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
Basic Structure of Disability Insurance in Chile
Chile has successfully integrated disability insurance into its retirement system. It is prefunded and it provides financial incentives (and opportunities) for private firms to control costs. If a worker becomes disabled before retiring, he receives a defined benefit. Part of this benefit is covered by his or her own retirement account. The remainder is covered by an insurance policy purchased by each pension fund (AFP), which provides the top-up needed for disability and survivors (D&S) benefits. This is accomplished through the private insurance market, with government providing detailed regulations and back-up guarantees.
Financing Disability Insurance Benefits. A worker who qualifies for disability insurance is guaranteed a defined benefit for the balance of his or her life. The amount of the benefit is based on the “reference wage” — the worker's average, inflation-adjusted wage over the prior 10 years. 3 For each of these years, if a worker has not contributed to the system, a zero is averaged in, lowering his reference wage and benefit. The ceiling for contributory wages also creates a ceiling on the reference wage. An insured worker is guaranteed to receive 70 percent of his average wage (if totally disabled) and 50 percent (if partially disabled), up to the maximum guaranteed benefit.
“Insured disabled workers are guaranteed 70 percent of their average pay.”
During an initial three-year period, a disabled worker receives a temporary defined benefit directly from his pension provider (the AFP). If a worker is certified as permanently disabled after the three-year provisional period, he has a choice of a lifetime annuity or a gradual withdrawal of money from his account. 4 The programmed withdrawal does not provide longevity insurance but does give the worker the right to bequeath any money left in the account if he should die.
If the worker doesn't have enough money in his account to purchase a pension that covers the defined benefit, the AFP is responsible for “topping up” the account to the required level. To cover the cost of this top-up and the three-year provisional benefit, each AFP is required to purchase a term group insurance policy. 5 Survivors' benefits are covered in the same way, by the same insurance policy.
The group disability insurance policy is funded by the general administrative charge each worker pays the AFP. Each AFP sets its own fees and, apart from a small flat component, charges all its affiliated workers the same percentage of their wages — regardless of age, gender, occupation or size of the account. AFP fees currently average about 2.4 percent of a worker's wages. This includes the combined cost of the group disability and survivors' insurance, which is about 1 percentage point of wages (of which the disability portion is two-thirds), and general administrative charges, which account for the other 1.4 percent. 6
Thus the total future pension of the disabled individual is prefunded — partly out of his own retirement savings and partly by the group insurance policy purchased by the AFP and financed by the D&S insurance fee paid by workers.
Determining the Degree of Disability. A disabled worker receives a defined benefit based on his degree of disability, as defined by medical criteria. 7 In general:
- If the degree of disability exceeds 67 percent, the claimant is considered totally disabled, whether or not he has continued to work, and he is granted a defined benefit equal to 70 percent of his wage.
- If the disability is between 50 percent and 67 percent, he is partially disabled and entitled to a 50 percent defined benefit.
- If the disability is less than 50 percent, he is not considered disabled.
Of the claims approved in 2004, 25 percent were for partial disability, a proportion that has been increasing over time. 8
“Workers qualify for disability
based solely on medical criteria, but they qualify for disability insurance based on their recent work history.”
Eligibility for Disability Insurance. While certification of a disability depends purely on medical grounds, eligibility for the insured defined benefit depends on recent work history. A worker qualifies for disability insurance benefits if he or she was working and contributing at the time of the claim, or meets certain other requirements. 9 In addition, the worker must not be receiving a retirement pension or be over the normal retirement age. Individuals who postpone pensioning past the normal retirement age, or who continue working while retired, are no longer covered by disability and survivors' insurance and do not have to pay the insurance fee. These eligibility conditions are less stringent than those of other countries.10 Workers who are certified as permanently disabled but are not eligible for insurance can withdraw money from their accounts as a life annuity or programmed withdrawal but do not get the top-up that ensures the defined benefit.
The Minimum Pension Guarantee. Whether or not they are eligible for the private insurance, disabled workers may qualify for the publicly-funded minimum pension guarantee (MPG). This requires 10 years of contributions and sometimes even less, over their lifetimes.
Disabled pensioners with large account balances tend to annuitize in order to have protection against the risk of outliving their savings. Those with small accumulations tend to take programmed withdrawals and rely on the MPG to provide longevity insurance: 11
- As of 2003, 60 percent of all disabled beneficiaries were taking programmed withdrawals — corresponding to the predominance of small retirement account balances among the disabled.
- The average monthly programmed withdrawal was roughly half the average annuity benefit payment.
- In 2003, more than half of disabled programmed withdrawal pensioners were drawing down their accounts at the minimum level (equal to the MPG), and another quarter had exhausted their accounts and were relying on the MPG.
In fact, the majority of current MPG recipients are disabled and survivor beneficiaries. [See the sidebar “The Minimum Pension Guarantee and Disabled Workers.”]
The Minimum Pension Guarantee and Disabled Workers
Any worker who has been certified as disabled can make programmed withdrawals from his or her personal retirement account, but many of the workers ineligible for insurance benefits have small account balances and quickly exhaust their funds. The probability of being certified as disabled has risen in the past decade, with a disproportionate share of the growth occurring among workers who do not qualify for disability insurance coverage. However, eligibility requirements for the Minimum Pension Guarantee (MPG) are looser than for disability insurance; thus, many workers who don't qualify for disability insurance do qualify to receive MPG benefits.
Furthermore, it is easier for a worker to qualify for the MPG when disabled than at retirement. While a nondisabled worker must have 20 years of contributions to receive the MPG at retirement, a disabled worker qualifies if he: 1) contributed to the social security system for at least 10 years; 1 2) contributed for at least two of the last five years; 3) contributed for 16 months if he joined the labor force within the last 2 years; or 4) was contributing at the date of disability if it was caused by an accident. 2 Since low-wage workers with 10 to 19 years of contributions can only qualify for the MPG if they are disabled, they have an incentive to seek disability certification.
Once they meet the eligibility criteria, several subgroups of disabled are likely to have personal accounts that fall below the MPG level: 1) workers who are granted disability status but are not eligible for insurance because they are not current contributors; 2) insured individuals who contributed for only a fraction of their working years; 3) insured individuals who choose programmed withdrawals and live longer than the out-dated mortality tables predict; 4) partially disabled workers who get only a 50 percent defined benefit; and 5) surviving widows of disabled workers. 3 Note that each of these categories is due to policy choices that reduce the cost of the private insurance but can increase the cost of the public contingent liability. The MPG serves as a safety valve for a cost-conscious private disability insurance system.
The MPG is indexed to inflation, not wages, but politicians have raised it by an average of about 2 percent a year above inflation to keep pace with wages. Increases in the MPG could eventually add substantially to the public cost of disability pensioners and their survivors, who may be young and live many years after retiring. As the MPG rises, allowable programmed withdrawals rise, the accounts are used up faster and the government must step in sooner. Based on these data, it seems likely that an increasing proportion of disabled pensioners will eventually receive the MPG. Private disability costs may remain constrained, but public spending will probably rise over time.
1 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.
2 If the individual has other sources of incomes, such as wages or a pension from the old public pension system, this may invalidate his eligibility for the MPG. However, it is not clear that this means-test is vigorously enforced.
3 Surviving widows of disabled workers were originally entitled to 60 percent of the MPG, but now receive 100 percent of the MPG.