Life expectancy rates in Latin America, particularly in Chile, are steadily increasing; averaging around 80 years old. Pensions have become one of the first red flags for this demographic change, as current replacement rates are not meeting the needs and expectations of people.
Today, people over 60 years old represent 16.7 percent of the total population in Chile. This is expected to be 20 percent by 2025, surpassing the percentage of those under 15. By 2015, this cohort would practically represent 30 percent of the population. This is the reality under which the Chilean pension system should be analysed (see Fig. 1).
The good news is that Chileans are living longer. However, we see that individual savings are not enough to cover the pensions required when living a longer life, which is due to several reasons. Only 10 percent of a Chilean salary is contributed to a pension with a maximum taxable amount. There are contribution gaps along working life; income has steadily increased since the inception of the system; and there is still a lot to do about the formalisation of jobs.
The good news is that Chileans are living longer
Three pillar system
President Michelle Bachelet introduced a new pension reform within her government programme. Consequently, the Presidential Advisory Commission on Pension Systems was set up, which should be in charge of reviewing the current pension model in order to analyse changes and improvements required to address the present and future of this ageing population. In general, in Chile we understand that improving the system requires strengthening the harmony and complementing the three pillars: solidarity, mandatory and voluntary.
AFP Capital has actively participated in discussing the improvements the system requires, presenting 11 proposals (see box out) to the Presidential Advisory Committee, which include extending the subsidy on young workers’ contributions from the current two-year limit for the first 10 years of work, and for 100 percent of the contribution. It is important to note that contributions paid in along the first 10 years of working life account for about 40 percent of the pension.
At AFP Capital, we also promote alternative fund investments in order to improve pensions by up to 15 percent. These assets include private equity, hedge funds, real estate, infrastructure and commodities, among others. It also encourages establishing a state-supported insurance, intended to guarantee a minimum replacement rate, and implemented for a number of contributing years. It has also suggested developing an insurance that guarantees a certain replacement rate based on the years paid in and the actual contribution payable in respect of the contributable income. Replacement rates guaranteed for 10, 15 and 20 years could be defined.
For middle-income people, there’s the development of the Strengthen Voluntary Pension Savings. With this, there are two ways to enable massive voluntary pension savings (APVC) for middle-income segments. The first is to strengthen the APVC, and secondly, to improve subsidies to APV – known as Scheme A. By moving towards a policy of continued employment, this would allow for the cultural changes required for this new workforce.
Getting the calculations right
This last point is significantly important, as the minimum retirement age in Chile is 65 for men and 60 for women, who, in return, have a longer life expectancy and lower pensions. While it is not a popular course of action, it is clear that with or without a law, the fact is that today Chileans must work longer in order to get better pensions. The calculation is clear: an eight percent pension increase over a working year.
Likewise, AFP Capital’s 30-year experience and knowhow in the financial asset management sector has helped to build public policies that are intended to improve the coverage, density and savings incentives for affiliates.
Therefore, this year SURA Asset Management, of which AFP Capital is a subsidiary, presented the study How to Strengthen Latin American Pension Systems: Experiences, lessons and propositions. The survey focuses on the six regional countries that made reforms in the 1980s and 1990s, introducing individual capitalisation defined contribution schemes, and where SURA Asset Management is present – Chile, Colombia, Mexico, Peru, El Salvador and Uruguay.
This document confirms that it is necessary to move towards a proper integration and complement within the pillars of the system, each meeting the objective they were created for, and strengthening the potential of the mandatory and voluntary individual capitalisation programmes.
A distinctive component of AFP Capital is its mission to be a savings guide for its affiliates, being with them to build their pensions along their life cycle through personalised and specialised advice.
The company has focused its efforts on explaining that building a good pension means saving every month, paying contributions for the total earnings, bridging the contribution gaps and considering a voluntary savings plan that will always help improve pensions and balance potential contribution gaps that one affiliate may have.
At AFP Capital we support our clients to build their ‘number’, which is the total amount of money they must have at the end of their working life in order to enjoy the future they want. Then, we analyse their risk profile and support them in defining a savings plan.
Thanks to this constant relationship, 442,200 customers have already built their number. Additionally, 548,616 clients have performed their Pension Scan, which is an innovative tool that is intended to inform our clients about their real situation and potential contribution gaps, and also foster voluntary savings.
Propositions to the Presidential Advisory Commission
Today, strengthening the client experience in all contact points has enabled them to be satisfied and better informed. In order to have significant participation, the company prepared 11 specific propositions that have already been submitted to the Presidential Advisory Commission, and which are structured around three themes:
I. Synchronising the three pillars
- Proposition 1: to produce a strong incentive for mandatory savings of young workers in the first 10 years of a pension plan.
- Proposition 2: establish an insurance that is supported by the state, in order to ensure a minimum replacement rate, and linked to a number of years of contributions paid in.
- Proposition 3: strengthen voluntary pension savings for the middle-income segment.
II. Improve the mandatory pillar
- Proposition 4: encourage alternative investments in funds in order to improve pensions by up to 15 percent.
- Proposition 5: implement a change from the current fee scheme to a fee-per-balance scheme.
- Proposition 6: integrate the role of the unemployment fund manager of Chile (AFC) into the pension fund managers (AFPs) in order to exploit the existing synergies between their functions.
- Proposition 7: integrate the self-employed, withholding mandatory contributions of five percent, 7.5 percent and 10 percent for all independent workers who issue professional invoices and whose monthly income exceeds minimum wage.
- Proposition 8: access free available money based on the minimum years of contribution in order to attach members to the system.
III. New ideas for further development
- Proposition 9: develop a policy that encourages continued employment after the legal retirement age.
- Proposition 10: actively promote education on and an awareness of social security through a public/private alliance.
- Proposition 11: evaluate implementation of the reverse mortgage.