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Latam Briefing: Pension reform in Chile

Woman holding Chilean money, Various peso banknotes, House budget concept

Few people in Chile would argue that the country’s pension system is perfect. But even fewer seem to agree about how exactly the reforms should go.

In early November, the government of President Gabriel Boric tabled a proposal to shake up the current system, which for a long time has been seen as a model for pension systems around the world.

But the 100% private pension system pioneered by Chile is also notorious for delivering paltry retirement pensions and was one of the main reasons behind the popular protests that took over the streets of Santiago and other major cities in 2019.

Chile’s pension system was implemented in the 1980s, during the dictatorship of Augusto Pinochet, who gave orthodox economists a free rein to reduce the involvement of the state in the economy.

Pensions are financed by contributions made by workers, a mandatory 10% fee that is discounted directly from their wage slips. They can choose, however, how their money will be managed. Fund administrators called AFPs are in charge of managing investment strategies from which each contributor can choose.

The system also has a solidarity pillar, to which the government contributes, which aims to provide retirement pensions to informal workers and other people who are unable to contribute regularly to an AFP-managed fund.

Chile’s pension system has been much vaulted by policy makers as it helps the state to maintain an enviable fiscal position, while at the same time raising money for investments in stocks, bonds and infrastructure that fuelled one of the most sophisticated capital markets in the region.

For many Chileans, however, it has thoroughly failed to meet its main goal, to wit, the funding of worthy retirements for people who paid into their pensions for decades.

Statistics show that pensions barely breach an average of 50% of the salaries earned by contributors at the end of their working lives. The system also adds to Chile’s woeful gender disparity in the labour market, as, while men retire with 58% of their salaries, the ratio among women is 47%, says Alejandro Charme, a consultant and former general counsel at Superintendencia de Pensiones, Chile’s pension supervisor.

“Wages in Chile are really low. The median income is equivalent to around $500,” he says. “Chile needs a system that pays better pensions. But the current systems needs to be reformed, not refounded.”

In his view, however, the latter is exactly what President Boric, the head of a left-wing government, has set out to do.

Some of Boric’s proposals, such as an increase of the level of contributions by current workers, have met with general approval. Boric wants to raise contribution levels by 6 percentage points, reaching 16% of salaries in the future.

Today, Chileans contribute 10% of their salaries to the individual capitalization plans and 1.54% to a mandatory workplace accident insurance plan. Adding to the mix the fees charged by the AFPs, the average bite to a workers’ salary amounts to 12.99%, according to Charme.

The number is well below the OECD average of 18.4%. Guillermo Larraín, an economist at Universidad de Chile, highlights that in countries like France it is as high as 27%.

“When the system was designed, it was believed that the accumulation of savings would be so big that it would have been enough to pay good pensions to everybody,” he points out.

That has not been the case by a country mile, so the increase of contribution levels proposed by Boric is hardly controversial.

However, other ideas in the proposal have met with fierce opposition. For example, the government wants to create a not-for-profit, state-owned fund company to manage the extra 6%, which will be contributed by employers rather than workers. Part of the new contribution will be directed to a reinforced solidarity fund that will guarantee the value of pensions earned by the poor.

Boric also said that the reform will “terminate” with the AFPs, through a reorganization of the industry that should result in lower fees. According to the plan, contributors will be able to choose whether they want an AFP, another financial company or the new state-owned firm to manage their savings.

Larrain believes that the new rules could inject some extra competition in the market.

“By changing the understanding of what a pension manager is, the market could be opened for several new players, and the rules of the game would change significantly for AFPs,” he says. “But one must not have too many illusions, as immobilism rules in the pension world.”

He notes, however, than the experience of other market that have opened the private pension system to competition, such as the UK and Sweden, has shown that the cost for contributors tends to fall as a result.

Not surprisingly, perhaps, AFPs reacted negatively to the proposals. FIAP, a trade association, said that the debate about pensions should privilege “reason over ideologic criteria” and that the current system can be reformed by increasing contributions and extending retirement ages. The sector has also made communication efforts to deny the view that AFPs make too much money to the detriment of Chilean workers, a widely-held perception that has been explored by left wing politicians like the president.

Ideological views aside, economists worry about the wisdom of letting a state-owned company decide how the savings of workers will be invested.

“The management of financial resources must be exclusively private,” Larrain says. “There may be a public offer, but in this case, it has to be marginal, compared to the private sector.”

The main problem, he said, is that the state has too many conflicts of interest and may prioritize investments in policies such as energy transition, support to strategic companies or incentives to SMEs, rather than investing the money with views of obtaining the best possible financial performance. Also, Larrain says that it is very hard for the state to manage investments at the same time that it regulates and supervise the system.

One example of the deviation of purpose took place during the Covid-19 pandemic, when the government of right-wing President Sebastián Piñera allowed workers to cash part of their pension savings to live through the lockdowns that affected the country. Some $55bn were taken out of the system, hampering pensions in the long run as a result.

“Anything that drifts away from the objectives of the pension system will distract the focus from a good reform,” Charme says.

The government claims that the new system, if approved as proposed, would raise pensions earned by men by 46%, and those paid to women by 52%. If today a worker that earns $425 a month would be entitled to a $280 pension at the time of retirement, the number would be $415 under the new rules.

What is not clear for many economists is how those values will be guaranteed.

“The only sure thing is that contributors will have the right to a pension in writing, but it will only be paid if there will be enough money for it,” Charme says.

Another idea that has divided stakeholders is the charging of the extra 6% which will be paid by companies. Larrain notes that it is just fair that Chilean employers get involved in the funding of the pension system.

“All over the world, pension systems are tripartite, but in Chile it is bipartite,” he says.

However, he stresses that it is not clear who, in the end, will end up paying the contributions, as costs tend to be transferred by companies to other stakeholders. For their part, trade associations have warned that an increase to their operational costs could have a negative impact on job creation at a time when Chile is going through a delicate economic cycle.

It all points to some heated discussions about pension reform in the months to come. Which is nothing surprising, as every Chilean government for a while already has tried, without significant success, to reform the system.

“My experience is that no bill gets out of Parliament the same way that it came in,” Charme points out.


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