Social Security and Social Insurance Research of Chile
This study is dedicated to overview of the social security and social insurance system of Chile. This country performed transition to personal accounts system and social security privatization over 30 years ago. Many researches consider this reform as a big success, because it made the country economy stronger, financial system healthier and provided more protection to the taxpayers. But there’re also some serious issues in the social security system.
- Social Security Expenditures: A historical perspective and a graph for it.
Chile was one of the pioneer countries in the Western hemisphere that introduced state social security coverage. In 1898, the state set up pension system for retired employees of the public sector. The first set of labor legislative documents was adopted in 1924. There were separate social security systems for workers (known as the Workers' Security Fund) and for private and public employees.
In the next decades social security system expanded sufficiently, by the 1970s, there were over 150 social security programs for different groups of employees, 35 pension funds were in operation. In May 1981 social security reform took place, and privatized system of individual accounts was created and replaced the old “Pay-as-you-go” (PAYG) social security system.
Currently, the country’s system of individual accounts consists of 6 fund management companies called “Administradoras de Fondos de Pensiones” or AFPs. Their total amount of assets under management reached equivalent of US$16.2 billion 91 trillion pesos as of the end of April, 2014.
Social security expenditure grew sufficiently over the past decades in absolute numbers (fig. 1). At the same time, share of social spending in GDP decreased since 2000 (fig.2).
Figure 1. Social expenditure (public& mandatory private), at current prices in national currency, billion. Source: OECD, National Accounts database
Figure 2. Social expenditure (public& mandatory private), % of GDP
Source: OECD, National Accounts database
Social spending per capita is 424 dollars in constant prices (fig. 3), this is one of the highest figures in Latin America.
Figure 3. Per capita public social spending on social security and assistance (USD at constant 2000 prices). Source: Economic Commission for Latin America and the Caribbean (ECLAC), social expenditure database
- Social Security Payment system (Pay-as-you go or fully funded or a mixture).
In 1981 Chile replaced is pay-as-you-go social security system with a private mandatory defined contribution schedule. The Chilean social security system is now fully funded. Private pension fund management companies (AFPs mentioned above) manage the employee’s social security contributions. Each employee has an individual annuity account. An employee affiliates with the pension fund of his choice; this affiliation is mandatory for all employees. For self-employed professionals the affiliation is on a voluntary basis. Mandatory deductions from the payroll amount to 10% of the gross salary (Rix 2). These sums are placed in the AFP chosen by the individual. Employees also can add voluntary deposits to their accounts.
- Data for Dependency Ratio (demographic data): changes over time.
According to CIA data, total dependency ratio in Chile amounts to 45%, including elderly dependency ratio 14.9% (estimate for 2014). Healthcare expenditures increase; population longevity grows over time (according to the World Bank data, life expectancy increased from 69 years in 1980 to 80 years in 2012), number of elderly people overcome reduced number of children. All this factors contribute to increasing elderly dependency ratio (figure 4). The ratio of older dependents to the population of working age increased by 5 percentage points between 1980 and 2012.
Figure 4. Age dependency ratio, old (% of working-age population). Source: the World Bank, World Development Indicators database
According to OECD data, elderly people in Chile received in 2009 30% of total public social expenditures.
- Data for Income Distribution among the Aged Population (the beneficiaries’).
According to OECD data, Gini ratio (for disposable income, after taxes) for Chilean people above 65 years old is 0.457, higher than in the U.S. (0.379) or Canada (0.292). Poverty rate among seniors is 0.293 (OECD).
The seniors are “over-represented in the top quintile of the household per capita income distribution” (Gasparini 11). Unlike many other Latin America countries, Chile’s seniors are not over-represented in the segments with the lowest income (fig.5).
Figure 5. Poverty headcount ratio by age (Gasparini 69).
- Describe the Structure of Social Security Tax: Employers and Employees contributions.
Before the social security system reform that took place in 1981 payroll taxes amounted to 25%, but it was not enough to provide adequate pension payouts to retirees.
In 1981, after the new program started, employees were required to contribute 10% of their salaries to a private pension fund and additional 3% - for life and disability insurance coverage (Idemoto 2).
Nowadays the employers make a basic contribution of 0.95% and also additional contribution (between 0 and 3.4% of payroll) for work accident insurance. Except these payments, employers must direct 1.26% for every employee’s death and disability insurance coverage.
Employees’ social security payouts covering healthcare and pension funds are made at a rate of 18.74% including 10% for pension funds and 1.74% administration commission. These contributions are paid on salaries up to a maximum level. This maximum level fluctuates, now it equivalents about $3 400.
Unemployment insurance is financed by the government and also by employers and employees. The contribution rates amount to 2.4% for employers and 0.6% for employees. The maximum salary is about $5 000 a month. Contribution for fixed-term employees is 3% and is paid by the employer.
- Collect Data for the Structure of Social Security Benefits (a measure such as the GRR) and show the re-distributional aspect of it (if present) on a graph.
In the Table 1 replacement rates data are shown for Chile in comparison with several countries of the World and also with OECD average.
In many countries of the World social security often carry a certain level of redistribution. Some individuals receive benefits more or less equivalent to their contributions. But in Chile the situation is different. The individual accounts system sharply reduced redistribution effect, because since then all benefits are calculated individually and payouts depend on personal contributions. Even upon death of an individual the accumulated and unused amount is not re-distributed between other retirees.
After inclusion of solidarity benefits in 2008, social security started to play a bigger role in lifetime income distribution. Models and simulations presented by Eduardo Fajnzylber in “Implicit redistribution in the Chilean Social Insurance System” paper demonstrate zero relationships between lifetime income and social security wealth (see figure 6). It means “the expected present value of pension benefits is, in general, equal to the expected present value of contributions” (Fajnzylber 13).
Figure 6. Plot of pension wealth versus pre-social security labor income, by gender, women labeled as “1.” Source: Fajnzylber, Implicit redistribution in the Chilean Social Insurance System.
- Retirement Age and Benefits eligibility, current and historical.
Currently, retirement age in Chile is 65 years for men and 60 for women. If a person has made contributions by over 20 years, the retirement age can be reduced.
Early retirement is possible in a case when personally accumulated funds are enough to provide a pension at the level of at least 70% of the average salary within the last 10 years or 80% of the minimum pension called PMAS (in Spanish, “pensión máxima con aporte solidario”). If the pension is lower than PMAS, an individual can apply for the old-age top-up benefit.
Previously, there was “state guaranteed minimum pension”, but it was replaced by so called “old-age social security solidarity top-up benefit.” To apply for this supplementary benefit, an individual must be of age at least 65. She or he must be Chilean resident for at least 20 years. This person must have a base pension from his individual account in the fund, and the level of pension must not exceed the PMAs level. The retiree’s family should be among the 60% of the country’s families with the lowest income.
There’s a special support program for women. At the age of 65, each woman receives a pension certificate for each child, which creates additional money inflow for this woman.
In the 80s retirement age was set at the current level (60 for women and 65 for men), but many people retire earlier. As Superintendencia de Administradora de Fondos de Pensiones data show, in 2006 almost half of retirees preferred early retirement, 11% of them retired before they reached the age of 50.
The main directions of using individual savings on pension accounts are the following:
- A person can take (actually – purchase from an AFP) an immediate annuity for free use;
- A retiree can set up regular (programmed) withdrawals, the monthly payouts depend on the total amount and the retiree’s life expectancy;
- A person can choose a deferred annuity (programmed withdrawals followed by immediate annuity upon the selected date);
- An individual can withdraw a sufficient part of their funds and set up the programmed payouts for the rest of the amount.
- Facts and data for Benefits for Family Relations: Spouses/domestic partners Benefits, Dependent Children’s Benefit, Widowers’ Benefits, etc.
As it was mentioned above, the Chilean social security system is based on individual contributions and individual benefits calculations. But there’re some benefits for close family members.
The first is survivor’s benefit, due to the widow and orphans of a deceased person of senior age. The widow receives 60% of disability or old-age pension (the widower gets 43%), if there are no children to support. If there are children, the spouse gets 50% (if it’s a widow) or 36% in case of the widower.
Each orphan under age of 18 receives 15% of the parent’s pension, if the orphan is student the pension – under the age of 24. If the deceased individual left a son or daughter who is partially disabled, those children can apply for the orphan’s pension even they’re older than 24 (in this case, they get 11% of the parent’s pension).
If there are no other survivors (neither a spouse nor children), 50% of the pension goes to each of his or her parents.
Social insurance program guarantees 60% of the salary of an individual to his spouse (if the widow is aged 55 or older) or, if the widow is younger than 55, - onetime payout amounted to two years of pension. Orphans get 20% of the deceased parent’s salary.
For low-income families, the Government offers family allowances program financed from the unified severance fund. These allowances are calculated individually taking into account the number of dependents. The following family member can qualify: children under 18, a spouse, a widowed mother, elderly or disabled parents, etc.
- Unemployment Insurance Benefits Program.
Chile is proud to have one of the most stable economies in Latin America with the total unemployment rate 7.1% (OECD, 2011 data). It’s relatively low ratio if compared with the U.S. (9%) or European Union data (9.7%).
Unemployment insurance is mandatory for all employees except self-employed professionals. Individual account contribution amount to 0.6% of monthly salary, in addition, an administrative commission is charged. Fixed-term employees are free of such contributions.
Employers also participate in funding unemployment insurance program, contributing 2.4% of overall payroll. 1.6% goes to individual employees’ accounts, 0.8% - to the solidarity fund. If the company hires fixed-term employees, its contribution for their unemployment insurance goes up to 3% of the payroll.
Amount of compensation paid in case of unemployment depends on an amount accumulated on severance accounts. The replacement ratio gradually decreases from 50% to 20% of the salary level.
According to OECD data, public unemployment spending in Chile amounted to only 0.1% of the country’s GDP in 2009 (in the U.S. – 0.9%).
- Health Care Coverage for the eligible recipients and their dependents.
Chile’s healthcare insurance system is represented by mandatory health insurance (public or private). The public branch is implemented through FONASA - the National Health Fund. The private branch is represented by numerous insurance companies providing health insurance.
All employees must enter the health insurance plan by contributing 7% of their income or pension per month, up to a monthly limit of about $2 000. The government subsidizes indigent and low-income beneficiaries.
Chilean legislation (the Explicit Health Guarantee) regulates emergency care and primary care (including screenings, consultations by specialists, acute care and many other healthcare services). Those covered by FONASA program can access healthcare services using either of two existing modalities. They can use public hospitals or private institutions having contractual relations with FONASA.
According to ECLAC (160), in 2009 Chile spent 3.7% of its GDP on public social payouts related to healthcare.
- Social Security Reforms: pending or implemented.
The major reform in Chilean social security system took place in 1981, when pay-as-you-go system was replaced by fully-funded system of individual accounts (Cerda 542). New public pension system was set up, consisting of the Social Security Services for workers and the Private Employees Fund for “white collars.” The network of privately owned pension fund management companies was established. Despite an expensive transition, this reform was a success.
The reform has a positive impact on Chile’s economy. Share of labor force participation among seniors aged 65-70 grew by 13%, according to the National Center for Policy Analysis. Large amount of funds were accumulated in the private sector and revived the capital markets. The savings rate went up from 10% to 27% of gross national product. With low unemployment and relatively high savings rate Chilean economy grew sufficiently (Piñera). In 2013 Chilean GDP grew by 4.2%, unemployment remained at its historical lows at the level of 5.5% (Mallen).
In 2008, another stage of social security system reform was put into force. This new stage addressed mostly uncovered segments of the population. It introduced two basic elements – the basic solidarity pension guaranteeing minimum payouts for poor seniors and a pension social top-up that enables contributors to individual pension accounts to increase their pension benefits (Behrman 3). As studies show, the reform, especially its targeted aid component had a positive impact on low-income families having an elderly family member (Behrman 13).
On April 29, 2014, Chili’s President Bachelet created a pension advisory commission to reassess the country's social security system of individual accounts. The decision was made after over 30 years of current system’s operation. The commission, consisting from Chili’s and international experts, is planning to present its conclusions and proposed recommendations by January 2015.
- Problems and issues with the system.
The transition to the new system of social security and social insurance contributed to the economic growth, but there are also some drawbacks in the current system.
The first issue was rather expensive transition to a new model. To finance the transition, the state had to accumulate budgetary surplus amounting to 5.5% of GDP (Kritzer 46). During this preparatory period the state had to cut public spending, reduce current benefits and to raise taxes.
The second issue is large funds management fees charged by AFPs. These fees lower the return of individual accounts. Fees as a share of funds contributions give one of the highest proportions in Latin American countries (Kritzer).
The next problem is insufficient coverage of the Chilean labor force. In 2007 only 54% of the working people were covered by social security system as compared with 70% in 1980 (Kritzer). This figure is much lower for self-employed people.
The related issue is low contribution density which is defined as a ratio of the number of years the employee contributed to the total number of years she could have contributed potentially. The current average contribution density is about 52%. It means that employees make active savings only during about half of their working lives (Social Security Administration 1).
The next challenge for the policy makers is pension adequacy. The government guarantees the minimum level of pension for individual account holders, but large share of employees don’t qualify for top-up benefits. A study done by Berstein, Larrain and Pino in 2006 showed that “45% of AFP members were expected to have a pension below the minimum level and most of this group (two-thirds) would not have qualified for the targeted aid because of a low number of years of contributions. Without any changes, by 2025 about 85% of these workers would not have enough years of contributions guaranteeing them an adequate level of pensions” (Kritzer).
The next issue is a low level of voluntary retirement savings. In 2006 only 20% of AFP contributors had voluntary pension accounts, and almost half of those accounts had zero balance (Kritzer, SAFP).
A month ago the Chilean government created a special commission to analyze the above mentioned issues, including the most important ones – contribution density, functioning of pension fund management companies, benefits adequacy for long-term contributors and, finally, a probable impact of current demographic challenges. The population in Chile, like in many countries, is aging rapidly, and, according to World Bank, by 2030 age of people over 60 will reach 21% of the total population. Growing longevity will cause the problematic situation when people will receive benefits for a longer time, basing at the same duration of active workforce participation.
The Chilean population is looking forward the next expected improvements of the social security systems addressing current gaps and issues.
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