Ageing and Longevity

To be fair or to be sustainable? That is the (retirement) question

The Chilean government is proposing wide-ranging reforms to the country's pension system Image: REUTERS/Rodrigo Garrido

Amish Gandhi
Principal, Mercer
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Hundreds of thousands of people march on the capital. They are protesting against a government-mandated retirement system that is perceived as favouring the investment firms which manage the people’s retirement accounts, rather than the people themselves. Is this an upcoming news story in New York, London or Beijing? No, it has already happened in Santiago, Chile, and may be an ominous sign of what is to come elsewhere.

What’s going on?

In the early 1980s, Chile became one of the first countries in the world to replace its state-funded 'pay-as-you-go' pension with a fully self-capitalized system funded by employees themselves (in other words, a defined contribution system). The Chilean system is one of the most sustainable in the world, as shown by the latest Melbourne Mercer Global Pension Index, which gives the country an overall score of 'B'. (The sustainability of pensions is an acute issue facing other countries.)

However, it scores less highly on measures of adequacy, as shown in the chart below. The issue of adequacy, which the government also acknowledges, is part of what led to the protests. The other key issue was the fees which are paid to private corporations that earn revenue from managing savings.

Image: MMGPI 2018

As mentioned in a recent World Economic Forum paper, increased longevity, the shift of responsibility from government and employers onto individuals, and insufficient savings rates are some of the key challenges facing retirement systems around the world. Gaps in employment history, such as those often faced by women who take on the responsibilities of family care, exacerbate the issue. For Chile, these issues are pertinent, and led to the president recently announcing a set of reforms to address the issues.

Ahead of the announcements, the World Economic Forum, in collaboration with Mercer, hosted a workshop in Santiago. Among the guests were government officials, including the Minister of Finance Felipe Larraín Bascuñán, local and international retirement practitioners, members of local industry and global academics. The workshop provided a venue for these experts to discuss the key findings to date on retirement reform issues; share the experiences and recommendations of retirement system providers that are considering or are implementing reforms; and discuss the key challenges faced by the Chilean pensions system and how the proposed reforms could address these.

What is the government proposing?

- Increase the level of savings from 10% to 14%, with the additional amount funded by employers (the existing 10% is funded by the employee) and to be gradually phased in.

- Strengthen the “Solidarity Pillar” to help those most in need of government support for their retirement income, through the “zero pillar” and “first pillar” systems. This is to be financed by the state.

- Fund an additional contribution to the middle class and address the gender pension gap. The state will finance a new contribution to middle-class pensioners who exceed the minimum contribution. This will be tied to anticipated working years, which will be differentiated by gender, to help close the gender gap. It will partially compensate for women’s anticipated shorter working lifetimes, which are often due to the responsibilities of family care.

- Encourage delays in the retirement age. Rather than increasing the retirement age, the state would incentivize people to stay in the workforce for longer by making additional contributions for those who voluntarily postpone their retirement age.

The above proposals are wide-ranging. They seek to address some of the most significant issues facing the Chilean system, specifically introducing measures to improve adequacy. Increasing the level of savings and delaying the retirement age (i.e. saving more and working for longer) are inevitably going to be two key tools for many countries that use defined contribution retirements systems.

Have you read?

Requiring the employer to fund the addition in the contribution rate should also promote a shared sense of responsibility for securing retirement outcomes across all key stakeholders in society. However, this should be viewed as just the first step. More will be needed from employers to improve working life and retirement outcomes, such as providing retraining options to employees, to address the gradual obsoletion of skill sets. Employers should also be encouraged to retain and hire older individuals. Governments can stimulate this through fiscal incentives.

Strengthening the pillars of support to those most in need through non-contributory (zero pillar) and contributory-based systems (pillar one) are also key to helping the vulnerable and preventing elderly poverty, an issue that affects many countries.

Perhaps the most revolutionary government proposal is to create an asymmetrical contribution system for the middle classes that addresses the additional hurdles faced by women. As discussed in a prior World Economic Forum paper, we are acutely aware how it is not only the well-established gender pay gap that affects retirement outcomes, but also the additional time that women tend to spend outside of the workforce for family responsibilities. Details are forthcoming on the Chilean proposal, but we would expect to see the differences in anticipated number of years spent in the workforce to be considered explicitly.

What next?

Aside from the bipartisanship that will be required to pass the proposed reforms (or a variation thereof), there is still more that can be done to help improve retirement outcomes. An increased focus on improving the coverage and participation of workers in the informal sectors of the economy will be key. This is an issue that is facing many countries.

In the case of Chile, the system has been shown to work well for people who are in continuous formal employment and are contributing to their retirement account. However, people who fall through the cracks are the most susceptible to having poor retirement outcomes. It is possible that existing tax systems and technology will be used to address this sector of the economy.

In addition (and soon to be discussed in more detail in a forthcoming World Economic Forum paper), increased scrutiny on the investment design of retirement systems will be necessary, given the outlook for lower investment returns in capital markets going forward. Once people are participating in a retirement savings system and are contributing enough, investment decisions become one of the most significant factors for retirement outcomes.

Chile’s path has been interesting and pioneering. What is clear is the willingness and resolve of the people, industry and the government to improve outcomes for all. The previous generation’s reform put in place a system that was renowned for being sustainable. The challenge now is to make it fair and adequate for everybody.

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Ageing and LongevityGender Inequality
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