Chile pension system
Encyclopedia
The Chile Pension system (Spanish
: Sistema Previsional) refers to old-age, disability and survivor pension
s for workers in Chile
. The pension system was changed by José Piñera
, during Augusto Pinochet
s military government
on November 4, 1980 from a PAYGO
-system to a fully funded capitalization system run by private sector
pension fund
s. Many critics and supporters see the reform as an important experiment under real conditions, that may give conclusions about the impact of the full conversion of a PAYGO-system to a capital funded system. The development was therefore internationally observed with great interest. Under Michelle Bachelet
's government the Chile Pension system was reformed again.
On November 4, 1980, under the leadership of José Piñera
, Secretary of Labor and Pensions under Augusto Pinochet
with the collaboration of his team of Chicago Boys
, the PAYGO pension system was changed to a capital funded system run by investment funds. José Piñera had the idea of privatizing the pension system for the first time when reading the book Capitalism and Freedom
from Milton Friedman
There have been implemented several (private) pension fund
s the so-called Administradoras de Fondos de Pensiones (AFPs). For all citizens who are legally defined as workers, employers must pay a proportion of the earnings to a pension fund. Workers who had already paid in the old system, got an option to continue to pay into the old system. But the statutory minimum contribution to the new private pension funds was set 11% lower than the contributions to the old pension system, therefore most workers changed to the new pension system.
There are government guarantees for the following cases:
The government pays a fixed amount as social assistance for those citizens who are not even entitled to minimum pension, the Pensiones Asistenciales (PASIS). But the provided amount of money is usually not nearly big enough to cover all people in need.
Because of the conversion from the PAYGO to the funded system until the year 2045 there will arise conversion costs. Because the contributions are made almost entirely in the new system, there are almost no more payments into the old system. The difference between the remaining contributions and the pensions that have to be paid out have to be financed by the Chilean government. These conversion costs are a big burden for the government budget:
and police
do not contribute in the workers pension system but participate in a separate PAYGO system.
The pension contributions are income tax
deductible
. The worker can choose one of six private pension administrators and change at will and also choose from among five funds (A to E, with A being the riskiest).
, but that performance is partly attributed to special factors. Also the expectable amount of benefits not only depends on the performance of pension funds but also on the amount of withdrawn administrative costs. The amount of administrative costs is considered a problem of the Chilean pension system.
In addition to or instead of the regular private pension workers may be entitled to state aid:
Retired workers whose private pensions are below a defined level are entitled to minimum pension (Garantía de Pensión Mínima). In this case, the government pays an additional pension.
People who have paid in nothing or contributed less than 20 years may get social assistance, the Pensiones Asistenciales (PASIS). But the Pensiones Asistenciales are paid from a fixed budget that is usually not big enough to cover everyone in need.
The number of workers who actually pay into the pension system decreased from 64% in 1980 (before the reform) to 58% by 2006 According to Patricio Navia an Diego Portales University professor, most people perceive the costs of pensions and the pensions themselves as unfair. Therefore they try to evade pension contributions.
Andras Uthoff, the director of the Social Development Division of the United Nations Economic Commission for Latin America (ECLAC) states that the reformed Chilean pension system does not work with the reformed Chilean labor market because only a small percentage of workers are able to finance meaningful pensions.
According to the projection of Berstein, Larrain and Pino Rios from the year 2005 (based on data from the period 1981 - 2003) the kind of pensions to expect are predicted as following:
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Sebastián Piñera
, the brother of José Piñera and later president of Chile, said during the presidential candidacy in 2006:
Under the Bachelet
government, the pension system was reformed again in the year 2008. Andrés Velasco, the leading economic adviser to the government, addressed the two main problems as the coverage of the population and the amount of the administrative costs. Too many people are outside the pension system, and capital accumulation
by using the pension funds is quite expensive The reform follows a recommendation by the World Bank
, who has found in the 1980 pension system a strong redistributive component at the expenses of low paid or occasionally unemployed workers. A big part of the Chilean population is not able to finance meaningful pensions, because many workers are not able to regularly contribute a higher amount of money. Additionally many workers have difficulties to achieve the 20 years of contributions to at least qualify for minimum pension. Since the pension funds charge high fixed administrative costs per insured person and only a small portion of the administrative costs depend on the amount of the capital account, capital accumulation by pension funds is very unprofitable for workers with lower incomes. The World Bank therefore recommended that the minimum pension and the Pensiones Asistenciales should be abolished and instead introduced a public risk pooling device financed by VAT
tax revenue.
The reform includes mainly the following points:
Supporting pension reform:
Critical of pension reform:
Spanish language
Spanish , also known as Castilian , is a Romance language in the Ibero-Romance group that evolved from several languages and dialects in central-northern Iberia around the 9th century and gradually spread with the expansion of the Kingdom of Castile into central and southern Iberia during the...
: Sistema Previsional) refers to old-age, disability and survivor pension
Pension
In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
s for workers in Chile
Chile
Chile ,officially the Republic of Chile , is a country in South America occupying a long, narrow coastal strip between the Andes mountains to the east and the Pacific Ocean to the west. It borders Peru to the north, Bolivia to the northeast, Argentina to the east, and the Drake Passage in the far...
. The pension system was changed by José Piñera
José Piñera
José Piñera is the architect of Chile's private pension system based on personal retirement accounts. Piñera has been called "the world's foremost advocate of privatizing public pension systems" as well as "the Pension Reform Pied Piper"...
, during Augusto Pinochet
Augusto Pinochet
Augusto José Ramón Pinochet Ugarte, more commonly known as Augusto Pinochet , was a Chilean army general and dictator who assumed power in a coup d'état on 11 September 1973...
s military government
Government Junta of Chile (1973)
Government Junta of Chile was the military junta established to rule Chile during the military dictatorship that followed the overthrow of President Salvador Allende in the 1973 Chilean coup d'état. It was the executive and legislative branch of government until December 17, 1974...
on November 4, 1980 from a PAYGO
PAYGO
PAYGO is the practice in the United States of financing expenditures with funds that are currently available rather than borrowed.-Budgeting:The PAYGO compels new spending or tax changes not to add to the federal deficit. Not to be confused with pay-as-you-go financing, which is when a government...
-system to a fully funded capitalization system run by private sector
Private sector
In economics, the private sector is that part of the economy, sometimes referred to as the citizen sector, which is run by private individuals or groups, usually as a means of enterprise for profit, and is not controlled by the state...
pension fund
Pension fund
A pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s. Many critics and supporters see the reform as an important experiment under real conditions, that may give conclusions about the impact of the full conversion of a PAYGO-system to a capital funded system. The development was therefore internationally observed with great interest. Under Michelle Bachelet
Michelle Bachelet
Verónica Michelle Bachelet Jeria is a Social Democrat politician who was President of Chile from 11 March 2006 to 11 March 2010. She was the first woman president of her country...
's government the Chile Pension system was reformed again.
History
A social security system was introduced in Chile in 1920, which included a PAYGO pension system. By 1973 the funding of the pension fund was low, though 73% of all Chilean workers paid into the system. The reason for this was that almost all workers contributed only the statutory minimum contribution, and many successfully evaded pension contributions. The poor payment record is attributed primarily to the fact that individual contributions had little correlation with anticipated pension benefits.Pension reform of 1980/81
José Piñera
José Piñera is the architect of Chile's private pension system based on personal retirement accounts. Piñera has been called "the world's foremost advocate of privatizing public pension systems" as well as "the Pension Reform Pied Piper"...
, Secretary of Labor and Pensions under Augusto Pinochet
Augusto Pinochet
Augusto José Ramón Pinochet Ugarte, more commonly known as Augusto Pinochet , was a Chilean army general and dictator who assumed power in a coup d'état on 11 September 1973...
with the collaboration of his team of Chicago Boys
Chicago Boys
The Chicago Boys were a group of young Chilean economists most of whom trained at the University of Chicago under Milton Friedman and Arnold Harberger, or at its affiliate in the economics department at the Catholic University of Chile...
, the PAYGO pension system was changed to a capital funded system run by investment funds. José Piñera had the idea of privatizing the pension system for the first time when reading the book Capitalism and Freedom
Capitalism and Freedom
Capitalism and Freedom is a book by Milton Friedman originally published in 1962 by the University of Chicago Press which discusses the role of economic capitalism in liberal society. It sold over 400,000 copies in the first 18 years and more than half a million since 1962. It has been translated...
from Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
There have been implemented several (private) pension fund
Pension fund
A pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s the so-called Administradoras de Fondos de Pensiones (AFPs). For all citizens who are legally defined as workers, employers must pay a proportion of the earnings to a pension fund. Workers who had already paid in the old system, got an option to continue to pay into the old system. But the statutory minimum contribution to the new private pension funds was set 11% lower than the contributions to the old pension system, therefore most workers changed to the new pension system.
Overview
The Chilean workers yearly contributions in the private pension fund are amounting to about 3.5% of gross domestic product. The pension payments from the pension funds are still relatively low, mainly because yet just a few depositors have reached the retirement age. Until 2008 the private pension funds have accumulated capital of an amount of 52.77% of gross domestic product.| Year | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 |
|---|---|---|---|---|---|---|---|
| Yearly contributions in % of gross domestic product | 3.57 | 3.40 | 3.48 | 3.57 | 3.32 | 3.44 | 3.49 |
| Pensions in % of gross domestic product | 1.95 | 1.99 | 1.99 | 1.78 | 1.64 | 0.90 | 1.92 |
| Capital accumulated in % of gross domestic product | 55.07 | 58.16 | 59.08 | 59.35 | 61.01 | 64.43 | 52.77 |
Government's responsibility
The establishment and the operation of the private pension funds are regulated by law. For e.g. any pension fund must deposit minimum reserves. The types of investments that are permitted are defined by law. The compliance of the private pension funds are supervised by a government regulator, the Superintendencia de AFP.There are government guarantees for the following cases:
- All citizens who have contributed to a fund for at least 20 years are guaranteed a minimum pension. The difference between the minimum pension and the pension entitlement from the investment fund is paid by government.
- If a pension fund is unable to perform a defined minimum profit, it will be liquidated and the collected assets will be transferred to another fund. In this case, the government solves the assets gap.
- In case of bankruptcyBankruptcyBankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
of a pension fund the government pays out the pensions on public expenses.
The government pays a fixed amount as social assistance for those citizens who are not even entitled to minimum pension, the Pensiones Asistenciales (PASIS). But the provided amount of money is usually not nearly big enough to cover all people in need.
Because of the conversion from the PAYGO to the funded system until the year 2045 there will arise conversion costs. Because the contributions are made almost entirely in the new system, there are almost no more payments into the old system. The difference between the remaining contributions and the pensions that have to be paid out have to be financed by the Chilean government. These conversion costs are a big burden for the government budget:
| Year | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 1989 | 1990 | 1991 | 1992 | 1993 | 1994 | 1995 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Conversion costs in % of Chilean gross domestic product Gross domestic product Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living.... |
4.10 | 8.30 | 7.50 | 7.70 | 6.70 | 6.30 | 5.40 | 5.20 | 4.50 | 4.60 | 4.50 | 4.30 | 4.50 | 4.50 | 4.40 |
Contributors
All workers and employees must pay into the system. Mandatory contributions amount 13% of the monthly income, the part of the monthly income that exceeds $ 2,000 U.S. is non-contributory. Self-employed individuals may contribute voluntarily, and salaried workers can also enhance their pension through additional voluntary contributions. The Chilean armed forcesMilitary of Chile
Chile's armed forces are subject to civilian control exercised by the president through the Minister of Defense. Military service of 12 to 24 months is mandatory for all male citizens upon turning 18. This conscription service can be postponed for educational or religious reasons...
and police
Carabineros de Chile
thumb|250px|Carabineros de Chile, patrolling a street in [[Santiago, Chile|Santiago]]The Carabiniers of Chile, are the uniformed Chilean national police force and gendarmerie, created on April 27, 1927. Their mission is to maintain order and create public respect for the laws of the country...
do not contribute in the workers pension system but participate in a separate PAYGO system.
The pension contributions are income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...
deductible
Tax deduction
Income tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...
. The worker can choose one of six private pension administrators and change at will and also choose from among five funds (A to E, with A being the riskiest).
Administrative costs
The pension funds are funded by administrative costs. The number and amount of administrative costs are not regulated by law. Typically there are case management fees for opening an account and for various changes. A part of the monthly pension contributions will be withheld too.Coverage
The performance of the Chilean pension funds is yet very good compared with the performance of private pension funds of developed countriesDeveloped country
A developed country is a country that has a high level of development according to some criteria. Which criteria, and which countries are classified as being developed, is a contentious issue...
, but that performance is partly attributed to special factors. Also the expectable amount of benefits not only depends on the performance of pension funds but also on the amount of withdrawn administrative costs. The amount of administrative costs is considered a problem of the Chilean pension system.
In addition to or instead of the regular private pension workers may be entitled to state aid:
Retired workers whose private pensions are below a defined level are entitled to minimum pension (Garantía de Pensión Mínima). In this case, the government pays an additional pension.
People who have paid in nothing or contributed less than 20 years may get social assistance, the Pensiones Asistenciales (PASIS). But the Pensiones Asistenciales are paid from a fixed budget that is usually not big enough to cover everyone in need.
The number of workers who actually pay into the pension system decreased from 64% in 1980 (before the reform) to 58% by 2006 According to Patricio Navia an Diego Portales University professor, most people perceive the costs of pensions and the pensions themselves as unfair. Therefore they try to evade pension contributions.
Andras Uthoff, the director of the Social Development Division of the United Nations Economic Commission for Latin America (ECLAC) states that the reformed Chilean pension system does not work with the reformed Chilean labor market because only a small percentage of workers are able to finance meaningful pensions.
According to the projection of Berstein, Larrain and Pino Rios from the year 2005 (based on data from the period 1981 - 2003) the kind of pensions to expect are predicted as following:
| 60 % of all workers are covered | Off those can expect a pension of: | ||
|---|---|---|---|
| social assistance (Pensiones Asistenciales) | minimum pension (Garantía de Pensión Mínima) | sufficient private pension | |
| 40 - 50 % | 10 % | 40 - 50 % | |
Sebastián Piñera
Sebastián Piñera
Miguel Juan Sebastián Piñera Echenique is a Chilean businessman and politician. He was elected President of Chile in January 2010, taking office in March 2010.- Education :...
, the brother of José Piñera and later president of Chile, said during the presidential candidacy in 2006:
Pension reform of 2008
Michelle Bachelet
Verónica Michelle Bachelet Jeria is a Social Democrat politician who was President of Chile from 11 March 2006 to 11 March 2010. She was the first woman president of her country...
government, the pension system was reformed again in the year 2008. Andrés Velasco, the leading economic adviser to the government, addressed the two main problems as the coverage of the population and the amount of the administrative costs. Too many people are outside the pension system, and capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
by using the pension funds is quite expensive The reform follows a recommendation by the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
, who has found in the 1980 pension system a strong redistributive component at the expenses of low paid or occasionally unemployed workers. A big part of the Chilean population is not able to finance meaningful pensions, because many workers are not able to regularly contribute a higher amount of money. Additionally many workers have difficulties to achieve the 20 years of contributions to at least qualify for minimum pension. Since the pension funds charge high fixed administrative costs per insured person and only a small portion of the administrative costs depend on the amount of the capital account, capital accumulation by pension funds is very unprofitable for workers with lower incomes. The World Bank therefore recommended that the minimum pension and the Pensiones Asistenciales should be abolished and instead introduced a public risk pooling device financed by VAT
Vat
Vat or VAT may refer to:* A type of container such as a barrel, storage tank, or tub, often constructed of welded sheet stainless steel, and used for holding, storing, and processing liquids such as milk, wine, and beer...
tax revenue.
The reform includes mainly the following points:
- The minimum pension and the Pensiones Asistenciales were replaced by a tax-funded solidary pension system (SPS). All citizens older than 65 years, that lived in Chile for at least 20 years and do not have a private pension on a defined minimum level qualify for an SPS pension.
- The legally defined framework within which pension fund investments are allowed has been extended.
- Within a transitional period lasting until 2015, self-employed individuals are also to be integrated into the pension system.
See also
- Chile under PinochetChile under PinochetChile was ruled by a military dictatorship headed by Augusto Pinochet from 1973 when Salvador Allende was overthrown in a coup d'etat until 1990 when the Chilean transition to democracy began. The authoritarian military government was characterized by systematic suppression of political parties and...
- Economy of ChileEconomy of ChileThe economy of Chile is ranked as an upper-middle income economy by the World Bank, and is one of South America's most stable and prosperous nations, leading Latin American nations in human development, competitiveness, income per capita, globalization, economic freedom, and low perception of...
- Chicago BoysChicago BoysThe Chicago Boys were a group of young Chilean economists most of whom trained at the University of Chicago under Milton Friedman and Arnold Harberger, or at its affiliate in the economics department at the Catholic University of Chile...
- Welfare reformWelfare reformWelfare reform refers to the process of reforming the framework of social security and welfare provisions, but what is considered reform is a matter of opinion. The term was used in the United States to support the Personal Responsibility and Work Opportunity Act...
External links
Supporting pension reform:
- International Center for Pension Reform, founded and headed by José PiñeraJosé PiñeraJosé Piñera is the architect of Chile's private pension system based on personal retirement accounts. Piñera has been called "the world's foremost advocate of privatizing public pension systems" as well as "the Pension Reform Pied Piper"...
himself
Critical of pension reform:
- Nicholas Barr: The Truth About Pension Reform, in: Finance & Development, September 2001, vol. 38, no. 3.