NYT: Chile's Retirees Find Shortfall in Private Plan

NY Times
January 27, 2005
Chile's Retirees Find Shortfall in Private Plan
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Tomás Munita for The New York Times
Dagoberto Sáez, retiring as a lab technician, is studying podiatry to
supplement a pension of $315 a month.
SANTIAGO, Chile - Nearly 25 years ago, Chile embarked on a sweeping
experiment that has since been emulated, in one way or another, in a score
of other countries. Rather than finance pensions through a system to which
workers, employers and the government all contributed, millions of people
began to pay 10 percent of their salaries to private investment accounts
that they controlled.
Under the Chilean program - which President Bush has cited as a model for
his plans to overhaul Social Security - the promise was that such
investments, by helping to spur economic growth and generating higher
returns, would deliver monthly pension benefits larger than what the
traditional system could offer.
But now that the first generation of workers to depend on the new system is
beginning to retire, Chileans are finding that it is falling far short of
what was originally advertised under the authoritarian government of Gen.
Augusto Pinochet.
For all the program's success in economic terms, the government continues to
direct billions of dollars to a safety net for those whose contributions
were not large enough to ensure even a minimum pension approaching $140 a
month. Many others - because they earned much of their income in the
underground economy, are self-employed, or work only seasonally - remain
outside the system altogether. Combined, those groups constitute roughly
half the Chilean labor force. Only half of workers are captured by the
Even many middle-class workers who contributed regularly are finding that
their private accounts - burdened with hidden fees that may have soaked up
as much as a third of their original investment - are failing to deliver as
much in benefits as they would have received if they had stayed in the old
Dagoberto Sáez, for example, is a 66-year-old laboratory technician here who
plans, because of a recent heart attack, to retire in March. He earns just
under $950 a month; his pension fund has told him that his nearly 24 years
of contributions will finance a 20-year annuity paying only $315 a month.
"Colleagues and friends with the same pay grade who stayed in the old
system, people who work right alongside me," he said, "are retiring with
pensions of almost $700 a month - good until they die. I have a salary that
allows me to live with dignity, and all of a sudden I am going to be plunged
into poverty, all because I made the mistake of believing the promises they
made to us back in 1981."
With many Chileans finding themselves in a situation much like that of Mr.
Sáez, people are still looking to the government, not private pension funds,
to ensure a secure retirement.
"It is evident the system requires reform," the minister of labor and
social security, Ricardo Scolari, said in an interview here. Chile's current
approach based on private pension funds has "important strengths," he said,
but "it is absolutely impossible to think that a system of this nature is
going to resolve the income needs of Chileans when they reach old age."
In formulating proposals in the United States for individual accounts,
advocates of partial privatization of Social Security have sought to
overcome some of the problems in Chile. They have suggested, for example,
setting low limits on the fees that fund managers will be allowed to charge
and continuing to provide a major part of retirement income through the
traditional system of guaranteed payments.
The program in Chile differs from the voluntary model that President Bush is
considering. Participation here has been not voluntary for people entering
the labor force since 1981.
On the other hand, Chile was careful before it started its private system to
accumulate several years of budget surpluses, in contrast to the recent
large deficits in the United States.
The Chilean example also makes clear that introducing private accounts does
not solve a lot of the problems faced in the United States, Europe and
Japan, where pay-as-you-go systems remain the principal means of government
retirement support.
Over all, Chile has spent more than $66 billion on benefits since
privatization was introduced. Despite initial projections that the system
would be self-sustaining by now, spending on pensions makes up more than a
quarter of the national budget, nearly as much as the spending on education
and health combined.
Faced with the likelihood of the gap remaining as it is or, as Mr. Scolari
said, "perhaps even widening," the Chilean government is contemplating a new
round of pension changes. Suggestions that have been floated include many
also under consideration in the United States and Europe, like reducing
benefits or setting a higher retirement age.
The problems have emerged despite what all here agree is the main strength
of the privatized system: an average 10 percent annual return on
investments. Those results have been achieved by the pension funds largely
through the purchase of stocks and corporate and government bonds -
investments that helped fuel an economic expansion giving Chile the highest
growth rate in Latin America over the last 20 years.
"The great success of the system is its high profit rate, more than double
what was initially projected," said Guillermo Arthur Errázuriz, executive
director of the Association of Pension Fund Administrators. "In total,
workers have set aside nearly $61 billion, which is invested in the sectors
of the economy that show the most potential."
Among the admirers of the privatized system here is Mr. Bush, who on a
visit in November called Chile "a great example" for other countries. On
other occasions, he has suggested that the United States could "take some
lessons from Chile, particularly when it comes to how to run our pension
The main architect of the Chilean system is José Piñera, who was labor and
social security minister from 1978 to 1980 during the Pinochet dictatorship.
Mr. Piñera is now chairman of the International Center for Pension Reform,
co-chairman of the Cato Institute's Project on Social Security Choice, and
he has been a board member of several Chilean corporations.
Mr. Piñera declined repeated requests to be interviewed for this article.
In an article on the Op-Ed page of The New York Times last month, though,
he extolled the Chilean system as one based on ownership, choice and
responsibility and one that is widely popular because it gives workers a
stake in the economy.
Among other achievements emphasized here by advocates of the privatized
funds are the creation of a modern capital market, cheaper credit for
companies that formerly could turn only to banks when they wanted to expand,
and a brake on deficit spending by the government.
Critics respond that the privatized system has been less successful in
ensuring a dignified retirement for the elderly.
"What we have is a system that is good for Chile but bad for most Chileans,"
said a government official who specializes in pension issues and who spoke
on condition of anonymity, fearing retaliation from corporate interests. "If
people really had freedom of choice, 90 percent of them would opt to go back
to the old system."
Among the complaints most often heard here is that contributors are forced
to pay exorbitant commissions to the pension funds. Exactly how much goes to
such fees is a subject of debate, but a recent World Bank study calculated
that a quarter to a third of all contributions paid by a person retiring in
2000 would have gone to pay such charges.
But most Chileans are unaware of how much they are paying to the funds
because the lengthy quarterly financial balance sheet they receive "is not
comprehensible," according to Guillermo Larraín, director of the
Superintendency of Pension Funds, a government agency. "It needs to be
replaced by a simple and transparent financial statement," he said, so
workers can determine which fund charges the lowest fees.
In recent years, the number of pension funds has been winnowed to 6 from a
high of 22 in the early 1990's. They have enjoyed record earnings, so much
so that foreign banks and insurance companies are investing in the industry.
While the pension fund association puts the average annual return on assets
just under 30 percent, government figures show profits of 50 percent in
2000, with some independent studies suggesting the funds did that well over
the five-year period ended in 2003.
Proponents of the system justify the high returns as an appropriate reward
for the risk they undertake. But a recent World Bank report, "Keeping the
Promise of Social Security in Latin America," minimized that, noting that
through the 1990's, only three large companies accounted for half of all
shares traded on the Santiago stock exchange and that pension funds tend to
follow a herd instinct and invest in the safest choices on the market.
Government officials like Mr. Larraín and Mr. Scolari acknowledge that
"commissions are high and need to come down." They say that "more
competition is needed" to foster lower fees. But existing regulations
frustrate the creation of new funds - something that seems just fine to
pension funds that have become a powerful political and economic force.
"The dynamic of the market," Mr. Larraín said, "is one of consolidation and
Some other problems of the Chilean system stem from factors that do not
apply with the same force in the United States and other advanced economies.
Nearly half of Chilean workers, for example, are employed off the books in
the so-called informal sector, while many others are hired as independent
contractors, who are not required to contribute to a pension account and do
not do so regularly because they cannot afford it.
By the government's own calculations, only about half the work force
contributes to a pension fund. "We are aware there is a big hole and that we
need to take corrective measures," Mr. Larraín said.
Because many of the claims initially made on behalf of the privatized system
proved exaggerated or inaccurate, the transition period has turned out to be
longer and more expensive than anticipated. The annual cost to the
government, still the guarantor of last resort, has remained steady at 5 to
6 percent of the nation's economic output. (By comparison, in 2003, Social
Security outlays in the United States totaled 4.2 percent of the gross
domestic product.)
Chile spends about $2 billion a year to pay retirees from its armed forces,
according to Mr. Scolari. The military imposed privatization on the rest of
the country, but was careful to preserve its own advantages and exclude
fellow soldiers from the system. Despite calls that the military be forced
to give up its exemption, no civilian government has been prepared to pursue
Proponents of the privatized system argue that those costs will diminish in
coming years, as those still receiving benefits from the old system
gradually die off. But critics disagree, pointing to the large numbers of
younger Chileans in the work force who either do not participate or whose
contributions will fall short of the amount required for a minimum pension.
For those remaining in the government's original pay-as-you-go system, the
maximum retirement benefit is now about $1,250 a month. The National Center
for Alternative Development Studies, a research institute here, calculates
that to get that same amount from a private pension fund, workers would have
to contribute more than $250,000 over their careers, a target that has been
reached by fewer than 500 of the private system's 7 million past and present
This leaves many Chileans in a situation that has led to the coining of a
phrase: "pension damage." There is now even an Association of People With
Pension Damage, 157,000 members and growing, that consists of Chileans,
mostly former government employees, who find that their pensions, based on
contributions to the private system, are significantly less than if they had
remained in the old system.
"They come to us in desperation," said Yasmir Fariña, the group's president,
"because those who stayed in the government system are often retiring with
monthly pensions twice as large as everyone else's."
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