complete impact of all the reforms, a more detailed analysis is warranted. Furthermore, international best practices set in article 71 of Convention 102 of the International Labor Organization, recommend to periodically performing actuarial studies to ensure the medium and long-run sustainability of any member country’s pension systems.

6

For more details see http://www3.bcu.gub.uy/a5585.html. AFAPs are supervised by the Superintendencia de Servicios Financieros.

Uruguay: 2011 Selected Issues
Author: International Monetary Fund