The Chilean Pension System: A Renewed View

1
The Chilean Pension System A Renewed View

Guillermo Larrain Rios Superintendent of Pension
Funds, President of AIOS Washington, February
2005
2
Chilean Pension Funds have grown steadily and
impressively
3
Chilean Pension Funds have grown steadily and
impressively
4
Chilean Pension Funds have grown steadily and
impressively
5
Macroeconomic impact of pension funds analytics
The Corbo/Schmidt-Hebbel model
Formalization
Labour Market
Total employ-ment
Growth
Pension Reform
Financial Developmt
TFP
Note these causalities!
Public financing of transition
Saving
Investment
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Macroeconomic impact of pension funds estimates
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Three general considerations about the Chilean
model

• 1) Demographics
• The old Chilean PAYG system was in crisis 32
  regimes, regressive, underfunded
• The AFP model started before the current
  demographic transition appeared
• From an actuarial point of view, DC systems are
  better prepared to adapt to the new demographic
  paradigm than DB systems for the simple reason
  than in the latter benefits are defined according
  to the dynamic of politics not of demographics
  and, obviously, they need not coincide

8
Three general considerations about the Chilean
model

• 2) Transitional costs
• New workers to new system strong incentives to
  older workers real wage increased for workers
  and employers contribution ceased.
• Fiscal deficit, persistent and long lasting
• Expenditure cuts in other areas to accommodate
  it.
• Specific political situation of Chile

9
Three general considerations about the Chilean
model
3) Complementary reforms and markets Pension
reform is not a miracle. WSJ (dec 22, 04) True
entitlement reform, in other words, would be more
than just an adjustment to the federal fiscal
situation. IT WOULD REFORM DEMOCRACY AND EVEN THE
CHARACTER OF THE ELECTORATE ITSELF"
p
F
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Some institutional requisites for diversification

• Fixed income
• Mortgage.
• Corporate.
• Variable Income
• Corporate culture, accountability
• Corporate governance
• Minority shareholders rights

• Inflation protection (Macro stability)
• Investment opportunities
• Contracts stable judicial framework
• Tax distortions minimized.
• Risk classification etc
• etc

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Exogenous problems Labour Markets

• Lifetime employment is over, job rotation,
  frequent unemployment episodes.
• This does not affect people equally
  employability differ according to education,
  economic sector, family linkages etc
• Poorer workers, more exposed to uncertainties.
• Important characteristic of the labor market
  its duality.

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Exogenous problems Labour Markets

• natural reluctance of many workers to contribute
  for pensions
• proliferation of formal self employed workers
  require savings to be liquid in case of need
  while pension assets are extremely illiquid

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Exogenous problems women, a special case

• Start working later
• Earn less (for same skills),
• Retire earlier
• Live longer

• Chile has lowest female participation rates, slow
  change in this

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Exogenous problems Life expectancy

• For given savings, now must finance more years
• Consequence pensions are smaller
• Two contradictions people live longer
• and retires earlier
• and feel better old age jobs!

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Endogenous problems accumulation and disbursement
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Endogenous problemscompetition and concentration

• Two design problems impact competition
• Inelasticity of demand mostly explained by the
  mandatory character of the product sold. The
  pension market is artificial, there is no
  spontaneous demand for it and thats why people
  do not pay much attention to relevant variables
  in this market specially while they are young.
• Economies of scale typical in financial sectors
  but more present here due to the necessary
  exclusive nature of the commercial firm that
  distribute pensions.

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Reforming the reform 1 Multifondos

• At the beginning there was only one portfolio
• Strict regulation on limits
• Minimum relative return

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Reforming the reform 1 Multifondos

• Herd behaviour appeared (more than elsewhere)
• Two opposing views on that
• minimize likelihood of individual errors of
  judgement safety element.
• as portfolios do not vary, nor do returns. AFPs
  offered only one portfolio, very similar to each
  other.
• From the perspective of the affiliate
• the benefit of being informed was smaller
  compared to the cost of doing it. The management
  of pension savings started to look more as a
  commodity inducing further indifference.
• People received statements but it was useless
  desinformation
• 93 declared they did not know the price
• 56 declared ignorance of the balance of their
  personal accounts
• 54 of men and 64 of women declared that they
  have never changed from one AFP to another

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Reforming the reform 1 Multifondos
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Reforming the reform 1 Multifondos

• Herd amplified 5 times.

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Reforming the reform 2 The Scomp
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Summary

• Chile has a succesful pension system. In spite of
  that, I requires reform in three areas
• Coverage independent workers, first pillar
• Industrial organization diminish barriers to
  entry
• Investment regime

23
The Chilean Pension System A Renewed View

Guillermo Larrain Rios Superintendent of Pension
Funds, President of AIOS Washington, February
2005