Pension reform in Chile: Closing the gap, not scrapping the system

A quarter-century ago, Chile replaced its traditional social security system with personal retirement accounts funded by workers and invested in stocks and bonds. The Chilean system functions very well for workers who contribute regularly, says Estelle James, a consulting economist on Social Security issues to the National Center for Policy Analysis in the U.S.

Consider:

An average Chilean worker who contributes for all 40 years of his working life and retires at age 65 will get a price-indexed pension that is 60 per cent of his final wage, assuming his account earned a 5 per cent rate of return; the pension will also cover his wife after he dies.

Even if he contributed for only half his working life, he would still get 30 per cent of his final wage.

If he began contributing 25 years ago when the system began and earned the 10 per cent average rate of return it has yielded since inception, his pension would be 85 per cent of his final wage.

Chile has handled the problem of low contributors in several ways, notes James:

Because many of the low contributors are married women who retired from the labour market when they had children, husbands in Chile are required to purchase joint pensions when they retire; this covers their widows (at 60 per cent of the primary benefit) as well as themselves, without imposing a cost on the general treasury.

Workers with 20 years of contributions are guaranteed a minimum pension by the government, financed out of general revenues.

Workers with less than 20 years of contributions are eligible for the smaller means-tested benefit (PASIS), also financed out of general revenues.

Source: Estelle James, Pension Reform in Chile: Closing the Gap, Not Scrapping the System, National Center for Policy Analysis, Brief Analysis No. 583, March 19, 2007.

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FMF Policy Bulletin/ 27 March 2007