Reforming successful reforms: The case of the Chilean pension system

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Reforming successful reforms The case of the
Chilean pension system

• Guillermo Larrain Rios

Presentation prepared for the IADB Washington
December 6 2004
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Chilean Pension Funds have grown steadily and
impressively
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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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Two general considerations about the Chilean model

• Demographics
• The old Chilean PAYG system was in crisis
• 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

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Two general considerations about the Chilean model

• 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

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Exogenous problems Labour Markets

• Lifetime employment is over more job rotation
  more frequent unemployment episodes.
• This does not affect people equally as
  employability differ according to education
  economic sector family linkages etc
• Poorer workers are more exposed to that
  uncertainties.
• One important characteristic of the emerging
  labor market is 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
• HOW COULD PENSIONS BE HIGHER

• Chile has lowest female participation rates
  catching up slowly.
• That requires
• reevaluation of the role of man at home
• support for working woman
• flexibility in labor contracts etc

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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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Reforming the reform 2 The Scomp

• information is spread among all companies. At a
  given date the pensioner will receive back all
  offers available to her or him in the whole
  market.

• Once the person receives the sheet she has five
  options. She may
• choose one of the offers in the sheet
• postpone any decision without time limit
• bargain with a salesperson for another offer but
  this is difficult ies
• ask the system for another round of offers
• call for an auction. Person is forced to choose
  the best offer.

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• information is spread anonimously among all
  companies that participate in the market that
  is all life insurance companies (that offer
  different kinds of annuities) and all AFPs (that
  offer programmed withdrawals). At a given date
  the pensioner will receive back all offers
  available to her or him in the whole market.

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Reforming successful reforms The case of the
Chilean pension system

• Guillermo Larrain Rios

Presentation prepared for the IADB Washington
December 6 2004
21
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