As part of wider efforts at social-security reform over the past 25 years, most governments in Latin America have endeavored to reduce the financial burden of paying pensions. Chile was the pioneer, introducing mandatory individual savings accounts in the early 1980s; in later years, Argentina, Bolivia, Colombia, Ecuador, Mexico, Peru, and Uruguay followed suit. The measures have been closely watched in the developed world, where aging populations are straining publicly funded pension systems.

The switch to private funding has brought Latin America significant benefits: lower public-sector liabilities in the long term, more robust capital markets, and improved transparency for individual benefits. However, two important challenges to the system have emerged, both requiring urgent attention.

First, income-replacement rates—which determine the amount of money an individual can expect at retirement—have been much lower than desired because of high fund-management commissions, decreasing government-bond yields, and lapses in contributions. As a result, many workers who relied on this savings mechanism have been disappointed.

Regulators have sought to address this problem by injecting new competition into the sector. But unexpectedly, this move resulted in added costs, as...