We’re told that one of the benefits of private accounts is that they’ll earn you higher returns on your investment than a public plan. But once the commissions of fund managers are taken out, the returns on investment in the Chilean system are not higher than average. Over the long term, leading up to retirement and subtracting the fees retained by the money managers, the returns are in the range of 4.5 to 6.5 per cent per year.
We’re also told that another benefit of multiple private plans is that money managers will compete with one another to attract customers. As it happens, there are very few firms managing pension accounts in Chile, and they mostly charge very similar fees. These fees are set as a percentage of the amount invested, and the firms have to charge all investors the same percentage rate. That means firms do best by getting large contributions from investors. So rather than offering lower rates to attract customers, most managers try to increase their profits by attracting funds from workers with higher, more stable incomes.
When the new scheme was introduced, the Chilean government made some arrangements to ease the transition. For example, it guaranteed a minimum pension to low-income workers who had contributed to the existing system for at least twenty years. It paid for the minimum pension out of regular taxes. It also introduced a means-tested “welfare” pension for the poor elderly, amounting to about half the minimum guaranteed pension and also paid for out of taxes. Later it converted these anti-poverty measures into a basic, universal pension.
In Chile – and more and more in Canada – a significant number of workers do not have regular, formal employment. Some are self-employed, and many are employed irregularly or in informal situations without secure wages or hours of work. What does the Chilean model provide for them?
Those who are self-employed, or who are outside the formal labour market, can contribute to a separate voluntary system. Those who are regularly employed and make the 10 per cent contribution to the mandatory system may make additional contributions, if they are able and willing, to this voluntary system as well. The number of firms managing voluntary pensions is greater than the number in the mandatory sector, so there’s somewhat more competition for customers. Still, the voluntary contributions come mainly from better-off workers. As with Registered Retirement Savings Plans in Canada, the tax benefit is greater for higher-income workers, and those workers obviously have more disposable income to invest.
The Chilean system has some aspects that are not so different from the current Canadian system. Where it does differ from the Canadian system, it creates problems that make it less attractive in meeting the goals of a good retirement income program.
In what way is the Chilean system like our Canadian one? First, the mandatory accounts are similar to the Canada Pension Plan, except that there are no mandatory contributions from employers. And the accounts are separate and privately managed. Second, the original minimum guaranteed pension had a function like the Old Age Security pension, except that it was available only to those who had paid into the pension system. Third, the means-tested welfare pension was like the Guaranteed Income Supplement, available to those with extremely low income, regardless of work experience.
How does the Chilean model differ from our system? First, the accounts, though heavily regulated and managed by very few firms, are invested by private companies who charge a significant administrative fee for their services. Second, pensions are not adjusted to account for years spent out of the labour force (while raising children, for example, or improving your education). Money managers charge high fees, and unemployment weakens pension accounts. Therefore the Chilean system – at least as it was originally designed – did not prevent high levels of poverty among the elderly.
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