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Regional Outlook : Pensions in Chile Pay Off Handsomely : Other Latin American countries are emulating the system, which requires workers to keep individual retirement accounts.


SANTIAGO, Chile — Those big bites out of Manuel Valladares' paychecks, unlike U.S. Social Security deductions, go straight to an individual retirement account. The dividends and interest it earns are for him.

And this nation's privately administered pension system has yielded handsome earnings for millions of Chileans since it was started in 1981--an average of 13% a year. Valladares, a 64-year-old messenger for an architectural firm, has no complaints.

"It's very good," he said. "I've been in it since '81, and I'm going to retire next year. I'm content."

Chileans are not the only ones who like the system. Neighboring Peru recently established a similar retirement program, and several other Latin American countries appear likely to do the same.

So Chile's social security revolution is beginning to spread. Some experts are even suggesting that the United States might do well to consider a pension system like Chile's.

Most government-run social security systems in Latin America are in deep financial trouble, as was Chile's old system. Governments have dipped heavily into retirement pension funds to pay for other programs. Maturing pension systems and populations have resulted in more pensions being paid out with fewer workers paying in.

In the 1960s, Chile's old system had 10 working contributors for every person receiving a pension. But by the 1980s, when the ratio was 2.2 to 1, the system was bleeding red ink.

Today, all of Latin America's government-run retirement funds are basically "pay-as-you-go" systems, similar to U.S. Social Security. Money coming in goes right back out to pay current pensions, and it's usually not enough.

Francisco Margozzini, general manager of Chile's Assn. of Pension Fund Administrators, predicted that the U.S. system eventually will also incur staggering deficits as the Baby Boom generation retires.

"The pay-as-you-go system is destined for financial crisis," Margozzini said. The only way to finance the increased pension burden is to take bigger and bigger bites out of paychecks--"which is not a solution, because you encourage evasion," he said. "Or you increase the retirement age, but that also has its limits."

The best solution, according to Margozzini, is a system of compulsory savings in individually capitalized accounts. And to guarantee that the government won't dip into those savings, the funds must be privately administered, he added.

That is a key selling point for Chile's privatized scheme. The accounts are similar to the voluntary 401K retirement accounts in the United States in that they both are privately run, individualized investment funds for retirement. But for Chilean workers, participation is obligatory, and the new funds replace rather than supplement the old government pension system.

A major criticism of the new system is that it lacks "solidarity" because it does not redistribute income in favor of the most needy--people who put less into their accounts will have smaller pensions.

Neither the government nor employers pay anything into the new system.

But the system does obligate workers to save for their retirement, and those savings can invigorate the national economy by increasing money available for investment. In Chile, the national rate of saving has climbed from 15% of gross domestic product (about the same as in the United States) to more than 20% since the new pension system began.

Through fund investment in mortgage securities for new real estate, the system has helped finance a construction boom. About 60% of all Chilean mortgage papers are held by pension fund administrators.

The accounts are managed by 18 competing financial firms called "administrators of pension funds," or AFPs, which are licensed and closely regulated by the government. Major foreign concerns, such as Aetna Life & Casualty and American International Group (AIG) of the United States, own controlling shares of some Chilean AFPs. Bankers Trust and Citibank also have bought into the system.

The rules for investment are strict--AFPs can have no more than 30% of their assets in common stocks, for example.

When the system started in Chile, new workers entering the labor force were obligated to join. Switching was optional for workers already covered by the old system, but there were strong incentives for changing to the new.

The move entitled workers to an increase of about 10% in take-home pay, which employers could afford because they no longer were required to match social security contributions for workers who switched. And workers leaving the old system also received special government bonds representing their vested equity in the government pension program.

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