Wait A Minute Chile's Nest Eggs Are Cracked

It's not often that a union calls for layoffs in its own industry, but that's what is happening in Chile's ballyhooed private pension fund system. The companies running the system, known as pension fund administrators (AFPs) quadrupled their sales forces, to 20,000, between 1992 and 1994. "There should only be 5,000 salespeople," says Reinaldo Valenzuela, secretary general of the AFP workers' union.

Why is Valenzuela griping? For one thing, because the soaring sales forces are pushing up the pension funds' operating costs. But that isn't the only problem dogging the AFPs. After 13 years of hefty returns--13.3% on average--the funds' 1995 results plummeted to -3.7% through the end of October, leaving this year's retirees high and dry.

In a country frequently held up as a free-market model for Latin America, the privatized pension system is often cited by economists as a brilliant achievement. In fact, it is successful by many measures, having helped finance Chile's rapid expansion in the past decade. Total domestic savings now equal 27% of gross domestic product, up from 4.4% in 1983. But the system's flaws have become all too evident, and change is afoot. "The system works well, but it does need some perfecting," admits Julio Bustamante, superintendent of the AFPs.

STICK-TO-IT BONUS. High on Bustamante's agenda is the issue of costs. The AFPs were created in 1981 as an alternative to a bankrupt pay-as-you-go state system. Workers had the option of staying in the old system or switching to AFPs. New entrants to the workforce must sign up with an AFP and are supposed to pay in 13% of their monthly salary, of which 10% goes to an individual account, about 1.2% to an insurance company, and the rest to costs.

The 18 AFPs work like mutual funds, with government-set investment limits that have been slowly broadened to include riskier instruments. Workers may switch AFPs as many as four times a year--one reason the marketing costs have risen to 15% of total costs, says Bustamante. He proposes offering workers a bonus for sticking with one AFP, a plan Congress is considering.

Even more worrisome than the system's high cost is its spotty coverage. Although almost all of Chile's more than 5 million workers are affiliated with AFPs, only 57% of them pay their monthly quotas. In some cases, the employers keep the money: The superintendent's office has 150,000 lawsuits pending against such deadbeat bosses. Other workers aren't interested in saving. And many simply can't afford the contributions.

ONE BASKET. Another drawback is that workers nearing retirement are extremely vulnerable to market shocks. One reason is that the funds' investment options are limited, resulting in poor diversification. As of Oct. 31, 40% of the $24 billion in the funds was invested in government bonds and 29% in Chilean equities (table). Nearly 70% of the equity investments were in five electric and telecommunications companies. Both sectors have done terribly this year. And government rules have made it impractical for AFPs to invest abroad. Partly because of the abysmal 1995 results, Bustamante is considering creating two types of funds within each AFP: one that is 100% fixed income--more appropriate for workers on the verge of retiring--and the other mixed.

Albert Cussen, CEO of AFP Provida, whose nearly $5 billion under management makes it the biggest AFP, thinks that having two funds is an excellent idea. "In the long run," he says, "it should help reduce competition among the AFPs." But the reform might create a new problem. "Allowing workers to switch back and forth between types of funds could generate great instability because the markets are so small," notes Francisco Margozzini, who heads the AFP trade association.

Under reforms enacted this year, funds are allowed to increase their equity and international investments, participate in project financing, and hedge with derivatives. Still under consideration: a proposal to let AFPs invest in mining megaprojects, a field dominated by foreign investors and state-run companies.

Chileans have by no means lost confidence in their vaunted AFPs. "The system's not a bad system. It's a good system," insists union leader Valenzuela. The trick now is to get the bugs out.

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