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Op-Ed ¦ Monday, June 29, 1998
Buyer Beware Chile Pension Plan

By David Langer

Should Chile's privatized social security system be the role model for our own Old-Age, Survivors and Disability Insurance? Its enthusiastic supporters propose we adopt the Chilean-style individual investment accounts for U.S. workers to accumulate retirement funds and dismantle a large portion of our Social Security. We are told that the private investment market
will generate such yields that privatized benefits will greatly exceed those from Social Security. This concept has been successfully sold to many other countries.

A study of Chile's program should therefore lead to a profitable basis for reconsideration of the U.S. program. But a reading of the literature leads to the startling discovery that Chile's system is not at all what the privatizers would ask us to adopt here - they would likely be embarrassed to do so. In fact, the program's expenses are exorbitant, it is highly regulated by Chile's government, it has saddled the Chilean government with incalculable costs and workers have practically no choice of investments. Moreover, its vaunted high investment yields seem to have been calculated without taking expenses into account.

The discovery of these undesirable characteristics comes as a surprise in light of the intensely favorable publicity the system has received here and abroad. Privatization proponents have evidently chosen not to burden the public with these negative aspects.

Thus the key lesson to be learned from Chile may be that when one looks past the glowing promotion of its privatized social security and notes the many drawbacks, it becomes essential to examine closely the major proposal being urged for adoption in the United States: Five percent of each worker's 62-percent Social Security contribution, would be placed in an individual account to be invested at virtually the worker's unlimited choice of investments. Does it have drawbacks, too, that are not being fully disclosed? Unfortunately, yes. Note the following:

Cost to privatize. American employers and workers will need to pay an additional combined contribution of 1.52 percent of taxable payroll until 2070. The U.S. Treasury would need to borrow amounts each year to pay the benefits otherwise paid by the workers' 5-percent contribution, which would now go into individual investment accounts. Supporters of the 5-percent proposal estimate the borrowing would ultimately reach a peak of $10 trillion and descend to zero by 2070.This would add $600 billion to the federal budget in the peak year.

Operating expenses. Social Security's expenses now come to less than 1 percent of annual concributions. The added expenses to administer the privatized portion would be 15 to 20 percent in about 20 years. The managers of the privatization operations (many of whom are also promoting privatization) would receive in the first 13 years about $240 billion to cover their costs of administration and profits.

Future yields. The additional government sale of Treasury securities on the public markets would likely drive up interest rates, raising federal operating costs and possibly dampening stock prices. Many workers might never see the big yields.

Federal underwriting. In the event of a stock market crash, the government would have to assume the responsibility of payments to retirees of specified minimum amounts. In addition, the purchasing power of retirees and other beneficiaries would be cut at a bad time, and workers in desperate need because of lost jobs or pay cuts could not be expected to take kindly to a sharp reduction in their nest eggs. Demands might even be made on the government for restitution.

Given that even sophisticated investors are regularly scammed, one can confidently predict that the scamming of workers and their beneficiaries would become a major growth industry.

The lesson from Chile may be summed up in two words: Caveat emptor!

- David Langer, a consulting actuary and president of David Langer Co., Inc.
New York


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