Chile’s pioneering pension reform attracted keen interest in Latin America and beyond when first introduced, in 1981. But a generation later, the much lauded obligatory private-pension scheme is showing signs of age. Projections have demonstrated that returns from the system will likely provide disappointing incomes for many participants. A large number of others—notably the poor and the self-employed—will receive no benefits at all.

President Michelle Bachelet, elected in early 2006, made this unexpected midlife crisis a major priority of her government and quickly appointed a special commission to investigate. After receiving its report, last August, her ministers included most of the wide-ranging recommendations in a bill currently before Congress.

The commission—chaired by Mario Marcel, an economist who was the budget director in the administration of Bachelet’s predecessor, Ricardo Lagos—played a crucial role in devising solutions to Chile’s pension problems. Rafael Rofman, the World Bank’s lead social-protection specialist for Latin America and the Caribbean, says that other countries in the region will pay close attention.

McKinsey’s Tim Dickson and Marcelo Larraguibel talked with Professor Marcel in the Santiago office of his private consultancy, Politeia Public Solutions, about the pressure for renewed change, the likely impact of his proposals, and Chile’s lessons...