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Hundreds of thousands took to the streets of Santiago last week to protest at a system of private pensions
many Chileans would like to see dismantled. The clamour for security in old age was just the latest sign of a
global problem, of retirement schemes which threaten disappointment, even poverty, for millions.
Chile stands out, however, because the programme introduced in 1981 by dictator Augusto Pinochet had long
been lauded and imitated. Bolivia, El Salvador and Mexico all replicated the system of individual pension
accounts wholesale, and even Kazakhstan saw aspects to copy.

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Disillusionment has set in due to challenges familiar the world over: people live longer and save less than
expected, some have no pension, while those who do have seen investments disappoint or face a future of
meagre income from stocks and bonds.
It also highlights how pension stress is not limited to public and corporate schemes which lack the money to
meet promised payments, and how even well regarded systems have flaws which have prompted calls for
reform: is there a better way?
Olivia Mitchell, a professor at the Wharton Business School who served on the recent Chilean Pension Reform
Commission, says greater education would help. Those who complain their pensions are low forget the public
or solidarity part of the system, she says, and if they did not contribute their entire work lives, they wont get
much from the system.
Formal Chilean employees are supposed to contribute a tenth of their gross salary to their pension accounts. A
more successful form of compulsion might be Australias, which demands employers pay at least 9.5 per cent
of all salaries into a superannuation scheme.
A weakness, however, is that compulsion ends at retirement, leaving the elderly able to fritter nest eggs.
Australia did the wrong thing, by not giving the right incentives when people get to retirement, says John
Ralfe, an independent pensions consultant.
In the UK retirees used to be effectively forced to buy an annuity, swapping a lump sum for a lifetime income.
Longer lives and falling bond yields have progressively reduced the income such lump sums can buy, making
what is effectively an insurance policy against living longer than you can afford unpopular.
We need a complete review into the sustainability of pensions. Funding defined benefit schemes in an era of
low rates is a bottomless pit and liabilities have mushroomed beyond what anyone expected
- Ros Altmann, UK pensions minister under David Cameron
The expense of providing such lifetime retirement income is also at the heart of challenges for schemes
offering so-called defined benefits. Highlighted by BHS a high street retailer which controversially collapsed
and so left the Pension Protection Fund to take over a scheme with a 571m deficit attention has returned to
the ability of these funds to provide promised income.
Most private sector companies have closed final salary pensions to new members, leaving an estimated 11m
people reliant on funds Hymans Robertson estimate have a combined 1tn deficit, thanks to a combination of
rising life expectancy and record low returns from financial markets.
The pressure has intensified since the UK voted to leave the EU, prompting a further collapse in bond yields.
As income from bonds shrinks, it means more money must be set aside to meet future payments.

Few can. We need a complete review into the sustainability of pensions, says Ros Altmann, the UKs
pensions minister under David Cameron. Funding defined benefit schemes in an era of low rates is a
bottomless pit and liabilities have mushroomed beyond what anyone expected.
Not all defined benefit systems have seen big gaps open up between assets and estimates of liabilities,
however.
Canadian schemes are well regarded, and largely well funded, thanks to changes made in the 1990s to the
way they invest. Professional in-house investment teams have built up holdings of property and infrastructure
assets including pipelines, roads and bridges as a source of secure, long-term, inflation-linked income streams.
The great majority of private sector workers are not members, however, so the thrust of recent reform efforts
has been to expand access to the Canada Pension Plan.
Pension solution lies in long-term thinking

A focus on cash flows that grow over time is critical for funds to meet their liabilities
In the Netherlands, by comparison, most employees are required to make significant contributions to defined
benefit schemes, typically organised on an industry-wide basis. Regulators have imposed conservative funding
assumptions, but there is also flexibility to cut benefits, as many did after the 2008 financial crisis, to reflect
losses.
Such safety valves provide a different tension, between the young and the old. The big problem is, having this
collective set up its unclear who owns the fund, says Ilja Boelaars, an economist who has campaigned for
reform. Young members are pitted against old when it comes to questions about risky investments, or whether
to raise benefits now, creating danger of a future shortfall.
Such funds can also be a poor fit for those who work on projects, regularly change jobs, or the self-employed.
Some, like Mr Boelaars, have pushed for savers to have individual accounts within large schemes that they can
identify and move, a shift towards an approach where the individual takes the risk.
Designing a system from scratch, the challenge would be to balance the better characteristics of those above:
compulsion, flexibility, individual ownership, some sharing of risk.
 It suggests a need for well managed, diversified and long-term orientated funds on the Canadian model, but
open to individual savers prepared to commit funds for months or years, rather than the days it takes to
withdraw money from mutual funds.

2018
The year by which all UK employers will have to provide defined contribution schemes to eligible staf
There are also more outlandish ideas, such as ways other than annuities to spread longevity risk. Outlined in
one 2014 paper: for those who opt in, the remaining retirement accounts of those who die each month are
shared out across the group.
In the UK, reforms have focused on expansion of defined contribution schemes, which all employers will have
to provide to eligible staff by 2018, when employees, employers and the government will collectively kick in 8
per cent of earnings.
The Department for Work and Pensions has also considered Defined Ambition pensions, where employers
provide workers with a greater level of certainty about their retirement income, but are allowed to walk away
from their promise if it became too expensive.
Yet for Mr Ralfe, the solution to pension stress can be reduced to a blunt message: People have to work
longer, spend less while theyre working and save more.
More from the FT pensions series:
Podcast: The dark future A dramatic decline in bond yields has added to the pressures of longer lifespans
and falling birth rates to create a looming social and political pensions crisis. John Authers and Robin
Wigglesworth discuss the looming crisis
Pensions: Low yields, high stress In the first article of a series, the Financial Times examines a creeping
social and political crisis
Target-dated funds need an overhaul TDFs help pension plans but face challenges of fees, asset allocation
and benchmarks
Canada quietly treads radical path on pensions Retirement funds push beyond bonds and stocks in search
of better returns
Pensions and bonds: the problem explained Bond mathematics and the scale of pension deficits

Chile pension reform comes under world spotlight

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The man who masterminded Chiles world-famous privatised pension system still calls it the Mercedes-Benz
of retirement systems, but that has proved an enraging comparison when the average pensioner is eking out
an income that turned out to be less than the minimum wage.
Jos Piera created the scheme as social security minister 35 years ago when Chile, under the military
dictatorship of Augusto Pinochet, was the worlds free-market laboratory. His recent defence, attacked as
arrogant and elitist, only fuelled the anger of protesters who have taken to the streets to demand the systems
reform or even its abolition.

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For many years, institutions like the World Bank held up Chiles defined-contributions pension system as an
example to follow, and it has been copied by more than 30 countries across Latin America, Southeast Asia and
Eastern Europe, but its legitimacy is in question, and President Michelle Bacheletis promising reforms to try to
shore up the system.
The World Bank is terrified that the Chilean model will fail, says David Blake, a pensions expert at the Cass
Business School in London.
David Bravo, who led a presidential commission on pensions reform last year, says it is a matter of perfecting
the existing system. Under Pinochet, Chile went from one extreme to the other. Now we are seeking
something a bit more balanced, he explains.
Pensions saving was privatised in 1981, when Chile was one of Latin Americas poorest countries and shunned
by foreign investors, and the new scheme replaced a failing state-funded pay-as-you-go system. By requiring
employees to set aside 10 per cent of their income, it provided a huge boost for savings, investment,
employment and growth.
In particular, Chiles nascent capital market roared to life, and pension funds now exceed $170bn, or around 70
per cent of GDP. This played a key role in turning Chile into the richest country in the region, lifting millions out
of poverty.
The problem is that most are not saving enough. The 10 per cent of pay that is sent to individual savings
accounts is about half the total put into pension schemes in developed countries, according to Mr Bravo. The
average monthly benefit is about $300, less than earnings from a minimum wage job. The problem is made
worse because many people have made only inconsistent payments and there is a large informal economy.
Women are especially hard hit.
Many also complain that a lack of competition has allowed the private companies, known as AFPs, that
manage the pension funds to earn disproportionately high fees. Investment returns have averaged more than 8
per cent since the system was founded but after commissions, net returns are closer to 3 per cent, according to
Mr Bravos commission report.
Related article

Pension disappointment: National solutions to a global problem

The blunt answer to pension stress is work longer, spend less and save more
Initially the Chilean model appeared to be very successful, but the sting in the tail appears to be that charges
extracted by the industry have resulted in pensions being much lower than otherwise would be the case, said
Mr Blake.
Ms Bachelet implemented a first round of pension reforms in 2008 during her first term, moving towards a
mixed public-private system by introducing a tax-funded solidarity scheme that supplemented the pensions of
the lowest income workers.
The reforms under discussion now go further. They include requiring companies to contribute 5 per cent of
workers pay to the solidarity fund, the introduction of a state-run AFP to increase competition, and measures to
keep fund managers commissions under control.
If Chiles reforms are successful, countries that face pensions shortfalls thanks to ageing populations and
historically low bond yields will continue to look to the country as an example.
Unlike many other countries where governments have racked up enormous debts to pay promised pensions to
public employees, that debt does not exist in Chile. The onus of saving has been transferred to individuals,
says Jonathan Callund, a pensions policy consultant based in Santiago.
The big risk is that pensions become a campaign issue as presidential elections approach, and the discussion
becomes polarised and reduced to slogans. Thats dangerous
- David Bravo, who led a presidential commission on pensions reform
Pensions may be in crisis worldwide, but one place where they are not is Chile, he says, arguing the system
is far from broken, even if it may need some tightening.
Whether or not significant reforms are approved by congress before presidential elections next year remains to
be seen. The current proposals could add around $1.5bn, or 0.5 per cent of GDP, to the fiscal burden of a
government that is already suffering from the end of the commodity boom.
Ms Bachelets political capital is also at historic lows her approval ratings have sunk to just 15 per cent
making negotiations in her divided coalition complex.
Although political analysts say it is unlikely that Chile will cave in to the demands of street protesters and follow
in the footsteps of countries like Argentina, which nationalised private pension fund managers in 2008, Mr
Bravo fears populist solutions.
The big risk is that pensions become a campaign issue as presidential elections approach, and the discussion
becomes polarised and reduced to slogans, said Mr Bravo. Thats dangerous.
Highlights from the FTs pensions series:
Pensions: Low yields, high stress In the first article of a series, the Financial Times examines a creeping
social and political crisis
The crumbling assumptions of US public pension plans How public pensions calculate their liabilities
comes under sharp scrutiny amid fears of a black hole
Canada quietly treads radical path on pensions Retirement funds push beyond bonds and stocks in search
of better returns
Pensions and bonds: the problem explained Bond mathematics and the scale of pension deficits
Podcast: The dark future A dramatic decline in bond yields has added to the pressures of longer lifespans
and falling birth rates to create a looming social and political pensions crisis. John Authers and Robin
Wigglesworth discuss the looming crisis

FT montage; EPA

Aug 30, 2016 MARKETS

Pension disappointment: National solutions

The blunt answer is work longer, spend less and save more