In Britain and Chile, lessons for revamping Social Security

A stretched social welfare budget. A right-of-center government keen to promote individual choice. An aging population. A pension system facing bankruptcy.

It sounds like the scenario outlined by President Bush as he urges changes to Social Security.

But it could equally apply to Britain 15 years ago, when the country began offering partially private pension accounts - a policy that was hugely popular at first, but has since proven highly controversial.

Ten years before that, in Chile, things were even more dire. The military government, facing what was by all accounts an unsustainable retirement program and a possible default on its obligation to retirees, replaced the state-run pay-as-you-go system with a three-pillared, largely private one. Twenty-five years later, Chile is looked to as a model of how to retool Social Security.

At least 20 countries have added some kind of private component to their traditional pension systems, with seven more in the process of implementing them. Each offers lessons on how - and how not - to revamp Social Security. With President Bush and his Cabinet in the middle of their "60 stops in 60 days" tour to tout changes to the US retirement system, the Monitor asked its correspondents in London and Santiago to examine two of those lessons.

Chile has what economists call a fully funded system, containing enough money to cover all retirees if they simultaneously decided to cash out.

The first pillar is the state's responsibility, which covers workers who retired before 1980 and guarantees minimum pensions for poor workers.

The second and main pillar is the obligatory monthly payroll deduction of 12.3 percent. Ten percent goes into the worker's own account, administered by one of six private pension funds, while 2.3 percent covers administrative fees. Unlike in the US, the payroll tax is funded entirely by the employee. At retirement - age 60 for women, 65 for men - they take out what they put in, plus accumulated gains. Currently 3.6 million Chileans, or 65 percent of the 5.5 million-person workforce, are actively contributing under this system.

The third pillar is a voluntary, tax-deductible savings plan administered by banks. One can withdraw before retirement, or add it to a pension. Some 420,000 Chileans have this type of savings. "We have to be proud of Chile's system," says Guillermo Arthur, who runs Chile's pension program. He says that pensions have grown an average of 10.4 percent since 1981, far exceeding the 4 percent that he says they need to be profitable.

Today, Chile has more than $60 billion in pension investments, equivalent to more than a third of the country's gross domestic product. Mr. Arthur says that these funds have been crucial to economic growth in the 1980s because pensions were invested in Chilean companies.

For pensioners who contributed to the system for more than 20 years, the government kicks in the difference between a retiree's pension and the state's guaranteed monthly minimum of 75,000 pesos ($132). A recent study by Chile's Association of Pension Fund Administrators showed that 72 to 84 percent of workers who are contributing under the second pillar can expect to receive more than the minimum.

Ilda Alvarez is among the many Chileans who didn't contribute for 20 years, so she only gets back what she put in, plus gains, but not a government subsidy. Her husband, Manuel, made screws for a living, and was able to contribute for 10 years, receiving only $100 a month now.

Rent alone costs nearly as much as her husband's pension, which means Ilda has to keep working, at 70, to earn an extra $120 a month. It's the only way to make ends meet. "Look, I can't complain," Ilda says, "because if we didn't contribute more, we don't receive more."

Under the old system, they would have received none of Manuel's pension if he had worked a day less than 10 years. And even then he still might have taken a loss. Before 1980, many people were paying in more than they got back, explains Tomas Flores, an analyst with Freedom and Development, an independent think tank in Santiago.

"Workers used to have to contribute 34 percent of their salary to pensions and limited health coverage. Today it's only 12 percent for pensions and 7 percent for optional health coverage," he says. "And the returns on that investment are much higher under the new system."

Mr. Flores says one problem Chile has grappled with is administrative costs and the lack of choice. "In Chile, there are only six options, and, really, three of those companies cover the bulk of pensions. My advice to the US is that they try to ensure healthy competition among pension plan providers, perhaps letting banks get involved, too."

Unbridled competition was the name of the game in Britain 15 years ago. In the late 1980s and early 1990s, workers snapped up the government's offer to switch some of their social-security payments to private accounts. The deal involved a lump-sum rebate from the state, a personalized retirement portfolio, and exposure to booming financial markets.

Now, more than a million people have claimed they've been duped in what was dubbed the "pension misspelling scandal." Lawsuits followed, and the government has paid out more than £13 billion ($24.9 million) in compensation. The scandal "eroded confidence in the pension system," says Carl Emmerson, an expert with the London-based Institute for Fiscal Studies.

The British pension-reform movement was born in the mid-1980s, when Prime Minister Margaret Thatcher promoted - and the public embraced - a credo of individualism, shareholder capitalism, and personal control over financial affairs.

Though the plan was voluntary, 6 million people, or eight times the government's estimate, took up the offer to switch out of the State Earnings Related Pension Scheme (SERPS) and into private pensions. "But it was put in place without any controls over the insurance industries selling the policies," says Noel Whiteside, a pensions expert at Warwick University, in central England.

Under the new plan, workers were responsible for investing their own retirement money. Pension sellers, working on commission, frequently coaxed them into unsuitable products, often overstating the potential for returns. "A lot of people were persuaded to leave good occupational schemes and transfer assets to personal pension plans," Dr. Whiteside says.

Richard Idle, a security worker, says he was missold a pension in 1988 by a car-insurance salesman. Four years later, his benefits were paltry and he scrambled to rejoin a company scheme. He was awarded compensation from the government of almost £20,000 ($38,000).

"I thought [the sellers] were advising on what was best, but afterwards I realized they were advising me on what was best for them," he says. He says that the current system is overly complex. "There is no way any normal working man is going to have any concept of it all," he says.

Scores of retirees still rely on a basic state pension, which was left in place after the 1980s reforms, though on a more limited basis. At £80 ($150) a week, it is considered modest, and pension advocate groups say some 2.5 million elderly currently languish in poverty.

Professor John Hills at the London School of Economics says that Mr. Bush's proposals appear to involve collective funds, which would reduce costs. "If that's the case, a lot of the costs would be pooled across many people and so would not be as high as in the UK," he says.