Pensions: Chile's other revolution

By Elliott Gotkine BBC South America correspondent

Shortly after General Augusto Pinochet toppled Chile's socialist president from power, another, altogether more peaceful revolution was set in train - pension reform. In the last of three articles on the country, BBC News Online looks at the effects of the reform, more than 20 years on.

Juan Pablo Langlois is not a happy man. Retired after more than three decades as a civil servant in Chile's Ministry of Transport, his pension amounts to just 430,000 pesos a month (around $664).

Chile's pension revolution was a quieter affair

"People who retired at the same time as me earn around half their salary," he laments. "I only get around a third."

The 67-year old architect says he lost out because in 1980, following Chile's pension reform, he switched his nest-egg from the National Pensions Institute (INP) to the new system, known as the Administrator of Pension Funds (AFP).

His colleagues opted to remain in the old scheme.

But while the AFP scheme may have left Mr Langlois worse off, for Chileans and the country as a whole, it's been a life-saver, saving the country an estimated 4% of GDP every year for each of its 23 years in operation.

Everyone who works, no matter how much or little they earn, pays 10% of their salary into an AFP.

The government contributes nothing (with the exception of those who, through illness or accident, couldn't contribute enough to guarantee them a minimum pension).

Going through 'the change'

The most important aspect of Chile's pension reform was that it switched from a defined-benefit scheme (where pensioners receive a fixed amount, irrespective of their contributions) to a defined contribution scheme (where pensioners' income is based on the money saved during the person's working life).

According to Guillermo Larrain, Chile's Superintendent of Pension Funds - in charge of regulation and supervision of Chilean pension fund system - there were three reasons behind the switch.

First, was to create a system that would help develop Chile's capital markets.

There was a sort of political design to spread private property as far and as fast as possible Guillermo Larrain Chile's Superintendent of Pension Funds

By obliging Chileans to invest in AFPs, which were then forced to invest in Chilean state securities, billons of dollars began pouring into the country's underdeveloped capital markets.

This restriction was later relaxed, first to allow investment in other types of Chilean security and then in foreign ones. Of the $40bn invested by Chilean AFPs, Mr Larrain says one-fifth is now invested abroad.

Ah, but pension funds in countries like Britain have struggled over the past few years, as the stock markets they invested in turned bearish.

So surely Chilean AFPs must have suffered too? Not according to Mr Larrain.

Because contributions are mandatory, he explains, the funds are more tightly regulated and prevented from putting too many nest-eggs in too few baskets.

"They may not maximise their returns in the way they could in a freer environment," he says. "But the risk that they take is also lower."

Less resented

The second reason for Chile's change was to do with the labour market.

Under the old system, people like our unhappy pensioner, Juan Pablo Langlois, simply had their pension contributions taken out of their pay packets, along with health insurance and other taxes.

Under the new system, it's seen more as a mandatory saving and so curries less resentment and is therefore less likely to be evaded.

Pensioners can run the risk of rip-off salesmen

This particularly applies to workers who may have operated in the informal sector, and therefore didn't pay taxes.

As non-tax payers, they would have been locked out of the new system. So it's had the effect of "inducing" more formalisation of the labour market, says Mr Larrain.

The third reason is political. After General Pinochet came to power, he set about an aggressive privatisation campaign, as he sought to undo the nationalisations of the man - Salvador Allende - he overthrew.

"There was a sort of political design to spread private property as far and as fast as possible," says Mr Larrain.

"They wanted to strengthen the idea of capitalism, of private property in all its forms."

So has Chile's pension reform been an unqualified success?

According to a study carried out by Chile's central bank, one-third of the extra GDP growth Chile experienced from 1981-2001 (average growth 4.6%) compared with 1960-1980 (average growth 3.1%), was down to its pension reform.

This equates to around half a point extra in annual GDP.

Where the AFP system has stumbled is with the beneficiaries.

First, because there is a maximum contribution limit of a around $100 a month (though people can take out separate private pensions); and second, because Chileans are given little or no choice when it comes to selecting an annuity.

The "brokers" that sell them are usually nothing more than glorified salesmen, pushing whatever product rakes in the largest commission.

Worse still, many people who buy annuities are unaware that the salesman's commission comes out of their pension savings, something which may sound all too familiar to victims of Britain's pension mis-selling scandal.

The good news is that a bill before Congress promises to solve these problems. The bad news, is that it's been there, gathering dust, for the best part of a decade.

But Mr Larrain is confident it'll be passed some time this year, and certainly long before the last beneficiary of the old pension system is no longer with us, in around 2050.