The privatization of Chile's pension plan has been a success for the government and fund mangers. But large questions loom about the effects on workers down the road.
After 18 years of privatization, Chile's pension fund managers have amassed $34 billion in pension assets, according to a report by the Cato Institute in Washington.
Chile made the move to privatize its pension assets in 1981. Since then, as many as 23 and as few as eight fund managers have run the pension assets for Chile's workers. Right now, the Cato report says, 95% of Chile's workers have their own pension savings accounts in the the defined contribution plan.
The plan has seen an average annual real rate of return of close to 11.3% since its inception. The new system has "allowed workers to retire with better and more secure pensions," according to its author, L. Jacob Rodriguez, an assistant director of the project on global economic liberty at the Washington-based think tank.
Currently, nine managers run the assets, which have grown to more than 40% of the country's gross domestic product. Each manager differs slightly in its asset allocation, but each runs about 80% of its portfolio in Chilean government and corporate bonds.
The managers are "specialized, single-purpose private companies called administradoras de fondos de pensiones," according to the report, "Chile's Private Pension System at 18: Its Current State and Future Challenges."
Before the privatization, Chile had a long history of government-run pension plans. In 1924, it was the first country in the Western Hemisphere to have a state-run pension plan when the government introduced a retirement fund for manual workers. The fund was the predecessor of the Servicio de Seguro Social, or the social security service, which was the main retirement system for workers until 1981.
Out of control
But by the 1970s, the pension plans had sprawled out of control. Two thousand social security laws existed in Chile. Contribution rates had risen to 26% from 16% of total payroll, according to the report.
Now, workers deposit 10% of their wages in their individual pension savings accounts. They also select the AFP of their choice.
The plan has been a success for the government but not necessarily the pensioners, others argue.
"The contribution and payout structure, as well as fees and annuity markets, penalize workers," said Teresa Ghilarducci, a professor of economics at University of Notre Dame in Notre Dame, Ind.
"Half the workers with accounts don't contribute," she said. When they retire, they will "come to the annuity market with a lower amount of money."
And many workers often don't contribute to their accounts -- and therefore don't accrue savings -- because they are paid off the books, she said.
Such "dormant" accounts pose a problem, according to a report by Milliman & Robertson, Seattle.
"Over time, a large percentage of individual accounts becomes 'dormant,' with no contributions flowing into them due to unemployment, self-employment, leave from the work force during child-bearing years for some women, and irregular collections," the report says. The consultant estimates that dormant accounts represent nearly 40% of the system.
Big business benefits
The timing of creating the new pension system helped stimulate big business in Chile, Ms. Ghilarducci said.
The privatization of Chile's retirement plan helped create demand for the equity and fixed-income issues for the array of state companies the government also was privatizing in the early 1980s, Ms. Ghilarducci said.
Pensioners invested in funds that in turn invested overwhelmingly in Chile's stock and bond markets, she said. "The investments aren't risky," she acknowledged. "Corporations needed to issue debt."
Chile's government also was politically motivated to make the change. Ms. Ghilarducci said that -- at the time -- government officials claimed the private defined contribution system would help stop communism in Chile because it would move workers' interests into alignment with the companies'.
In the end, the plan is less than perfect for Chile's workers, some believe. It's next-to-impossible to make accurate predictions what workers eventually will receive, she said.
In addition, the country's workers must contribute for 20 years to qualify for the government-promised payout if the scheme collapses, she said.
The government has promised long-term contributors pensions of two-thirds the minimum wage if a fund manager fails.
This potentially could place a tremendous burden on the government, she said.
"They traded the threat of short-term liabilities for the chance of longer term liabilities," she said.