Treasury Proposes Chile Model to Lower Risk for Older Savers

The Finance Ministry has decided on a major overhaul of the Israeli pension system to reduce financial risks for older savers. In a press conference to announce the proposed changes, Finance Minister Yuval Steinitz also promised that the fees charged by pension managers would be cut.

The big change would be to automatically, gradually lower of risk levels as savers age. This is known as the Chilean Model. The new rules will apply to all retirement savings.

Steinitz Sarig - Michal Fattal - 05012012
Michal Fattal

The maximum level of fees charged by pension managers would drop from 2% to 1.2% of savings, Steinitz promised. Steinitz said he will bring the proposal to the Knesset for approval within weeks. The minister said the goal is to protect the less affluent, the people that typically end up paying the highest fees.

The treasury decided to switch to the Chilean Model three years ago. The financial meltdown of 2008 exposed the problem of preserving the value of savings in a time of collapse, such as after the bankruptcy of Lehman Brothers. People near retirement age saw their pension savings wither: and they didn't have enough time for their portfolios to recover. These people lost a large part of their pensions.

The Chilean Model automatically shifts part of the pension savings from a riskier stock-based investment policy to a safer one with more government bonds as the saver ages. This reduces the risk of losing a large part of the savings as retirement nears. The details of the Israeli version are quite complicated and have not all been finalized, but the proposed plan includes five levels of risk. Savers will be shifted automatically between the levels - from the high-risk to the lower-risk levels - based on age.

The treasury, however, will not set the exact makeup of the portfolios for each level of risk. Instead, it will allow pension funds to decide on beneficial formulations based on general outlines set by the ministry.

The pension fund management companies will develop the characteristics of each risk level, but they will have to justify their decisions and explain how the move from one level to another protects customers' savings and reduces risk for older savers.

The Finance Ministry will not make the new model mandatory for all savers, although the default choice will be to join the new program unless the customer specifically opts out. Also, a customer can choose not to be placed in the pension fund's risk level designated for her age: For example, a 30-year-old can ask to have her money placed in the less-risky portfolio, designed for those 50 and older.

Today, almost all savers have their pension monies placed in a "general" savings portfolio, which is based on the average age of all fund members. These investment portfolios include stocks, corporate and government bonds, and various non-negotiable assets such as real estate or private bond issues. The new portfolios will have different mixes of these assets, with the criteria shifting toward assets which are less risky as the saver grows older.

Oded Sarig, the Commissioner of Capital Markets, Insurance and Savings in the Finance Ministry, said he expects funds will flow only gradually from the present allocations to new assets and there should be no shock to financial markets from the changes. The new regulations will apply at first only to new money invested after the changes take effect.

Support for the changes is almost unanimous. Governor of the Bank of Israel Stanley Fischer supports the new model, as do most capital market organizations. Comparing returns between various financial firms will be difficult however, due to complications in comparing different risk levels across different age groups for the pension savings plans.