What can the Dutch learn from the Chilean pension system?

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What can the

Dutch

learn

from the

Chilean

Pension System?

Yentl Goosens (5806674)

Faculty of Economics & Business

Actuarial Sciences and Mathematical Finance

Master Thesis

Supervised by J. Kuné

December 4, 2013

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“ Knowledge comes by taking things apart:

analysis.

But wisdom comes by putting things together. ”

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Preface

The master thesis “What can the Dutch learn from the Chilean Pension System?” that is lying in front of you, is written on the basis of my study program Actuarial Science and

Mathematical Finance at the University of Amsterdam.

In the beginning, I've read many papers and literature about different countries. It soon became clear that Chile has a very interesting pension system, where the Dutch can learn from. The investigation into the Chilean pension system compared to the Dutch system went smoothly.While conducting this research, I've learned a lot. Sometimes it was hard, but I'm happy with the result.

This is due to the excellent guidance of my supervisor Jan Kuné, who I would like to thank for sharing his actuarial knowledge about pensions and guiding my thesis. Secondly, I thank Rob Kaas for sharing his knowledge about the design, implementation, assessment and reporting of actuarial research. In addition, I also want to thank Pieter Omtzigt,

Thomas Wijffels and Jeroen Breen for sharing their connections with me. Following I would like to say a word of thanks to Pieter Marres for sharing his knowledge about the Chilean pension system. Finally, I want to thank my friends and family for their support, helping hand but also patience when I was full of stories about my thesis.

I hope you will enjoy this thesis as much as I did! If you have any questions you can always contact me by emailing yentlgoosens@gmail.com.

Yentl Goosens, Amsterdam, 2013

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Summary

This thesis analyzes the Chilean pension system as compared to the Dutch pension system based on eleven aspects: the retirement result, guarantee, affordability, solidarity, the demographics, the economic development, the risks and risk management, accountability and supervision, freedom of choice, expropriation and communication. The most important issue is what the Dutch can learn of the Chilean pension system.

The Dutch pension system maintains its second place in the ranking of best pension systems in the world, although the stability of the pension system in our country is something inferior (Mercer, 2013). The pension system in the Netherlands is under increasing pressure by an aging population and a low return on investments. The problems are long and the system is no longer maintained in its current form.

The Dutch system is very complex and also difficult to understand, also the laws and regulations often change. On the other hand the Chilean pension system, based on individual saving accounts, is known for its simplicity, clarity and transparency. Other countries have already adopted the Chilean pension model, partial or total. According

Pieter Omtzigt it is impossible to apply the Chilean pension system in the Netherlands. But in my opinion it is certainly possible to learn from the Chilean pension system and adapt the good aspects in a “new” pension system.

The good aspects are the individual saving accounts where the Chilean pension system is based on and its freedom of choice. These aspects leads into better pension awareness, competition, flexible and better quality offerings and mobility in the labor market. The communication is simple, clear, modern and up-to-date. The implementation and the cost of the asset management are relatively low in Chile. The employer withholds ten per cent of each employee's monthly salary. Of these ten per cent premium, thirty per cent is used for costs. However, the resulting retirement is on the low side. But to increase the retirement result, a higher percentage of the salary can be inserted.

In short, we can certainly learn from the Chilean pension system and use it as a basis for a new pension system.

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Index

1. Introduction ... 11

2. The Eleven Aspects ... 14

3. The Netherlands – The Dutch Pension System ... 17

3.1 A Brief History ... 19

3.2 System Overview: The Three Pillars ... 21

3.3 The future of the Dutch Pension System ... 23

3.4 Analyzing the eleven aspects ... 26

4. Chile - The Chilean Pension System ... 34

4.1 Key Indicators ... 36

4.2 Short Summary ... 40

4.3 A Brief History ... 42

4.4 System overview: Three Tiers ... 43

4.5 Analyzing the eleven aspects ... 49

5. Conclusion and Discussion ... 61

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11 Master Thesis Actuarial Sciences and Mathematical Finance (UvA) Y Goosens

1. Introduction

Netherlands maintains its second place in the ranking of best pension systems in the world, although the stability of the pension system in our country is something inferior. This is evident from the global pension index of consulting firm Mercer, published in October (Mercer, 2013). The total score of the Dutch system, compared to last year fell from 78.9 to 78.3. "This is still an excellent score, but the trend is downwards and some business has deteriorated," the researchers said. However, the pension system in the Netherlands is under increasing pressure by an aging population and a low return on investments. The problems are long and the system is no longer maintained in its current form.

More often the Dutch pension system is under attack and Dutch pension funds get a lot of criticism because they do not have enough money on hand to meet all their future

obligations, partly due to the rising life expectancy and the financial crisis. Last week, it was announced that thirty pension may have to cut the pension entitlements. These funds do not meet the required coverage ratio of 105 per cent. "That you have to cut now, means the bankruptcy of the current system," says Gijs van Dijk, pensions spokesman for the FNV1_.

Of the employees accruing pension through their employer, 55 per cent do not have much faith in their pension fund or pension insurer. Even one in ten have no trust in their pension fund (Centraal Bureau voor Statistiek (CBS), 2012). Not only the trust in the pension provider is in a bad state. Dutch are also poorly informed about pensions. More than 66 per cent of employees are full pension unconscious and is unaware of his future retirement income (TNS NIPO, 2012).

Reform of the pension system is needed to ensure that a good income can be offered at retirement. To keep pensions affordable, the government wants to change the pension system thoroughly. For example, the state pension age will be raised gradually to 67 in 2021 and the age for supplementary pension goes from 2014 up to 67 years. The scheme is called the Witteveen framework. The Rutte-Asscher wants to adapt the Witteveen framework. The tax-accrual rate will go 0.4% down and the rules for pension funds become stricter. In

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implications for both employers and employees. Most employers have to adapt the future of their pension.

But instead of always tinkering with pensions, would it not be better to change the whole pension system. Also other countries in Europe, such as France and Italy, are struggling with pension problems. A lot of these countries debate on the Chilean model, as shown in

figure 5. Because the results of the Chilean system are remarkable. In less than 30 years Chile has built up a pension assets of 112 billion USD, about 85 per cent of GDP. The efficiency of the system is averaged nine per cent per year since its introduction in 1981, significantly more than the four per cent efficiency of the pension system of The

Netherlands (Marres, 2013).

The Chilean system is based on individual savings accounts. In the Chilean system the employee is not attached to a particular insurer or pension fund for long time. The only obligation is to be lodged in a chosen pension bank banking the pension money. Currently, every Chilean worker can choose between six different pension banks (AFPs) themselves. They compete with each other on service and efficiency and they all do their utmost to achieve an as high as possible return. This is important because if the investment results are disappointing, the worker can switch to a competitive pension bank. The pension banks are transparent so that no fraud occurs. As four times a year, each employee receives his pension bank account statement with the final balance, including a justification of the costs incurred. By the time the employee wants to retire, the employee used the balance he has saved up to buy an annuity on retirement from an insurer. Most of the employees choose the insurer with the highest benefit for the accumulated savings, so there is a free market. Because of the simplicity, clarity and transparency of the Chilean pension system some other countries have already adopted the Chilean pension model, partial or total. According to Pieter Omtzigt3_{, Dutch politician and spokesman for fiscal affairs, pensions and foreign}

2_{The Financial Assessment Framework (FTK) are the financial requirements that pension funds must meet. The}

current legal standards no longer suffice. That the financial crisis has shown the past period. That is why the government wants to change the FTK. The starting point is a realistic assessment of the financial position of the fund.

3_{Pieter Herman Omtzigt (The Hague, January 8, 1974) is a Dutch politician. He is on behalf of the Christian}

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affairs, it is impossible to apply a totally different pension scheme such as the Chilean

pension system in the Netherlands. So, it is certainly possible to learn from different pension systems such as the Chilean pension system. This study describes what the Netherlands can learn of the Chilean pension system. Based on eleven aspects and a sample calculation this study examines what the Netherlands can learn from the Chilean pension system But this study is also considered about the strengths of the system as we know it today.

To see where the weaknesses and strengths of the Dutch pension system are, first the eleven aspects will be defined in chapter 2. Then the Dutch pension system will be examined in chapter 3. This chapter gives a brief history and a system overview of the Dutch pension system based on the three pillars. A subchapter is added with the most recent developments in the world of pensions in the Netherlands. Subsequently the eleven aspects will be

analyzed based on the eleven aspects as described in chapter 2. Afterwards, in chapter 4, the Chilean pension system will be described. Also this chapter will give a brief history, a short comparison of the key indicators between the Dutch pension system and the Chilean pension system, and a system overview of the Chilean pension system based on the three tiers. Following, the eleven aspects will be analyzed based for the Chilean pension system. Chapter 5 contains the conclusion and discussion and answers the research question; what the Netherlands can learn of the Chilean pension system.

Representatives. Omtzigt keeps busy in parliament including pensions, taxes, new health care system, renewal of social security and foreign affairs.

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2. The Eleven Aspects

This chapter describes the eleven aspects which are analyzed in the Dutch and Chilean pension system. It also explains why these eleven aspects are considered. The eleven aspects that will be analyzed are:

1. The retirement result 2. Guarantee

3. Affordability 4. Solidarity

5. The Demographics

6. The Economic Development 7. The Risk and Risk Management 8. Accountability and Supervision 9. Freedom of choice

10. Expropriation 11. Communication

The most important thing a person who retires want to know is, of course, how much you get when you retire, the retirement result. Because it is very difficult to compare these results between two totally different systems, a simplified calculation is made. For the calculations, we assume a single man who builds up a pension at age 25. He has a full career, without any breaks for childcare or unemployment. The gross earnings, this is the proportion of the average wage that the individual is assumed to earn throughout his career, is hundred per cent of average wage. He will retire at the national retirement age. The discount rate will be 2 per cent and is equal to the real earnings growth. The price inflation will be 2.5 per cent. Because the average income is very different from country to country, the

effectiveness of the system will be calculated in terms of the ratio of the pension as compared to the average wage, the gross replacement rate. The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking account of personal income taxes and social security contributions paid by workers and pensioners.

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The next question a pensioner will ask himself is, what is the guarantee of the calculated entitlements? Is there a minimum pension a pensioner will receive or does the government guarantees a minimum return. But a system that provides a high retirement result with a high guarantee is priceless. So there must also be focused on the affordability of the system. An opinion poll by Maurice de Hond among over 1,600 people, commissioned by pension provider Syntrus Achmea shows that Dutch want more choice in the pension system, without giving up solidarity between young and old. Eighty per cent want to choose a pension fund by themself. Over seventy per cent want to be able to determine which pension contributions are invested themselves. At the same time, a large majority for maintaining solidarity between elderly and young people in the system. The number of supporters among youth is as high as among the elderly. The Dutch people will have freedom of choice without giving up the solidarity in the current system. But is this possible, or is it one or the other. Therefore, solidarity and freedom of choice in the pension system must be properly analyzed.

Research also shows that of the employees accruing pension through their employer, 55 per cent do not have much faith in their pension fund or pension insurer. Even one in ten have no trust in their pension fund (Centraal Bureau voor Statistiek (CBS), 2012). Not only the trust in the pension provider is in a bad state. Dutch are also poorly informed about

pensions. More than 66 per cent of employees are full pension unconscious and is unaware of his future retirement income (TNS NIPO, 2012). Is the communication better organized in Chile?

To what extent the government interferes with the pensions? Who does supervision and accountability of the regulations of the pensions. What are the risks that they need to monitor and how is the risk managed. It is important that the government does its oversight retirement money but that they cannot come at the enormous sum of pension money, expropriation.

Chile is one of South America's most stable and prosperous nations (BBC News, 2012) and has an emerging economy, with an expected growth of 4.5 per cent of the GDP in 2013 (EY, 2013). This the opposite of the economy of Netherlands which is since one month out of the recession; there was a growth of 0.1 per cent "but still no real recovery”. Not only the

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expectancy is of great importance. Because if someone is living ten years longer the pension

must also be paid ten years longer.That makes huge differences in the provision to be

calculated.

So these eleven aspects will be first analyzed for the Dutch pension system and thereafter for the Chilean pension system, to see where the weaknesses and strengths of the Dutch pension system are, and which of these aspect can be improved on the basis of the Chilean pension system.

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THE NETHERLANDS

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3.1 A Brief History

Until the 19th century there was no pension system organized in the Netherlands. People had to take care of that by themselves. Since not everyone had the opportunity to save, the only other possible pension provision was to get a lot of children so they could take care of you later. This extended family, with several generations living together for centuries was quite common. The only form of pension in the Middle Ages were the guilds who sought for their older colleagues, or their widows. Also the church often took care of the elderly in itself. But these facilities were so limited and applied only for craftsmen who were members of a guild or were dependent on the kindness of others.

In 1836, for the first time a disability pension for civil servants was set up. This first plan was developed for the general government staff in the establishment of the Algemeen Burgerlijk Pensioenfonds (ABP). This was followed by a general statutory pension scheme for civil servants in 1846. The first collective pension scheme for pensioners was developed by the Prussian chancellor Otto von Bismarck (1815-1898). Known as the "Iron Chancellor", he was the one who launched the "Ouderdoms- en Invaliditeitsverzekering Wet" in 1889. Initially, the retirement age was 70, which was reduced to 65 years later. The system of Bismarck was based on the level of income during the working years.

This law remained valid until 1947. Then, there was the new law “De noodwet ouderdomsvoorziening (Noodwet Drees)”. This law arranged that everyone in the

Netherlands received a fixed basic pension after your 65th birthday, while they did not have

to pay a premium.On January 1, 1957 the AOW became applicable. The government pays

the state pension from the pension contributions that citizens pay. Chapter 3.2 discusses the AOW in detail.

Large companies with many employees thought that it was convenient to a collective fund to found here. Thus, the pension funds originated. The oldest company pension was the

pension fund of the Hollandsche IJzeren Spoorweg Maatschappij (HSM) which originated in 1845. The first corporate fund was created in 1881 by the Stork brothers. Not much later, in 1886, Jacques van Marken created a pension plan for its employees in its Delft yeast and alcohol factory. A pension fund for an entire industry would just be coming. The first Dutch

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pension fund industry was founded in 1917 in Leeuwarden Cooperative Insurance. Workers in a part of the dairy industry could join that fund.

In 1936 a company does not appear to meet his pension obligations, which showed that there was a need for more comprehensive legislation. That came in 1952 in the form of the

Pensioen- en Spaarfondsen Wet (PSW). De Pensioenwet4_{replaced the older PSW and}

became valid on January 1, 2007.

4_{‘De Pensioenwet’ describes the roles and responsibilities of employer, employee and pension provider in}

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THE DUTCH PENSION SYSTEM

3.2 System Overview: The Three Pillars

This chapter describes the tree pillars of the Dutch pension system. The first pillar is a basic pension, the second pillar is the supplementary pension and the 'third pillar is voluntary, it contains all the income amenities people take themselves such as annuities and life insurance. The third tier will only be briefly explained as the focus on the first two cows is located.

3.2.1 First Pillar: The Government

The Algemene Ouderdomswet AOW is the 1st pillar of the pension system. The AOW came into force in 1957 and provides people who have achieved the state pension age a basic income. Everyone who lives or works in the Netherlands automatically builds AOW. The retirement age was always 65 years, but goes up gradually from 2013. The cabinet Rutte-Asscher wants to raise the retirement age faster to 66 years in 2018 and 67 in 2021. The state pension provides a basic income, the level of which is linked to the statutory minimum

wage. Pensioners living alone receive 70% of the minimum wage (€ 1,025.145_{gross per}

month) and married couples and couples living together each receive 50% of the minimum wage (approximately €818.06 gross per month). This pillar aims to create a basic provision, which will prevent poverty among the elderly. AOW is made up of rights that are obtained for each year that one before the state pension age eventually force resides in the

Netherlands 50 years. One does not have to be effective. Each year, so 1/50th, is to pick up 2% of the maximum AOW built up. The amount of AOW is a function of the number of years of contribution. In addition to the state pension, there are other situations in which the government pays pensions: disability and death. These are called de Algemene

Nabestaandenwet (ANW) en de Wet Inkomen en Arbeid (WIA). In this first case, your dependents receive a pension. Your surviving spouse (and/or your child) will receive a monthly amount.

5_{Amounts from July 1, 2013. * The gross amount includes the KOB top-up for senior taxpayers. The gross}

amount excludes the holiday allowance. Data is received from The Sociale Verzekeringsbank (SVB), the organization that implements national insurance schemes in the Netherlands

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3.2.2 Second Pillar: The Employer

The second pillar consist of pension from the employer and are called the collective pension schemes. This retired workers receive an supplementary payment on top of the state

pension AOW. Pension plans may vary considerably from one employer. Moreover, not every employer is required to provide a pension scheme for its employees. About 90% of employers have a supplementary pension. These pension schemes are administered by a pension fund or by an insurance company. The company and pension fund are strictly separated under Dutch law. Pension funds are legally and financially independent from the companies. If a company gets into financial difficulties the pension fund will therefore not be directly affected.

In the Netherlands there are three different types of pension funds:

 Industry-wide pension funds for a whole sector, such as bakers, metal workers and

officials;

 Corporate pension funds for a single company or a corporation such as Shell or KLM;

 Pension funds for independent professionals such as general practitioners,

physiotherapists and pharmacists.

In addition to these funds, it is also possible to bring a pension scheme by an insurer. All

pension funds and pension insurers are supervised by the Dutch Central Bank (DNB)6_{. Unlike}

insurance funds have a profit target for shareholders. All the money is earmarked for the fund (the collective). In general, the employee pays 1/3 of the premium and the employer 2/3 but rates may vary by fund, insurance company or employer differences. In due time, the accumulated pension creates the so-called pension capital from which the pension is paid eventually. During the construction period, one speaks of pension reserve. The pension is tax-free, in the sense that the accumulated capital is not taxed. In box 3 of Dutch tax the benefits are taxable.

6_{De Nederlandsche Bank (DNB) is a public limited company (naamloze vennootschap) whose day-to-day policy}

rests with the Governing Board. Being an NV, DNB has a Supervisory Board (Raad van Commissarissen). In addition, there is an advisory body called the Bank Council (Bankraad).

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The three most common pension plans are the defined benefit schemes and the defined contribution scheme. In a final salary scheme (“eindloonregeling”), the amount of pension related to the last salary. With an average salary scheme (“middelloonregeling”), the amount of pension related to the annual salary. In a defined contribution plan (“DC-regeling”), the amount of the pension is not directly related to the salary, but depends on the amount of the pension depends on the investment performance of the premiums paid at the time of retirement. The investment risks are borne by the employee. The majority of pension schemes are DB schemes.

In addition to DB and DC plans, there are also hybrid schemes, called Collective Defined Contribution (CDC) plans. It is an intermediate form that is becoming more common as a pension scheme. The main feature of the CDC scheme is that it is clear in advance what costs the employer pays the pension. The employer shall establish a certain percentage of the wage bill or the sum of pension policies available to finance. This total premium workers receive a pension that is often very similar to a career average scheme. If the premium is not sufficient in any year, the employees in that year receive less buildup in the pension scheme. The Dutch Central Bank shall, moreover, a requirement that the premium up to five years is fixed and that it is not already clear that the premium is insufficient in this period in advance.

3.2.3 Third Pillar: Private

The third pillar is voluntary, all income provisions that affect people themselves fall below such annuities and life insurance. On top of the state pension and the employer, the

employee may provide additional pension supplement itself. The employee may increase the pension by saving, investing or buying an annuity insurance itself. Self-employed often must provide their supplementary pension yourself, they can do this with individual insurance. As follows, people can save extra pension and often taking advantage of tax benefits.

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There have been many changes in the pension world of Netherlands. Many of these changes are already set, while some are only suggestions. The main changes will be described in this chapter.

The state pension age will be raised gradually to 67 in 2021 and the age for supplementary pension goes from 2014 up to 67 years. Since 1957, we have an unchanged retirement age of 65. Due to rising age expectancy this is no longer sustainable. Thus, for men since the introduction of the state pension, life expectancy rose from 71 then to 79 years now. For women, the increase was even stronger, from 74 to 83 years now. These results strongly increase the state pension costs. In addition to the increase in life expectancy has an aging society strongly influenced the rise in expenses. The tax law limits set on what should be built up as pension. As of January 1, 2014, the retirement age as set out at once to 67 years. So this adjustment is not equal with the gradual increase of the state retirement age itself. With the adjustment of the retirement age the permitted percentage to build pension is also reduced. The law takes the view that to achieve now two years longer the same retirement pension can be built and the annual accrual rate can therefore be adjusted downwards. In addition, people with an income from € 100,000 no longer gain tax deduction for their saving pension plans. The scheme is called the Witteveen framework.

The Financial Assessment Framework ( FTK ) are the financial requirements that pension funds must meet. The current legal standards no longer suffice. That the financial crisis has shown the past period . That is why the government wants to change the FTK . The starting point is a realistic assessment of the financial position of the fund . The main elements of the new ranking system :

 There will be a new framework for assessing existing and new contracts. This

framework has the same basic principles, but also separate rules for existing and new contracts.

 Social partners and funds must be open before the distribution of financial risks. So

do young people and older people where they're at.

 Funds may more effectively respond to daily rates of the financial markets.

 The legal framework ensures that pension funds take better account of the funding

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 Funds have the ability to adapt the pensions better to life expectancy.

The government has plans for the new rules for pension funds (the new FTK) presented to the House. End of 2013, the government intends to offer the necessary legislation to the House (Rijksoverheid, 2013).

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3.4 Analyzing the eleven aspects

When analyzing the Chilean pension model, I study the eleven aspects as described in chapter 2.

3.4.1 The Retirement Result

What is the retirement income a Dutch person eventually get to retire?Of course it is

difficult to determine. The OECD has taken all the rules and regulations of the legislated pension systems and put these into a simple pensions calculator so that you can assess the future entitlement. The calculation is based on a single man who builds up a pension at age 25. He has a full career, without any breaks for childcare or unemployment. The gross earnings, this is the proportion of the average wage that the individual is assumed to earn throughout his/her career, for the Dutch male is hundred per cent of average wage. The average wage in 2012 was 43,277 USD. He will retire at the national retirement age of 65. The discount rate will be 2 per cent and is equal to the real earnings growth. The price inflation will be 2.5%.

The effectiveness is measured in the gross replacement rate. The gross replacement rate is defined as gross pension entitlement divided by gross pre-retirement earnings. It is a measure of how effectively a pension system provides income during retirement to replace earnings, the main source of income prior to retirement. The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking account of personal income taxes and social security contributions paid by workers and pensioners. Figure 1 shows these pension replacement rates as compared to individual earnings, as proportion of the average earnings. The gross replacement rate is 83 per cent7

of average wage and the net replacement rate is 92 per cent of the average wage.

7_{The calculation I checked by myself and the results were consistent with those of the pension calculator of the}

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Figure 1: pension replacement rates as compared to individual earnings for the Netherlands (OECD)

3.4.2 Guarantee

To ensure the current high value fixed pension premiums should be increased substantially. On behalf of the committee, the CPB has calculated that if nothing changes in the system, the premium by about thirty per cent should increase. For the next twenty years, from 17 to 19 per cent. The Committee notes that there is "no more stretch is in the pension." The guarantee of conditional pension does not seem to be feasible. Because of the financial crisis, many pension funds were not indexed annually and some pension funds had to cut the pensions.

3.4.3 Affordability

In his first Speech from the Throne, the new king of the Netherlands, Willem Alexander spoke about pensions. "Pensions are under pressure," said Willem-Alexander, on behalf of the cabinet Rutte II. "The affordability of public schemes and facilities the next time an important issue for the government." It has become clear that the Dutch pension system slowly becomes priceless. Because the Netherlands is aging and there are therefore relatively fewer people who pay premium compared to pensioners. The Dutch also all live

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longer and they will therefore longer enjoy their retirement. Also must be taken into account that the stock market in the future will not show the high profits as the past did.

Due to the deteriorating financial position of pension funds by the financial and economic crisis, most funds could not grant indexation more. Many pension funds have recently even have to reduce pensions. The affordability of the AOW, partly due to the increasing life expectancy of the population in the future no longer feasible. The cost to the state pension will continue to rise, and as will even be priceless in the future.

Also the costs to manage pensions incurred by Dutch pension funds have increased by an average of nearly 4 per cent last year. That according to calculations by the Pension Federation, based on 154 annual pension.

3.4.4 Solidarity

In the Dutch pension system, young people and older people are in solidarity with each other. This is not a voluntary action, because everyone is under an obligation. There is talk of 'social solidarity', a form of solidarity organized by the government.

As well in the Dutch collective system participant builds each year a fixed percentage of salary if future pension entitlements. All participants pay the same premium for this to the pension fund, the average premium. So there is in determining the contribution rate does not take into account individual differences such as age, gender, health and income. In this way there is solidarity between groups of participants. With the mandatory the

intergenerational solidarity in the pension system is organized. In theory, the risk of a disappointing yield will be spread over several generations. A generation with disappointing yields and investment results will not be subordinated to a generation with good yield and investment results. When investment performance transcends the buffer. Of these, the future generations will benefit. If the investment returns are bad period, the buffer

decreases. This can then be supplemented by current and future generations. Thus, different generations of solidarity with one another. However, this solidarity is limited because the buffers of pension funds do not fluctuate. During the financial crisis, this has become clear. The current generation has the disappointing investment returns to itself. At this time, the

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setbacks are captured by not indexing the pension and, where possible, to shorten the pensions. The pension of the older pensioners, young people and future generations are at less risk. Their accrued pension rights are relatively small. Solidarity between generations, the major premise of the Dutch pension system is thus further reduced.

In supplementary pensions often involve intra-generational solidarity various pension participants. There is talk of subsidizing solidarity. In that case, certain groups in advance better or worse off because they participate in the pension system. After all, one by a younger inlaid premium pays for much longer than an older inlaid premium, yet they are building for the same premium both on the same pension. Also women on average live longer than men but they do not pay higher premiums than men.

3.4.5 The Demographics

In the Netherlands there is demographic transition (DT). Demographic Transition is the path going from one stage of constant population, with high birth and mortality rates, to another one with low birth and low mortality rates. The life expectancy for the total population for the Netherlands rises slowly since 1950. Shown in figure 4. The life expectancy at birth for a Dutch male is 79.6, for a female this is 83.1. At the retirement age the difference in life expectancy between men and women became less. The life expectancy at the retirement age for men, which is 65, is 83.1 and for women, estimated at retirement age 65, this will be 86.2, this is estimated at the retirement age of 60 (OECD, 2013).

In 2010, the year the first cohort of post-war baby boom 65 years attained the pension age. This also marks the time when the aging population in the Netherlands in a momentum will come. Is at present 15% of the population 65 years or older. In 2040 more than one in four will be 65 years or older, shown in figure 5.

3.4.6 The Economic Development

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foreign trade. The Netherlands is the 17th largest economy of the world, the GDP per capita is roughly $43,277 which puts it in the top 10 of richest nations in the world (United Nations, 2013). The Dutch economy experienced a major growth late 90s spurt in growth rates above 4%. In the first years after the turn of the century, the growth declined. The Internet bubble and the terrorist attacks in the United States on September 11, 2001 have played an

important role. In 2006 and 2007 the economy grew again by more than 3%, but in response to the global crisis in 2009 there was a decline of 3.5%, followed by a very limited growth and sharply rising debt and unemployment from 2010 to present. Since one month is the Netherlands from recession. The economy grew in the third quarter of this year by 0.1 per cent, reports the Central Bureau of Statistics (CBS).

The GDP per capita, the labor force, the investment rate, the unemployment rate and the public debt of the Netherlands compared to Chile are described in chapter 4.5.6 on page 57.

3.4.7 The Risks and Risk Management

Chile ranked 10th among 139 countries in risk management, according to the WEF’s Global Risks 2013 report. Many plans are hybrid schemes. This means that when the fund is in financial difficulties, all parties make their contribution to the recovery. This is called risk sharing. Group pension funds can share the risks. In the entity, it becomes possible to share market risks that is not or only at a high cost can be secured. The proper management of these risks, taking risks in investments where it suits the target and avoiding risks that any proceeds in return, have thus become key tasks of the pension fund board. De

Pensioenfederatie (2013) wrote an excellent report where he makes a diagnosis of the integral risk management for pension funds.

3.4.8 Accountability and Supervision

The rules for pensions are in the Pensions Act (“De Pensioenwet”). This law regulates the duties and responsibilities of pension funds, employers and employees. There are two organizations that supervise pension funds and insurance companies: the Dutch Central

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Bank (DNB) and the Netherlands Authority for the Financial Markets (AFM). They both have their own control area.

The Dutch Central Bank (DNB) examines the financial position of the pension funds. DNB assesses whether the pension funds are financially healthy and whether they can be

expected to fulfill their obligations in the future. The DNB is also responsible for substantive regulation, such as monitoring that pension funds comply with the standards set for them. The DNB regulates the pension fund and not the implementing body. Final responsibility for administering the pension scheme rests with the pension fund, even though the daily administration rests with the implementing body.

A pension fund must always have sufficient liquidities available to pay the pensions. The Financial Assessment Framework, which is part of the Pensions Act, sets out the

requirements for the financial position of a pension fund. A pension fund’s financial position is reflected largely by the coverage ratio. This expresses the relationship between the fund’s assets and the pensions to be paid in the future (pension liabilities).

The minimum coverage ratio is 105%. This means that the capital must amount to 105% of the liabilities. In addition a pension fund must hold enough buffers (equity) to be able to cope with financial setbacks. The size of these buffers depends on many factors, but for an average pension fund the required coverage ratio including the required buffers is

approximately 125%. The greater the investment risks and the higher the average age in the pension fund, the higher the buffer requirements. The fund’s capital as well as the liabilities are valued at market price.

If there is a funding shortfall (coverage ratio less than 105%), the fund must submit a recovery plan to the DNB. The coverage ratio must regain the 105% level within 3 years. A fund subsequently has a total of 15 years in which to rebuild the required buffers. In exceptional circumstances the 3-year recovery period may be extended. This occurred recently (extension to 5 years) as a result of problems related to the credit crunch. The Dutch Authority for the Financial Markets (AFM) monitors the behavior of pension funds, in particular regarding the obligations to provide information to members. The AFM

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also monitors the duty of care; pension funds, who offer pension products with freedom of investment, must actually provide this investment support to their (former) members. Under the Pensions Act, pension administrators are obliged to properly inform the people for whom they manage the pension or to whom they pay the pension benefits about their pension rights. This helps people to properly assess their financial situation and to make the right choices for their retirement. This is useful if people think they will not have sufficient income to live on after their retirement or wish to take early retirements or would like to spend some time abroad. In these circumstances people can make a conscious choice to supplement the income they can expect from the first and second pillars. For example, the Pensions Act states that people must receive information in writing when joining the pension scheme and they must receive an annual pension statement. It also specifies at which points in time information must be provided and that this information must be written in clear language. The Pensions Act also specifies that the pension administrators must establish and manage a joint register of pensions from 2011. This register is designed to enable members, deferred members and former partners to gain insight into their pension entitlements in a simple manner via internet (Reichert, 2011).

3.4.9 Freedom of choice

Currently, there is in the current pension system of the Netherlands barely freedom of choice. Are you employed by a company with a pension plan, then you actually go also automatically entered into the scheme of the company. You may not choose the pension fund or pension provider that your retirement savings will manage. The only choice that there is within the DC scheme. Participants in DC plans currently have choice in building. Dutch want greater choice in the pension system, without giving up the solidarity between older and younger people. Eighty per cent want to choose a pension fund itself. Over seventy per cent want to be able to determine which pension contributions are invested themselves. According to a poll by Maurice de Hond among over 1,600 people,

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3.4.10 Expropriation

Together with the AFM, DNB supervises all activities of the pension providers. The AFM is an independent administrative body, which simply means that the government carries out tasks independently, without in this case, to fall. Under the direct responsibility of the Ministry of Finance. Role of the AFM is keeping conduct supervision of the financial markets. So the DNB and AFM are institutions under the supervision of Government. In the Dutch pension system the expropriation is well organized.

3.4.11 Communication

In June, the Ministry of Social Affairs and Employment of the Netherlands a large-scale study into pension communication. However, research shows that of all the (active) participants only 29% open to information on pensions, 71% is not open. Among the beneficiaries, there is more interest, 63% is open to pension information. More than 66% of employees are full pension unconscious and is unaware of his future retirement income.

The pension communication in the Netherlands is not good, that is the evident from various studies. Previously, nothing was done about the pension communication. Today, pension communication became much more important. Beginning in July 2012 sent the Minister of Social Affairs and Employment (Social Affairs), Henk Kamp, thirty recommendations to the government to improve the Pension communication. These thirty recommendations are presented in the report “Pensioen in duidelijke taal” of the ministry.

The legal communication are the starting letter and the yearly Uniform Pension Overview (UPO), as you can see in appendix I. These do not contribute to a better understanding of the pension scheme by participants.

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CHILE

THE CHILEAN PENSION SYSTEM

Chile is a country that is almost twenty times as long as the Netherlands, about as wide, and with a population of equal size. Where in the Netherlands aging is visible

everywhere, the streets of Chile are determined by young people. Chile is one of South America's most stable and prosperous nations and has an emerging economy, with an enormous expected economic growth. Since the 80’s Chile has a new pension system based on individual savings accounts developed by José Piñera. Many other countries have adopted the Chilean pension system or are debating to apply the Chilean model. This chapter shows an outline of the Chilean pension system.

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4.1 Key Indicators

Chile, officially the Republic of Chile is a country in South America, bordering Peru, Bolivia and Argentina. It is sandwiched between the Pacific Ocean and the Andes. The capital is Santiago and the parliament is based in Valparaíso. It is a country that is almost twenty times as long as the Netherlands, as wide, and a population of equal size.

Chile is one of South America's most stable and prosperous nations (BBC News, 2012) and has an emerging economy, with an expected growth of 4.5 per cent of the GDP in 2013 (EY, 2013). Chile is a founding member of the United Nations, the Union of South American Nations and the Community of Latin American and Caribbean States. In May 2010, Chile became the first South American nation to join the Organisation for Economic Co-operation

and Development8_{(OECD, 2010).}

In 1980 José Piñera developed the Chile's private pension system based on individual saving accounts. The retirement age for men and women is different in Chile. The retirement age for a male is 65 and 60 for a female (OECD, 2011). The life expectancy at birth for a Chilean male is 76.0, for a female this is five years more. At the retirement age the difference in life expectancy between men and women became less. The life expectancy at the retirement age for men, which is 65, is 81.6 and for women, estimated at retirement age 60, this will be 83.8, this is estimated at the retirement age of 60 (OECD, 2013). The gross national income per capita is 16,336 US Dollars (OECD, 2012). This is a lot less than the gross national income per capita of the Netherlands. In Chile 5.2 per cent of the GDP9_{is used for pension spending}

(OECD, 2011). The life expectancy for women is significance higher than for men.

In Chile almost all of the people have a home with indoor flushing toilet for the sole use of their households (OECD, 2013). From the total population 61.3 per cent has an job and 9.3

8_{The Organisation for Economic Co-operation and Development (OECD) promotes policies that will}

improve the economic and social well-being of people around the world.

9_{Gross domestic product (GDP) is the market value of all officially recognized final goods and services}

produced within a country in a given period of time. GDP per capita is often considered an indicator of a country's standard of living.

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THE CHILEAN PENSION SYSTEM

per cent is above the retirement age of 65 (OECD, 2013). A summary of these facts are given in table 1. This table give also a comparison with the key indicators of the Netherlands.

Key Indicators Unit The Netherlands Chile

Retirement age Years (M/F) 65 - 65 65 - 60

Gross national income per capita USD 43,277 16,336

Pension spending % of GDP 4.7 5.2

Life expectancy at birth Years (M/F) 79.6 - 83.1 76.0 - 81.0

Life expectancy at retirement age Years (M/F) 83.1 - 86.2 81.6 - 83.8

Home ownership10 _{% total} ₁₀₀ _90.6

Working Population % total 74.9 61.3

Population ages 65 and above % total 15.9 9.3

Table 1. Overview key indicators Chile compared with the Netherlands data from WorldBank 2013.

A visualization of the population pyramids of Chile and the Netherlands, based on the United Nations data World 2010, are given in figure 3 and 4. A population pyramid, also called an age pyramid or age picture diagram, is a graphical illustration that shows the distribution of various age classes in a population. The population pyramids of Chile and the Netherlands in 2010 are not really the same. The population pyramid of the Netherlands shows one bulge, where the oldest people in this bulge are 65 years old. This can be explained by the

legendary baby boom after World War II (1946-1953). The population pyramid of Chile shows two bulges. These two bulges can be explained by the fact that in the 1930s the death rates declined sharply and in the 1960s the birth rates declined sharply (Princeton, 2013). The shape for the population pyramids in the year 2060 are almost the same for Chile compared to the Netherlands, as shown in figure 4.

The distribution of the elderly as compared to the working population is represented by the old-age dependency ratio. The old-age dependency ratio is an important indicator because

10_{This indicator refers to the percentage of the population living in a dwelling with indoor flushing}

toilet for the sole use of their households. Flushing toilets outside the dwelling are not to be

considered in this item. Flushing toilets in a room where there is also a shower unit or a bath are also counted.

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it measures the heaviness that demographics stance for pension systems. It measures the proportion how many people there are of working age (20-64) relative to the number of the population aged 65+ (the pensioners). The evolution of dependency ratios depends on mortality rates, fertility rates and migration. The old-age dependency ratio’s from 1950 till 2100 for Chile and the Netherlands are shown in figure 2.

𝑂𝑙𝑑 𝑎𝑔𝑒 𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑐𝑦 𝑟𝑎𝑡𝑖𝑜 = 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑎𝑔𝑒𝑠 65 +

𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑎𝑔𝑒𝑠 16 − 64 × 100

At the moment the old-age dependency ratio is around 25 per cent for Chile and 15 per cent for the Netherlands. To interpreted as how many independent workers have to provide for one pensioner the inverse of the dependency ratio can be used. That means that at this moment in time there are approximately seven people of working age for every one of pension age in Chile and approximately four in the Netherlands. Predictions shows that in the future this ratio will increase extremely for both countries and that Chile will pass the Netherlands. Data is received from World Population Prospects: The 2012 Revision.

Figure 2: The old-age dependency ratio’s from 1950 till 2100 for Chile and the Netherlands 0% 10% 20% 30% 40% 50% 60% 70% 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090

65+/15-64 pop.

Old-age dependency ratio

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Figure 3: population pyramid of the Netherlands and Chile in 2010

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4.2 Short Summary

In 1980, Chile has renounced the old socialist PAYG11_{and opted for a new fully funded}

system. The Chilean system is based on individual savings accounts. José Piñera is the designer of the pension system. In the Chilean system is that the employee is not attached to a particular insurer or pension fund for long time. The only obligation is to be lodged in a chosen pension bank banking the pension money. Currently, every Chilean worker can choose between six different pension banks (AFPs) themselves. They compete with each other on service and efficiency and they all do their utmost to achieve an as high as possible return. This is important because if the investment results are disappointing, the worker can switch to a competitive pension bank. The pension banks are transparent so that no fraud occurs. The employee nor the employer pays social security to the government. As four times a year, each employee receives his pension bank account statement with the final balance, including a justification of the costs incurred.

By the time the employee wants to retire, the employee used the balance he has saved up to buy an annuity on retirement from an insurer. Most of the employees choose the insurer with the highest benefit for the accumulated savings, so there is a free market.

The results of the Chilean system are remarkable. In less than 30 years Chile has built up a pension assets of 112 billion USD, about 85 per cent of GDP. The efficiency of the system is averaged nine per cent per year since its introduction in 1981, significantly more than the four per cent efficiency of the pension system of The Netherlands (Marres, Pensioenen onder druk: wat kunnen we leren van de Chilenen?, 2013).

The risks are collected collectively in the pension banks administered by an insurance company. This financial institutions focus only on their core business: the (pension) banks manage the pension savings accounts, the insurers cover the risks. Market forces and the simplicity of the Chilean system ensuring low cost and stability.

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Because of the simplicity, clarity and transparency of the Chilean pension system some other countries have already adopted the Chilean pension model, partial or total. Also a lot of countries debate on the Chilean model, as shown in figure 5.

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4.3 A Brief History

The first social security system was introduced in Chile in 1920s. This was a Pay-as-You go system. In a Pay-as-You go system (PAYG) pensions are paid out of current premium income. In a PAYG, there is no build-up of pension assets. The PAYG maintains a very high degree of solidarity. However PAYG is sensitive to demographic change as the population ages changes the ratio between pensioners and workers. Workers have more pensioners, so the premium should rise or retirement should be reduced. Countries with PAYG solve this by jumping, in many cases by the temporary pension from public funds but also those general funds must ultimately be borne by the taxpayer.

By 1973 the funding of the pension fund was low, though 73 per cent of all Chilean workers paid into the system. The reason for this was that almost all workers contributed only the statutory minimum contribution, and many successfully evaded pension contributions. The poor payment record is attributed primarily to the fact that individual contributions had little correlation with anticipated pension benefits (Vial Ruiz-Tagle, 1988).

By 1979 there were 32 pension institutions in total, with 2,291,183 workers paying into them, and over a hundred different pension schemes. All these public pension programs were defined benefit and financed on a pay-as-you-go basis. Each scheme had significant differences in requirements for retirement, contribution rates and benefits (OECD, 2011). This system was really unfair and did not cover all the workers. So the government

introduced a new pension system in 1980. The new pension system was established on a defined contribution basis with individual savings accounts managed by private firms called the Pension Fund Administrators or “AFPs”. Workers who had contributed, at the time of the reform, to one of the previous public pension schemes could stay in the old system or switch to the new one (but not switch back). New contributors could only participate in the new system (OECD, 2011).

In 2008 a solidarity system was introduced to the people with no contributions. It replaces the previous poverty prevention programs with a unique scheme that guarantees that all individuals in the sixty per cent less affluent fraction of the population will have a

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4.4 System overview: Three Tiers

This chapter describes the tree tiers of the Chilean pension model. The model has a

redistributive first tier, a second tier of mandatory individual accounts and a voluntary third tier. First, the redistributive first tier will be explained, this tier was significantly expanded in a pension reform in 2008. Then, the individual saving accounts, based on the

defined-contribution (DC) type, are described. The third tier will only be briefly explained as the focus on the first two cows is located.

4.4.1 First Tier: Poverty Prevention

The first tier is called the poverty prevention tier and provides old age and disability

subsidies, financed by tax revenues, it is also called the solidarity pension system. The main goal of this tier, as the name says, is to prevent poverty. The first phase was implemented in July 2008, with forty per cent of the poorest population covered. Nowadays, sixty per cent of the target population is covered.

All the citizens who have lived in Chile for at least twenty years, and for at least four of the past five years and aged 65 and older and be a member of a family that is rated among the sixty per cent poorest in the country, will participate this tier (Superintendencia de

Pensiones, 2013). They can only participate if they pass the means test12_{(Shelton, 2012).}

The Chilean government pays a Basic Solidarity Pension (BSP/PSB) to individuals who pass this means test and who have not contributed to the second tier, the individual saving accounts. The Basic Solidarity Pension is about 158 USD per month (Gobierno, 2013). Individuals who did contributed to individual saving accounts and pass the means test, but whose self-financed monthly benefit is less than 494 USD are entitled to a Pension Solidarity Complement (APS) (Superintendencia de Pensiones, 2013).

12_{The means test, which applies to both the Basic Solidarity Pension and the Pension Solidarity}

Component, is measured at the household level and is designed to determine that a beneficiary does not belong to the top forty per cent of the population based on income from earnings and pensions, by age and disability status.

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The disability program provides benefits, for individuals between the ages of 18 and 64, under similar conditions. Once disabled individuals reach the age of 65, they are entitled to old-age solidarity benefits (OECD, 2011). Figure 2 describes these solidarity subsidies as a function of the self-financed pensions from the compulsory pension system.

Figure 2. Subsidies and final pensions under the New Solidarity Pillar Source: Superintendencia de Pensiones

4.4.2 Second Tier: Mandatory Individual Accounts

In the second tier it is compulsory for employees to contribute ten per cent of their total salary to an individual saving accounts, up to a max on monthly taxable earnings of sixty

unidades de fomento (UF)13_{. The individual saving accounts, are based on the}

defined-contribution (DC) type, where the amount of the pension depends on the premiums paid during the construction phase and the return on it is achieved. All employees need to

13_{Unidades de fomento, or UF, are real, inflation-adjusted units that have been used for a variety of}

purposes in Chile since 1967, including pension contributions and guaranteed benefits under the pension system, private and public loans, housing values, construction costs, and other purposes. In 2008, 60 UF were equal to eight times the minimum wage and 291 per cent of average earnings (OECD, Pensions at a Glance 2011, Paris, France, p. 2011, http://dx.doi.org/10.1787/

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participate except civil servants and other government employees, they have their own scheme. Participation is not yet mandatory for the self-employed, the unemployed, those in the informal sector or those who were covered by the old public pension system (OECD, 2011). The employers are required to withhold the contributions of the employees and forward it to the AFP of the employees choice (OECD, 2011).

An AFP is a Pension Fund Administrator regulated by Chile’s Superintendent of Pensions. These AFPs regulates an employee’s pension investments and administers pension benefits, including collecting pension contributions, keeping records, managing pension investments, calculating retirement annuities and paying retirement annuities. So the AFPs protect the assets of the members and reduce risk in hope to guarantee an acceptable return. The whole return on the fund is assigned to the individual accounts. The AFPs must comply with a minimum investment return rule with regards to the pension funds that they manage. The minimum required investment return is measured on the basis of the average real yield of all the pension funds of the same type. The AFP must also have an Obligatory Reserve, funded with its own resources, equivalent to one per cent of the pension funds under management. This asset is invested in the pension fund’s accounting units and constitutes a safeguard, in addition to the Yield Fluctuation Reserve, to ensure that the required minimum yield is achieved (Shelton, 2012).

Employees pay administrative charges and the employers pay risk premiums to the AFPs. Both charges are levied in addition to the ten per cent mandatory contribution. The rate of the mandatory contribution is low in comparison to international standards. The AFPs are free to set fees and commissions, on condition that these are the same for all participants. At the moment there are six AFPs. Workers may choose any AFP and may switch AFPs at any time for a fee (Shelton, 2012). Approximately three per cent of the workers will switch (Marres, 2013).

Each AFP has five different funds, called Funds A to E. Whereas fund A is an voluntary one. These funds are made by the law of the government and have different degree of risk. All the funds have a different proportion in variable income securities and fixed income

securities (Soto, 2005). These variable income securities are for example equities and have a higher risk than fixed income securities such as mortgages, government bonds and bank

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deposits. Fund A has the highest amount in equities and hence the highest level of risk (40-80%). Logically, Fund E has the lowest amount in equities (0%) and hence the lowest level of risk. Funds cannot overlap in the proportions of equity; so fund A must always hold a larger proportion in equities than fund B, and fund B in order more than fund C and so on

(Superintendent of Pensions, Fourth Edition). A range of the minimum and the maximum proportions in equity is given in table 2.

Fund Minimum Limit Maximum Limit

A 40% 80%

B 25% 60%

C 15% 40%

D 5% 20%

E 0% 0%

Table 2. Overview proportion in equity for each fund

As a result, employees can choose between the six AFPs and additionally between five funds. Employees can switch freely two times a year from one fund to another within the same AFP. Administrators are allowed to charge a fee in the case of more than two transfers in order to avoid excessive administration cost and the possibility of negative effects on the capital market (Shelton, 2012). As of today, no administrator has charged this fee. There is only one restriction for pensioners, they may only choose between Funds C, D and E. This because the funds have a lower risk, so that pensioners will be prevented for the volatility of the yield of the funds with a greater proportion of variable income instruments, and, on the other side, for the high risks in the investments made by the portfolio manager with their balances (mandatory contributions) (Superintendent of Pensions, Fourth Edition).

Table 3 gives an overview of the real return of the funds in the month August 2013, one year from September 2012 till August 2013, three years from September 2010 till August 2013.

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A B C D E

August 2013 -3,74% -2,92% -1,92% -0,90% -0,13%

Sept 2012 – August 2013 4,51% 2,74% 3,38% 3,83% 3,66%

Sept 2010 – August 201314 _0,80% _0,85% _1,77% _2,79% _3,65%

Table 3. Overview real return for each fund Source: Ficha Estadística Previsional

Table 4 gives an overview of the transfers between the funds.

No _A _B _C _D _E A 15,087 12,1% 19,6% 7,7% 60,6% B 15,507 28,4% 18,5% 9,1% 44,0% C 9,767 21,8% 12,8% 10,0% 55,4% D 3,653 29,9% 11,9% 13,7% 44,6% E 66,313 86,4% 10,0% 3,2% 0,4%

Table 4. Overview transfers between funds Source: Ficha Estadística Previsional

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4.4.3 Third Tier: Voluntary Additional Savings

It is an employee allowed more than 10 per cent of his salary per month to save through voluntary savings. This is done in the third pillar: voluntary addition saving. This additional savings are deductible from his income tax, this to promote employer-sponsored voluntary pension plans (APVC15_{) . In general, a worker will pay more than the minimum 10 per cent if}

he may appreciate to receive higher benefits or he wants to retire earlier. The third tier involves voluntary additional saving products, such as certain savings products authorized by the Chilean government, including voluntary savings accounts managed by the AFPs, mutual funds offered by banks, and savings products offered by insurance companies. Contributors may pay up to 50 UF per month (unindexed) to voluntary savings vehicles, over and above the mandatory 10 per cent basic contribution to the AFP. Contributions may be made on a periodic basis or on a single occasion (Shelton, 2012). Only 26 per cent of the people are using this third tier. Because the focus of this thesis is not on the voluntary additional saving opportunities, I will not go into this tier too much.

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4.5 Analyzing the eleven aspects

When analyzing the Chilean pension model, I study the eleven aspects as described in chapter 2.

4.5.1 The Retirement Result

What is the retirement income a Chilean person eventually get to retire?Of course it is difficult to determine. The OECD has taken all the rules and regulations of the legislated pension systems and put these into a simple pensions calculator so that you can assess the future entitlement. The calculation is based on a single man who builds up a pension at age 25. He has a full career, without any breaks for childcare or unemployment. The gross earnings, this is the proportion of the average wage that the individual is assumed to earn throughout his/her career, for the Chilean male is hundred per cent of average wage. The average wage in 2012 was 16,336 USD. He will retire at the national retirement age of 65. The discount rate will be 2 per cent and is equal to the real earnings growth. The price inflation will be 2.5 per cent. The rate of return used for the calculations is 5 per cent. Most of the people are in funds C and the rate of return in funds C for all the AFPs is

approximately around the 5 per cent for the last ten years. This is shown in Appendix II. The effectiveness is measured in the gross replacement rate. The gross replacement rate is defined as gross pension entitlement divided by gross pre-retirement earnings. It is a measure of how effectively a pension system provides income during retirement to replace earnings, the main source of income prior to retirement. The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking account of personal income taxes and social security contributions paid by workers and pensioners. Figure 6 shows these pension replacement rates as compared to individual earnings, as proportion of the average earnings. The gross replacement rate is 49.4 per cent16_{of average wage and the net replacement rate is 57.7 per cent of the average wage.}

16_{The calculation I checked by myself and the results were consistent with those of the pension calculator of}

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Figure 6:pension replacement rates as compared to individual earnings for Chile 5% (OECD)

The result is very dependent on the rate of return. If the rate of return rises to 7 per cent, the gross replacement rate is 74.3 per cent of average wage and the net replacement rate is 82.9 per cent of the average wage. This is shown in figure 7.

Figure 7: pension replacement rates as compared to individual earnings for Chile 3.5% (OECD)

But if the rate of return drops to 3.5 per cent, the gross replacement rate is 38.0 per cent of average wage and the net replacement rate is 47.4 per cent of the average wage. This sounds low, but it is still equal to the average of the countries participating in the OECD.