REPORT OF THE PRESIDENTIAL ADVISORY COUNCIL FOR PENSION REFORM

1. REPORT OF THE PRESIDENTIAL ADVISORY COUNCIL FOR PENSION REFORM SOLIDARITY PILLAR: A KEY FEATURE OF THE PROPOSED REFORM MARIO MARCEL, Chairman Seminar Reforming Pension Reform Regional Operations Department I, Inter-American Development Bank Washington D.C., November 27, 2006

2. Projections of current system Projected distribution of pensioners of cohort 2020-2025 according to value of pension Source: Berstein, Larraín y Pino (2006) • The unequal distribution of contribution densities, plus 20-year contribution requirement, means that pensions might be be more unequally distributed than the highly unequal labour earnings

3. Reform targets

4. New solidarity pillar • Assessment: current non-contributory benefits weak, loosely integrated • Proposal: create new solidarity pillar to replace current MPG and PASIS • Related goals: universal coverage, prevent poverty at old age, increase replacement rate, reduce replacement rate gaps • Main aim is to integrate all Chileans to pension system and to support those with lower capacity to contribute

5. New solidarity pillar • Elligibility: lower 60% of households, 5 years of residence • Based on Universal Basic Pension of maximum value of US$ 140/month, gradually withdrawn as self-financed contributory pension increases • Withdraw rate designed so that total pension always increases in response to higher contributory effort • UBP completely absorbed for contributory pension of US$ 350/month

6. New solidarity pillar Pension values SP support PF: Pensión final PMAS Pensión máxima con aporte solidario PBU Pensión básica universal PAFE Pensión autofinanciada estimada

7. Solidarity pillar: illustration Current MP

8. New solidarity pillar • Main advantages: • SP integrated into CP • Distortions from contribution requisites eliminated • Risks: • Weaken incentives to contribute • Fiscal costs • Enabling conditions: • Resources released by transition • Enforcement of contributions • Side effects: • Gender equity

9. Proposed institutional structure

10. Expected results

11. An integrated system

12. A more efficient incentive structure Replacement rates and fiscal cost per density of contributions Fuente: Superintendencia de AFP

13. Impact on replacement rates Ordenado en base a quintiles de fondo proyectado. Fuente: Superintendencia de AFP.

14. Incidence of government transfers

15. Impact upon pensions: men

16. Impact upon pensions: women

17. Impact upon pensions: selected cases

18. Pension system and social protection • HD studies reveal high insecurity in Chilean population • Insecurity is due more to the lack of effective protection mechanisms than to size or likelyhood of contingencies • Surveys commissiones by the Council revealed: • Aging generates two conflicting views: golden years vs. old destitute • Pension system as necessary, but insufficient resource to set future course • Savings valued as source of support for old age • But lack of control over funds, mistrust to AFPs, uncertainty inherent to defined contribution regime • In the face of uncertainty many choose not to think about it, look forward to luck, successful business • People prepared to larger effort but need to see more challenging environment for AFPs

19. Implications to the development of a social protection system in Chile • Pension system as key component of social protection: aging as certain event • Universal coverage, pension as a right • Solidarity through tax system • Consolidate public-private mixture in pensions • Interplay of different components os social protection: pensions, health care, work injury, maternity, pre-school childcare, unemployment • Keep the social protection package together • Impact upon uncertainty, likelyhood to take up business risks, labour market operation, innovation

20. Salud pensiones Maternidad Cesantía Cuidado infantil Accidentes del trabajo Progress in social protection 1999

21. Salud pensiones Maternidad Cesantía Cuidado infantil Accidentes del trabajo Progress in social protection ¿2010?

22. Financial effects Gasto anual como % del PIB

23. Fiscal pension commitments

24. Recent record (*) Incluye efecto de pensiones especiales a exonerados y víctimas de violaciones a los derechos humanos

25. Transition issues • The Concil did not propose to provide benefits only in 2025 • The report provides estimates for 2025 to account for steady-state effects and funding feasibility • Feasibility does not require to reduce funding for other purposes; same current composition of spending • If reform reduces insecurity, it benefits the current working generation • Report indicates need to design transtion on the basis of better information, unavailable to Council • Faster transition or other commitments might require to raise taxes • Accelerating the transition might require not only to sort out financing needs but also operational and institutional requirements • Short transition of 5-6 years feasible

26. Solidarity pillar and pension reform • Different component of reform closely intertwined, high cost of separating them out • Strengthening of capitalization regime key to ensure success of solidarity pillar • Three key links: • Goals: New Solidarity Pillar aimes at increasing coverage, preventing poverty at old age; strengthening of capitalization pillar aims at raising replacement rates • Moral hazard on contribution to capitalization system • Cost: more accumulation in capitalization funds due to higher densities and profitability reduces fiscal costs of solidarity pillar by 1/5