Reforming Pinochet’s pension reform

Pinochet abolished the state-run pay-as-you-go pension system, which funded retirement benefits from currently collected social-security contributions (a kind of income tax). Instead, individual re-tirement accounts were created. These funds are invested in capital markets, and pensions depend on the account balance and the return on investments. It was promised that this system would result in
– lower overall costs,
– more people covered, and
– higher pensions.
None of this came about.

The conversion to the private system cost Chile dearly. The effects are still being felt. The average annual deficit of the public pension system was 4.7 % of GDP between 1981 and 2004, because it had to cover enormous expenses, including
– continuing pensions under the old system,
– transfer of entitlements due under the old system to private pension funds, and
– funding of welfare pensions for the needy (including subsidising pensions to achieve the minimum-pension level).

The pension systems of the police and armed forces cost the state a further 1.3 % of GDP each year. The dictatorship did not touch their pension schemes. All summed up, the government’s annual pension deficit has on average been higher than before Pinochet’s reform in 1980.

In 2007, about 62 % of salaried workers paid into some private pension fund, and the old public system continued to apply for 3.7 %. The coverage rate is thus the highest in Latin America. However, it has hardly changed since 1975, so there hasn’t been any progress.
Moreover, members of private pension funds tend to pay contributions only sporadically, on average for about half of their working lives. Men cover almost 60 % of their work time, but women less than 44 %. Calculations for the private-pension system were originally based on the assumption that contributions would be paid for 80 % of a working life. Today, a mere 30 % of contributors reach that level. One quarter, however, only cover 24 % of their working life.

Low pensions

In 2007, the Chilean state was still funding almost 70 % of all pension payments. Significant items included retirement pensions from preexisting entitlements and welfare spending for the poor, as defined by binding criteria. Women draw two thirds of the state pensions. On average, however, they do not even achieve two thirds of the benefit level typical of men.

Indeed, the state even funds the bulk of the benefits paid by the private funds. These payments reflect contributions made to the public system before the reform, the rates of which were later adjusted.

The pension payments by the private pension-fund administrators (AFPs) are lower than those paid by the state. On average, the AFPs pay only € 229 per month for old age, survivors’ and disability pensions. The average is 18 % higher in the state-run system. From the AFPs, old-age pensions amount to an average of € 219 – one third below the comparative public-system figure.

Nonetheless, poverty remains a huge challenge. Four fifths of the people entitled to public pension benefits receive less than € 240. In contrast, about nine per cent (mostly former police officers and members of the military) draw an average old-age pension of € 764 from the state.

It was promised that AFP contributors would receive 80 % of their final salary as pensions. This has not come true. According to the President’s Advisory Council, men will receive on average only 51 % of their final salary between 2020 and 2025, and women only 28 %. Besides gender, qualifications matter. Women who only attended primary school get pensions worth an average of only 11 % of their final salary. The private system has simply not delivered on its promises (see box).

The “solidarity pillar”

Under President Michelle Bachelet reforms were undertaken to tackle these problems. The most important element was the introduction of a “solidarity pillar” to replace the other state programmes. It is not based on personal savings, but funded from taxes. This pillar will guarantee basic pensions, disability pensions, various pension credits and a child bonus. The solidarity pension (at € 85 since July 2008 and set to increase to about € 110 in July this year), is up to
56 % above the previous welfare pensions, which were handled very restrictively.

Recipients of these funds are people who are not entitled to payments from
AFPs, provided they are at least 65 years old and their families belong to the poorest 40 % of the people. By 2012, the poorest
60 % are to be covered. It is expected that women will receive 60 % of the solidarity pensions.

The solidarity pillar will also subsidise AFP pensions, if these are below a rate of
€ 100. By 2012, this threshold is to rise to
€ 365. An AFP pension of currently € 115 will be progressively increased by 64 % until 2012. By way of comparison, the minimum wage today is about € 200. All benefits will be regularly adjusted to inflation.

According to official estimates, 1.3 million Chileans (out of a population of 16.5 million) will draw payments from the solidarity system by 2012. For each child, women get an 18-months’ bonus in their AFP account from the tax authorities. Voluntary contributions can be made for mothers who are not in paid employment. At the same time, the government wants to boost childcare facilities, in order for women to become able to return to paid work fast.

The state will also subsidise the personal AFP pension accounts of young men between the ages of 18 and 35 years for 24 months. This measure is meant to boost employment and contribute to higher pensions in old age. A further allowance goes to employers, who are thus able to reduce their labour costs by five per cent.

Further law reforms will make sure that more people are covered and that contributions into personal AFP accounts are paid more regularly. For example, self-employed workers will have to join the AFP system after a seven-year transition period. From 2018 on, this will also apply to health insurance.

Other measures were designed to bring greater transparency, competition and efficiency to private pension funds. A new government agency will regulate and monitor the AFPs henceforth. An innovative approach consists in an annual tender in which the AFP that takes the lowest commission will get that year’s new generation of contributors. In turn, it will have to grant the favourable conditions to all other contributors too. A particularly important measure was the abolition of the flat-rate commissions that had been in use so far. These fixed payments had drastically reduced pension disbursements for low-income earners.

Limited reform

The latest pension reform in Chile recognises social security as a human right. It emphasises the state’s role in creating social justice. The “solidarity pillar” also grants the poor a pension entitlement.

However, the system has not been changed. In the future, cautious social redistribution will be carried out, with free-market logic still serving as the guiding principle. The new law will reduce poverty among the elderly. At the same time, more people will pay into the AFP system, and 60 % of the population will receive higher pensions. Moreover, gender equality will be promoted.

Employers, however, have so far not been made to pay contributions to the AFP accounts of their staff. Involving them in the pension schemes, would generate more money, so benefits could be increased. That would be only fair given that Chile’s tax law is regressive, burdening high incomes less than low ones.

The basic direction of reforms makes sense. However, the centre-left coalition, which has been in office for eighteen years, could have done more. The basic dilemma of Chile’s welfare-state policy lies in the contradiction between a (neo-) liberal economic and financial order and high social policy ambitions. A different economic model, a different approach to taxation and a stronger, more capable state would be appropriate to achieve the latter.