The Restructuring of the Chilean Pension System

By Irina Becker

Chile belonged to one of the pioneers in South America in implementing a welfare state. Since the early 1950s the pension system was financed by a system of distribution, i.e.money for pensions was raised by current insurance premiums of employees, employers and government. But this old system developed severe deficiencies over time: on the one hand there were too many different insurance systems (more than 200 regulations) and insurance funds, on the other hand large inequalities prevailed in the distribution of the payments. Politically powerful pressure groups (e.g. military) gained numerous privileges. This system not only led to inequality, but also to high costs and inefficiency. Additionally, the general demographic development came into effect:due to medical progress and rise in living standards people grew older which yielded higher pension costs for the state. For these reasons reform discussions had already started in the 60s, without success of implementation.

The military regime of Pinochet eliminated most salient inequalities of the pension system in 1979 and in the 1980s a process of unification and standardization of the multiple pension funds took place. One would question whether a democratic gouvernment could have undertaken such strict and unpopular measures in a similar rough way.

Nevertheless, on May 1^st, 1981, the old pension system was substituted by one of individual capitalization, which is based on the neoliberal ideology of the Chicago School. It assigns a subsidiary role to the state, entrusts its operations to competing private corporations of exclusive dedication (AFPs-"Administradores de Fondos de Pensiones"), is regulated and supervised by a state agency and counts on substantial government guarantees and subsidies.

The concept of "individual capitalization" means that the basis for the volume of the insurance payments is the personal effort of each individual. The old-age pension scheme nowadays is mainly carried by private pension funds, AFPs, which have to compete for the insured and are liable for a rational and efficient distribution.

Since 1983 the following regulations have come into effect:

• It is only allowed to sign contracts with private entities, from which people can choose freely. Switches to other companies are possible.

• It is mandatory for wage and salary earners to sign a pension insurance.

• Self-employed may insure themselves on a voluntary base.

• The employer (in contrast to the past) does not have to pay any contributions. Exception: accident insurance.

• Each insurant owns a private account and has to pay contributions to the insurance company ("individual capitalization").

• The contributions get invested on the capital market. The insured receive fixed pension payments with the rate of inflation being set off (increases, for example as an adjustment to general economic developments are not planned).

• The old system was discontinued. Insured of the old system were allowed to switch within five years to the new system. In case someone reached the retirement age during the transition period, the state paid a "bonus of recognition" (Bono de Reconocimiento).

• The statutory age of retirement was set to 65 years for men and 60 years for women.

• The state grants a minimum pension (by extra-payments to the insurance companies) and provides guarantees in case of AFP bancruptcy.

Hence, the pension gets calculated on the basis of the cumulated contributions and the return of the investments of the pension funds on the capital market.

The majority of the insured switched to the new system, because contributions in general were lower compared to the old system. In 1982 already more than 70 % of the social security insured belonged to the new system, by the end of 1990 3,7 million people joined the AFPs (that is 85% of the wage-earning population). But this number also contains those, who paid their contributions too late or even did not pay them at all. Hence, the real percentage has to be corrected to about 60-65% of the wage-earning population.

Some critical remarks regarding the new system

• The state pays a minimum pension only after 20 years of paying contribution.

• In case of a bancruptcy of an AFP all costs have to be absorbed by the state, which yields for the state either higher debts (transferring the burden to future generations) or higher taxes (imposing the burden on the current generation) or shifting ressources from other public programs.

• Despite the privatization of social insurance there are still high costs left for the state (for example the transfer payments when switching from the old to the new system or the contributions for the minimum pension, in addition to the pensions of the old system, which have to be maintained by decreasing contributions)

For the majority of the Chileans the new system does not mean progress. Especially, low-income workers or frequently unemployed ones can hardly afford necessary payments for an adequate pension. The principle of individual capitalization therefore reproduces existing social inequalities and even deepened them. But an evaluation whether the Chilean model succeeded or failed can only be done in the long terms, when a great many of the insured have reached retirement age. Actually, a favourable proportion of payers of contributions against beneficiaries leads to a high surplus. The capital market received strong impulses from the privatization. In the past 10 years the AFPs reached a high rentability at an average of 13% p.a.. In 1988 the new insurance system and its inherent private savings amounted only to 3% of the GDP, while in 1991 the accumulated funds ran up to 30 % of the GDP and 50 % of the whole investments of the finance system.

The Chilean model not only raised the interest of other South American states but also of some European countries in search of an efficient reform. Guided by the Chilean model, Argentine, Colombia and Peru privatized their old age pension four years ago. Bolivia, Mexico and El Salvador followed lately.

The Chilean pension system surely is not perfect. Its implementation, in part, had rough consequences for the population and could most likely only be enforced by a dictatorship regime. Anyway, it seems that a state in search of alternatives to a state pension system should take a close look on the Chilean model, which is given highest ranks in actual discussions of pension system reforms.

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