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Investor Behavior and Fund Performance under a Privatized Retirement Accounts System: Evidence from Chile

Authors

Abstract

In the U.S. and in Chile, there have been heated debates about the relative merits of a decentralized privatized pension system relative to a more traditional social security system. On the firm side, there are concerns that pension funds engage in anticompetitive behavior and take advantage of consumers’ by charging high fees and account maintenance changes. On the consumer side, there are concerns that consumers do not select wisely among funds and take on too much risk. Any pension system with insurance features to protect against low levels of pension accumulations is potentially subject to moral hazard problems, in the form of consumers’ taking on too much risk. In the case of Chile, the government provides a minimum pension benefit to those with low pension accumulations, which can make some consumers more willing to take risks. For these reasons, the Chilean government introduced regulations on pension fund firms’ investments designed to limit risk. This paper analyzes the determinants of consumers’ choices of pension fund and of pension fund characteristics (performance and fees), taking into account governmental regulations. In particular, it estimates a demand and supply model of the pension fund investment market using a longitudinal household dataset gathered in 2002 and 2004 in Chile, administrative data on fund choices, and longitudinal data on cost determinants of pension funds. We find that the existing regulation actually increases the level of risk in the market, reduces heterogeneity across firms, and reduces incentives for consumers to participate in the pension fund program. We suggest alternative more effective forms of regulation.

Key Findings

  • Low participation in the Chilean pension system, which is mandatory only for full-time workers in the formal sector, is due in part to the large informal sector of the economy.
  • Regulation requiring that pension fund administrators deliver a return within 2 percent of the industry average encourages more risk taking than if portfolio risk were regulated.
  • Fewer people also participate in the pension plan because of the risk taking by pension firms.
  • Older and younger individuals are more averse to risk.
  • The market is efficiently served by more than one firm.

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Project

Paper ID

WP 2009-209

Publication Type

Working Paper

Publication Year

2009