# **I. Introduction**

Twenty-six years ago, Chile embarked on a radical pension reform. Its mandatory pay-as-you-go (PAYG) system was replaced with a fully-funded defined contribution (DC) scheme – a paradigm shift that became highly influential in other emerging countries. Since the early 1990s, nine countries in Latin America (LAC) and eleven countries in Eastern Europe introduced mandatory DC schemes as part of broader multipillar pension systems.<sup>1</sup> The details of the DC pillars and their role within the larger multi-pillar pension system vary across countries. All these reforms, however, aimed at increasing the level of funding through a mandatory individual savings pillar and changing the approach toward intergenerational risk sharing. In addition, high-income OECD countries are actively promoting the expansion of voluntary pillars through occupational or retail plans and, in a number of these countries, such as Australia, Sweden, and the UK, funded schemes are increasingly important components of the mandatory pension system.<sup>2, 3</sup> In most reformed countries in LAC and Eastern Europe, the paradigm shift was initially motivated by the need to reduce the fiscal pressure created by generous mandatory defined benefit (DB) plans. In addition, such costly systems were frequently characterized by low coverage.<sup>4</sup> In LAC, such moves coincided with increased macroeconomic stability and the pursuit of greater fiscal prudence after having experienced highly unstable times, often coupled with a decline in real GDP per capita in the 1980s. Countries of Eastern Europe witnessed not only a fundamental transformation of their societies and economies in the 1990s, but also of their retirement schemes (Fultz and Ruck 2000, and Müller 2002a) and many of them, including Hungary and Poland, decided to improve the financial health of their public pension insurance with a series of parametric reforms or a switch to a Notional Defined Contribution (NDC) PAYG system, while complementing it with a mandatory private tier.<sup>5, 6</sup> The paradigm shift, thus, has reduced fiscal imbalances created by generous DB plans, facilitated portability, and, in

> 1The effective years of implementation of initial reform are: (a) LAC: Peru (1992), Argentina and Colombia (1994), Uruguay (1996), Bolivia and Mexico (1997), El Salvador (1998), Costa Rica (2001), and the Dominican Republic (2003); and (b) Eastern Europe: Hungary and Kazakhstan, (1998), Poland (1999), Latvia and Macedonia (2001), Bulgaria, Croatia, Estonia, Kosovo and Lithuania (voluntary also for new entrants) (2002), and Slovakia (2005).

> 2 Australia’s mandatory system relies solely on funded schemes, occupational or personal plans.

> 3 The coverage of occupational schemes in countries such as Denmark and the Netherlands is large enough to consider them quasi-mandatory schemes.

> 4 See, for example, Aiyer (1997), Holzmann (1998) and Gill et al. (2005).

> 5 With few exceptions (e.g., the Czech Republic), the transition period in Eastern Europe caused a sharp decline in the public revenue base due to increased informality and unemployment (World Bank 2002). At the same time, expenditures soared as many workers benefited from early retirement provisions and, in some cases, used disability insurance as a means to avoid unemployment, especially in Poland. The combination of these two factors resulted in high and unsustainable fiscal deficits.

> 6 Bulgaria, Croatia, Estonia, Latvia, Lithuania and Macedonia also decided to implement a multi-pillar pension scheme with a mandatory funded tier, while Kosovo shifted to a large mandatory funded pillar. The Czech Republic and Slovenia are a few of the Eastern European countries that did not pursue a mandatory second tier.

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