Contractual Savings In Countries With A Small Financial Sector

## **INTRODUCTION**

At present, 49% and 32% of the world workforce (approximately 800m) is covered by mandatory, publicly managed defined benefit (DB) pay-as-you-go (PAYG) and partially funded schemes, respectively. The rest of the workforce is covered by a mix of public DB and private defined contribution (DC). Only 10-15% of it is covered by public and/or private DC schemes. In mature economies with flat demographic pyramids like Poland, Italy and Slovenia, universal coverage is norm, public pension spending can reach 15% of GDP, and gross implicit pension debt can be as high as 400% of GDP. Ageing of population is bound to increase pressure on countries to reform their pension systems and so far, at least 12 countries have adopted radical reforms and some other 20 countries are in the process of formulating serious reform proposals.

The alternatives of allowing for massive immigration and/or delaying considerably the compulsory retirement age, or to reduce benefits or increase contributions to maintain/improve the financial viability of unfunded schemes are not politically feasible and this will encourage increased funding of pension liabilities in the future. The trends that emerge from the recent wave of reforms are: i) more funding of current liabilities; ii) more private management of assets; iii) more DC schemes; and iv) more individual responsibility and choice.

This paper heavily draws on work carried out in the Financial Sector Development Department of the World Bank studying the impact of contractual savings (pensions and life insurance) institution development on financial markets] and related work carried out within the Financial Sector Vice Presidency of the World Bank<sup>2</sup> . The value added of this paper is in the identification of policy options and possible sequencing for the successful development of contractual savings in countries with small financial markets. The development of contractual savings is associated here to the development of a funded pensions pillar. No specific position is here taken on the issue of public and private sector participation in the provision of pensions or on the design details of the private component.

The paper is organized in the following way. Section I discusses the specificity of small financial systems. Section II discusses the minimum pre-requisites for the successful development of contractual savings. Section III discusses the likely benefits for the rest of the financial sector of the development of contractual savings in small financial systems. Section IV discusses the options available to policy makers in these countries to provide private pensions. Conclusions follow in Section V.

# **I WHAT CHARACTERIZES COUNTRIES WITH SMALL FINANCIAL** SECTORS?

Small financial sectors are usually found in small, open economies with small population. Table 1 lists 87 countries with M2 less than US$ 5 billion, for which 1999 data was

> ' See Catalan _et al._ (2001), Impavido and Musalem (2000), Impavido _et al._ (2001a and 2001b), Vittas

> (1998a andl998b) and the papers there referenced.

> **2** See Glaessner and Valdds-Prieto (1998) and Bossone _et al._ (2001).

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