New Pension Reform in Chile: Some Comments

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New Pension Reform in ChileSome Comments

• Heinz P. Rudolph
• The World Bank
• November 27, 2006

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Intermediate Objectives of the Proposal

• Integrated and strong first pillar
• Increase density of contributions
• Increase price competition
• Improve risk management and increase returns of
  contributions
• Strengthen the voluntary pillar
• Increase Transparency and Predictability of the
  system

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General Comment

• Highly comprehensive and ambitious
• The Presidential Commission was in line with the
  highest expectations.
• It provides a general framework that will help to
  move the Chilean system to a multi-pillar scheme.
• Unbalanced equilibrium between carrots and sticks

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Competition and IO

• The pension system has to be non expensive
• Competition has not been able to substantially
  reduce costs
• It can be explained by
• Unnecessary regulations
• But also by the nature of the product

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Definition of the pension service

• What do AFPs sell?
• What is the best plan for an individual?
• How people know that is choosing the best plan?
• Is it the return of the last month?
• Is it the quality of service?
• Is it the expected return?
• Is it the quality of management?
• .Not a clear answer

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Competition

• If we cannot define the product or advise
  appropriately people to choose a plan, how can we
  create competition?
• Is it more competition more switchovers?
• Is it more competition different rates of
  returns?
• Until now we have not seen effective competition
  in this market
• Room for creation of elaborated and artificial
  competition (bidding) and incentives for taking
  advantage of scale economies.

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Alternative Approach

• AFPs would be regulated as any utility company
• Forget about competition and focus on cost
  reduction
• Price ceilings
• Regulation of the quality of service
• There are good experiences in Sweden and Poland

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Alternative Approach (2)

• If you want to take advantage of scale economies,
  you have to design it as such
• Mandatory contributions by internet for companies
  with more than x workers (IRS system).
• A single Individual Accounts Manager (IRS)
• Collection of contributions, account management,
  client support, etc.
• Multiple fund managers

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Competition

• Not clear that the voluntary approach will get to
  far in terms of cost reduction.
• And involve additional risk associated to the
  possibility of other financial institutions to
  offer pension services
• The supervisory framework is not prepared for
  dealing with this issues experience of
  consolidation of BBVA and Bansander was unnoticed
  by supervisors.
• Consolidated supervision is not designed to solve
  the problems of tide sales, shared sales force
  and other specific problems.

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Investments

• More flexibility in regulation of investments
  portfolios is very welcome.
• Proposals need to be considered with long
  transitions.
• Risk management is not well developed in all
  pension funds and SAFP is not well prepared to
  handle risk based supervision
• Careful with VaR and other metrics (they are not
  the panacea)
• Replace the limit abroad by the currency limit is
  risky (90 of currency forwards maturates in less
  than 90 days).
• There are different mechanisms to make more
  flexible the Minimum Return Guarantee (i.e.
  reporting period)

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Total Fees over Assets