A national pension system should be managed by a competitive private sector subject to Âmarket-friendly regulation by government, says Jose Pinera, the architect of the world-renowned Chilean pension fund system and founder and president of the International Centre for Pension Reform.
Pinera is in South Africa at the invitation of Sanlam to discuss the lessons learnt in the reformation of the Chilean pension system.
Chile’s reforms have been celeÂbrated globally and adopted in 30 countries since it moved from a bankrupt, pay-as-you-go welfare system, which was funded by taxpayers, to a long-term savings plan with workers providing for their own retirement, based on mandatory contributions.
The social security system proposed by the South African government is likely to operate along the same lines, but Pinera has some interesting insights, which should help to form the debate on how the system will be run.
Chile is held as a shining example because, since its system’s inception in 1980, workers have seen average annual returns of 10% above inflation, meaning that even the poorest workers accumulated a lot of money.
Pinera argues that the success is because workers could choose individually which fund managers would manage their money, creating competition for this lucrative savings pool, currently equal to 80% of Chile’s GDP.
At the time of introducing the reforms, Pinera was lobbied by union and business leaders to allow them to choose which fund managers should be selected to manage the workers’ funds. Pinera believed this would lead to corruption and insisted that any fund manager would be allowed to compete for the workers’ money.
“I believe in the private sector for efficiency, I know it creates oligopolies so I was adamant that there would be free entry to industry.” Pinera says by allowing domestic and foreign companies to compete for workers’ money it prevented collusion, drove down commission costs and improved service.
In Chile administration costs of pension funds are as low as 0,5% of assets under management compared with more than 2% in South Africa.
Pinera says workers are able to move fund managers every 90 days if they are unhappy with the return or service.
Before the reforms Chile experienced the same issues with private pension funds as South Africa has been grappling with.
Pinera says the old system manifested all of the worst aspects of a monopolistic bureaucracy. “It was opaque and difficult to understand for anyone who was not a lawyer or an expert. Service was anything but ‘user-friendly’. The administrators did not see pensioners as customers. Instead, they were viewed and treated as annoying statistical problems, or even as liabilities.”
He says that under the new system, the pension fund managers are competitive, profit-oriented enterprises, eager to win new clients and keep the old ones happy. Although the system is private, the government still has a key role to play in setting prudent investment ceilings, prosecuting fraud and regulating competitive business practices.
“It requires private companies to be transparent and honest in investments and to be well diversified. Since inception we have never lost any money.”
In Chile the government acts as the supervisory body that oversees the private companies, but Pinera says he would like to see that changed and to have a fully independent body, such as the Central Bank, overseeing the regulation to ensure there is never a political motivation. “There is a lot of money in these funds and I am afraid that in the future the government may appoint a political adviser to channel money to certain investments.”
But is this model, where workers individually choose their own fund managers, realistic in South Africa where we have low levels of financial literacy? Absolutely, says Pinera, adding that when the Chilean system came into being there was virtually no financial market and no financial education.
Pinera says one has to trust that with enough education workers will develop the ability to choose their pension fund manager. “If you want an educated workforce you have to start somewhere or else you will never have it.”
How the system works
The Chilean model follows the idea of defined contributions in which individuals have mandatory savings accounts for their retirement, rather than government funding pension payouts from current tax earnings.
Individuals each have to save 10% of their annual income, which they use to purchase an annuity on retirement. Individuals can save up to a further 10% before tax in the same fund for life crises should they become ill or retrenched.
Chile, like South Africa, has workers who do not earn enough to contribute fully to a pension or who have been mostly unemployed. While South Africa is proposing wage subsidies to deal with this issue, in Chile the government tops up the account to the level where the retiree can purchase a minimum annuity.
Based on the spectacular returns from the Chilean experience, if a worker earns R5 000 a month, he or she would contribute R500 to the fund. After 40 years at an after inflation growth rate of 10%, he or she would have R3-million to purchase an annuity at today’s value.