How Will the Annuities Market Develop If Social Security Includes Individual Accounts? The Case of Chile

Published: 2003
Project ID: UM03-07


In 1981 Chile adopted its new multi-pillar system, which featured privately managed individual accounts. Starting in 1983 payouts from the accounts were permitted and detailed rules about payouts were put in place. The Chilean scheme therefore gives us an opportunity to examine how pensioners and pension providers react to individual account systems during the payout stage and how regulations shape these reactions. We use aggregate time series data obtained from the pension fund and insurance industry regulators, individual-level data on all annuitants in the system, and interviews with pension providers and regulators for this analysis. Retirees in Chile have a choice between early versus normal retirement from the system and between annuitization versus programmed withdrawals (PW); lump sum withdrawals are largely ruled out. These choices determine the time stream of benefits and the eventual financial burden that will be placed on the public treasury. Almost two-thirds of all retirees have annuitized, but this proportion differs greatly between early and normal age retirees. Currently 60% of all retirees have chosen to retire early, many before age 55. (Early retirement means that they stop contributing and start withdrawing; it does not mean that they stop working). Most (85% of) early retirees have annuitized, while most (66% of) normal age retirees have taken PW. We present evidence that this disparate behavior is explained by incentives and constraints stemming from guarantees and regulations on pensioners and pension providers. These rules have lead workers with small accumulations to take PW at the normal age, with the minimum pension guarantee providing longevity and investment insurance. They lead workers with large accumulations to retire early, with annuities providing insurance. Regulations have given insurance companies selling annuities a competitive advantage in marketing to this group, and they do so aggressively. Early access to retirement saving through early retirement or front-loaded PW imposes a potential financial burden on the government because of the minimum pension guarantee, which has been rising in real value through time. As a result, the expected public share of the total pension payout grows with a cohort’s age and may exceed expectations as cohorts that retired under the new system grow very old. Annuitization mitigates (but does not completely eliminate) this cost to the public treasury. This analysis suggests that, with appropriate incentives, a high proportion of pensioners will purchase annuities in countries with individual account systems. But these 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.