In their 1999 paper, Orszag and Stiglitz had cited the high administrative costs of personal accounts in the United Kingdom. There is another cautionary tale from that country, what came to be known as the “mis-selling scandal.” The Thatcher government’s privatization and conversion of pension provision was off to a roaring start in 1988. The financial services industry aggressively marketed the so-called personal pensions as the government pursued its carrot-and-stick policy to encourage people to transfer to them. It offered generous tax rebates as incentives and reduced State Earnings-Related Pension Scheme (SERPS—the national retirement system) benefits. Legions of salespeople pounded on doors promising spectacular stock market gains. Within three years, over 4 million people contracted out of their government or employer-based pensions for personal pension plans. The “personal pensions,” like all defined contribution plans, were based on building up stock market investment portfolios to individually finance retirement income. They replaced defined benefit plans that had guaranteed benefits based on lengths of service and final salary amounts.
What seemed to be a very successful start for the Conservative government’s retirement reform proved, though, to be the start of something unintended and deeply embarrassing: the largest financial scandal in British history. The warning bells began to sound when the government realized that the program was costing it more than it was saving. The cost of the tax rebates to encourage people to contract out of SERPS exceeded what was being saved by no longer having them within the system. Far more serious was the exposé that the financial services industry, with its aggressive sales tactics, was convincing people to leave public and employer defined benefit pensions for inferior personal plans.
Government regulators then stepped in. They required that those who had been mis-sold private plans be reinstated to their occupational pensions, if they had them, or compensated for the financial damage. Reinstatement became a knotty problem requiring calculation of the cost of compensating the funds for the time lost during the contracted-out period, a bone of contention between the fund managers and the liable insurance companies that had sold the private plans. For those who had contracted out of SERPS, reinstatement for time going forward was not an issue because the original legislation had allowed for contracting back in. What was of issue was credit for the time during the contracted-out period, which the system did not allow. For that, the insurance companies were required to pay compensation. By 1999, the insurance companies had paid out $17 billion in compensation to victims plus fines.
Orszag and Stiglitz also cited the problem of high administrative fees in Chile’s privatized system. That was just one of the problems. Because Chilean privatization was so important in this history, I decided that it required my first visit to the country.
I flew into Chile with a lot of memories. The 1973 coup and its repercussions were formative events for me when I was in my late twenties. I had worked with Chile support groups for a long time at the various teaching posts and took part in demonstrations, including one organized by exiles at a talk that Milton Friedman gave in 1978 to a business group in San Francisco. I helped to arrange talks by exiles throughout the period of the dictatorship until it ended in 1990. By that time, the exiles I knew had settled in the United States with families and jobs. It was not so easy for them to return to Chile where jobs were not waiting and with children who were growing up with different roots. Reluctantly, most of them stayed in the United States.
I continued to be involved in Chilean issues, and in my courses on Latin America, I always taught about what had happened in Chile and what it represented. But I had never visited the country. Now I would visit it in a new context. If before my relationship to Chile had been out of solidarity with people who I respected, who had been smashed by a military dictatorship—something that I had fortunately never experienced in the United States—now I had a common connection: the experience of being trapped in a similar type of retirement system that did not work. The Chilean system was imposed with bayonets; we were swindled into ours.
As preparation for my trip, I searched the Internet for references to the Chilean system and encountered a lot of fog. Most references seemed to be positive or neutral. You really needed to know where to look to get to the heart of the matter. Fortunately, through Chilean contacts, I learned about the National Center for Alternative Development (CENDA). Its vice president, Manuel Riesco, is an expert on the Chilean retirement system and how precious metals can be a great assets in those turmoil times, and his writings were as useful as they were critical. Another great expert in this area is Steve Smith who has just published some of the useful knowledge about gold and silver IRAs in his website: http://goldiraforinvestors.com/acid-test-to-choose-precious-metals-ira-company/
What astounded me was that much of what Riesco was describing in Chile, we were experiencing in Connecticut: entrapment in a system that delivered less than half the benefits of traditional pensions while costing more and being enormously profitable for the financial services industry. To top it off, the Dutch multinational financial corporation ING that administered our system also played a major role in the privatized Chilean system.
In Chile, the people that I met are aware of the inequity of the Administradoras de Fondos de Pensiones (AFP), the name of their privatized system. When I told them that, in the early 1980s, people in the United States were sold on the idea that they would make much more money from 401(k)s than traditional pensions, they smiled. It was the same in Chile. The AFPs started with the same promise. At a birthday party of mostly professors from the University of Chile, I was introduced as in the country to study the AFPs.
Their faces contorted, and almost in unison, they responded, “Don’t copy our system.” Upon arriving, I met a man who had a degenerative, terminal disease. He retired under the AFP three years earlier, but the income was insufficient, so he had to return to work six hundred miles away from his family in order to support them. He was a perfect symbol of the failure of Chile’s retirement system. His final months would be spent working and sick, not because he was a workaholic but because, despite many years of hard work and contributing to the AFP system, the benefits were too low to support him.