Chile’s famed pensions system faces an existential crisis

Chile’s celebrated $200bn private pensions system has served as a model for dozens of emerging markets since it was introduced in the 1980s. Now, it faces an existential crisis as public support for the model fades and populist politicians allow savers to withdraw funds during the coronavirus crisis.

The lower house of congress voted to allow Chileans to withdraw another 10 per cent of their pension funds last week, following a similar measure in July that saw withdrawals of some $17bn.

Congress could yet approve a third withdrawal next year, putting at risk a pool of savings that has driven the growth of Chile’s capital markets and jeopardising future returns. 

Investors are increasingly concerned that the country’s famed economic model that has driven decades of steady growth is disintegrating. 

“Chile is a country in Latin America but it is not a Latin American country because there [have been] no attacks on investors or crazy economic policies. This is exactly what is at risk now,” said a senior pensions industry executive familiar with the Chilean market.

Since the outbreak of violent protests late last year demanding greater equality in Chile — with inadequate pension payouts a particular bone of contention — the pro-business government of President Sebastián Piñera “has presided over a degradation of institutional quality of such magnitude that we wonder what the future will be”, added the executive.

Few would deny that Chile’s pension system needs reform.

Established almost 40 years ago during General Augusto Pinochet’s military dictatorship, Chile’s defined contribution model was the first fully private pensions system in the world. It was widely praised by institutions such as the World Bank and seen as a key part of the Chilean economic success story.

But problems with the model have become more apparent in recent years. The 10 per cent contribution rate is low, and paid fully by employees with nothing from employers except disability insurance. While the number of years of contributions varies between people, it is generally considered to be not long enough. The result is that about 80 per cent of pensioners receive less than the minimum wage.

The private pensions industry believes it is being made the scapegoat for a government failure to make employers contribute their fair share.

In a referendum last month, Chileans voted to replace the country’s dictatorship-era constitution with a new charter, which is likely to lead to a greater role for the state in the economy. The government has put together generous fiscal spending packages amounting to about 12 per cent of GDP since the outbreak of the pandemic, but critics say this is still not enough to heal the economic damage and stop people from making early withdrawals.

“No one thinks that it is optimal to confront the crisis with money from pensions,” said Maite Orsini, a leftist opposition legislator. “Even so, Chilean families still need money to get to the end of the month . . . We have no other option.”

“There are two ways of looking at this,” said Andras Uthoff, a pensions expert in Santiago. “If you look at the people most in need who can’t support themselves, given that the government has been very mean in terms of social protection policy [during the coronavirus crisis], it would be reasonable to accept the withdrawal. But in terms of the pension system, it’s a very bad idea.” 

Many are worried that by draining resources from pension funds now, the state will eventually be forced to pick up the slack and pour more resources into Chile’s pension system. That could raise the spectre of a permanent deterioration in public finances, as has happened in Brazil. Some believe that this is the covert agenda of Chile’s left: to replace the private system with a fully state-funded model.

Chile’s government spends less than 3 per cent of GDP on pensions, compared with an average of 8 per cent in the OECD. But critics of the new withdrawals argue that taking out up to a fifth of the system’s assets to be spent now will only further weaken it. 

“Effectively what they are doing today means lower pensions in future,” said Fernando Larrain, director-general of the association of pension administrators. He said he was worried that the second pension withdrawal will put more than 4m people — or nearly half of the system’s 10-11m contributors — in a critical situation.

“These people will have zero funds and they are predominantly young and female,” he added.

One of the greatest problems is that there is little consensus over how to reform Chile’s pension system, according to Andrés Solimano, an economist and former World Bank country director in Santiago. He said this was compounded by a crisis of legitimacy of the political system reflected in the push for a new constitution.

“It doesn’t make sense to decide today on a new pension system for the next 30 years. Now is not the time to embark on structural reform,” he said, suggesting that a question about pensions reform could be included in elections to draw up a constitutional assembly next April.

Hanging in the balance is a hefty pension pot that some fear is an attractive prize for populist politicians that have their eyes set on presidential elections next year.

“There is a lack of leadership by the government,” warned another industry executive. “They are not protecting what made the Chilean economy successful, and they are being led by populism. They are mortgaging the future of Chile.”

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