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The Chilean Pension System: A Renewed View

The Chilean Pension System: A Renewed View. Guillermo Larrain Rios Superintendent of Pension Funds, President of AIOS Washington, February 2005. Chilean Pension Funds have grown steadily and impressively. Chilean Pension Funds have grown steadily and impressively.

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The Chilean Pension System: A Renewed View

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  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

  6. Macroeconomic impact of pension funds: estimates

  7. 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. S S’ Dt+DFP Dt 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

  10. Some institutional requisites for diversification • Fixed income: • Mortgage. • Corporate. • Variable Income • Corporate culture, accountability • Corporate governance • Minority shareholder´s rights • Inflation protection (Macro stability) • Investment opportunities • Contracts: stable judicial framework • Tax distortions minimized. • Risk classification… etc… • etc…

  11. 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.

  12. 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

  13. 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

  14. 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!

  15. Disbursement phase: • LIC • AFP • Accumulation phase: • AFP (P2) • Voluntary (P3) P1: Solidarity through State Endogenous problems: accumulation and disbursement

  16. Endogenous problems:competition 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 that´s 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.

  17. Reforming the reform 1: Multifondos • At the beginning there was only one portfolio • Strict regulation on limits • Minimum relative return

  18. 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

  19. Reforming the reform 1: Multifondos

  20. Reforming the reform 1: Multifondos • Herd amplified 5 times.

  21. Reforming the reform 2: The Scomp

  22. 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

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