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Benefits and Pensions MonitorRevisiting Latin America’s Pension SystemBy: Jim Helik It has now been 25 years since Chile developed what was seen as revolutionary at the time – instituting a national Defined Contribution pension system, following the collapse of the previous government-run system. In this system, workers must contribute 10 per cent of their pay to a private savings account, with many options available as to the provider and the investments that are allowed. Elements of this DC system have since been put in place in a dozen other Latin American countries. So what have we learned in the past quarter century? Central Dilemmas There are many ways to judge a national pension system, ranging from measuring how savings have accrued to the individual, or seeing how broad the coverage of a national system is. One system for analysis is found in a 1994 publication of the World Bank, titled Averting the Old Age Crisis. In this report, the World Bank laid out what it termed the three central dilemmas of any pension privatization scheme, which apply equally to Latin America as they do to Canada and any other country. These questions are:
All of these are critical questions, so let’s see how Chile stacks up. The Chilean system has met the latter two critical points. Overall, the system has provided the average saver with a 10 per cent real rate of return since inception. Local financial markets have developed so that there are a range of investment, insurance, and annuity choices and providers. C o m b i n e d with banking and financial sector reforms begun in the 1980s, the adoption of new and improved accounting and reporting standards, and restructuring of the insurance industry, the system is mostly successful – especially as compared with the performance and confidence people placed in the old system.
Financial Decisions Yet there are concerns, as with any DC plan, around the first point, that contributors may not be making the best financial decisions. Some are making the decision not to participate at all. In Chile, workers in the wage and salary ‘formal’ sector are required to pay into the pension system, while selfemployed workers are not required to do so, though they may pay voluntarily. Not surprisingly, savings of self-employed workers are about one-third of those of the ‘formal’ sector. And, despite the fact that the system has been up and running for more than two decades, financial literacy remains very low. In a recent survey, a majority of plan members in Chile did not know their contribution rate (which has been fixed at 10 per cent since the plan began), over half did not know their pension balance amounts, and 90 per cent of the plan’s participants did not know how commissions, fees, and other charges are structured in their plan. The last two critical issues are concerns in other countries, such as Argentina, where the ‘firewall’ between private pension plans (largely set up following the Chilean DC system) has largely disappeared. As the country’s economy hit crisis after crisis, a complicated ‘asset swap’ was undertaken, where private pension account balances were ‘borrowed’ to bail out the rest of the economy. Other countries have restricted individuals to holding only government bonds in their pension accounts which, while giving the government a new source of funding, is seldom in the best interests of individual investors. The argument has been made that from a fiduciary point of view, in countries with a weak domestic equity environment, government bonds may be the most prudent investment for individuals. But when does fiduciary duty end, and government meddling in private decision-making begin? Larger Point And this leads to the larger point, the three dilemmas are still valid and unresolved – and perhaps unresolvable. Personal economic responsibility is good, but what about those who make the wrong choices? When does necessary regulatory oversight become too intrusive, and when does ‘government help’ end up negating the whole idea behind a DC plan? Until there is a consensus around these issues, we might be able to say that a private pension system is better than what was there before, but we are still left wondering where to go from here. Jim Helik is co-author of ‘Energy Markets Risk Management,’a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
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