Economic Results of the Pensions Privatization

Economic Results of the Pensions Privatization

Chile's pensions system, which started to operate in May 1981, is based on individual capitalization of funds. This system determines a minimum basic contribution equal to 10 percent of disposable income and makes the benefit a function of an individual's contributions during his or her active life. Benefits for incapacity and survival are financed by complementary insurance with financial reserves. Decree Law 3,500 of 1981 institutes a social security system that make contributions obligatory for dependent workers who joined the labor force after December 31, 1982, and makes them voluntary for independent workers and those who had already contributed to the traditional pension funds. The old pay-as-you-go system, which was being phased out, covered all those workers who had entered the labor force in 1982 or earlier and who chose not to transfer to the new capitalization system. The reform responds to a need that has been recognized before, when the old system had entered a phase of serious financial difficulties.

In the reformed system, the state now plays a fundamental role in regulating and monitoring operations and guaranteeing "solidarity in the base" through a minimum pension. All workers, after contributing a minimum amount (15 percent of their gross income annually), have the right to a minimum pension of 85 percent of their minimum salary, even if their life-time contributions to the system result in a smaller benefit. The new system brought about an increase in coverage, with the proportion of independent workers covered increasing from 58 percent in 1985 to 79 percent in 1990. The proportion of dependent workers covered increased from 79 percent in 1985 to 92 percent in 1990.

Article 28 of Decree Law 3,500 establishes that the numerous Pension Fund Administrators (Administradoras de Fondos de Pensiones--AFPs) are authorized to charge a fee to cover their administrative costs. The most important restriction is that, with a few exceptions, fees have to be the same for all affiliates in a given AFP. After a relative increase in the fees between 1981 and 1983, competition resulted in a steady decline in the cost to individuals. In 1990 the cost for an "average contributor" was 33 percent lower in real terms than in December 1983. Commissions fell from 5 percent of taxable income in 1985 to about 3.2 percent in 1990. In 1992 the AFPs were charging about 0.9 percent of salary in insurance premiums and 1.8 percent in commissions, for a total of 2.7 percent.

Strict norms regulate the investment of pension funds. Only certain instruments may be used, and there are clear limits on the distribution of investments by type of instrument. The dynamism of the Chilean capital market since the early 1980s has forced constant revisions of these norms. Pension funds are the largest institutional investors in the capital market, representing 26.5 percent of GDP in 1990 (compared with 0.9 percent in 1981). The average real return to investment of Chilean pension funds between 1981 and 1990 was 13 percent. In 1992 AFPs were authorized to invest up to 3 percent of their portfolios abroad, double the previous maximum.

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