Rodrigo ValdésSchool of Government

Catholic University of Chile

Perspective #1

2Source: SBIF, SP and SVS.

Financial assets(as percentage of GDP)

0

40

80

120

160

200

240

1990 2000 2005 2010 2016

Investment funds Mutual funds

Insurance companies Pension funds

Bank loans to private sector

Financial assets, selected countries*(2013, as percentage of GDP)

0 60 120 180 240 300 360 420

Peru

Mexico

Colombia

Brazil

Chile

Australia

Sweden

UnitedStates

* Includes pension fund assets, mutual fund assets, insurance companies assets and bank loans to private sector.Source: Financial Markey Indicators, Word Bank.

3

0

1

2

3

4

5

1960-1980 1981-2011

Initial growth Pension reform Unexplained

Perspective #1 (cont’d)

Source: Corbo and Schmidt-Hebbel (2003)

4

Perspective #2

Forecast, as of 2000, by the Industry Association:

Source: El Mercurio

Perspective #3

Median replacement rate for actual retirees 2007-2014 (with respect to their last wage):

• Self-financed: 20%• Total (with government top up): 40%

July 2017 average photo of private managers (AFP) affiliates:• Contributors wage = $ 1,143• Self-financed pension = $ 329• Total pension = $ 354

5

Perspective #4

6

7

Agenda

1980 Reform – the system core

• Objective: consumption smoothing

• Defined contribution = 10% (employee)

• Individual retirement accounts

• Managed by privately-managed for-profit regulated-institutions

• Transition from old PAYG still ongoing

• Private annuity market or regulated withdrawal during retirement (65 men, 60 women)

8

2001 Improvements

• Voluntary pillar with tax-deferral benefits

• Objective: complement mandatory savings

• Limited use given tax rates

• People to choose between 5 funds

• Objective: increase risk-return possibilities

• ≈50% go with the default path

• A few try to time the market

9

2008 Reform – Solidarity pillar

• General taxes-funded “universal” top-up

• Objective: alleviate poverty

• Means-test access to poorest 60%

10

45°

Self-financed

Totalpension

MinimumPension($160)

$470

11

Agenda

0 to 3 4 to 17 18 to 29 30 to 44 45 to 59 60 +

2006 39,6 38,5 24,5 29,2 22,5 22,8

2009 37,2 34,4 23,4 25,0 20,5 16,5

2011 34,4 32,5 19,9 22,3 16,8 13,7

2013 23,2 21,6 13,3 13,7 11,2 8,4

2015 19,5 17,8 11,0 11,3 9,0 6,6

Source: MDS, Encuesta Casen 1996-2015.

Population in poverty

Solidarity pillar has been quite effective

12

-71%˜-50%

Median replacement rate*

Self-financed TotalG

ende

r Women 12% 29%

Men 33% 52%

Total 20% 40%

Qui

ntile

1 14% 110%

2 10% 55%

3 18% 41%

4 26% 35%

5 26% 27%

Total 20% 40%

Source: Superintendencia de Pensiones.(*) With respect to last wage.

Larger gaps: women and middle class

13

Contributing years are critical, solidarity pillar concentrates in low density

14

0

10

20

30

40

50

0-1 1-5 6-10 11-15 16-20 21-25 26-30 30+

Years contributing

Self-financed

Median Mean

Women 45% 48%

Men 64% 58%

Total 54% 52%

Note: Based on new reterees between 2007 and 2014.Source: Superintendencia de Pensiones.

Contributing densities are a significant problem (watch for incentives)

Contributing periods / periods since affiliation

15

Self-employed barely participate

16Source: Superintendencia de Pensiones.

Contributors / Workers by type

0

0.2

0.4

0.6

0.8

1

Salaried

Self-employed

17Source: CELADE, Revisión 2015.

Expected Additional Years at 65

As everywhere…A longer expected life

11.713.613.2

16.117.6

20.919.5

22.721.824.6

0

5

10

15

20

25

30

1950-1951 1980-1981 2015-2016 2030-2031 2050-2051

Men Women

Source: Superintendencia de Pensiones.

Annual Real Return, Intermediate Portfolio (%)

As everywhere…Lower rates of return

18

-20

-15

-10

-5

0

5

10

15

20

25

30

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

80´: 12,3% 90´: 10,4%00´: 6,3% 10´: 4,0%

Source: Superintendencia de Pensiones.

AFP Return on Equity (%)

Excess profits?

19

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Need to increase the contribution rate… a no brainer

20Source: Pensions at a Glance, 2015, REO, FMI 2017.

Worker Employer Total

Chile 11,2 1,4 12,6

OECD 6,7 10,9 17,6

LATAM 7,1 7,1 14,2

Mandatory contribution rate (% of wages)

21

Agenda

Key principles

• Improve DC pensions.

• Increase savings for retirement.

• Introduce degrees of solidarity and risk-sharing in the DC system (income, gender).

• Maintain the CD system funding separated from the solidarity pillar’s.

• Insure sustainability and preserve incentives.

• Improve the system social /political acceptance.

22

Key economic and political restrictions

• Very limited fiscal money.

• Pensions should increase now.

• Current private system should not receive more money, nor reduce its importance.

23

Source: Ministerio de Hacienda.

Highly Independent

PublicBoard

Personal Accounts3%

2%

New Colective Savings System

24

New 5% employer contribution

Women’s top-up

Intergenerational transfers

Intragenerational savings

Source: Ministerio de Hacienda.

Highly Independent

PublicBoard

Personal Accounts3%

2%

New Colective Savings System

25

New 5% employer contribution

Women’s top-up

Intergenerational transfers

Intragenerational savings

Incentive to delay retirement(compensate longer expected life)

Top-up to Increase of self-financed pension in at least 20%

Annual redistribution among contributors (per capita)

Use of new 5% contribution (with initial transition)

26Fuente: Dirección de Presupuestos.

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

5%

2019

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

2052

2055

2058

2061

2064

2067

2070

2073

2076

2079

Effect in pension, men, median income, different retirement years

27

0%

10%

20%

30%

40%

50%

60%

2019

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

2052

2055

2058

2061

2064

2067

Ahorro Personal Intergeneracional Estado Estacionario

Effect in pension, women, median income, different retirement years

28

0%

10%

20%

30%

40%

50%

60%

70%

2019

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

2052

2055

2058

2061

2064

2067

Ahorro Personal Intergeneracional

Bono Mujer Mediana Estado Estacionario

29

Agenda

Other proposals

• From the center-right opposition• Increase the employer contribution by 4% and save it in the

current AFP system

• Increase the solidarity pillar (especially for the eldest)

• From the left opposition • Move to a PAYG system

• AFP system with lower contributions, maintaining private property over current savings

• From center-left presidential candidates• Small tweaks to the government proposal

• Increase the solidarity pillar

30

31

Agenda

Final remarks, some questions

• Is politically sustainable a system with mandatory individual savings and a tax-funded minimum safety net only?

• Probably not. Need more risk-sharing, including for the middle class.

• Government action is not seen as part of the pension system.

• Is politically sustainable a system where only private, for-profit, entities manage pension savings?

• Perhaps, but watch out to become too much “Wall Street” and too little “Social Security”.

• Excess profits and excess power are problematic.

32

Final remarks, some questions

• Critical to differentiate consumption smoothing from poverty alleviation objectives:

• Proportional benefits (rather than focused, progressive) are counterintuitive and unlikely to be funded out of taxes.

• When contribution densities are a key problem, watch out for wrong incentives.

• Likely outcome? • Unclear at this stage. We will probably see compromises

• We will see more reforms. Pensions systems have to adapt.

33

Rodrigo ValdésSchool of Government

Catholic University of Chile