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The Challenge of Pension Systems
in LAC: What’s next for reforms?
Mariano BoschLabor Markets and Social Security Unit
Inter-American Development Bank
*Opinions are my own, and not necessarily coincide with opinions of IDB or its
board of directors. This presentation benefits from the work of a number of IDB
colleagues: Solange Berstein, Mariano Bosch, Santiago Levy and Angel Melguizo
as well as Elodie Bataille, Maria Eugenia de Diego, Angel Muñoz, Laura Oliveri,
and Juan Miguel Villa. It also benefits from our joint work with colleagues at WB, IZA Institute for Labor and OECD.
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Initial thoughts
Many pensions systems in Latin America and the Caribbean underwent
extensive reforms in the 90s yet, often, such reforms did not fulfill the
expectations.
Today, pensions systems in many countries continue being affected by
problems of low coverage, inadequate pensions, regressivity, fiscal
unsustainability, adverse incentives for formal job creation, and
weak institutions. As countries are considering avenues to move
forward, they are discovering there are unpleasant tradeoffs.
This presentation presents these challenges and tradeoffs and argues
that reforms need to be rooted in a deeper understanding of how
labor markets work. It also argues that moving forward is urgent: the
demographic bonus will not last long. Unless comprehensive reforms take
place, most countries will not be able to sustain the future consumption of
their older populations.
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The contextDependency ratios: Regions of the world 1950-2100
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Three messages
1) Pension systems in LAC are impacted with problems of low coverage, inadequate pensions, fiscal unsustainability, regressivity, adverse incentives and weak institutions.
• Many of these problems arise due to poorly functioning labor markets.
• Others are in the system design
• Reforms in the 90s to move from DB to DC systems did not ameliorate these problems. And created a few problems of their own.
2) Beyond fiscal, social security systems may affect economic growth and redistribution.
3) Substantive reforms are needed.
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The next wave of reforms
We believe reforms need to focus on:
• Rethinking the design of the systems with special emphasis on the fundamental parameters and the implicit redistribution
• Increasing contribution density (formality).
• Reforming and/or expanding non-contributory pensions in ways that are incentive-compatible and fiscally sound.
• Creating stronger institutions.
• Dealing with the political economy of pension reform
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This presentation borrows
from 3 recent IDB publications
Pensions at a Glance, 2014Better Pensions,
Better Jobs, 2013Social Insurance, Informality
and Labor Markets, 2015
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Only 4 out of 10 people 65+ in the region
get a “contributive” pension
Percentage of persons 65 and older with a contributive pension, 2013
Source: IDB, Labor Markets and Social Security Indicators, based on household
surveys.
* Administrative data was used to estimate coverage in these countries.
LAC-19: 39.6%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
HN
D
SLV
GT
M
PR
Y
DO
M
NIC
BO
L
CO
L
EC
U
ME
X
PE
R
JA
M
PA
N
CR
I
BR
A*
VE
N
CH
L
AR
G*
UR
Y*
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And less than half of workers
workers contribute to a pension
Percentage of contributors out of total employed, 2013
Source: IDB, Labor Markets and Social Security Indicators
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Contributions are low for those with low income,
non salaried and in small companies
Percentage of contributors out of total employed, by income decile in LAC, 2010
Source: Bosh, Melguizo, Pages (2013)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Pe
rce
nta
ge
of
co
ntr
ibu
tors
Small (2-5) Medium (6-50)
Large (50 +)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Pe
rce
nta
ge
of
co
ntr
ibu
tors
Salaried Non-salaried
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We estimate that coverage will
also be low in the future
Ranges of the percentage of adults 65+ without
an adequate contributory pension in 2050
Source: Bosch, Melguizo, Pages (2013)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
UR
Y
CH
L
BR
A
CR
I
PA
N
AR
G
EC
U
SL
V
DO
M
CO
L
VE
N
PR
Y
JA
M
NIC
HN
D
ME
X
PE
R
GT
M
BO
L
Pe
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nta
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of
65
+ w
ith
ou
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ad
eq
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te c
on
trib
uto
ry p
en
sio
n
IDB estimates Outside estimates
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Replacement rates may be too low in DC
systems and too high in DB…Net replacement rate of pension systems in LAC at average years of contribution
Source: ‘Pensions at a Glance: Latin America and the Caribbean’, 2013
ARG
BOL
BRA
CHL
COL
PAN
ECU
SLV GTMHND
JAM
MEX
NIC
CRI
PRY
PER
DOM
URU
VENLAC19
USA
COL
PER
0
20
40
60
80
100
0 20 40 60 80 100
Co
ntr
ibu
tory
pe
nsio
n c
ove
rag
e p
op
ula
tio
n >
6
5 y
ea
rs o
f a
ge
Coverage for population over 65 on contributory systems and replacement rates for average salary worker
Defined
contributions
Mixed system;
Defined benefits;
Replacement rates - average wage
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Those with low income receive a lump sum payment,
often at a discount, which defeats the purposeFlow of workers reaching de-accumulation stage
Note: Refers to affiliates who reached pension age during 2013.
Source: Bosch, Berstein, Oliveri and Villa, 2015.
RPM
RAIS
Pension
35%
Return of contributions (without interest)
65%
Pension
17%
Return of contributions (with interest)
82%
Minimum pension guarantee fund
1%
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Another example: Colombia
Source: IDB, 2015
Transferences from affiliates not receiving a
pension to pensioners
Transferences from all
Colombians to high
income affiliates who
retire
65%
Of affiliates
<1%
30%
4%
Mill
ions o
f pesos
Married Single Married Single
Contribute per MW
RPM
during 10 years
Contribute per MW
RPM
during 20 years
Contribute per
MW RPM
during 26 years
Contribute for
5 MW RPM
during 26 years
Contribute for 25 MW
RPM during 26 years
Subsides in the RPM
(NPV of the amount the contributor gets from the system minus what she contributes
capitalized at 4%)
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Because low coverage and population youth, public
expenditure today is still low but will grow in future
Source: ‘Pensions at a Glance: Latin America and the Caribbean’, 2013
* Government pension expenditure without contributions.
Public expenditure in pensions in % of GDP and Demographics
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Because low coverage and population youth, public
expenditure today is still low but will grow in future
Source: ‘Pensions at a Glance: Latin America and the Caribbean’, 2013
* Government pension expenditure without contributions.
Public expenditure in pensions in % of GDP and Demographics
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Costs of social security and other
labor mandates are high in the region
Wage and non-wage costs relative to GDP per worker vs Share of salaried workers
Source: ‘The Age of Productivity’, IDB, 2010
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform: Alternative
Arrangements and behavioral
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Policy makers are faced with two objectives
Increase coverage today
Secure coverage in the future
Non-contributory Pensions
Increasing contributions
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Non contributive pensions
are spreading quickly
Source: IDB Labor Markets and Social Security Indicators
* Administrative data was used to estimate coverage in these countries.
LAC-19 Total. 65.8%
LAC-19
Contributive. 39.6%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%H
ND
GT
M
DO
M
SL
V
NIC
PE
R
PR
Y
JA
M
VE
N
CO
L
ME
X
CR
I
EC
U
PA
N
BR
A*
CH
L
UR
Y*
AR
G*
BO
L
Pe
nsio
n c
ove
rag
e 6
5+
Non - contributive Contributive
Percentage of people older than 65 that get a pension, 2013
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Non-contributory pensions as one of the major
innovations
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Non-contributory pensions can be extremely
effective in reducing poverty in old age
0
20
40
60
80
100
19
90
19
92
19
93
19
95
19
96
19
97
19
98
19
99
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
11
20
12
rural Menor_10 Mayor_65
<10
Average
65+
Poverty in Rural Brazil ($2.5 day): 1990-2012
1991: Expansions of rural pensions
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Design is important
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Design is important
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Design is important
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Comlombian Tax ReformShare of workers contributing to pensions
(13 metropolitan areas) 2007-2015
Growth rate 2007-2012: 4.45% anual
Growth rate 2013-2015: 4.11% anual
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Behavioral interventions
Behavioural interventions
Fuente: Bosch et al (2015)
Self-employed Salaried
Non Contributors Contributors Non Contributors Contributors
Default Options
Forcing active decisions
Comitment devices
Simplification
Matching contributions
Loteries
Reminders
Microinsurance
Enforcement
Financial Education
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The MEI program in Brazil• Large proportion of labor force are self-employed: (20%) 17M
self employed
• In 2009 the MEI started to cover those self employed at ta reduced cost. Today 5% MW offering a pension that is 100% of the MW
• Today: 5 Affiliates, only 50% contributes at a given time.
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The MEI program in Brazil
Increase in contributions with respect to previous month
Fuente: Bosch et al (2015)
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Increase in contributions with respect to previous month
April
Fuente: Bosch et al (2015)
The MEI program in Brazil
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Increase in contributions with respect to previous month
May
Fuente: Bosch et al (2015)
The MEI program in Brazil
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Increase in contributions with respect to previous month
June
Fuente: Bosch et al (2015)
The MEI program in Brazil
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The MEI program in BrazilPrices vs Reminders
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What direction for reforms?
Coverage & Adequacy
• Make sure that the expansion of non-contributory pensions occurs in a sustainable & incentive-compatible way.
Trade offs possible: Targeting--Less costly, but incentives?; Universal--less incentive problems, but more costly.
Need to integrate non-contributory pensions into overall system.
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What direction for reforms?
It is imperative to rethink the overall design of the systems → otherwise, high future costs.
• Reexamine fundamental parameters and in a way that is compatible with the political economy
• Finance social security with sources of income other than labor taxes.
• Use more thoroughly behavioral economics (defaults, reminders, particularly for the self-employed)
• Increase enforcement
• Increase the value of social security for workers ---financial education, information, etc.
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What direction for reforms?
Redistribution
• Understand and redesign implicit redistribution
Reinforce institutions.
• Better policy design, regulation, supervision and fund management.
• Improve accountability
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Lastly, need to establish a road map
Need to define vision with final end, but to get there a series of
reforms needed:The political economy is tricky
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THANK YOU!
blogs.iadb.org/trabajo
@Carmen_Pages
@BID_Trabajo
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Theoretical replacement ratios in the region
are not low, particularly in DB systemsNet replacement rate of pension systems in LAC
Average earners
Source: ‘Pensions at a Glance: Latin America and the Caribbean’, 2013
Mixed DC DB
0
20
40
60
80
100
120
Do
min
ican
Rep
ub
lic
Mex
ico
Hai
ti
Suri
nam
e
Trin
idad
an
d T
ob
ago
Bo
livia
El S
alva
do
r
Ch
ile
Bah
amas
Bra
zil
Nic
arag
ua
LAC
26
Bar
bad
os
Ho
nd
ura
s
OEC
D
Gu
atem
ala
Bel
ize
Co
lom
bia
Jam
aica
Gu
yan
a
Pan
ama
Per
u
Co
sta
Ric
a
Arg
en
tin
a
Nic
arag
ua
Ven
ezu
ela
Ecu
ado
r
Par
agu
ay
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Theoretical rates fall short: very few people
contribute all their lives, due to high rotation
Net replacement rate* of pension systems in LAC by average years of contribution
Source: ‘Pensions at a Glance: Latin America and the Caribbean’, 2013
*Calculated based on average income. LAC – non-weighted average
Mixed DC DB
0%
20%
40%
60%
80%
100%
120%
0%
20%
40%
60%
80%
100%
120%
100% contribution 60% contribution 30% contribution
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Turnover is high: workers are sometimes
in the system and sometimes notProbability of moving between formal and informal work during one year
Source: IDB, based on household surveys of the region
9.6
16.7 17.3
8.5
11.9 12.7
9.3
20.619.1
13.311.4 10.9
7.4 75.7 5.3
0
5
10
15
20
25
BRA COL VEN ARG MEX ECU PRY PER
formal --> informal informal ---> formal
• On average 13% of formal workers today will be informal in a year,
and 10% of informal will be formal in a year.
• It is more appropriate to talk about people “when they are formal”,
and “when they are informal”.
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Turnover is particularly high
for those with lower earningsAverage years of contribution,
People aged between 25-55 years, 2012
Source: ELPS, 2012
5
14
1817
22
11
17
20
28
18
0
5
10
15
20
25
30
Until 1 MW 1-2 MW 2-3 MW 3-4 MW 4 and more MW
Year
s o
f co
ntr
ibu
tio
n
Colombia El Salvador
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Low income people tend not to reach the minimum
years of contribution and not to qualify for pensions
Average of people who contribute less than 20 years (Colombia-El Salvador)
People aged between 50-55 years
Source: Estimation based on ELPS, 2012
91%
64%
41%
55%
37%
81%
64%
40%
13%
51%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Until 1 MW 1-2 MW 2-3 MW 3-4 MW 4 and more MW
Pe
rce
nta
ge
Colombia El Salvador
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Social security systems
differentiate by job category
(The world of
registered in SS formality)
salaried
no registered
workers (The world of
informality)
Citizens non-salaried
no workers
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Many workers in other categories:
is this exogenous?
Percentage of self employed workers, 2013
Source: IDB, Labor Markets and Social Security Indicators.
LAC-19: 29%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
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1. Social security challenges in LAC
1.1 Low coverage
1.2 Inadequate pensions
1.3 Regressivity
1.4 Rising expenditure
1.5 Incentives to informality
1.6 Weak institutions
2. Avenues for reform
THE CHALLENGE
OF PENSION SYSTEMS
IN LAC: WHAT’S NEXT
FOR REFORMS?
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Institutions for non-contributory
pensions have not been established yetMexico, evolution of ‘non-contributory’ pensions
2002
Program begins
only for Mexico
City
2008
Program
expands to
cities < 20,000
2009
Program
expands to
cities <30,000
2012
Program
expands across
the country
2013
Retirement age
decreased from
70 to 65 years
old
2014
A law was
proposed to
duplicate
pension amount
2007
Program begins at federal
level but only for cities
<500 and adults>70
In parallel, 18 state governments created additional programs
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Non Contributory pensions in LAC
Source: IDB, 2015
Country Name Benefit adjustment
Argentina Programa de Pensiones No Contributivas (Vejez) mp (d)
Bolivia Renta Universal de Vejez "Renta Dignidad" d
Brazil Benefício de Prestação Continuada mw
Brazil Previdência Rural mw
Chile Pensión Básica Solidaria de Vejez i
Colombia Programa de Protección Social al Adulto Mayor d
Costa Rica Régimen No Contributivo de Pensiones por Monto Básico d / mp
Ecuador Pensión para Adultos Mayores d
El Salvador Nuestros Mayores Derechos d
Guatemala Programa de aporte económico del Adulto Mayor dw
Mexico Pensión para Adultos Mayores d
Panama Asistencia Económica para Adultos Mayores de 70 y más d
Paraguay Pensión Alimentaria para Adultos Mayores en pobreza d / mw
Peru Programa Nacional de Asistencia Solidaria "Pensión 65" d
Uruguay Pensión No Contributiva por Vejez e Invalidez d
Venezuela Gran Misión Amor Mayor d
d: discresional
mp: minimum pension
i: inflation
mw: minimum wage
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How non-contributory pensions are
adjusted has large consequences on costsCost of providing a 10% of GDP per capita pensions
(as a percentage of GDP)
Source: Bosch, Melguizo, Pages, 2013
0.0
0.5
1.0
1.5
2.0
2.5
HN
D
GT
M
NIC
BO
L
PR
Y
CO
L
VE
N
DO
M
PE
R
EC
U
ME
X
CR
I
ALC
-19
PA
N
SLV
BR
A
JA
M
CH
L
AR
G
UR
Y
Co
st a
s a
pe
rce
nta
ge
of G
DP
Cost in 2010 Cost in 2050 (inflation-indexed) Cost in 2050 (GDP per capita-indexed)
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Fragmentation
Fragmented institutions – each ones sees only a part.
Absence of one single institution supervising the system as a whole.
The required information to monitor, evaluate and correct the system is not easily accessible and it is disperse among several institutions.
Lack of accountability
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Potential problems
•Room to gain operational efficiency•Low diversification of investments & low returns •Under development of local capital markets limiting investment opportunities•High administration costs •Increased dispersion of functions and lack of a comprehensive view of Pension Systems•Potential governance fragility of institutions•In some cases weakness or lack of technical supervision