The re-engineering of Social Security

Nation's Business, May, 1997 by James Worsham, Robert T. Gray

1996 Life expectancy at birth is 72.5 years for males and 79.3 for females. There are 31 beneficiaries for every 100 workers. Payments to retirees and dependent survivors of deceased workers exceed $300 billion. An advisory commission breaks into three factions that fail to agree on specifics for dealing with long-term financial problems of the system. All three factions endorse some form of private investment of payments from employers and employees.

RELATED ARTICLE: The Chilean Precedent

When radical reform of the U.S. Social Security system is proposed, the talk usually turns to Chile, which has become the marquee example of privatization--or having retirement assets in nongovernmental hands.

The change in handling of retirement assets in that Latin American nation of 14.3 million came in 1981, when the then-military government threw out a pay-as-you-go system heading toward insolvency Chile's was similar to the U.S. system, in which today's workers finance the benefits of today's retirees.

In its place, Chile set up a system of private retirement accounts, they are funded by mandatory contributions from employees in the form of payroll deductions and are run by heavily regulated private-sector retirement-plan administrators.

"Our reform was a radical, even revolutionary approach, but with a prudent execution," says Jose Pinera, who was Chile's minister of labor and social security at the time. He is now based at the Cato Institute, a libertarian public-policy research organization in Washington, D.C.

Putting the new system into effect required a transition period to deal with the different generations of individuals who would be affected, Pinera said.

Under the transition of 10 to 30 years, retirees already receiving pension benefits from the old system could elect to stay in it. Individuals already in the work force could opt to stay in the old system or shift to the new system. If they moved to the new system, they would get a transferable credit (called a "recognition bond," redeemable upon retirement) for what they had paid into the old system. All new entrants to the labor force were required to go into the new system.

Today, about 5 million workers participate in Chile's privatized system, and 3.2 million are making contributions regularly The mandatory 10 percent deduction from their paychecks goes into a private savings account administered by "pension-fund administrator' firms which are regulated by the government. The accounts are portable--they can be taken from job to job.

About 40 percent of all the assets are in Chilean-backed government bonds, Pinera says. The average rate of return since 1981 has been over 12 percent, including a 2.5 percent decline in 1995.

When workers retire, they can turn their savings into annuities or make scheduled withdrawals. The Chilean government guarantees everyone a "minimum pension," says Pinera, and the government will make up the difference between what retirement accounts provide and the minimum guaranteed pension level.