the ratio of the elderly to the working age population increases, while the cost of selfinsurance through individual savings remains unchanged. In sum, it makes sense to give greater importance to individual savings in social security systems as new generations live longer than old ones. This does not mean, of course, that there is no significant room left for an insurance (risk-pooling) component in reformed pension systems. Insurance is relevant to hedge against the relatively lower-probability risks. It can take the form of market insurance—e.g., annuities to hedge against the risk of outliving in retirement the savings accumulated while working. It can also take the form of a social safety net—e.g., a PAYG “first pillar” designed to deal with the risk of falling into poverty in old age.

As the reformed pension systems in the region continue to mature, new and complex challenges are emerging that were not well anticipated at the reform inception. The ability of policymakers to adequately address these challenges is key to enhancing the performance of the reformed systems and ensuring their socio-political sustainability. While the big emerging challenges in this area can be identified and characterized, the development of suitable policy answers is at an early stage.

Arguably, the biggest challenge for the Latin pension systems is posed by their low coverage (Gill, Packard, and Yermo, 2004). This challenge, however, falls outside the scope of financial development policy and mainly concerns social protection policy. To be sure, there are some links to financial policy. For example, reformers had originally expected— rather naïvely—that involving financial markets in the management of individual savings for retirement would spontaneously lead to increases in coverage. Workers would no longer see their pension contributions as a tax, the argument went, but as their own money and would therefore voluntarily join the system, leading to a natural expansion of coverage.<sup>36</sup> From hindsight, it is clear that the expectation was exaggerated and that the impact of pension reform on coverage has been rather small.<sup>37</sup> Be it as it may and given the scope of this paper, we must avoid dwelling on the crucial issue of coverage and move on to discuss some of the emerging issues in DC pension systems that concern of financial development policy. To this end, we focus on three key challenges in achieving the objectives of second-pillar based pension system: (i) raising 36 Packard (2001) analyzes empirically the impact of Chile-style pension reforms on coverage in Latin America and finds a positive incentive effect, but one that occurs only gradually, as workers become familiar with the new social security system.

37 Pension coverage of the economically active population is worrisomely low throughout the region and it has not increased appreciably since the reform in most cases. In all Latin countries, with the exception of Chile, less than half of the economically active population participates in the mandatory pension system, and in many countries coverage is below 25 percent. Low coverage is clearly a bigger source of policymaker insomnia than the problems of access to finance for SMEs or the lack of equity market development. Low pension coverage today means a high and growing risk of people falling into poverty in old age in the future—i.e., a looming social crisis. The risk of poverty in old age is, compared to the risk of outliving the working age, of a lower probability type. Hence, as noted, it is a risk that is in principle better dealt with through pooling (insurance) rather than saving (self-insurance). The debate has, therefore, refocused on the potential complementary role of a revised PAYG “first pillar” in addressing the coverage problem. First pillar systems are by definition based on risk pooling across individuals and could be used to set a floor to old age income for most citizens, but that floor would need to be funded either through additional worker contributions or out of general revenues, not a trivial task.

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