“Accomplishments and Challenges in the Chilean Pension System”

Francisco SilvaSuperintendencia de Valores y Seguros of Chile

IAIS Annual Conference9 October 2002

Santiago de Chile

Table of Contents

I. Objectives of the Chilean Pension System

II. Structure of Incentives for the Chilean Model

III. Dilemma and Coordination of Objectives in the Regulation

IV. Conceptual Elements of the Latest Amendments to the System

V. Proposals of Improvements to the Chilean Pension System

I. Objectives of the ChileanPension System

General Objectives of the System

To minimise the Government risk in paying Pensions (subsidiary role of the Government).

Coordination of objectives in the regulation. To assure pensioners a fair pension when retiring

(Private sector role). To strengthen the Chilean capital market.

II. Structure of Incentives for the Chilean Model.

Structure of the Chilean System

CompulsorySaving

Affiliates

PensionFunds

Mutual Funds

Investment Funds

Insurance

AccumulatedFund

ScheduleWithdrawal

Labour Cycle RetirementDate

AfterRetirement

Annuity

VoluntarySaving

Incentives Scheme

Incentives Scheme for Competing among Pension Funds Managers

Profitability No. AffiliatesElements

• Portfolio Analysis

• Flexibility to assume risk and differentiation

• Attract affiliates through better profitability and lower management costs

Analysis Structure

Pensioners

Pension FundManagers

Funds

FinancialMarket

1 Efficiency

6 Competition

3 Interest

2 Efficient Contract

4 Low Costs

5 Strengthening

7 Knowledge

(Specifics Objectives of the System)

III. Dilemma and Coordinationof Objectives in the Regulation

Relation between Regulation Objectives

Maximisation of Social Security

Efficient Regulation of the Capital Market

1 2

• Minimise Government risk

• Reduce competition from profits

• Diminish Risk

• Promote the use of securities

• To generate competition profits

• Risk Diversification

Asymmetry of Interests

Regulation Dilemma

rs

s

r

Regulation based on social standard

21

r2

r1

(Asymmetry of Interests from Regulators)

U2

U1

Usocial

Solution to Conflict of Regulation(Nash Equilibrium)

Two Conditions: 1) Minimise Government Risk

2) Maximise Institutional Investors Profits

Government Risk

Y (Income)

(Risk)

Y min

= (Y)+

Zone of Personal Risk or by Group

IV. Conceptual Elements of the Latest Amendments to the System.

Pillars of the Pension System

Pension System

SocialSecurity

CompulsorySaving

VoluntarySaving

Pillars of the Pension System

Pension System

SocialSecurity

Government assure a minimum pension.

Minimise Government risk, increasing the effort of individual saving.

Pillars of the Pension System

Pension System

CompulsorySaving

Require a minimum individual saving to finance the pension.

Minimise the government risk, increasing the effort of individual saving.

Pillars of the Pension System

Pension System

VoluntarySaving

Improve replace rate. Align incentives so people

increase individual saving. Minimise government risk,

increase individual saving.

Opening Voluntary Pension Saving

Participation of insurance companies, mutual and investment funds managers, and for housing funds in the Voluntary Pension Saving Scheme Market.

Collective Regulation.

Analysis Structure

Pensioners

Pension FundManagers

Funds

FinancialMarket

1 Efficiency

6 Competition

3 Interests

2 Efficient Contract

4 Low Costs

5 Strengthening

7 Knowledge

(Specifics Objectives of the System)Improve with Amendments

Creation of Multi-funds for Pension Funds Managers.

Increase the number of type of Funds in the Pension Fund System, from two to five (Types A, B, C, D y E).

Maximum and Minimum Investment Limits in variable income securities.

Maximum

Limit

Allow

Compulsory

Minimum

Limit

Fund A 80 % 40 %

Fund B 60 % 25 %

Fund C 40 % 15 %

Fund D 20 % 5 %

Fund E Not Allow Not allow

Analysis Structure

Pensioners

Pension FundManagers

Funds

FinancialMarket

1 Efficiency

6 Competition

3 Interests

2 Efficient Contract

4 Low Costs

5 Strengthening

7 Knowledge

(Specifics Objectives of the System)Improve with Amendments

V. Proposals of Improvements to the Chilean Pension System.

Proposed Third Pillar Amendment

Amendment based on the US 401(k) plans. Main characteristics:

Employer contribution in proportion to employee contribution.

Tax incentives for employer and employee. Fairness conditions as an increasing

incentive.

Analysis Structure

Pensioners

Pension FundManagers

Funds

FinancialMarket

1 Efficiency

6 Competition

3 Interests

2 Efficient Contract

4 Low Costs

5 Strengthening

7 Knowledge

(Specifics Objectives of the System)Improve with Amendments

Proposed Second Pillar Amendment To limit the compulsory contribution of each person,

among the minimum of: (a) 10% salary with a maximum of 6 UF, and (b) a projected salary percentage that added to

his/her accumulate fund, would allow to reach a minimum saving to obtain X time a minimum pension, Y years before his/her retirement age (x>1; Y>5).

In the case that (b) < (a), the difference (a)-(b) must be saved using any pension plan, including voluntary saving managers.

Nash equilibrium is maintained within objectives of regulation: Increasing competition in the financial market

and the pensions market, partially opening actual compulsory saving to other fund managers and to insurance companies (voluntary pension saving model).

Setting boundaries to Government risk.

Proposed Second Pillar Amendment

Analysis Structure

Pensioners

Pension FundManagers

Funds

FinancialMarket

1 Efficiency

6 Competition

3 Interests

2 Efficient Contract

4 Low Costs

5 Strengthening

7 Knowledge

(Specifics Objectives of the System)Improve with Amendments

Align incentives to avoid herd behaviour. The effective correction in the difference regarding average

profitability, allows the reduction of risk, however generating an herd behaviour that decreases competition (another example of conflicting objectives in regulation).

Analyse the convenience of providing vertically integrated functions of collecting, account management and portfolio management. The effective economies of scale in the first two functions

could produce a strong concentration, damaging competition in portfolio management.

Second Pillar:Increasing Efficiency

Proposed First Pillar Amendment

Change actual Government subsidy that assures minimum monthly pension for system pensioners, for a one time subsidy given at the moment of retirement, for the necessarily amount to finance a annuity equivalent to the minimum pension.

Allows the elimination of a contingency that nowadays is assumed by the State, transferring it to the market.

If the private sector is more efficient than the State in the portfolio and risk management, this subsidy should constitute a minor government burden than the actual system, ceteris paribus the coverage.

Summarizing…

First Pillar: Reduce government risk transferring contingencies

to the private sector. Segundo Pillar:

Increase competition, opening compulsory saving to other agents of the financial market, reducing government risk.

Third Pillar: Increase coverage, introducing a model similar to

the 401(k) plans.