Costa Rican Pension System Options for Reform

June 1995 Costa Rica's demographic structure is becoming increasingly unfavorable, and its pension system is maturing, so reform of the social security system should be implemented without delay. One option for comprehensive reform is to move toward a multipillar system, with a basic pay-as-you-go public pillar complemented by a defined-contribution savings pillar and additional voluntary savings schemes. The Costa Rican Social Insurance Fund---the country's main social security institution---was established in 1941 to provide compulsory social insurance coverage for employees, through old-age, disability, and survivor pensions, as well as sickness and maternity benefits. The current status of the pension system is alarming, and reform is urgently needed. Among other things: ° The system is costly to the government. ° It promises generous benefits that are difficult to sustain. ° Contribution rates are low. ° The link between contributions and benefits is weak. ° Inflation indexing is inadequate and ad hoc. ° Although there is no explicit early retirement system, individuals have found a substitute for early retirement in disability pensions. ° Health benefits to pensioners are paid out of pension contributions. ° The system's reserves have not been well invested. Reform of the system should be immediate. At a minimum, reform should include: ° Reduced benefits. ° Higher contribution rates. ° A higher retirement age. ° A stronger link between contributions and benefits. ° The unbundling of health and pension accounts. This paper---a product of the Finance and Private Sector Development Division, Policy Research Department---is part of a larger effort in the department to study old age security.