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A Personal Burden

Chile switched to a privatized pension system nearly 25 years ago, and millions of workers still fall through the cracks

By Marla Dickerson
Times Staff Writer

February 13, 2005

Weary from decades of working nights and weekends at a public hospital, nursing assistant Inelia Pardo Acevedo recently retired.

But the 64-year-old plans to look for a part-time job to pad the nest egg in her personal retirement account. The $225 a month she draws under Chile's privatized system doesn't stretch far. And what galls her is that colleagues who stuck with traditional pension plans get three times as much, guaranteed for the rest of their lives.

The government "painted this wonderful picture of private accounts," Pardo said. "They fooled me. They fooled us all."

As the Social Security debate heats up in the United States, many are looking south to Chile, where nearly a quarter century of experience with privatization hasn't settled the question of how to best construct an old-age safety net.

In 1981, Chile scrapped a pay-as-you-go system similar to the one in the U.S., in which the contributions of active workers were used to pay pensions of existing retirees. Instead, many Chileans began funneling 10% of their wages into professionally managed private accounts that allowed them to invest in stocks and bonds.

Nearly two dozen nations, including Britain, Argentina, Sweden and Singapore, have since adopted some version of Chile's plan. President Bush has lauded it as "a great example" of why Americans should be allowed to divert a portion of their Social Security contributions to personal accounts.

By some measures, the switch has been a resounding success. Private retirement savings have fueled Chile's capital markets, boosted the nation's economic growth and restored fairness to a system that once doled out benefits based on workers' political clout.

Chileans have tucked away more than $60 billion into their own accounts, the equivalent of two-thirds of the nation's gross domestic product. Average returns on those investments have topped 10%.

But high management fees have trimmed retirees' payouts substantially, while big holes remain in Chile's safety net. An estimated half of the nation's workers aren't saving enough to qualify for even a minimum government pension of about $134 a month. The transition has been brutal for the first wave of retirees such as Pardo, many of whom made the change too late in their careers to reap the full benefits of compound interest.

And although many pension experts laud individual accounts as the only way to assure long-term solvency, opinion polls show that most Chileans are skeptical of their pioneering reform.

"Millions of Chileans would go back to the old system if they could," said Manuel Riesco, director of the National Center for Alternative Development Studies, a Santiago think tank critical of Chile's reform.

Even supporters of Chile's model say that proponents of U.S. privatization may be raising expectations too high. Economists doubt American workers would see such lofty investment returns, or that the economy would get the same lift, in part because the U.S. appears unwilling to swallow the tough fiscal medicine that Chile endured to make the transition.

Guillermo Larrain Rios, who heads the regulatory body that oversees Chile's pension system, marveled at a recent article by a U.S. newspaper columnist who predicted that privatization would reform democracy and even the character of the American electorate.

"It is irresponsible to ask a pension reform to do all that," Larrain said. "Our reform was a good one. But it has limits."

The U.S. faces the same demographic pressures that propelled Chile's bold move. The Andean nation, however, began its experiment with privatization at a very different point in its development. Chile was a military dictatorship saddled with a hodgepodge of rickety, disparate pension plans when leader Gen. Augusto Pinochet allowed U.S.-educated Chilean economist Jose Piñera to construct a single program centered on private accounts.

All salaried employees entering the labor force after the program's inception in 1981 were required to enroll in the new system. Meanwhile, the government enticed most workers in the old plans to switch. It did that by dangling carrots such as lower withholding taxes, by providing them with so-called recognition bonds to give them credit for their previous contributions, and by offering them a chance to earn fat returns in the stock and bond markets.

"They promised us gold and riches," said Maria Quintanilla Carvajal, 63, a government secretary who rued the day that she left her guaranteed-benefit plan to invest on her own behalf.

Quintanilla and hundreds of thousands of Chileans approaching retirement age are finding that they would have been better off remaining in the old system. The gap stems mainly from the way some workers' recognition bonds were calculated, resulting in lower benefits at retirement. Workers have formed an advocacy group that is pressuring the government to compensate them for their so-called pension damage.

While most everyone agrees that these workers were shortchanged, experts say the culprit is Pinochet-era policies that stiffed them on the conversion, rather than a problem with private accounts, which have delivered solid returns.

Some argue that the true performance of the reformed system can't be evaluated until after 2020, when the first generation of workers to have spent their entire careers contributing to their own accounts begins to retire. Still, a survey conducted last year showed that more than half of those Chileans polled had little or no confidence in the privatized system.

Nieves Stuardo Arevalo is among them. At first blush, the 48-year-old social worker would seem to have every reason for optimism. She entered the workforce the same year as pension reform was born and has contributed steadily ever since. The $52,000 she has saved is a small fortune in a nation with annual per capita income of about $4,500, and she is only half-way through her working life. But the lack of a fixed lifetime benefit spooks her.

"It's really not much" considering how long people live these days, she said of her nest egg. "It worries me."

Stuardo is one of the lucky ones. The Chilean government guarantees a so-called minimum pension to workers who have contributed to the system for at least 20 years in the event they outlive their savings. That figure ranges from $134 to $153 a month depending on the retiree's age.

The trouble, critics say, is that nearly half the workforce isn't saving enough to qualify for even that modest sum. Participation is purely voluntary for the self-employed and those toiling in Chile's sizable underground economy, so few bother. Many other workers move in and out of the formal economy on short-term contracts, and thus contribute to their investment accounts only sporadically. Nearly 60% of Chileans enrolled in the system have accumulated less than $3,500.

Millions of workers fell through the gaps of the old system as well. But some studies have concluded that the problem has worsened under privatization. That has some analysts concerned about a wave of elderly poor swamping Chile's welfare rolls down the road.

"There is going to be tremendous pressure … to raise taxes," said Andras Uthoff, an economist at the United Nations Economic Commission for Latin America and the Caribbean in Santiago.

To be sure, the coverage gap bedeviling Chile's privatized system wouldn't be a major issue for the U.S., where the underground economy is smaller and the self-employed are already paying into Social Security.

And the U.S. would probably do better on costs. The Chilean pension market is controlled by just six management companies, whose fees and profits have been criticized as excessive. An average Chilean worker who retired in 2000 would have seen half of his contributions eaten up by fees, according to a recent World Bank study.

Pension experts believe Uncle Sam would be able to demand much better terms given its clout and the competitiveness of U.S. financial markets.

Although the U.S. can avoid some of the biggest pitfalls of Chile's privatization, it isn't likely to experience the same benefits. For example, privatization helped Chile develop its fledgling capital markets, but America's are already the most sophisticated in the world. In addition, Chilean investors profited from some uncanny market timing that brought them huge gains in both the bond and stock markets early on, a situation that appears unlikely to repeat itself in the U.S.

Those banking on a Chilean-style economic growth spurt are bound to be disappointed as well. Pension privatization helped Chile boost its national savings rate and freed up capital to fuel the private sector, but only because the nation ran big budget surpluses to help pay for the transition. Those and a slew of other changes to open Chile's economy have resulted in average GDP growth exceeding 5.5% annually since 1990.

In contrast, the U.S. is burdened with huge budget deficits. And the Bush administration has proposed borrowing even more to maintain existing Social Security promises to retirees if his plan is approved and younger workers begin channeling a portion of their contributions to their own personal accounts.

The end result, said Chilean economist Joseph Ramos, is that the U.S. will get no net increase in its national savings rate, "so you're not going to get the powerful growth effect we saw in Chile."

While privatization may have been good for Chile's economy, workers like Quintanilla say it hasn't done much for them.

"I'll probably have to work the rest of my life now," she said. "I'm angry."

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Social insecurity

In any given month, only about half of Chileans with personal retirement accounts contribute to them. And most participants had accumulated less than $3,500 as of September 2004.

Chilean workers' participation in private accounts
Not contributing: 51%
Contributing: 49%

Breakdown of private accounts by size
$3,481 or less: 59%
$3,482 to 8,702: 19%
$8,703 to $17,403: 11%
More than $17,404: 11%

Source: Chile's Superintendent of Pension Fund Administrators
Los Angeles Times
http://www.latimes.com/business/la-fi-chile13feb13,0,5035829.story?coll=la-home-business

Copyright 2005 Los Angeles Times

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Sweden’s Choice

By Susan Stranahan and Carol Simons

February 2005

Sweden dramatically altered its pension law in 1999. Similar to U.S. Social Security, Sweden’s old system paid out a defined benefit based on salary and years of employment, using contributions from current workers to support retirees.

The new plan includes mandatory individual accounts. Of the 18.5 percent payroll tax that workers set aside for retirement, 16 percent goes to a defined benefit program. The other 2.5 percent must be put into individual investment accounts. Workers choose from some 650 funds or accept the government-managed default fund.

The government launched the private account plan with a massive public relations campaign that encouraged participants to select their own portfolios, says Annika Sundén, an economist at the Center for Retirement Research at Boston College. "There was tremendous emphasis that ‘now you have the chance to affect your benefit in a positive way.’ People were very enthusiastic."

Then the market dropped. "Most people lost money and have not recuperated," Sundén says. "The default fund performed better than the average portfolio, and people started questioning the wisdom of managing their own pension funds." However, she says, during the last six months, the default fund returned 7.2 percent, outperforming the defined benefit program.

When the plan began, 68 percent of participants chose their own portfolio. In 2001 that number decreased to 20 percent of new participants. Last year it dropped to 10 percent. "The experience taught people that the best thing to do is not do anything, even though this goes against the whole idea of choice in the first place," Sundén says.

Privatization Bombed in Britain | Privatization Bombed in Britain

Privatization Bombed in Britain

Now they’re looking for a way out

By Norma Cohen

February 2005

The president’s bold new plan to partly privatize Social Security, which has many on Wall Street salivating, is not new at all. In fact, it looks remarkably similar to Britain’s 25-year experiment with pension reform, which included substituting private investment accounts for a portion of government pension benefits. It is an experiment now regarded as a dismal failure.

In short, the British public—and government—lost money. They learned the hard way that the costs of administering private accounts can affect returns and reduce the size of a retirement pot by up to 30 percent.

Unusual for Britain, there is now an emerging consensus among labor and business, liberals and conservatives, that the government pension system—the United Kingdom’s counterpart to Social Security—needs serious reform. Recommendations for an overhaul are expected after the elections in May.

One reason for the intense attention is that the U.K.’s traditionally generous system of employer-sponsored pensions is collapsing, exposing the weakness of the government pension system just as more retirees are being forced to rely on it.

So while the United States is looking at privatization, British experts are eyeing the more generous and simpler U.S. Social Security system.

David Willetts, a Conservative member of Parliament whose intellectual acumen has earned him the nickname "Two Brains," is one admirer of the American system. "I like the way they distinguish between Social Security and means-tested welfare," he says. "They have higher Social Security benefits to keep elderly people off welfare."

The Confederation of British Industry (CBI), the functional equivalent of the U.S. Chamber of Commerce, last year made a surprising call for a higher state retirement benefit to be paid for by raising taxes and the retirement age, from 65 to 70. The maximum payout for a single person at age 65 is around 4,200 pounds per year, or about $8,000, although British retirees do not pay for health care or prescription drugs. (In the United States the average annual Social Security benefit is $11,000.)

"Not many people would think that Britain, with its emphasis on social programs, would be less generous than the United States," says Anthony Thompson, head of pensions policy at CBI. "We were surprised ourselves."

CBI’s U-turn on pension policy stems partly from self-interest. Government spending on state pensions has been low, and workplace pensions have traditionally been generous. Now employers are straining under the burden and want the government to play a greater role.

The National Association of Pension Funds, an employers’ group, agrees. It’s "actually cheaper for the state to carry the risk," says Chief Executive Christine Farnish, adding that in looking for a system that offers the best combination of modest guaranteed retirement benefits and low cost, the U.S. Social Security program seems the best model. "It doesn’t have to make a profit, and it delivers efficiencies of scale that most companies would die for," she says.

The story of how Britain’s retirement system reached its current crisis began 25 years ago, when Margaret Thatcher’s Conservatives swept to power on a tide of national disgust at high unemployment, high taxes and poor services. Though her pension reforms were ideological, they were also pragmatic: tax cuts could not be delivered without some cuts in benefits. So the first reform, passed in 1979, was to link increases in state pension benefits to prices instead of wages, something the Bush administration is considering.

Ros Altmann, a Harvard-trained specialist in pension economics who is on the board of the London School of Economics, says that at the time neither the voting public nor most politicians understood the true implications of altering that link. But advocates for the change knew what they were doing: they were slowing the rate of growth in pension increases, because wages have historically risen by 1.5 to 2 percentage points ahead of inflation each year.

"Two percent doesn’t sound like much," Altmann says. "But with the effects of compound interest, that amounts to nearly a 50 percent reduction in the value of benefits over 30 to 40 years."

Thatcher’s second reform was based on ideology. The Thatcherites wanted a home-owning, share-owning nation, something similarly expressed by the Bush administration. The idea was to replace the so-called "nanny state," in which government looked out for people, with a state in which everyone would have to look out for themselves.

In 1986 the Thatcher government offered to let people divert part of their social security taxes into a personal investment account similar to a 401(k). For help in designing the plan, the government turned to the insurance industry, the main source of long-term investment products in Britain. By assigning this role to the industry that would benefit most, the government had in effect asked the fox to design the chicken coop.

The competition to sell pension investment products to the public was intense. Products were numerous and complicated, and few people could understand them. Fees and costs often were not fully disclosed by agents, who could pocket a portion of the first few years’ sales. Rules were poorly designed and rarely enforced.

At the start, the public response was wildly positive, and the program was hailed as one of the triumphs of the Tory government. By 1991 more than 4 million Britons had signed up, attracted by the promise of generous tax incentives.

It soon became apparent that all was not well. More money was being lost by taxes being diverted to private accounts than the government would have paid out in entitlements. Gone was a 1.58 billion-pound surplus in the National Insurance Fund.

Worst of all, many workers who switched from good company pension plans to private investments ended up with a poorer retirement. Since the private investments required upfront charges and commissions, plus annual administration fees, there was often little on which investment returns could accumulate. People began to realize that they could no longer be certain that investment returns would equal what they had given up by switching to private accounts. Later, after the stock market crash in 2001, even the insurance industry began advising customers to return to the government system.

In 2004 alone, 500,000 people abandoned private pensions and moved back into the traditional government plan. Another 250,000 are expected to move back this year.

In dealing with its problems, the U.K. Pensions Commission has concluded that there are only four possible solutions: cut state retirement benefits, increase taxes, increase personal savings or delay retirement. Noting that there is no political support for the first choice, the commission determined that each of the three other choices, on its own, would be too painful and that only some combination could work.

According to U.K. Pension Commission Chairman Adair Turner, a vice president of Merrill Lynch in London and the former director general of the U.K.’s biggest business lobbying group: "There are no other choices."

Norma Cohen covers pension issues for the Financial Times in London.

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