Peaceful marches in 2018 

In the early 1980s Chile became the first OECD nation to switch from a Pay as you go pension system to a system dependent on private pensions. True the long-tail of state liabilities isn’t due to end till 2045 but today, most Chileans are dependent on their private pension fund administrators (AFPs).

The result is mass poverty , rioting in the streets and calls for emergency state intervention to reduce the grinding poverty that Chile sees today. The deterioration of the situation over the past twelve months is marked by the change of type of protest.

The death of Chile’s pension promise https://t.co/2jkdHjke3o via @financialtimes

— Pension Plowman (@henryhtapper) December 2, 2019

What went wrong?

Throughout the late nineties and well into this century, Chilean politicians were being feted by Western politicians, keen to embrace the Chilean model and reduce state dependency among the old. Britain was no exception. The NAPF were intrigued, right wing think-tanks launched models for British pensions based on Chilean APFs, the Conservative party flirted with launching a privatisation of pensions in the UK.

It would have been , of course, a disaster. And the reason why sensible people backed away from such doctrinaire solutions were carefully laid out by the OECD in a percipient report, published in 1998.

Re-reading that report, I am alarmed by the similarity in the claims of the Chileans then and our claims for auto-enrolment today.

The first “benefit” of  the Chilean system was that it was entirely free market.

The new system allows the workers to choose the AFP they want to affiliate with, to transfer their funds among them, and to have voluntary savings accounts…..There is no collective affiliation or any restrictions on mobility between competing funds.

This was what Britain adopted – to little affect – by introducing Stakeholder pensions. It proved a resounding failure, without a substantial carrot (employer contributions) or stick (compulsion), Stakeholder pensions remain on the top shelf of pension products

But the Chilean system went further and introduced an employer funded pension contribution

All dependent employed workers (including civil servants) must contribute to the retirement system. It is, however, optional for self employed people. Contributions are equal to 10% of the monthly salary up to US$ 2.000. . The relatively low rate of contributions and the strong link between them and benefits play an important role in reducing evasion and stimulated participation in the system.

This has distinct similarities to what was introduced from 2012 in Britain through auto-enrolment. An employer funded capped and defined contribution with a clear link between money in and money out. Something that the state cannot steal.

But even fifteen years in , the coverage of this system hadn’t substantially moved the dial

In 1996, the number of affiliates to the new system was 5.57 million representing 99% of the labour force. The percentage of contributors is significantly smaller: 3.1 millions in 1996, or just 59% of those employed.

The politicians suggested that all workers had access to a pension , but 40% of workers were out in the cold. The increase in coverage was significant, as much by the 35% of those in employment who missed out as by the 12% who were included.

Adding the contributors to the old system, the total coverage of the Chilean pension system rose form 53% of total employment in 1982 to 65% in 1995.

The Financial Times , 20 years after the OECD report is today saying the same thing

the system is designed to benefit those who remain in formal employment for much of their working lives and are thus able to make regular payments. Chile’s large informal sector — as many as one-third of the population are in irregular employment — means that many people pay little or nothing over their lives.

The relatively low percentage of contributors is one of the most important weaknesses of the system and is explained basically by informality in labour markets, the low rate of contribution of self-employed and the moral hazard created by the existence of the government guarantee of minimum pensions.

The toxic combination of a bargain cost of  a third of the state system and a market free for all made an easy win for the Chilean Government.

But the people who were paying for their success were the savers and those who were benefiting from the payments were the AFPS. The administrative costs of setting up the AFPS were front-end loaded so that the early contributions of the Chilean people simply paid for their pensions infrastructure

These costs, however, declined gradually and by 1996, they amounted to 3% of wages or 10% of contributions. In terms of accumulated assets, administrative costs have declined from almost 15% in 1983 to 1.8% in 1993.

But – as in Britain in the 1980s and 1990s, the cost of sales for these AFPS was uncapped and ruinous to the pension pots of a generation of savers.

It has been estimated that in the first half of the 1990s, marketing and sales costs exceeded one third of total costs. Moreover, there is evidence that in the last few years that these costs have increased significantly. Most of these increases have been related to the expansion of sales forces. The number of sales people in the system as a whole rose from 3,500 in 1990 to almost 15,000 in early 1995

What Britain learned from Chile was a simple economic lesson

Competition among AFPs has not been in terms of prices and benefits to affiliates, but in terms of “accessibility” to potential customers

The OECD report’s conclusions end on a somber note.

A final fiscal risk must be mentioned. This is the relatively low level of contributions as compared to affiliations.

This probably means that a large number of people “passed trough” the system at one point or another of their working life, but will not have enough funds to finance a decent pension and will not qualify for a minimum pension under the fiscal guarantee (20 years of contributions is one of the requirements).

This means that in the next 10 to 20 years, the Chilean government will face mounting pressures to relax the constraints to get access to minimum pensions.

Seldom can a report have been so percipient.

Will we avert a Chilean style crisis?

There are some who believe that auto-enrolment will end badly. They reckon without the state safety net of the State Pension and the resilience of the remaining defined benefit system (underpinned by the PPF).

We do not have the market free-for-all that beset Chile’s APFs and make them worth about half of what was promised.

But we do have a bargain-basement contribution structure which is seducing many ordinary people into thinking “I’m in a pension – I’m alright”.

This must be the biggest worry for policy-makers viewing the rioting in Santiago.

We have to make one of two decisions and then promote them.

Either we do what Chile did not do and put up contribution rates for everyone to make auto-enrolment target replacement rates that meet the Moderate living standards laid down by the PLSA’s retirement living standards. This will mean a substantial hike in auto-enrolment contribution rates along the lines of the PLSA’s recommendations

Or we tell people that their  workplace pensions are a start and not an end and that to retire in the style to which they’ve become accustomed, they are going to have to work longer , save harder or take some big risks (that come off) like relying on lifetime mortgages and/or speculation.

Chile was never an exact proxy for Britain, we have a much stronger system of consumer protections, a less authoritative Government and a stronger financial services sector.

But Britain flirted with the destruction of the state pension and a switch to reliance on the private sector and thankfully pulled back.

We should look at what is happening in Santiago today with alarm and some relief. There but for the Grace of God – went we.

And we could still go there, if we don’t manage our saver’s expectations appropriately

Perhaps the message should move on