Pension System Reforms in Chile

The funding of pension systems generates fiscal and political pressure throughout the world; Chile is no exception. Following months of mass demonstrations calling for better pensions and strong political and fiscal pressure to deal with this issue, President Michelle Bachelet’s administration sent a legislative package to Congress in an attempt to address this important topic during her last eight months in office.

Extend – Legislative Report 

August 17, 2017

The funding of pension systems generates fiscal and political pressure throughout the world; Chile is no exception. Following months of mass demonstrations calling for better pensions and strong political and fiscal pressure to deal with this issue, President Michelle Bachelet’s administration sent a legislative package to Congress in an attempt to address this important topic during her last eight months in office. The process will not be free of political and technical complexities, especially since presidential, congressional and regional elections will be held on November 19th, with a likely runoff for president in December.

Chile radically modified its pension funding system in 1980 during the dictatorship of General Augusto Pinochet, establishing a mechanism of individual capitalization managed by private companies set up exclusively for this purpose. That model has been implemented in other nations since then. Although these companies (known as Pension Fund Administrators or AFPs) have done a good job managing pensions and seeking returns, the pensions received by most of the population are far below expectations (albeit for reasons unrelated to their management that have more to do with the funding system and structure of the Chilean labor market, among other factors). This growing frustration and adverse social conditions for pensioners has led to a loss of legitimacy in the individual capitalization system.

The last major change to the pension system was made precisely under President Bachelet’s previous administration (2008). Unlike then, this new reform does not enjoy broad consensus. Also in contrast to 2008, the recently proposed changes will affect some of the foundations of the funding and management system. The AFPs are not being eliminated from the model, neither then nor now, which has been criticized by some radical sectors.

For the government, the political challenge lies in passing this pension reform in the short-term and in the middle of election season. For the country–as in many other nations–the challenge is to responsibly address fiscal and social pressures to build an equitable pension system.

The government’s proposed legislation contains three bills with the following main points:

• Increase in individual payments, to be paid by the employer, from 10% to 15% over a period of six years. Of this additional 5%, 3% will go to individual funds as a personal contribution and the other 2% will go to a Collective Savings Fund as a solidarity contribution.

• A constitutional reform to create a new, state-owned managing body known as the Collective Savings Council that would be autonomous just like the Chilean Central Bank or the Office of the Comptroller. A favorable vote of three-fifths of practicing legislators is required to pass this reform.

• A law to create the Collective Savings Council to manage the additional 5% contribution. If the constitutional reform is passed, this law might require a favorable vote of four-sevenths of legislators to pass. It would consist of a seven-member council appointed by the President of Chile and confirmed by two-thirds of the Senate.

• The additional 2% solidarity contribution would be split and allocated as follows: to finance an intergenerational solidarity contribution (to improve the pensions of current retirees), a compensatory bonus for women (with an incentive to retire after the age of 60 in an attempt to match the 65-year limit for men), and an intragenerational solidarity contribution (the balance remaining from the prior two uses will be distributed in proportion to the months paid in by all contributors).

• Strengthening of coverage of the pension system by gradually incorporating all self employed workers, creating insurance for pension “lagoons” (when contributions are not made due to unemployment periods) financed by unemployment insurance and a gradual increase in the amount of earnings on which compulsory contributions are due.

• Several enhancements to the pension system’s so-called Solidarity Pillar created in 2008.

• Several modifications to AFP regulations, mainly:

o More involvement of and information for members regarding AFP management, including mechanisms for participating in appointing directors.

o Improvements in mechanisms for competition among AFPs (e.g. enhancing the tender system for new members).

o No AFP fees for members that pay in after the legal retirement age and/or continue working.

o Increase of amount of earnings on which compulsory contributions are due and freezing of AFP fees at that level (since these are calculated on the basis of the member’s gross salary).

o Obligation of CEOs, investment managers and risk managers to invest 25% of their salaries in the same instruments as the managed funds.

o Limitations on members changing their savings among different funds with different risk levels (Chile currently has five different types of funds).

As observed, the most substantial change is the increase in the pay-in rate from 10% to 15% over six years and the creation of a new state-owned institution in charge of managing these new funds. The proposal of allocating 2% to a collective fund has generated considerable criticism from AFPs, right-wing sectors and some moderate, center-left groups. For some economists, the idea of funding a collective pension fund with a percentage of an employee’s personal contribution constitutes an employment tax. Some have voiced the option of funding them with general taxes, such as, for example, a 1% increase in VAT. In order to ensure the soundness of the new, state-owned entity, the government has proposed a constitutional reform and considered the experiences of the Canada Pension Plan Investment Board and the U.S. Thrift Savings Plan, among others.

In the midst of elections, former president Piñera (2010-2014), who is today’s best option for becoming president in March 2018, has also presented a formula for improving pensions that is very different from the current government’s proposal. He calls for increasing the individual contribution by 3% to 4%, to be paid by the employer, but fully allocated to the individual capitalization account and managed by the AFPs. He also considers indexing the retirement age to life expectancy, incorporating more stimulus for delaying retirement, gradually setting the same retirement age for men and women, and increasing fiscal spending from the current 0.7% of GDP to more than 1% to improve the Solidarity Pillar, among other measures.

The prospects for success for Bachelet’s proposal seem slim. The constitutional reform seems especially unlikely, if not impossible, given the quorum it requires in Congress. This will probably be a core point of discussion as the presidential election draws near. Without that constitutional reform, the law to create the Collective Savings Fund could require a quorum of less than four-sevenths, which would make it more viable. The diverse modifications to the AFP regulations could be more viable from a political perspective, but they are still far from addressing the real issues that are currently applying pressure to truly improve pensions. Without a doubt, the more necessary measure in this package seems to be beginning to increase the individual contribution, which presently averages 19.6% in OECD countries and is very far from Chile’s current 10%.

For more information please contact:

Isabel Hohlberg
Partner & Business Manager
ihohlberg@extend.cl
Direct +56 224 377 712
Central +56 224 377 700
Mobile +56 982 287 253

Felipe del Solar
Public Affairs Director
fdelsolar@extend.cl
Direct +56 224 377 757
Central +56 224 377 700
Mobile +56 9 87297736

Author

Isabel Hohlberg/Felipe del Solar

Partner and Business Manager/Public Affairs Director

Leave a Reply

Your email address will not be published. Required fields are marked *