Chile - Social Security

Social security

Chile was one of the first countries in the Americas to establish state-sponsored social security coverage. In 1898 the government set up a retirement pension system for public employees. In 1924 the government approved a comprehensive set of labor laws and established a national social insurance system for workers. In large part, the authorities were responding to pressure exerted by the growing number of worker organizations and strikes. At the same time, a separate social-insurance system was set up for private white-collar employees, and the one for public employees was reorganized. The pension system for workers was known as the Workers' Security Fund (Caja del Seguro Obrero) and was modeled partly on the system pioneered by Otto von Bismarck, first chancellor of the German Empire (1871-90). The fund (caja) was established administratively as a semiautonomous state agency that received income from employer and worker contributions, as well as from state coffers. The systems for private and public employees provided higher benefits than the workers' caja, and they were financed in the same manner, except that the state acted as the employer for public employees as well. The armed forces had a separate pension system.

The Workers' Security Fund was reorganized in 1952, becoming the Social Insurance Service (Servicio de Seguro Social--SSS). Until its demise under the military government, the SSS served as the primary agency for the state-run social security system. SSS coverage expanded over the years. By the 1960s, in addition to providing old-age pensions to its main beneficiaries, it gave, at their death, pensions to their widows (but not their widowers) and to minor children, if any. It also paid flat monthly sums for each immediate family dependent, income payments for qualified illnesses and disabilities, and several months of unemployment insurance, albeit all at very low levels.

Although the fund originally was meant to meet the needs of miners and urban blue-collar and service workers, including domestics, over the years the number of occupational groups that participated in what became a system of different semiautonomous state funds increased greatly. By the early 1970s, there were thirty-five different pension funds (although three of them served 90 percent of contributors) and more than 150 social security regimes for the various occupational groups. This expansion led to many inequities because the newly incorporated groups demanded and obtained by law special treatments and new benefits that had been denied to original participants, even when these new groups' programs were added to existing funds. There was not even a standard retirement age for all groups. Funding for the various pension programs became extremely complex because the state's contributions were drawn by law from different tax bases. This pattern of growth of social security institutions is typical of countries in which the system is not conceived from the very beginning on a universal basis but rather is established for particular categories of employment. Because coverage continued to be conditioned on the employment history of the main beneficiary, it was never extended to all Chileans, even during its heyday in the early 1970s.

The military government initially hoped to rationalize what had become an unwieldy system, but eventually it changed the whole system completely. It decided not to continue with a basic organizational principle of most social security systems, the payas -you-go system, whereby benefits are paid out of funds collected from those who are still contributing. In addition, the government decided to privatize the organization and management of pension funds and to discontinue the state's own contributions to them. Thus, the military regime enacted the legal basis for the creation of privately run pension-fund companies, stipulating that all new workers entering the labor force had to establish their accounts in the new pension companies. Moreover, the government also created incentives for people in the semiautonomous, state-run system to transfer out of that system by reducing the proportion of each employee's paycheck that would be deducted under the new system to about 15 percent of gross income, instead of the prior 20 percent or 25 percent, and by permitting a transfer of funds based on the number of years individuals had paid into the system.

The new privately run pension funds are based on the notion of individual capitalization accounts. Pension amounts are set by how much there is in the individual account, which is determined by the total that has been contributed plus a proportional share of the pension fund's investments. In any event, by law no pension is allowed to fall below 70 percent of an individual's last monthly salary. If there are insufficient funds to generate the required pension levels in the account, the pension fund company must make up the difference. If the company is unable to meet its obligations, the state, which guarantees the system, has to cover the shortfall.

Employees are allowed to choose the pension-fund company that will handle their account, and those who are self-employed may also elect to establish individual accounts. This choice is intended to stimulate competition among pension-fund companies in order to keep the administrative fees charged to account holders at a reasonable level, and to encourage the companies to invest the money they accumulate so as to generate the highest yields. Employers no longer contribute to employees' pensions under the new system. Disability and survival pensions are paid out of an account funded by a 3.8 percent share of the 15 percent the account holders contribute, leaving the remaining 11.2 percent to build up the pension-generating account. The 3.8 percent share is contracted out by the pension funds to life insurance companies, many of them newly created to meet the enormous increase in demand for their services. Individual account holders are also permitted to make payments in excess of the obligatory minimum. The retirement age is set at sixty-five years for men and sixty years for women, although individuals who accumulate enough funds to obtain a pension equal to 110 percent of the minimum pension may retire earlier.

The new system took effect in 1981, and the great majority of the contributing population opted to change to it. Deciding not to make substantial changes in the social security system, the Aylwin government increased the minimum pension paid by what remained of the state-run social security system by about 30 percent in real terms. By December 1990, there were about 3.7 million people, or 79 percent of the labor force, with accounts in fourteen pension-fund companies, called Pension Fund Administrators (Administradoras de Fondos de Pensiones--AFPs). A large proportion of the uncovered population consisted of self-employed people; only 3 percent of the total accounts came from that group. The funds gathered large sums of money relative to the size of the national economy. By the end of 1992, the pension and life insurance companies had accumulated an estimated US$15 billion. The state regulates and oversees the pension-fund companies through a newly created office that issues strict investment guidelines.

This radical departure from past institutional practices in the pension system is unique, and it drew considerable attention from experts in other Latin America countries also facing looming financial crises in their own social security systems. By generating large amounts of capital in the private sector, the new system energized the previously anemic Chilean capital markets. Because it has operated only for about a decade, however, it has yet to meet the test that will occur when the new pension funds have to pay out in benefits what would correspond to an actuarially normal load. Most of the nation's retirees and older workers have stayed in the state-run social security system, now called the Institute of Pension Fund Normalization (Instituto de Normalizaci�n Previsional--INP). By the end of 1990, the private pension companies were only paying out benefits to 2.3 percent of their affiliates.

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