Regional Outlook : Pensions in Chile Pay Off Handsomely : Other Latin American countries are emulating the system, which requires workers to keep individual retirement accounts.


Those big bites out of Manuel Valladares’ paychecks, unlike U.S. Social Security deductions, go straight to an individual retirement account. The dividends and interest it earns are for him.

And this nation’s privately administered pension system has yielded handsome earnings for millions of Chileans since it was started in 1981--an average of 13% a year. Valladares, a 64-year-old messenger for an architectural firm, has no complaints.

“It’s very good,” he said. “I’ve been in it since ’81, and I’m going to retire next year. I’m content.”

Chileans are not the only ones who like the system. Neighboring Peru recently established a similar retirement program, and several other Latin American countries appear likely to do the same.


So Chile’s social security revolution is beginning to spread. Some experts are even suggesting that the United States might do well to consider a pension system like Chile’s.

Most government-run social security systems in Latin America are in deep financial trouble, as was Chile’s old system. Governments have dipped heavily into retirement pension funds to pay for other programs. Maturing pension systems and populations have resulted in more pensions being paid out with fewer workers paying in.

In the 1960s, Chile’s old system had 10 working contributors for every person receiving a pension. But by the 1980s, when the ratio was 2.2 to 1, the system was bleeding red ink.

Today, all of Latin America’s government-run retirement funds are basically “pay-as-you-go” systems, similar to U.S. Social Security. Money coming in goes right back out to pay current pensions, and it’s usually not enough.

Francisco Margozzini, general manager of Chile’s Assn. of Pension Fund Administrators, predicted that the U.S. system eventually will also incur staggering deficits as the Baby Boom generation retires.

“The pay-as-you-go system is destined for financial crisis,” Margozzini said. The only way to finance the increased pension burden is to take bigger and bigger bites out of paychecks--"which is not a solution, because you encourage evasion,” he said. “Or you increase the retirement age, but that also has its limits.”

The best solution, according to Margozzini, is a system of compulsory savings in individually capitalized accounts. And to guarantee that the government won’t dip into those savings, the funds must be privately administered, he added.

That is a key selling point for Chile’s privatized scheme. The accounts are similar to the voluntary 401K retirement accounts in the United States in that they both are privately run, individualized investment funds for retirement. But for Chilean workers, participation is obligatory, and the new funds replace rather than supplement the old government pension system.


A major criticism of the new system is that it lacks “solidarity” because it does not redistribute income in favor of the most needy--people who put less into their accounts will have smaller pensions.

Neither the government nor employers pay anything into the new system.

But the system does obligate workers to save for their retirement, and those savings can invigorate the national economy by increasing money available for investment. In Chile, the national rate of saving has climbed from 15% of gross domestic product (about the same as in the United States) to more than 20% since the new pension system began.

Through fund investment in mortgage securities for new real estate, the system has helped finance a construction boom. About 60% of all Chilean mortgage papers are held by pension fund administrators.


The accounts are managed by 18 competing financial firms called “administrators of pension funds,” or AFPs, which are licensed and closely regulated by the government. Major foreign concerns, such as Aetna Life & Casualty and American International Group (AIG) of the United States, own controlling shares of some Chilean AFPs. Bankers Trust and Citibank also have bought into the system.

The rules for investment are strict--AFPs can have no more than 30% of their assets in common stocks, for example.

When the system started in Chile, new workers entering the labor force were obligated to join. Switching was optional for workers already covered by the old system, but there were strong incentives for changing to the new.

The move entitled workers to an increase of about 10% in take-home pay, which employers could afford because they no longer were required to match social security contributions for workers who switched. And workers leaving the old system also received special government bonds representing their vested equity in the government pension program.


Those who did not leave the old system have the right to government-paid pensions on retirement. Financing those pensions costs the government about 5% of Chile’s gross domestic product, an obligation that has been met so far thanks to the thriving economy, the government’s solid financial position and proceeds from the privatization of state-owned companies.

Under the new pension system, each employee contributes 10% of his salary to the fund. He also pays between 1% and 3% for health insurance, disability insurance and AFP commissions.

While many Latin American countries are studying Chile’s system, differing political and economic conditions make it more difficult for some to start a privately run pension system.

In 1981, Chile was governed by a military dictatorship, so political resistance to the scheme was muted. And the government had already undertaken major market reforms that made profitable investment of the pension funds feasible. Inflation was under control, government finances were in order and the private sector was primed for rapid growth.


Similar economic conditions prevailed in Mexico when that country’s government considered a retirement system like Chile’s. But because of opposition by labor and other interests, changes in the Mexican system have fallen far short of what Chile has.

The new Mexican system, started last year, requires employers to contribute 2% of each worker’s salary to individual retirement accounts that initially are being administered by banks. But unless contributions are increased, experts say, the individual pensions paid from the accounts are unlikely to amount to much.

In June, Peru became the first Latin American country to adopt a system modeled after Chile’s. The eight new Peruvian pension fund administrators are affiliated with Chilean AFPs and foreign companies, including AIG, Aetna and Bank of America.

In less than four months, more than 300,000 workers made the voluntary switch to the new system, even though they receive no net pay increase as an incentive for switching. (They receive a 13% raise if they switch, but that is about the same percentage that comes out of their pay and goes into their new retirement accounts.)


Gabriel Herrera, the Chilean manager of a Peruvian AFP named Union, said the initial number of switches was not as big as expected but still encouraging. “It shows that it is a system that has been born vigorous,” he said in an interview in Lima.

If the Peruvian economy expands and the government manages its finances well, it will have sufficient resources to meet its obligations to the old system, Herrera said. And he predicted that the accumulating capital of the privately administered pension funds will be an important “lever for development” of the economy.

Elsewhere in the region:

* The Colombian government has submitted a bill to Congress for the creation of a system similar to Chile’s.


* In Argentina, the Congress has passed a bill to create a new system, although some critics say the plan has been watered down so much that it would be far less effective than the Chilean system. The Argentine plan, which won final approval last week in the Senate, will automatically switch all workers to individual retirement accounts starting next year except those who choose to stay in the government pension system.

* Government studies in Bolivia have produced a detailed plan for a system similar to Chile’s. The new administration of President Gonzalo Sanchez de Lozada is expected to shepherd a bill through Congress.

* Paraguay’s new president, Juan Carlos Wasmosy, also has promised to privatize the pension system, but technical studies still need to be done.

* Brazilian authorities have begun studies and have shown interest in the Chilean system, as have officials and private groups in Venezuela, El Salvador and other countries of Latin America.


In some countries, authorities are considering a mixed system, in which privately administered pension funds would be designed to supplement reformed government social security programs. In other countries, a system like Chile’s would be difficult to introduce without other major economic reforms.

“It’s not very well understood that you need quite a number of conditions to produce good results, to pay good pensions,” said Gunther Held, an expert on pension systems with the Santiago-based U.N. Economic Commission for Latin America and the Caribbean.

Some of those conditions include monetary stability with low rates of inflation, a solvent public sector that can continue paying pensions earned under the old system and a growing private capital market that can absorb investment by the new system.

Held emphasized that to meet such conditions in many Latin American countries, the switch to a privately run pension program would need to be part of a broad economic restructuring project.


“That is actually our main message,” Held said. “This is not an isolated reform. Pension reform is seen as part of a larger reform toward a market economy structure.”

And even in Chile, the new pension system still is far from perfect.

“I’m not doing well,” complained Rudelinda Alvarez, 50, a nursing assistant. Standing outside the offices of a Santiago fund administrator, she said her account has grown too little since she entered the system in 1987.

“I am thinking of changing to another AFP, because I’m not advancing at all,” she said. “I am very dissatisfied.”


Margozzini, of the Assn. of Pension Fund Administrators, said switches from one company to another have reached an annual level of 800,000.

“That’s a monstrous figure,” he said. But he said that proposals to limit such switching will lower costs and commissions.

Pension Solution

Chile’s privately administered pension system has yielded handsome earnings for millions since it was lanched in 1981.


* Growth in Total Funds

In billions of U.S. dollars as of December of each year.

May 1993: $12,541

* Real Annual Yields (Adjusted for inflation)


* Investments Held by Chilean Pension Fund (As of May 31, 1993)

Central bank and treasury bonds: 41.5%

Bank deposits and bonds: 11.7%

Mortgage securities: 14.2%


Corporate bonds and debentures: 9.1%

Common stock: 23.2%

Shares in investment funds: 0.2%

Foreign investments: 0.1%


Source: Assn. of Pension Fund Administrators