Chile Confronts Problems Caused by Social Security Privatization

Remember when Chile's private account system was hailed as a model for Social Security reform? As this article notes, the Chilean system was endorsed by President Bush, who has called it "a great example" from which the United States can "take some lessons." So what are the lessons?:

Chile's Candidates Agree to Agree on Pension Woes, by Larry Rohter, NY Times: Michelle Bachelet is a pediatrician and a Socialist, while Sebastián Piñera is a billionaire businessman and a conservative. They may agree on little as the opposing candidates in Chile's election for president, but they concur on one important point: the country's much vaunted and much copied privatized pension system needs immediate repair. ... [D]issatisfaction with the system has emerged as one of the hot-button issues in the election...

"Most people perceive the costs of pensions and the pensions themselves as unfair," said Patricio Navia, a political science professor at New York University and at Diego Portales University here. "Many of those who started work when the system was first adopted are realizing that they have not been able to contribute enough to get a significant pension," ... they resent "overhead costs that are so high" and that have led to record profits for the pension funds that manage contributions automatically deducted from workers' paychecks. ...

"There are two big issues, coverage and costs," Andrés Velasco, Ms. Bachelet's economic adviser, said ... "Too many people are outside the system," he said, adding that too many of those in the system have found that "saving via the pension funds is quite expensive." ...

[S]skeptics point to another developing problem: many young people, who should be enrolling in the system early to accrue maximum benefit, are staying out or paying in very little. Some cannot afford to contribute beyond the obligatory minimum payment, which is 10 percent of wages, while others are either self-employed or have been hired by companies as low-paid independent contract workers and therefore do not have to contribute at all. ...

[E]ven advocates of an untrammeled free market, like Mr. Piñera, the conservative candidate, are jumping in with criticisms, to the surprise of some here. Mr. Piñera is the brother of José Piñera, the former labor minister who imposed the personal account system during the dictatorship of Gen. Augusto Pinochet. [and co-chairman of the Project on Social Security Choice at the conservative Cato Institute] ... "Chile's social security system requires deep reforms in all sectors, because half of Chileans have no pension coverage, and of those who do, 40 percent are going to find it hard to reach the minimum level," Mr. Piñera said ... "This has to be confronted now..." ...

Comments

[Mark Thoma]

Thanks anne.

[A comment]

Not meaning to defend Bush, but to be fair, Chile's pension system was internationally praised by virtually everyone. Now faults have emerged - but most of the international community has been pointing to the Chilean model as an example for the last 10 years:

http://www.npr.org/templates/story/story.php?storyId=4580360

http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:20287681~pagePK:34370~piPK:42768~theSitePK:4607,00.html

http://www.eldis.org/static/DOC6003.htm

[ilsm]

Bush has a talent for getting it wrong. On WMD he needed no help.

On Chile his supporting studies were done by cheerleaders.

There have been ample detractors of Chile and Maggie Thatcher's innovations in the recent past.

Just not easily heard over the din of worshipful propaganda...........

[anne]

http://www.nytimes.com/2004/12/17/opinion/17krugman.html?ex=1261026000&en=91b997e7fd69b792&ei=5090&partner=rssuserland

December 17, 2004

Buying Into Failure
By PAUL KRUGMAN

Decades of conservative marketing have convinced Americans that government programs always create bloated bureaucracies, while the private sector is always lean and efficient. But when it comes to retirement security, the opposite is true. More than 99 percent of Social Security's revenues go toward benefits, and less than 1 percent for overhead. In Chile's system, management fees are around 20 times as high. And that's a typical number for privatized systems.

These fees cut sharply into the returns individuals can expect on their accounts. In Britain, which has had a privatized system since the days of Margaret Thatcher, alarm over the large fees charged by some investment companies eventually led government regulators to impose a "charge cap." Even so, fees continue to take a large bite out of British retirement savings.

A reasonable prediction for the real rate of return on personal accounts in the U.S. is 4 percent or less. If we introduce a system with British-level management fees, net returns to workers will be reduced by more than a quarter. Add in deep cuts in guaranteed benefits and a big increase in risk, and we're looking at a "reform" that hurts everyone except the investment industry....

Privatizers who laud the Chilean system never mention that it has yet to deliver on its promise to reduce government spending. More than 20 years after the system was created, the government is still pouring in money. Why? Because, as a Federal Reserve study puts it, the Chilean government must "provide subsidies for workers failing to accumulate enough capital to provide a minimum pension." In other words, privatization would have condemned many retirees to dire poverty, and the government stepped back in to save them.

The same thing is happening in Britain. Its Pensions Commission warns that those who think Mrs. Thatcher's privatization solved the pension problem are living in a "fool's paradise." A lot of additional government spending will be required to avoid the return of widespread poverty among the elderly - a problem that Britain, like the U.S., thought it had solved....

[anne]

http://money.guardian.co.uk/pensions/story/0,6453,1325200,00.html

October 12, 2004

Australia May Hold Key to Pensions
By Patrick Collinson - Guardian

The publication today of the Adair Turner report on pensions will prompt an orgy of headlines about how millions of Britons face pension misery. Yet one country grasped the nettle of pension reform a decade ago and pension misery is no longer part of the national psyche.

In the 1980s Australia faced the same dilemma as Britain - an ageing population, too few people saving and a state pension withering on the vine. Less than half the population, especially women and minorities, were part of a company pension scheme.

Today 95% of full-time employees in Australia have a company pension, compared with half in Britain. Approaching three-quarters of part-time workers have a pension, compared with less than 15% in the UK. And since the mid-1980s, Australia's nine million workers have seen the value of their pension assets soar from A$30bn (£12.2bn) to nearly A$600bn today.

At the heart of Australia's pension system are compulsory employer contributions, brought in by a Labor government in 1992 and backed by unions, but strongly opposed at the time by small business groups.

In 1992, every business in Australia was ordered to put aside 3% of each employee's salary into a superannuation scheme. The contribution rate was started at a low level then increased to hit its target of 9% in 2002, where it remains today. Employees were encouraged through tax incentives to pay into the schemes, known as "the super"....

[me]

"Not meaning to defend Bush, but to be fair,"

A lot of us are still right and he is still wrong.

[Bruce Webb]

A comment "Not meaning to defend Bush, but to be fair, Chile's pension system was internationally praised by virtually everyone."

Bruce "Not meaning to defend Bush, but to be fair, the United States Social Security system was internationally derided by virtually everyone."

A very small percentage of Americans even now would agree with the statement "Social Security is fully funded going forward." A larger but still small percentage predicted we would not find deployable WMD in Iraq.

It really doesn't matter how many people shared or share Bush's illusions or delusions: he has a National Security apparatus and any number of Economic Boards whose jobs are to help him get it right. The President has the positive obligation to use the best possible information available to him. Bush made it clear he only wanted information that supported preselected policy decisions.

That's his bad. And no one else.

[anne]

Remember, there is a puzzle about the portfolios of Chile's pension plans as well as the Chilean stock market. Chile has had easily the weakest market in Latin America since 1990. These last 10 years, the Chilean index is up 5.8% a year. Only Argentina is near at 6.9%. Wish I understood.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5994&u=4|3|...

Tufted Titmouse Looking for Eastern Screech-owl
New York City--Central Park, The Ramble.

Careful, careful :)

[mauisurfer]

Please someone post some real data on the "overhead costs" and profits involved in Chilean SS.
THis wsj piece quotes a Chilean saying they are too high, but I would very much like to know what they actually are.
Thanks

[anne]

http://www.nytimes.com/2006/01/10/international/americas/10chile.html?ex=1294549200&en=597516f5ad9fbb0a&ei=5090&partner=rssuserland&emc=rss

January 10, 2006

Chile's Candidates Agree to Agree on Pension Woes
By LARRY ROHTER

According to a recent study here, Chile's pension funds, whose number has shrunk to 6 from more than 20 as competition has diminished, recorded an average annual profitability of more than 50 percent during a recent five-year period. Other studies, including one conducted by the World Bank, indicate that pension funds retain between a quarter and a third of workers' contributions in the form of commissions, insurance and other administrative fees....

[anne]

http://www.nytimes.com/2005/01/27/business/worldbusiness/27pension.html?ex=1264568400&en=c1f60bb2633eed23&ei=5090&partner=rssuserland

January 27, 2005

Chile's Retirees Find Shortfall in Private Plan
By LARRY ROHTER

SANTIAGO, Chile - Nearly 25 years ago, Chile embarked on a sweeping experiment that has since been emulated, in one way or another, in a score of other countries. Rather than finance pensions through a system to which workers, employers and the government all contributed, millions of people began to pay 10 percent of their salaries to private investment accounts that they controlled.

Under the Chilean program - which President Bush has cited as a model for his plans to overhaul Social Security - the promise was that such investments, by helping to spur economic growth and generating higher returns, would deliver monthly pension benefits larger than what the traditional system could offer.

But now that the first generation of workers to depend on the new system is beginning to retire, Chileans are finding that it is falling far short of what was originally advertised under the authoritarian government of Gen. Augusto Pinochet....

Even many middle-class workers who contributed regularly are finding that their private accounts - burdened with hidden fees that may have soaked up as much as a third of their original investment - are failing to deliver as much in benefits as they would have received if they had stayed in the old system.

Dagoberto Sáez, for example, is a 66-year-old laboratory technician here who plans, because of a recent heart attack, to retire in March. He earns just under $950 a month; his pension fund has told him that his nearly 24 years of contributions will finance a 20-year annuity paying only $315 a month.

"Colleagues and friends with the same pay grade who stayed in the old system, people who work right alongside me," he said, "are retiring with pensions of almost $700 a month - good until they die. I have a salary that allows me to live with dignity, and all of a sudden I am going to be plunged into poverty, all because I made the mistake of believing the promises they made to us back in 1981." ...

"What we have is a system that is good for Chile but bad for most Chileans," said a government official who specializes in pension issues and who spoke on condition of anonymity, fearing retaliation from corporate interests. "If people really had freedom of choice, 90 percent of them would opt to go back to the old system."

Among the complaints most often heard here is that contributors are forced to pay exorbitant commissions to the pension funds. Exactly how much goes to such fees is a subject of debate, but a recent World Bank study calculated that a quarter to a third of all contributions paid by a person retiring in 2000 would have gone to pay such charges.

But most Chileans are unaware of how much they are paying to the funds because the lengthy quarterly financial balance sheet they receive "is not comprehensible," according to Guillermo Larraín, director of the Superintendency of Pension Funds, a government agency. "It needs to be replaced by a simple and transparent financial statement," he said, so workers can determine which fund charges the lowest fees.

In recent years, the number of pension funds has been winnowed to 6 from a high of 22 in the early 1990's. They have enjoyed record earnings, so much so that foreign banks and insurance companies are investing in the industry. While the pension fund association puts the average annual return on assets just under 30 percent, government figures show profits of 50 percent in 2000, with some independent studies suggesting the funds did that well over the five-year period ended in 2003.

Proponents of the system justify the high returns as an appropriate reward for the risk they undertake. But a recent World Bank report, "Keeping the Promise of Social Security in Latin America," minimized that, noting that through the 1990's, only three large companies accounted for half of all shares traded on the Santiago stock exchange and that pension funds tend to follow a herd instinct and invest in the safest choices on the market....

[anne]

Notice, as in Chile and Britain, carefully how much damage the financial services industry can do when not suitably competitive. We seem to be finding quite another pension privatizing outcome in Sweden, however, which is oddly never ever mentioned by American "privateers" :)

[anne]

Imagine screaming headline from the foundations: "Sweden Shows the Way on Social Security" :) The problem is Sweden has well strengthened the public-private pension system, and the Swedish stock market, oh dear oh dear, has been booming. Sweden? Sweden?

[anne]

http://www.nybooks.com/articles/17771

March 10, 2005

America's Senior Moment
By Paul Krugman - New York Review of Books

Suppose that we end up with a system like that of Britain or Chile, in which mutual funds compete to attract private accounts. In that case, there's every reason to believe that fees will take a large bite. In 2003, the average "expense ratio" on US stock funds - the ratio of all the various fees charged by management to the amount invested - was 1.5 percent. In Britain, providers' charges used to take more than 2 percent off the return of the average retirement account; new regulations have reduced that, but only to about 1.1 percent. Put fees of that magnitude plus a realistic rate of return on stocks into a typical numerical model of privatization...and privatization quickly turns into a sure-fire losing proposition: the government borrows to establish private accounts that if anything yield an expected rate of return lower than the rate the government pays on its bonds; yet those accounts introduce a major new element of risk....

[anne]

The expense ratio on American stock funds is 1.5%, by comparison Vanguard has a 0.19% expense ratio for small investors for the total stock market index.

[anne]

Think about the astonishing losses of pension returns by financial companies that have taken 25% to 33% of contributions year after year in charges. Good grief. Each $100 contributed becomes $75 invested. So, it takes a 33% gain to get to the original $100 contributed. Then, remember that the Chilean stock market has been the poorest performing stock market in Latin America since 1990. Astonishing.

[anne]

The Chilean public-private pension system, which is 25 years old, has been impossibly compromised by the astonishing charges by investment companies. I do the math, and I can scarcely believe how perverse the charges are. Financial companies charge 25% to 33% of contributions year after year for investment, while the average return for Chilean stocks for a decade has been 5.8% a year.

[anne]

Problem, how long does it take an investor who gives $100 dollar to a mutual fund which then invests $75 dollars to get back to $100 with a return of 5.8% a year?

[anne]

http://cep.cl/Cenda/Cen_Documentos/Pub_MR/Articulos/Varios/Pensiones_USA_1.html

December, 2004

Private Pensions in Chile, a Quarter Century On
By Manuel Riesco

Santiago, Chile

Most of the Chilean workforce was, in fact, forced to join the new system, including all those workers hired since 1981, who were given no choice at all. Those who were working under a formal contract at the time were given the one-time choice to change or stay in the old pay-as-you-go system. In practice, however, most were forcibly induced to change to the new system by their employers, and by a huge propaganda campaign implemented by the dictatorship that promised better wages today and better pensions tomorrow for those who changed. Transition arrangements for those who changed to the new system specified that the State would contribute to their new pension accounts with an amount called "recognition bond," with the equivalent of their past contributions to the old system. Nevertheless, the amount of "recognition bonds" was calculated as the average of wages earned in 1978, 1979, and 1980, which happened to be years when wages were still very depressed after the slashing of roughly half their buying power in the wake of the 1973 coup. Furthermore, contributions into the system during the 1980s were also meager, because wages were again depressed, and unemployment reached levels of 30% of the workforce, during the severe economic crisis that affected Chile in 1982 and lasted four or five years. In addition, for State employees, contributions into the pension accounts were further depressed during the 1980s, because they were calculated over only a part of their salaries.

As a result, if two work colleagues reach retirement age in Chile today, both with the same salary and the same number of years contributing to social security, one of them who remained in the old pay-as-you-go and the other who changed to the AFP system back in 1981, the latter will receive less than one-half of the pension of the former. This huge difference has been documented in hundreds of thousands of individual cases by the Association of Employees with Previsional Damage, and their demand for a reparation has been heard by parliament, where a group of members of Congress belonging to all political parties presented the problem to the government, which has since started negotiations with the affected workers.

The above not withstanding, the privatization of pensions may have been a mixed blessing for the Chilean workforce. On the one hand, as all Chilean workers own individual pension accounts that are reviewed monthly, they provide excellent statistics of their crude labor reality. The numbers indicate that the modern Chilean workforce is composed mainly by a huge mass of persons who permanently move in and out of short-term salaried jobs, half of which last less than 4 months, and in most cases less than a year. While they are not working for a salary, Chileans survive working on their own—when they are able to do so; because at present, for example, around 10% of the workforce is unemployed, even according to government figures that are widely considered underestimating the real joblessness rate. As a result, 70% of the workforce contributes less than six months each year into their pension accounts, and over half of the workforce contributes less than 4 months each year. These figures show a huge bias for the worse in the case of women and the poorest....

The author is External Research Coordinator on social policy matters for the United Nations Research Institute for Social Development.

[anne]

http://www.nytimes.com/2004/12/01/opinion/01pinera.html?ex=1259643600&en=be72ab1c6fc3ab15&ei=5090&partner=rssuserland

December 1, 2004

Retiring in Chile
By JOSÉ PIÑERA

Santiago, Chile — During his visit here last month, President Bush pointed out that the Chilean pension model was a "great example" for Social Security reform in the United States.

For 24 years, I have championed the Chilean retirement system, which is based on ownership, choice and personal responsibility. Having discussed our reforms with Mr. Bush as long ago as 1997 when he was governor of Texas, and having spoken at the White House Summit on Social Security in 1998 during the Clinton administration, I believe there is now an opportunity for a bipartisan agreement in the United States in this crucial area of public policy.

The Chilean retirement system was originally based on exactly the same principle that guides the United States' system. It originated in 19th century Prussia, where Bismarck created a pay-as-you-go-system. But such a defined-benefit system is not only hostage to demographic trends, it also has a fatal flaw: it destroys the link between individual contributions and benefits, or, in other words, between personal effort and reward.

Chile's Social Security Reform Act of 1980 allowed current workers to opt out of the government-run pension system financed by a payroll tax and instead contribute to a personal retirement account. What determines those workers' retirement benefit is the amount of money accumulated in their personal account during their working years. Neither the workers nor the employers pay a payroll tax. Nor do these workers collect a government-financed benefit.

Instead, 10 percent of their pretax wage is deposited monthly into a personal account. Workers may voluntarily contribute up to an additional 10 percent a month in pretax wages. The invested amounts grow tax-free, and the workers pay tax on this money only when they withdraw it for retirement.

Upon retiring, workers may choose from three payout options: purchase a family annuity from a life insurance company, indexed to inflation; leave their funds in the personal account and make monthly withdrawals, subject to limits based on life expectancy (if a worker dies, the remaining funds form a part of his estate); or any combination of the previous two. In all cases, if the money exceeds the amount needed to provide a monthly benefit equal to 70 percent of the workers' most recent wages, then the workers can withdraw the surplus as a lump sum.

A worker who has reached retirement age and has contributed for at least 20 years but whose accumulated fund is not enough to provide a "minimum pension," as defined by law, receives that amount from the government once funds in the personal account have been depleted....

[anne]

http://cep.cl/Cenda/Cen_Documentos/Pub_MR/Articulos/Varios/Pensiones_USA_1.html

December, 2004

Private Pensions in Chile, a Quarter Century On
By Manuel Riesco

In Chile today there is a wide consensus among experts that the Chilean private pension system will provide pensions on its own only to the upper income minority of the affiliates to the system. Even for them, it seems highly unsatisfactory, mainly because of the high fees charged by private pension administrators. These, in turn, are six companies that have become the most profitable Chilean industry, one that proved immune to the recent recession, as it reaped an average return on assets of over 50% a year from 1999 to 2003....

Recent studies by the State regulator of the private pension administrators, Superintendencia de Administradoras de Fondos de Pensiones (AFP) have concluded that over half of the affiliates to the new system will never be able to save enough in their pension accounts at retirement, to fund even the "minimum pension," which is set presently in the order of 100 US dollars a month....

All of the above studies agree as well that the State guarantee of "minimum pension" is almost completely ineffective, because very few affiliates in need of that guarantee will comply with its pre requisite of 20 years contributions into the system. On the other hand, most affiliates do not apply for the non-contributive "assistance pension" offered by the State, which presently amounts to about 50 US dollars a month, because it is subject to quotas, and targeted to the extremely poor. The above leaves most of the Chilean workforce with no entitlement at all regarding pensions—except withdrawing the meager funds accumulated in their individual pension accounts....

[anne]

http://www.nytimes.com/2006/01/15/international/americas/15chile.html?ex=1294981200&en=2a9b541eeb738394&ei=5090&partner=rssuserland&emc=rss

January 15, 2006

Chile Is Ready to Elect a President Unlike Any Other
By LARRY ROHTER

SANTIAGO, Chile - Chileans elect a new president on Sunday, and no matter whom they choose, the winner will make history. The front-runner, Michelle Bachelet, would be the first woman to be elected president in Chile; her rival, Sebastián Piñera, would be the first billionaire to hold that office here.

There could be other firsts, too, for Chile, a country that may be the most formally religious and socially conservative in Latin America. Ms. Bachelet, 54, a pediatrician who has not held an elective office but who has been minister of health and defense, is the daughter of a general who died in prison after the overthrow of Salvador Allende in 1973.

She has had three children by two men, one of whom she never married, and lived with another who had links to a guerrilla group, according to recent biographies. She is not married and is often described as a single mother. She identifies herself publicly as agnostic....

[Chile has a woman President.]