“ Accomplishments and Challenges in the Chilean Pension System ”

1. IAIS Annual Conference 9 October 2002 Santiago de Chile “Accomplishments and Challenges in the Chilean Pension System” Francisco Silva Superintendencia de Valores y Seguros of Chile

2. 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

3. Objectives of the ChileanPension System

4. 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.

5. II. Structure of Incentives for the Chilean Model.

6. Structure of the Chilean System Pension Funds Compulsory Saving Annuity Affiliates Mutual Funds Accumulated Fund Voluntary Saving Schedule Withdrawal Investment Funds Insurance Retirement Date After Retirement Labour Cycle

7. Incentives Scheme Incentives Scheme for Competing among Pension Funds Managers Profitability No. Affiliates Elements • Portfolio Analysis • Flexibility to assume risk and differentiation • Attract affiliates through better profitability and lower management costs

8. Analysis Structure (Specifics Objectives of the System) 1 Efficiency Pension Fund Managers 4 Low Costs 2 Efficient Contract 6 Competition Funds 5 Strengthening 3 Interest Pensioners Financial Market 7 Knowledge

9. III. Dilemma and Coordinationof Objectives in the Regulation

10. Relation between Regulation Objectives Efficient Regulation of the Capital Market 1 2 Maximisation of Social Security • Minimise Government risk • Reduce competition from profits • Diminish Risk • Promote the use of securities • To generate competition profits • Risk Diversification Asymmetry of Interests

11. Regulation Dilemma (Asymmetry of Interests fromRegulators) r Usocial U2 r2 rs r1 U1 1 s 2  Regulation based on social standard

12. Solution to Conflict of Regulation (Nash Equilibrium) (Risk)   =  (Y) + Zone of Personal Risk or by Group Government Risk Y (Income) Y min Two Conditions: 1) Minimise Government Risk 2) Maximise Institutional Investors Profits

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

14. Pillars of the Pension System Pension System Compulsory Saving Voluntary Saving Social Security

15. Pillars of the Pension System • Government assure a minimum pension. • Minimise Government risk, increasing the effort of individual saving. Pension System Social Security

16. Pillars of the Pension System • Require a minimum individual saving to finance the pension. • Minimise the government risk, increasing the effort of individual saving. Pension System Compulsory Saving

17. Pillars of the Pension System • Improve replace rate. • Align incentives so people increase individual saving. • Minimise government risk, increase individual saving. Pension System Voluntary Saving

18. 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.

19. Analysis Structure Improve with Amendments (Specifics Objectives of the System) 1 Efficiency Pension Fund Managers 4 Low Costs 6 Competition 2 Efficient Contract Funds 5 Strengthening 3 Interests Financial Market Pensioners 7 Knowledge

20. 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.

21. Analysis Structure Improve with Amendments (Specifics Objectives of the System) 1 Efficiency Pension Fund Managers 4 Low Costs 6 Competition 2 Efficient Contract Funds 5 Strengthening 3 Interests Financial Market Pensioners 7 Knowledge

22. Proposals of Improvements to the Chilean Pension System.

23. 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.

24. Analysis Structure Improve with Amendments (Specifics Objectives of the System) 1 Efficiency Pension Fund Managers 4 Low Costs 6 Competition 2 Efficient Contract Funds 5 Strengthening 3 Interests Financial Market Pensioners 7 Knowledge

25. 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.

26. Proposed Second Pillar Amendment • 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.

27. Analysis Structure Improve with Amendments (Specifics Objectives of the System) 1 Efficiency Pension Fund Managers 4 Low Costs 6 Competition 2 Efficient Contract Funds 5 Strengthening 3 Interests Financial Market Pensioners 7 Knowledge

28. Second Pillar:Increasing Efficiency • 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.

29. 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.

30. 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.