Chile's next generation pension reform.

Introduction In 1981, Chile introduced a new system of privately managed individual accounts, also called capitalization, replacing its public pay-as-you-go pension system (PAYG). Since 1990, 10 other countries in the region have adopted some form of what has become known as the "Chilean model": Argentina (1994), Bolivia (1997), Colombia (1993), Costa Rica (1995), Dominican Republic (2003), El Salvador (1998), Mexico (1997), Panama (2008), Peru (1993), and Uruguay (1996). Over the years, Chile made some major changes to its capitalization system, such as liberalizing investment rules and increasing the type and number of pension funds that a pension fund management company (AFP) must offer its account holders. However, despite these and other changes, a number of policy challenges remain unresolved including large groups of workers who are not covered and irregular worker participation rates, both of which could lead to inadequate retirement benefits. Also, according to international standards, the administrative fees the AFPs are charging account holders are high and could significantly decrease the size of a worker's pension. Law 20.255 enacted in March 2008 overhauls the individual accounts system and incorporates previously uncovered groups. The law includes measures to provide adequate benefits to a larger portion of the population, ensure more gender equity, encourage greater competition in the pension fund industry, improve the AFP's management of financial risk to increase the return on the workers' contributions, change the rules for financing survivors and disability insurance, establish more opportunities for voluntary savings, and improve financial literacy. This paper presents a brief overview of Chile's individual account system and the major changes made to it prior to 2007. The paper then focuses on the major policy challenges that have led to additional reforms and summarizes the provisions of Law 20.255 that address many of the system's shortcomings. System Overview In 1981, Chile implemented its mandatory individual retirement account system allowing workers to choose between the public PAYG and the privately managed system, except those workers eligible to retire within 5 years. Since December 31, 1982, new entrants to the labor force must join the new capitalization system and set up individual accounts with the AFP of their choice. The public PAYG system is being phased out as the number of beneficiaries declines and is expected to close by 2050. Workers must contribute 10 percent of their monthly earnings, up to a maximum of 60 Unidades de Fomento (UFs) (US$2,427) per month to their individual accounts.1 Each month AFPs charge contributors an administrative fee and a premium for survivors and disability insurance: as of September 2008, an average of 0.99 percent of earnings and 1.71 percent of earnings, respectively (SUPEN 2007-2008). Workers are free to choose any AFP and may change from one AFP to another at any time. Workers may also make voluntary contributions to their individual accounts and to separate, voluntary retirement savings accounts. Employers are not required to contribute to their employees' accounts and participation is voluntary for the self-employed. An AFP is a private company whose functions are limited to managing pension funds and providing and administering certain pension benefits. AFPs collect workers' contributions, credit them to the workers' accounts, and invest these monies according to regulations set by the government. AFPs also contract with an insurance company to provide survivors and disability insurance for their members. Until July 2008, the Superintendent of Pension Fund Management Companies (SAFP), an autonomous government agency that was associated with the minister of labor and social security, oversaw and licensed AFPs. At the normal retirement age (65 for men and 60 for women), workers can use the balance in their individual accounts to do one of the following:2 * Purchase an immediate annuity to provide the retiree with lifetime benefits. …