regime on providers of retirement products to minimize the bankruptcy risk faced by pensioners. It has also introduced state guarantees to protect pensioners against provider insolvency as well as aberrant behavior.

The capital regulation of pension companies includes a stipulated minimum capital that rises with the number of beneficiaries but is generally low and does not act as a barrier to entry. For an APF with 10,000 members or more, the minimum capital amounts to 20,000 UF or about 850,000 USD. A more stringent capital requirement is the obligatory reserve ( _encaje_ ) of 1 percent of the value of assets under management.<sup>38</sup> The _encaje_ is required to be invested in units of the fund in order to ensure an alignment of interests between the pension companies and their members. The _encaje_ is designed to support the minimum relative rate of return guarantee that Chilean AFPs are required to observe. The guarantee initially specified that the average real rate of return of any company could not be lower than 50 percent of the average of all AFPs or the average return minus 2 percent over the preceding 12 months. In 2002, the period of calculation was extended to 36 months and was applied to each of the five funds that AFPs were then required to offer, while the spread below the average was differentiated by type of fund, being higher for the more volatile A and B funds (4 percent) and lower for more conservative funds (2 percent). The _encaje_ and the minimum relative return guarantee are intended to protect workers from aberrant managers. They have been effective in forcing AFPs to stay close to the average of the industry. The guarantee has never been called.

AFPs do not suffer from any mismatching between their assets and liabilities because the value of liabilities is by definition equal to the value of assets. The only other capital regulation concerns the valuation of assets which are required to be marked-to-market. As most assets have to be invested in instruments that are traded on public markets, asset valuation is relatively straightforward, but challenges are arising with the valuation of instruments such as derivatives and private equity funds.

The capital regulation of life insurance companies is far more complex. Since long-term annuity business dominates the balance sheets of life insurers, the valuation of assets and liabilities and the regulation of any mismatches between them play a critical part in determining the capital adequacy of life insurers. Chile introduced the so-called CALCE reserve rule to regulate the asset/liability mismatches.

The first step in CALCE is to calculate the asset and liability cash flows for ten different maturity brackets. The asset flows depend on the characteristics of particular instruments but the liability flows need to be expressed in actuarial terms, allowing for the survival probabilities of the main and contingent beneficiaries. The life tables used for calculating the survival probabilities are specified by the regulators. They used to be based on data from the early 1980s (RV-85) but were replaced with the more up-to-date tables RV-04 in 2005. Insurance companies are free to use their own life tables for pricing annuities but have to use the standardized tables for the CALCE rule.

> 38 The _encaje_ was initially set equal to 5 percent of assets but this was found to be excessive and was quickly lowered to the current level

32