Economic Policy Review ISSN 1313 - 0544

PRIVATISATION OF THE PENSION SYSTEM IN CHILE - 27 YEARS LATER

Author: IME / 09.10.2008
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At the beginning of October, invited by IME, Mr. Jose Pinera would arrive in Sofia. He started the privatization of the pension system in Chile in 1981.  We are convinced that this is the proper way for Bulgaria as well and for that reason we offer this brief information about the Chilean reform. On our web page you could find the pension calculator, which shows beyond any doubt that the pensions in a private capital pension system are significantly greater than the pensions with the expense coverage system.

Background

  • During the period 1975 - 1980 approximately 40% of the pension cost had been financed from the state budget or the deficit of the public social security system was approximately 3% of the GDP.
  • The ratio of people paying social security to retired people who were getting pensions was reduced from 3.2 to 2.2 from 1974 to 1980 with a trend for greater aging of the population.
  • The old system for social security could be characterized by unequal treatment of the insured - persons who pay social security on higher wages near the end on the period used to get higher pensions, that people who had made the same payments to the system, but had been paying at the same salary during their working life.
  • During 1980 the people who paid social security were about 47.8% of the active population in Chile. The unemployment is at 10.4%. During 2000 already 58.4% of the labor force in Chile pays social security to one of the two systems.

The pension reform in Chile during 1981

  • The workers are obligated to pay minimum 10% of their salaries in the pension funds under the new capital system. Those who elected to remain with the public social security system of Chile pay in on the average 24.4% of their salary.
  • The workers who have moved to the new system have increased their available income on the average with 12.6% during 1981 as a result of the lower payments in the capital system, taking into account the administrative costs and the taxes for operating the new system, which represent 3.5 - 4.0% of the gross salary in 1982 - 1983 
  • During the transition towards the new system, the participants received bonds in recognition of their accumulated pension rights up to that moment. The state undertook the obligation to pay the accumulated pension rights as a partial pension at the time of the legally defined retirement age. If a person decides to retire earlier, he could sell the bonds on the secondary market.
  • The payments in the pension funds are deducted from the taxable base on which the personal income taxes are levied. The workers do not pay taxes on the income from interest and investment profit during the period when the funds are accumulated. When the payment of the pension begins it is levied with taxes but at lower rates than the usual.
  • Under the new system the worker may retire at any age they desire. When they retire earlier, than the legally defined age, certain requirements must be met, related to the size of the pension - the pension must be at least 50% of the average gross salary of the person during the last 10 years and to be equal to at least 110% of the guarantied minimal state pension. 
  • The transition to the new pension system, based on capital accumulating principal, for the people working before 1981 had been voluntarily. During 1981 about 1.4 million workers entered into the new system or 66% of all people paying social security. During 2002 more than 95% of the Chilean workers were insured through the new system.
  • The people participating in the new capital system could select freely the fund, where they participate and to change their decision depending on the risk, which they were ready to undertake and the required rate of return.  
  • During 1980 the people paying social security represented 47.8% of the Chilean labor force. The unemployment was 10.4%. During 2000 already 58.4% of the labor force was participating in one of the two systems.  
  • During 1997 the unemployment went down to 5%.
  • 16 years after the beginning of the reform, the average pension was already 50 - 100% higher than the pensions which the workers could have received under the old system.
  • The average real return on the investments in the pension funds from 1981 to 2002 was 10.5% per year.
  • Twelve pension associations were established during 1981. During the following years new players appeared, the rules were changed, some of the associations consolidated. During 2002 were operating 7 associations which achieve economies of scale.
  • The funds accumulated in the pension funds represented 55% of the GDP during 2001.
  • The administrative costs and the taxes to operate the accounts in the pension funds have been drastically reduced from 1981, as a result of the economies of scale, accumulated resources and the advances in technology. During 2002 the administrative costs represented 2.4% of the gross salary of the participating employees. The real administrative costs, on the average per one participant are reduced by 11% for the period 1982-2002 with a trend for continuous reductions. At present the administrative costs in Chile are among the lowest compared to the costs to those of the pension funds in Latin America.  
  • The role of the state in the new system is limited only to the supervision and control functions. The state guarantees certain amount of the minimal pension and covers the difference between the pension earned and the minimal pension. The condition which must be met by the workers is to have been paying social security for a minimum of 20 years.
  • During the period 1981-99 the average annual deficit of the social security system (which included the operating deficit of the old social security system and the costs for paying the bonds for the accumulated pension rights) is equal to 3.25% of GDP. According to forecasts during 2015 (or 34 years after the beginning of the reform) the deficit would be 2.32% of the GDP and would continue to decline.
  • One of the criticisms of the new pension system is that, according to the forecasts, during 2025 46% of the persons who began to pay social security under the new system during 1981 would receive pensions below the minimal and would not have the right to a minimal pension, because they would not have the required 20 years of payments. Such critic is not relevant for Bulgaria, because under the Social security code if a person is over the retirement age, but had been paying social security for less than 20 years he would not have the right of a pension for length of service and age. Hence, under the public social security system the person would not get pension for length of service.
  • The average real growth of the GDP in Chile for the period 1960-1980 was 3.1%. The average growth of the GDP for the period 1981-2001 is 4.6%. According to some assessments (Corbo and Schmidt-Hebbel, Macroeconomic Effects of Pension Reform in Chile, 2003) the pension reform has contributed between 0.5 and 0.9 percentage points to the real growth of the economy during that period.
  • The channels of influence of the pension reform on the economic growth are (Corbo and Schmidt-Hebbel):

- Increased savings and investments in the economy - the contribution to the annual growth of GDP is between 0.13 and 0.32 percentage points.

- Increased employment and productivity on the labor market - the contribution is between 0.1 and 0.15 percentage points.

- Development of the capital and financial market and increased productivity in the economy - the contribution is between 0.2 and 0.27 percentage points.

 

Stated briefly:

- The people elect the personal accounts instead of the state system voluntarily - during the transition period, when the people working during the reform had the choice whether or not to remain in the state system and approximately 66% of all people paying social security had elected the personal pension payments.

- The achieved profitability is high and insures greater pensions.

- The reform encourages the people to pay social security and that has a lot of side effects on the economy and the state budget.

- The state is playing very important role - to guarantee, supervise and regulate the system.