Chile adopted a new pension system featuring privately managed individual accounts in 1981. The system gives us an opportunity, based on more than 20 years of experience, to examine how pensioners and pension providers react when individual accounts replace government-run, defined benefit pension systems, and how various regulations shape these reactions. This paper focuses on the payout stage.

Retirees in Chile have a choice between early and normal retirement. They also can choose between annuities and programmed withdrawals. In general:

• Workers who choose annuities turn their retirement accounts over to an insurance company, and receive a guaranteed income for life, indexed for inflation; but they forgo the right to leave a bequest to heirs.
• Workers who choose programmed withdrawals leave the account with a pension fund administrator and withdraw annually an amount determined by a formula set by law; retirees can leave a bequest to their heirs, but they run the risk of exhausting the account before they die.
• Regardless of the option chosen, the government provides a safety net in the form of a minimum pension guarantee to all workers who have contributed to the system for at least 20 years.

Almost two-thirds of all retirees have chosen annuities - a very high proportion compared with annuities markets in other countries. However, early retirees and normal age retirees tend to make different choices. The normal retirement age is 65 for men and 60 for women, but many workers have met the preconditions to retire at an earlier age. (Early retirement means that they start withdrawing and may stop contributing; it does not necessarily mean that they stop working.)

• Currently 60 percent of all retirees have chosen to retire early, many before age 55, and 85 percent of them have annuitized.
• By contrast, 66 percent of normal age retirees have taken programmed withdrawals.
• Moreover, the average pension for early retirees is almost twice the average pension for normal age retirees, and among normal age retirees the average annuity is almost twice the size of the average programmed withdrawal.

These annuitization patterns are explained by regulations and guarantees that constrain payout choices, permit early retirement and give a competitive advantage to insurance companies selling annuities. Insurance companies market annuities aggressively and competition forces them to offer a high rate of return on price-indexed annuities. The minimum pension guarantee leads workers with small accumulations to take programmed withdrawals at the normal retirement age, while those with large accumulations acquire insurance against outliving their retirement savings (or a fall in the value of their savings) through annuitization at an earlier age.

Adverse selection occurs when people in poor health choose programmed withdrawals, while people with longer life expectancies choose annuities. Such behavior may have had a small impact on the system, but it does not seem to be a big problem, as indicated by the high rate of annuitization. As a result, the Chilean life insurance industry has grown from infancy in 1980 to an industry with annuity premiums that currently exceed $1 billion annually and reserves that exceed $10 billion.

The evidence suggests that, with appropriate incentives, a high proportion of pensioners in countries with individual account systems will purchase annuities. The Chilean experience also shows that in designing the payout stage, countries need to coordinate early withdrawal conditions with minimum pensions and other safety nets in order to avoid moral hazard problems and unexpected public liabilities.