On 4 November 1980, Chile approved a set of radical reforms to create a system of individual savings accounts for its citizens. The agreement required private pension companies to establish funds within six months resulting in the first accounts being created on 1 May 1981, to coincide with world labour day.
Dr Jose Pinera, a driving force behind the pension reforms in Chile appeared as the keynote speaker at Sanlam's 2007 Employee Benefits Symposium. He shared some of the processes which were integral in creating a successful system in his home country.
National individual savings account system is the first pillar of the social security reform implemented in Chile. In Chile, the total of pension funds under management ahs reached 80% of Gross National Product (GNP) or 80% of USD 15 billion.
Exploiting the power of compound interest
The accumulation of money is essential to the success of the individual savings account system. Pinera acknowledged that the power of the system is best illustrated over a period of 20 or more years. "I have seen USD 500, 000 accumulated in a common worker account because of the power of compound interest," said Pinera.
Soon after the implementation of the social security reforms in Chile, 95% of workers elected to join the fund. They save by way of a 10% mandatory contribution to their individual savings account with the option to contribute an additional 10%.
Accountholders have two options to enter retirement. The first, which 75% of accountholders adopt, is to buy an annuity for life when they reach retirement age. The Chilean government approached insurance companies to ensure that life annuities would provide inflation beating payments. The goal is to provide the retiree with "a constant, in purchasing power, amount of money for life."
The second option is to keep the capital in the individual savings account and make monthly 'program' withdrawals. These withdrawals were calculated using a formula adjusted to ensure a safe withdrawal level. The benefit of this option was that the balance in the individual savings account remained in the family in the event of an early death.
Clearly defined roles
Part of the challenge with social security reform is ensuring that government and private sector accept the different roles they have to play
According to Pinera, "the second pillar of the system was who would manage this system." The obvious choice was the private sector for the simple reason that the system required huge administrative processing capacities.
"The cost of managing a system of savings account depends crucially on the high efficiency of the information processing system," said Pinera. A small change in administrative fees can result in a 10% or 20% reduction in the final fund. The cost of administering the fund today could have a huge impact on the consumption of the saver in old age.
Government plays a technical and supervisory role. In Chile, a technical advisory board was established to supervise the savings environment. The department enjoyed strong powers to penalise pension fund administrators who contravened the rules.
Minimum interference and maximum competitiveness
Pinera reveals some interesting anecdotes experienced as the Chilean system neared implementation. The first was a last ditch attempt by trade union officials to secure the power to decide where pension funds would be invested. If Pinera could guarantee them this power, they promised full backing for the plan. The second was an approach by the Chilean banks to become the only companies handling the investment of the funds. Both of these demands were turned down.
What impressed FAnews most was the revelation that in more than 20 years of fund management there had not been one financial scandal to throw the system into doubt. The Chilean people adopted the change with a national fervour which we seldom see in South Africa.
If we want to succeed in the tricky field of social security reform we would do well to study the Chilean approach and implement a system that is in the national interest rather than pandering to the interests of government or the private sector.
Editor's thoughts:
The Chilean pension reform is successful because the system enjoys support from all of its citizens. Will South Africa be able to instil a similar level of national pride in their social security product? Send your comments to gareth@fanews.co.za. Also read my article - Making the National Security System Work - click here