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Santiago de Chile. (Jose Luis Stephens/Photos.com)
Santiago de Chile. (Jose Luis Stephens/Photos.com)

Book excerpt

Should Canada reform its pension system to mirror Chile’s? Add to ...

In 2008, the government of Chile made some changes to improve the system. Ironically for those people who think we should bring the Chilean model to Canada, many of those changes have made the system in Chile more like the one we currently have here. The Chileans replaced their minimum guaranteed pension and their welfare pension with a basic pension, payable to everyone at age sixty-five, regardless of work experience. Like the Canadian Old Age Security pension, it’s funded out of general tax revenue and is taxed back from those with high incomes. Chile also undertook some changes to make the operation of individual accounts better and to subsidize the pension contributions of low-income workers. Yet private management fees remain and annuity rates are still set by the private market.

So what lessons does the Chilean experience have for us here in Canada? First, even though the management of pension funds is private, the Chilean government has been called upon to regulate these funds so that workers do not face investment risk and longevity risk without protection. Second, Chile, like Canada, has not trusted an unfettered private market to prevent poverty among the aged. It too has introduced a basic pension paid from general taxation. Both countries have apparently agreed that it’s desirable to make a modest redistribution of income by taxing the better-off to pay pensions to those less well-off. Third, the fees charged by private money managers are supposedly justified by higher investment returns at the same level of risk. The Chilean example suggests that the returns from private managers are not higher if any measures are taken to reduce risk.

We should explain why that last point is important. Some advocates of the Chilean model for Canada argue that the Chilean results are distorted because their money managers are restricted in the range of investments they can make. Reduce the restrictions, they say, and the returns will be higher. That’s fine, except restrictions on money managers are generally intended to reduce investment risk. Most of us would probably say it’s okay for individuals to take risks voluntarily when they can afford to do so, in order to seek higher rewards. But most wage earners don’t have the flexibility of high income to take such risks. Shouldn’t they have a good chance to secure their retirement income with reasonable returns and less risk?

The way to do that, of course, is with a scheme that requires contributions from both employers and employees, makes some provision for years out of work, and combines many workers or “investors” in one plan. In that way, the risks and gains are shared, and the ups and downs in both are smoothed out.

Excerpt from Pension Confidential:50 things you don’t know about your pension and investments. By Robert Drummond & Chris Roberts. Reprinted by permission of James Lorimer & Company, Ltd.

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