Prefunded Pension Systems: Recent Developments

Abstract

From the mid-1990s to the onset of the financial crisis, prefunded pension systems, based on individual retirement savings accounts, were spreading around the world. The UK was initially a world leader in this, due to the system of contracting out, which had allowed people to opt out of part of the state pension scheme and save for their own pension instead. Since 2008, there has been a global U-turn. Private pension systems are now in retreat and the old-fashioned paternalistic welfare state is reasserting itself. The UK is no exception. The contracting-out system, which worked so well for over half a century, has now been ended. Even in Chile, which has long been regarded as the ‘Mecca’ of private prefunded pensions, the mood has turned against that system. If even Chile has lost faith in privatisation and prefunding, what hope is there for an expansion of such systems elsewhere? It is therefore necessary for international observers to interpret the Chilean experience correctly. However unpopular it may be at the moment, it remains the case that Chile’s private pension system has been a success story. It has provided consistently high rates of return and it has been an active ingredient in the country’s rapid economic development. The reason why pensions in Chile have fallen behind expectations is insufficient savings, not any ‘failures’ of the system as such. Only one in three men, and one in four women, save regularly, and in addition, the contribution rate and the retirement age are set too low. The system offers decent pensions and excellent value for money to those who save regularly. But it cannot magically turn a record of sporadic savings into a comfortable old-age living standard – and nor could any other pension system. Whatever problems the Chilean prefunded system may have, these are highly country-specific, and not applicable to the UK. In order to defuse the ‘demographic time bomb’, the UK would do well to reanimate its successful system of contracting out, and promote private pension savings.