Changing demographics as a result of aging populations and the consequent need to reform pension systems will be among Latin America’s biggest challenges in the coming decades, Fernando Larraín, the director of the AFP Association of Chile, a private organization that includes all pension managers in the country, said April 11 during an event at the Inter-American Dialogue. Chile’s pension system is currently under review in Congress, with the financial committee of the lower chamber discussing President Sebastián Piñera’s proposed reform. However, the current legislation does not address some of the most critical issues of the future, said Larraín. “It’s a major problem for policymakers this century—it’s an issue of importance on the scale of climate change,” Larraín said after the event.
Chile’s current pension system, in place since 1980, has been seen as a model for governments in Latin America and elsewhere. It consists of three pillars—a tax-financed solidarity pillar that provides a safety net for Chile’s poorest 60 percent, a mandatory individual contribution pillar and a voluntary pillar. It has among the highest participation rates in Latin American pension systems, with around 70 percent of Chileans paying into it, according to Olivia Mitchell, an economist at the University of Pennsylvania, who also spoke at the event.
Yet benefit payouts have been lower than expected, causing discontent among many Chileans. Several reasons can explain this, Mitchell said, including relatively low contribution amounts and large gaps in between workers’ contributions, as the formality of their work may vary throughout the years. Among other factors, an increase in life expectancy and higher GDP per capita have made Chile a more developed country, while the parameters of the pension system, including the retirement age, remain rooted in 1980s demographics, said Larraín. Chile needs more productive workers to pay into the system, Mitchell said. “We’ve got to invest in financial literacy, reduce fees, and we’re going to have to save a lot more,” she added.
Piñera’s administration has proposed changes to tackle these challenges, including raising employers’ contributions to individual accounts to 4 percent of salary as well as increasing government contributions to a pooled fund. His overhaul focuses on substantially strengthening the solidarity pillar and includes partial lump-sum incentives to deter retirement and encourage contributions past age 60, Mitchell said. The reform debate has stalled on several points, including which entities would manage the increase in employers’ contributions, the role of the state and on resolving short-term problems, such as current retirees who have not accrued substantial benefits over time.
World Bank economist Truman Packard said at the event that debates about Chile’s pension system have focused on the wrong things. Instead of debating whether the system should be privately or publicly managed, or whether it should revert to a pay-as-you-go model, Chileans should focus on finding the best balance between risk pooling and individual benefits, the mandatory versus voluntary aspects of contributions and the benefits a centralized or decentralized system. Most of all, governments should be transparent about the replacement rates that defined contribution systems can yield, he said, which could help prevent future discontent and the potential for social unrest.
“Being honest about what can be achieved from a defined contribution plan is first and foremost,” Packard said. “Because then people say I’m contributing into something that has credibility. But if it starts out as a false promise … then all you’re doing is creating problems down the road.”
The Latin America Advisor features Q&A with leaders in politics, economics, and finance every business day. The publication is available to members of the Dialogue’s Corporate Program and others by subscription.