As part of the debate currently underway in Chile regarding efforts to improve the national pension system, the Chilean-American Chamber of Commerce (AmCham) and El Mercurio have staged the seminar “Challenges for modern pension fund administrators”. During the event, local and international experts put forward their respective arguments and recommendations on the issue.
The President of AmCham, Kathleen Barclay, took the opportunity to review the Chilean model and to discuss ongoing efforts being made to improve the system, and in the process, the overall quality of life for the retired. Barclay reiterated that one of the biggest problems stemming from this issue, in both Chile and around the world, is the increasingly aging population. This situation has been brought about by a combination of a decreasing birth rate and a longer life expectancy. As a consequence, there are currently greater numbers of retired workers, and for longer periods of time, than there are people in employment. These phenomena are placing public pension systems in jeopardy. It is also a scenario affecting the privatized pension systems.
In order to meet expectations set by the pension schemes, experts have stressed the need to save more or to save for longer. In Chile, the target replacement rate is 70%. Within this context, and during the seminar, the Minister of Labor and Social Forecast, Javiera Blanco, invited the different actors to work together in devising solutions to resolve the challenge. She also highlighted the work being done by the Bravo Commission and emphasized the need to create a state AFP for increasing coverage and competition in the sector.
Chile in the OECD
All pension systems have three objectives: combating poverty; redistribution, meaning the public systems are “distributive”; and ensuring individuals save part of their employment earnings over the course of their life to finance their retirement.
In order to achieve these objectives, the Chilean pension system is based on three pillars: the obligatory pillar (10% of earnings), the solidarity pillar (to improve the pensions of those who have – whether through gaps or evasion – made reduced contributions), and the voluntary pillar (with which the pension holder may make additional contributions to increase the funds available to them at the time of their retirement).
Different members of the OECD have different systems. For example, the United States has an individual voluntary contribution scheme; others use criteria for funding pensions via distribution (financed by contributions from individuals working today); or pension capitalization is run publicly and not privately; or there is a mixed system, as is the case in Chile.
Pablo Antolín Nicolás.
In this context, the Principal Economist at the Private Pension Unit of the OECD, Pablo Antolín Nicolás, highlighted the contribution or defined-contribution pension, in which the amount received by an individual is directly related to their contribution and the returns made on their savings: one of the biggest advantages. “Obviously, for the pension holder, it is much easier to understand a promise than to depend on the fluctuations of contributions”, he said, in reference to distribution systems. However, he warned that in addition to the advantages of these systems, there are also disadvantages.
“There are countries in which the replacement rates are very high, like Spain, Austria, Hungary, Italy and Turkey. This is what the systems promise, but it doesn’t mean they are financially viable and, in fact, it’s these countries that have financial problems in their public distribution systems”, he pointed out.
Regarding Chile, he stated that the voluntary coverage is not too low in relation to other OECD countries, although it is low in comparison to other obligatory systems. Nonetheless, he highlighted the performance of the pension funds, which during the 2002-2012 period have been among the best.
“In the OECD, we don’t say that contributions have to be 20% or 25%, we merely suggest that if someone wishes to secure a certain replacement rate or a specific pension amount, they need to calculate the necessary level of contributions over their working life in order for it to be reached. The question of what this rate should be, that is one for each individual country and system”, he clarified.
The required reform
During the first panel, discussions focused on the characteristics of the current pension system in Chile, including a series of recommendations made on behalf of the expert participants.
The ex-chief economist at the OECD and Director of AFP Habitat, Klaus Schmidt-Hebbel, suggested a gradual increase to the contribution rate (over three years) from the current 10% to 13%. He argued that this increase should initially be covered by employers. Furthermore, he proposed a gradual increase (over seven to 14 years) to the age of retirement for men and women, with both being raised to 67.
In addition, the Superintendent of Pensions, Tamara Agnic noted that, “this also places greater responsibility on the employer, as there is no benefit to increasing the retirement age if there are no jobs available for older persons”.
The panel also discussed contribution gaps and evasion. One certainty in this area is that the failure to make contributions during certain periods will have a significant final impact on an individual’s pension. This is especially the case for younger age groups.
“The evasion rate is 19%, so there is a huge opportunity for improvement”, stressed the President of the Association of Pension Fund Administrators, Rodrigo Pérez. He also recommended unemployment insurance for addressing the contribution gaps.
In terms of profitability, Agnic highlighted the multi-funds tool, which through the provision of different investment options, diversifies risk. However, in line with the rest of the panel, she agreed that it is an incredibly difficult issue to control, and that it is not always easy to foresee movements in the market.
The Superintendent stated that, “providing the freedom to choose different funds is a responsibility and contributors must be educated on the pertinent issues”: a position that was shared unanimously by the panel. In this regard, the experts recommended the AFPs consider a more comprehensive system of advice, including monitoring of risk profiles of the contributors in each type of fund. In this way, users could be more informed and recommendations made as to the best fund in which to invest.
The view from the United States
The event was also attended by Gregory Burrows, Senior Vice President of Retirement and Investor Services at Principal Financial Group. Burrows was categorical in stressing that there is no better model in the world than the one in Chile. “Every country, including Chile, is seeking the right formula for retirement, but there is no magic wand”, he said. He also took the chance to praise the Chilean pension system, in comparison to those of other countries, above all for its solidarity and voluntary pillars.
The expert emphasized that workers should take responsibility for their own retirements, a process in which education is a key part of them understanding their role. In this regard, he claimed that savings in Chile should aim to reach 12%, 13% or 15% over a 45 year period, in order to guarantee a good retirement.
He also praised the 401(k) system in the United States. Although not obligatory, it brings together 88 million US citizens and provides them with a savings rate three times that of an individual opening their own private account. This example points to the ability of workers to save for their own future, but with employers also playing an important role, as they are offered tax benefits to encourage their participation.
In this way, by means of its own experience and in conjunction with international recommendations, Chile must now devise the best possible formula for its pension system. And just like in the rest of the world, its population is also aging. This is altering the ratio of the number of contributors in regard to the amount of years they need to finance.
“If the number of years one needs to finance increases, the ratio changes and problems of sustainability, solvency and proficiency arise as a result”, said the OECD’s Antolín. As a consequence, he recommended diversifying the sector by involving both public and private actors.