CHILE'S BALLYHOOED PENSION SYSTEM HAS A DARK SIDE, EXPERTS SAY
By Jane Bussey Herald Business Writer
It is hard to rain on Chile's pension parade.
After all, the private pension fund system has been touted as one of the key factors in Chile's economic success, copied by a handful of Latin American countries and boosted as a model for the United States.
But a number of economists now caution that the system has its flaws, which Chileans are discovering, and it may not be suitable for industrialized countries that have well-developed social security systems with strong future obligations.
Backers of the program, implemented by former Chilean dictator Augusto Pinochet in 1981 to take the place of a bankrupt government pension plan, are devoted to the system of privately run retirement accounts.
``I am an apostle,'' said Julio Bustamante, superintendent for the Administrators of Pension Funds, who sings the praises of the pension system at conferences in the United States and Latin America. ``The [funds] have been a deciding factor in the economic growth that Chile has had.'' Not everyone is so reverential about the system.
``That is the rosy side and that is true,'' said economist Manuel Riesco. ``But like everything in life, it has its opposite side.''
Riesco, who has analyzed pension funds, known as AFPs, for the Center for National Studies for Alternative Development in Santiago, cites the problems of the large upfront commissions earned by the fund management firms and the numbers of Chileans not covered by the system.
The pros and cons of Chile's pension system take on greater importance because ``privatizing'' Social Security is an idea proposed in the United States.
The architect of Chile's program, Jose Piñera, former labor minister under Pinochet, regularly addresses audiences in the United States, including one at the Biltmore Hotel in Miami this year, and lawmakers on Capitol Hill. He calls it ``this great crusade'' to replace Social Security with private retirement funds.
No one is saying Chile is not better off with a program that functions in place of a system that did not, but economists are more cautious in their appraisal.
``The success of the [Chilean] system has been exaggerated,'' said Thomas Macurdy, an economist at Stanford University. ``It was kind of easy to switch because there wasn't much value in it [the old system].''
Under the Chilean program, workers make monthly deposits into private retirement accounts, which are managed by eight management firms. The funds are available for withdrawals after workers reach a certain age, much like a 401(k) plan works in the United States. The older system is much like U.S. Social Security, known as ``pay-as-you-go;'' funds paid in by younger workers are used to pay for the benefits of retired workers. But in most of Latin America, high inflation and economic problems in the 1980s left these systems bankrupt, and citizens lost confidence that governments would provide them with any real benefits after retirement.
The U.S. Social Security system, which has had a surplus almost since its inception, invests its funds in U.S. Treasury bills. Chilean private pension funds invest almost 40 percent of their assets in government bonds, about 30 percent in financial instruments, and about 18 percent in companies traded on the Santiago stock exchange. Some 11.5 percent of the funds are invested in foreign stocks and bonds.
Macurdy, along with his Stanford colleague John Shoven, recently wrote a paper examining the economics of investing Social Security money in private securities instead of government bonds. The research concluded that this change amounts to an asset swap and does not increase national savings. Furthermore, retirement funds invested in the stock market would have lost money 20 percent to 25 percent of the time over the past two decades, according to the study.
``You don't increase your wealth by simply changing your portfolio,'' Macurdy said. ``All this paper does is demonstrate there's no such thing as a free lunch.''
Chile is still paying for both systems. Under most calculations, the majority of Chileans today are not covered by private pension plans. Although signing up with a private plan is now mandatory, about half of Chilean workers did not choose to join the private program when it was launched in 1981. The government will pick up the tab.
``Of those who have joined the system, about half don't contribute enough to receive a pension,'' Riesco said, referring to the requirement that to qualify for a private pension, workers must make monthly contributions for 20 years. Government welfare also will be required to support them.
``So all this famous AFP system is a system for 25 percent of the workers,'' Riesco said. ``This picture is far different from the rosy one.'' Bustamante places the number of Chileans who cannot make monthly payments at about nearly one-third of the system, 1.5 million workers out of the 5.2 million enrolled in the private plans.
The difficulties the unemployed or underemployed have in meeting the requirements in Chile are mirrored in other countries. In Argentina, about half of the 7.3 million workers enrolled in private pension plans cannot afford to make the monthly contributions. Many of Mexico's members do not have full-time jobs.
Riesco also is critical of the commissions charged by the fund managers. Chilean workers have 12.5 percent of their salary retained for the pensions, with 10 percent being deposited directly into their retirement accounts, 0.6 percent going to disability insurance and the remaining 1.9 percent going to the funds as a ``front-loaded'' management fee.
``That's really an astonishingly high number,'' said Doug Henwood, a New York economic analyst and author of the book Wall Street.
Bustamante insisted that these commissions end up being just a fraction of the $34 billion managed by the private funds.
But it is as if an American employee had $125 deducted each month for a 401(k) pension plan and found that $19 was going to the fund manager. Riesco's suggestion is that the management commission be reduced from 1.9 percent currently to 1 percent and the extra money be used to fund unemployment insurance. He noted that the management firms posted profits of $375 million in the first nine months of 1998, while the funds under management shrunk by $3.8 billion.
The usual 401(k) plan in the United States has no front-loaded fee; annual management fees on the typical U.S. mutual fund average 1.4 percent. For the U.S. Social Security program, 1 percent is spent on administrative fees to run the program.
Henwood is concerned that in the fervor over surging stock markets in recent years, which has created a wealth sensation, people have lost track of what is necessary to feed and clothe retired populations in the future.
``There is no way a society can feed itself in the future by saving big pots of money,'' Henwood said. ``They are just creating these big piles of assets that don't necessarily correspond to real assets that take care of people in the future.''
Ensuring that retired people are taken care of means investments in industry, infrastructure like roads and bridges and health and education,'' Henwood said.
``Whatever this great big pile of money is, it is just an accounting concept unless you can turn it into real resources of some kind,'' he said.