Private Pension Annuities in Chile

Policy Reports | Social Security

No. 271
Thursday, December 09, 2004
by Estelle James

Lessons for the United States and Other Countries

Our evidence suggests that the major reasons for the high rate of annuitization are the regulations, guarantees and incentives built into the Chilean pension system. This structure has also stimulated the development of a new multi-billion dollar industry — the life insurance industry, specializing in annuities — practically from scratch. It is ironic that marketing, which has been the subject of much criticism during the accumulation stage, seems to play a socially useful role — encouraging annuitization — during the payout stage. Two-thirds of all retirees have annuitized and annuitization mitigates some of the risks of early retirement faced by pensioners and the public treasury.

The good news for other countries is that:

  • Detailed regulatory policies can strongly influence worker and pensioner behavior, and in Chile have gone far toward ensuring lifelong security for workers and their spouses.
  • In Chile these regulatory policies include ruling out almost all lump sum distributions at retirement and any distributions prior to retirement, requiring price-indexed and joint pensions, and permitting work without contributions after a specified accumulation level has been reached.
  • Life insurance companies quickly developed in response to the demand for annuities, further stimulated this demand by aggressive marketing and provide a high money’s worth ratio for price-indexed annuities (enabled by the availability of many indexed financial instruments in Chile).
  • Under these conditions, adverse selection due to asymmetric information does not seem to pose a major problem. l It appears that with appropriate incentives a high proportion of pensioners will purchase annuities that provide longevity insurance and reduce the government’s fiscal liabilities.

But important caveats also emerge:

  • In Chile regulations give insurance companies selling annuities a competitive edge over fund administrators selling programmed withdrawal pensions.
  • Programmed withdrawals may lead to low retirement incomes or high public subsidies for the very old, unless they are buttressed by deferred annuity requirements.
  • If early withdrawal is permitted, many workers seem to choose that option, so early withdrawal conditions must be chosen with great care.
  • If these payout rules are not well coordinated with minimum pension guarantees and other safety net provisions, this may lead to moral hazard problems and unexpected public liabilities in the future.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.

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