The Chilean Pension System
Chile began a comprehensive reform of its social security system in the early 1980s. The Chilean private pension system was created through the adoption on November 13, 1980 of the Pensions Law to eliminate many of the problems associated with the former social security system. Under the Pensions Law, a privately administered system of individual pension plans replaced the social security system. Under the pension system in place prior to enactment of the Pensions Law, contributions from current workers were used to fund pension payments, although there was a limited correlation between the amount contributed and the amount received by each worker upon retirement.
The current pension system is based on individualized accounts with fully funded, vestable and portable benefits. It has averaged real annual returns on the assets under management of 10.3% since its origin, nearly doubling the growth rate of the GDP. As of December 31, 2001, the pension funds had financial resources of approximately US$35.4 billion representing approximately 53% of GDP. Between January 2001 and December 2001, pension funds increased 13% in real terms. Many countries, including Argentina, Colombia, Mexico and Peru, have implemented similar pension systems and others (in the Americas and Europe) are studying the implementation of similar systems.
The pension system creates individual savings accounts, where employees are obligated to save 10% of every month's salary for retirement, which is deductible from their taxable income. These funds are managed by one of several private sector pension fund administrators known as AFPs, who use long-term growth investment strategies. All AFPs are subject to extensive and continuous regulatory review. The principal regulator is the Superintendency of Pension Funds or SAFP and AFPs are also regulated by the Central Bank. In addition, AFPs that are listed on a stock exchange are regulated by the SVS, which regulates the securities and insurance industries. Finally, the rating commission, composed of the pension, securities and banking superintendents and representatives of the AFP industry determine whether securities qualify as acceptable for pension fund investment. The Central Bank fixes limits among various types of permitted investments for AFPs, subject to ranges of maximum percentages established by law. As of December 2002, there are seven AFPs in operation, including five that are listed on the Santiago Stock Exchange.
Employees are free to choose the AFP they wish to manage their funds and may switch if they are dissatisfied with the performance of their investments. In addition, employees are free to introduce additional voluntary savings into the system in what is known as the "Second Account." In 1984, the last year in which workers could elect not to participate in the new system, approximately 19% of the individuals who participated in the old system, principally older workers near retirement, elected to stay in the old system. Over the years more workers have continued to be incorporated into the AFP system and as of September 30, 2002, there were 6.5 million AFP affiliates. As of August 31, 2002, 174,413 non-retired individuals were making contributions to the traditional social security system.
Workers who participated in the traditional social security system and shifted to the new system received from the government an interest-earning past-service recognition bond reflecting an estimate of the value of their previous contributions into the old system. This bond is indexed to the CPI, has a 4% real annual interest rate and is held by the AFP for the benefit of the affiliate. It is held separately from the amounts held in an individual's saving account. The bond becomes payable into the individual's saving account at the time the individual reaches the age of eligibility for retirement, or upon the individual's death or disability. The government defines these obligations as a "social" expenditure.
An AFP must meet a required minimum level of investment return, which is tied to the average performance of all funds in the pension system. In the event that the fund managed by the AFP fails to achieve this minimum return, the AFP is required to cover the difference. The Pensions Law requires that each AFP maintain a capital reserve fund equal to one percent of the value of its pension fund. The purpose of the reserve fund is to provide a cushion in the event that the performance of an individual pension fund drops below a minimum level. If a deficit is not covered or if reserves are not replenished, the AFP will be liquidated by the SAFP and the government will guarantee the minimum level of investment return. The government will then transfer the accounts to another AFP. Historically, the required minimum return on fund investments has led to the various AFPs having similar pension fund portfolios.
The government also guarantees modest minimum old-age, life and disability pensions for individuals who have made contributions for a certain minimum number of years regardless of the level of contributions actually made into the individual's saving account at an AFP. In case of the bankruptcy of an AFP, the government guarantees certain limited liabilities of the AFP. The government is liable for 100% of this obligation up to the amount of the legal minimum pension and for 75% of the pensions above the minimum up to 45UF monthly (US$1,115 at December 31, 2001).
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