Us & Chile's Spcial Security System

Amid concerns of a collapsing United States Social Security System, the search for a new, better system has heightened to a frantic pace. In the hunt for this new system, the United States would be wise to consider the privatized system of Chile as a guide to its own pension fund system reformation. Here, we analyze the two systems, their similarities and differences, and the take-aways that the United States should glean from Chile's version of pension fund issuance.

Basics of the Chilean Social Security System

Chile's new privatized social security system replaced the old, bankrupt state-run system in May 1981 under General Pinochet. The new system had several unique features about it that still spark hot debate over its efficacy. Under the new structure, workers were required to contribute 10% of their monthly salary towards a private pension management firm account. An additional 3% of salaries went to commission fees for the pension managers and towards disability and survivors insurance. Retirement benefits were then essentially linked to the amount an individual contributed and the rate of return of the private pension management firm. Furthermore, the government also guaranteed to fill in for the discrepancy between the minimum pension amounts (Leiva 1-3).

The new system, therefore, had fundamentally three aspects to it: the government's role, the private pension fund managers' role, and the savings of individual workers. This three tiered system allowed for different groups to share in the responsibility of Social Security, lifting the burden off of the government. The government's role includes financing a part of the minimum pensions and all the pensions for the elderly poor. The Private Sector manages the mandatory Social Security savings of workers. Finally, Chile's workforce saves and invests their earnings (Chile's Pension Reform 2). The individual accounts that were created under this system incentivize savings, thus fueling spending and the markets, and they encourage higher productivity. These factors create an environment that fosters overall economic growth (Chile's Pension Reform 2).

Successes of Chilean Pension Fund Privatization

One of the main successes of the privatization of the Chilean pension system was that it left individuals with the mental perception that their pension would be available to them when they retired. This is a directly a result of the fact that the new system gives a return to individuals based on what they contribute. This also gives motive to individuals to put more money into their pensions so that they can retire early, or so they receive higher annuities when they do retire.

The new system that Chile has implemented gives the individual some control over how his or her pension money will be invested. Administradores de Fondos de Pensiones (AFPs) run the pensions. There are a number of different AFPs for each individual to choose from and each AFP is a private company that gets to choose how to invest an individual's money. One AFP can invest heavily in one sector of the market while another AFP may not invest in that sector at all. All the while, the government of Chile facilitates and imposes restrictions on their investing so these companies do not become reckless. Experts believe that this has been good for the country because it has led to increased investment in different financial markets in Chile leading to the growth of those markets.

Since its inception, the system has given an average annual return of 12.8% in real terms. Its success is further validated when we analyze the level of unemployment within Chile. The payroll tax cuts that came as a result of switching out of the old system has led to a lower level of unemployment within Chile which experts believe have sparked economic growth. Economic growth within the country is at 7% now, double its historical rate of 3.5% before 1980 when it switched over.

Though proven successful on many levels, the system still has its disadvantages and poses certain risks for the future. For one, the system must coexist with the old pay-as-you-go system it replaced in 1980. The government must continue to pay benefits to those individuals that retired before the inception of this new system. Experts believe these two systems must to coexist until about 2045. As mentioned, the government must still issue benefits even though it has faced a sharp decline in its income because of lost social security taxes. The government must also finance recognition bonds for those individuals that transferred from the old system into the new system.

There may always be the threat that operating costs to make the system run will deplete the actual returns of the system. In 1984, 90% of the contribution to the system was used to cover administrative expenses; the number has gone down since then. There is also the concern that many people will not reach their minimum benefit or that their pensions will become depleted. In such cases, the discrepancy must be met by the government. The government will also have to step in if an AFP happens to default.

The United States Social Security System

The current United States Social Security system is also known as the OASDI system (Social Security - summary of programs). These initials represent the 4 aspects that social security gives aid to: "OA" for Old Age or those who are retiring, "S" for Survivors or those who have lost their spouse, "D" for Disability or those who have suffered an injury while on the job, and "I" for Insurance.

Of this social security tax, one-half must be paid by the employee and the other one-half must be paid by their employers. Those individuals who are self-employed bear the burden of paying the entire social security tax themselves (Social Security - summary of programs).

This system is also known as the "Pay-As-You-Go" system, which was formerly used by the Chilean government (Berlin). Under this system, current tax receipts are used to pay current benefits. Essentially, this means that the social security taxes paid now will be used to pay those that are eligible for social security tax now. A major flaw of this system is the risk of a poor future economy.

In the U.S since the early 1980's, social security revenues have exceeded social security liabilities on a yearly basis. Thus, this excess revenue has been building up in what is known as the Social Security trust fund. Recent revenue projections, however, predict that social security expenses will start exceeding revenues as early as 2018.