Integrated Disability and Retirement Systems in Chile
Saturday, September 01, 2007
by Estelle James and Augusto Iglesias
Table of Contents
- Executive Summary
- Basic Structure of Disability Insurance in Chile
- How Costs Are Controlled in the Assessment Procedure
- How Adverse Selection Is Reduced
- The Chilean System versus PAYGO
- Comparisons between Chile and other Countries
- Lessons for Other Countries
- About the Authors
- This paper is based on Estelle James, Augusto Iglesias and Alejandro Cox Edwards, “Disability Insurance with Prefunding and Private Participation:The Chilean Model,” forthcoming.
- David Autor and Mark C. Duggan, “The Growth in the Social Security Disability Rolls: A Fiscal Crisis Unfolding,” Journal of Economic Perspectives , Vol. 20, No. 3, summer 2006, pages 71-96.
- For workers who have not been in the social security system for 10 years, wages are averaged over a shorter period, with a minimum of 24 months.
- The annuity lasts the entire lifetime, thereby providing longevity insurance. The programmed withdrawal has the same lifetime expected present value as the annuity but payouts are more front-loaded and uncertain and the money may be used up before the person dies. For more details on payout modes see Estelle James, Guillermo Martinez and Augusto Iglesias, “The Payout Stage in Chile: Who Annuitizes and Why?” Journal of Pension Economics and Finance , Vol. 5, No. 2, 2006; available at http://www.estellejames.com/downloads/payout-chile.pdf.
- The typical policy shares the risk between the AFP and the insurer: The AFP covers disability costs for the group up to a contractually agreed-upon maximum (such as 1 percent of wages), while the insurance company takes over once the maximum cost for the group has been reached. If disability costs are below the ceiling, the insurer and AFP share the savings. This limits the risk for the AFP and covers extreme costs.
- The breakdown between administrative costs and disability insurance and survivors' insurance is based on data analysis by the authors.
- The Medical Boards have the discretion to increase this percentage in some cases. The Medical Boards use specified “complementary factors” in the case of older, low-income members or when the member loses the ability to perform his or her normal job.
- “Sistema de Calificacion de Invalidez: Informe Estadistico,” Association of AFPs, 2004.
- To be eligible for disability benefits, a worker must either 1) be working and contributing at the time of the claim or 2) have contributed during the last 12 months and also paid at least six contributions in the year immediately preceding the last registered contribution, or 3) (if self-employed) have made at least one contribution in the calendar month before the date of the claim.
- For example, 3 years of contributions are typically required in Latin America, 5 years in OECD countries. In the United States the applicant must have worked in 5 of the last 10 years and cannot be working currently. Organization for Economic Cooperation and Development, Transforming Disability into Ability (Paris: OECD Press, 2003); Carlos Grushka and Gustavo Demarco, “Disability Pensions and Social Security Reform Analysis of the Latin American Experience,” World Bank, Social Protection Discussion Paper No. 0325, December 2003; Emily Andrews, “Disability Insurance: Programs and Practice,” World Bank, Social Protection Discussion Paper, April 1998 .
- This is true of nondisabled retirees as well. If those on programmed withdrawals exhaust their accounts, the state pays their pension at the MPG level, providing they meet the eligibility requirements. Retirees whose accumulations are not large enough to purchase an annuity greater than the MPG initially must take programmed withdrawals and spend down their accounts. Disabled retirees who don't qualify for the top-up are more likely to be in this situation. See Estelle James, Guillermo Martinez and Augusto Iglesias, “The Payout Stage in Chile: Who Annuitizes and Why?”; and Alejandra Edwards and Estelle James, “Pension Reform and Postponed Retirement: Evidence from Chile,” University of Michigan Research Retirement Center, Working Paper No. 2006-147, December 2006; available at http://deepblue.lib.umich.edu/bitstream/2027.42/49333/3/wp147.pdf.txt.
- For example, suppose the AFP starts out with a total fee of 2.4 percent of the worker's wage and an actual cost of 2 percent, half of which is the insurance cost, thereby earning the 0.4 percent difference as profit. If it cuts the insurance cost to 0.8 percent and continues charging the same fee (because that is the market price charged by its competitors), its profits increase by 50 percent: (2 percent – 1.8 percent)/0.4 percent = 50 percent.
- Applications are rejected if individuals have lost less than 50 percent of their working capacity or are disabled by a labor accident or occupational illness, in which case the disability is covered by a different program.
- This permanency of disability status is quite common in other countries too, either on a formal or de facto basis — movement out of disability status is rare. See OECD, Transforming Disability into Ability (Paris: OECD Press, 2003); and “Sistema de Calificacion de Invalidez: Informe Estadistico,” Association of AFPs, 2004. The additional payment to cover the cost of the life annuity is made when the disability is certified as permanent. During the three-year period of temporary disability the AFP pays the defined benefit directly to the individual as a “provisional pension.” In the few cases where the permanent claim is rejected, the AFP must make the contributions to the worker's account that he would have made during the three years of temporary disability, to maintain the size of his eventual old age pension.
- For example, in the United States appeals can only be brought by workers whose initial claims have been denied, so appeals inevitably increase approved cases. In 2000, only 38 percent of claims were approved initially, but more than half of those denied benefits appealed so the proportion ultimately approved was 55 percent. It is possible that initial decisions are more negative than they would be otherwise, knowing that one-sided reversals will take place subsequently. Data are not available on how many appeals against denials were made by worker-claimants in Chile. “Charting the Future of Social Security's Disability Programs: The Need for Fundamental Change,” U.S. Social Security Advisory Board, January 2001, pages 8, 18, 19; available at http://www.ssab.gov/Publications/Disability/disabilitywhitepap.pdf.
- “Sistema de Calificacion de Invalidez: Informe Estadistico,” Association of AFPs, 2004.
- Calculations by the authors based on “Sistema de Calificacion de Invalidez: Informe Estadistico,” Association of AFPs, 2004.
- Although the Medical Board does not require information about employment during the transitional period, the AFP usually informs them in cases where work has continued. Thus, work is not necessarily held against the individual in the reassessment procedure, but it may be.
- Participation in the social security system varies widely around the mean. See Solange Berstein, Guillermo Larrain and Francisco Pino, “Cobertura, Densidad y Pensiones en Chile. Proyección a 20 años plazo,” Superintendencia de AFP, Working Paper No. 12, November 2005; available at http://www.safp.cl/files/doctrab/DT00012.pdf; Alberto Arenas de Mesa, Jere Behrman and David Bravo, “Characteristics of and Determinants of the Density of Contributions in a Private Social Security System,” University of Michigan Retirement Research Center, Working Paper No. 2004-077, February 2004; available at http://www.mrrc.isr.umich.edu/publications/Papers/pdf/wp077.pdf.
- The definition of the reference wage creates somewhat questionable disparities among individuals. For example, an individual who worked steadily for 20 years, then intermittently for 10 years, has a larger account but gets a lower disability pension than a person who worked intermittently for 20 years, then steadily for 10 years, assuming they both have the same wage and retire on disability at the same age. See Emily Andrews, “Disability Insurance: Programs and Practice,” World Bank, Social Protection Discussion Paper, April 1998; available at http://info.worldbank.org/etools/docs/library/77186/november2003/readings/disability.pdf; “Charting the Future of Social Security's Disability Programs: The Need for Fundamental Change,” U.S. Social Security Advisory Board, January 2001; available at http://www.ssab.org/Publications/Disability/disabilitywhitepap.pdf.
- Some AFPs have acquired the reputation of doing this and also of fighting claims vigorously. This reputation may induce affiliated workers who are contemplating filing a claim to switch to another AFP.
- Interestingly, Eastern European countries which followed the Chilean model for normal retirement did not adopt the Chilean disability system in order to avoid these initial transition costs as well as the difficulties in adjusting assessment rules to private standards. See Agnieszka Chlon-Dominczak, “Evaluation of Reform Experiences in Eastern Europe,” International Federation of Pension Funds Administrators, May 2003; available at http://www.fiap.cl/p4_fiap_eng/antialone.html?page=http://www.fiap.cl/p4_fiap_eng/site/edic/base/part/articles.html.
- The simulation assumes workers enter the labor force at age 20 and work until retirement or disability, with a 10 percent contribution to the retirement account, a 4.5 percent rate of return and wage growth of 2 percent annually. The PAYGO and Chilean systems are assumed to have the same population age structure and age-specific incidence of disability.
- Many other factors contribute to these differences in disability rates and fees, including some unrelated to the way disabilities are assessed or benefits financed. These include, in particular, the age structure of the population, the definition of disability, the generosity and indexation of benefits, and whether they cover the worker until the normal retirement age or death.
- “Charting the Future of Social Security's Disability Programs: The Need for Fundamental Change,” U.S. Social Security Advisory Board, January 2001; and Emily Andrews, “Disability Insurance: Programs and Practice.”
- AIOS, “Boletín Estadistico,” La Asociación Internacional de Organismos de Supervisión de Fondos de Pensiones, No. 13, June 2005. Available at http://www.aiosfp.org.
- The authors approximate the insured population in Chile as consisting of an average of contributors and affiliated workers, since all contributors plus some noncontributing affiliates are insured. The OECD numbers treat all individuals in the age group as if they were insured. If this definition were used for Chile, its disability rate would be much lower than that given above, because of the wide disparity between the number of residents and number of insured persons. OECD, Transforming Disability into Ability (Paris: OECD Press, 2003).
- “Annual Report,” U.S. Social Security Board of Trustees, 2005. A comparison of disability pension rates in the new and old Chilean systems, using the Cox proportional hazard model, shows that, among 40-to-65-year-olds, the proportion of nonpensioned participants who become newly disabled at any given age is 60 percent to 70 percent lower in the new system. For example, a single man in the old system had a 0.5 percent chance of becoming newly disabled at age 54, but in the new system this probability falls to 0.18 percent. In the old system, the probability of becoming newly disabled peaked at 1.5 percent for a 58-year-old single man, but in the new system this man had a hazard rate of only 0.5 percent. See Estelle James, Augusto Iglesias and Alejandra Cox Edwards, “Disability Insurance with Prefunding and Private Participation: The Chilean Model,” forthcoming.
- Emily Andrews, “Disability Insurance: Programs and Practice,” page 17. Note that different methods of calculating replacement rates may be used for different countries so these rates are not completely comparable.
- Interestingly, the new unemployment insurance system instituted by Chile, which also uses a combination of individual accounts and insurance, puts all workers into a single pool and auctions off the rights to handle the insurance to a single provider — perhaps to avoid selection and related problems. The bidder that won: a consortium of AFPs.
- For similar recommendations see “Charting the Future of Social Security's Disability Programs: The Need for Fundamental Change;” also see David H. Autor and Mark G. Duggan, “The Growth in the Social Security Disability Rolls: A Fiscal Crisis Unfolding,” Journal of Economic Perspectives , Vol. 20, No. 3, Summer 2006, pages 71-96.