Organizing individual retirement accounts through the institutional market and with constrained choice could substantially lower administrative costs. The tradeoff: rebidding problems, weaker performance incentives, inflexibility in the face of unforeseen contingencies, and an increased probability of corruption, collusion, and regulatory capture. What is the most cost-effective way to organize individual accounts that are part of a mandatory social security system? Defined-contribution individual-account components of social security systems are criticized for being too expensive. James, Smalhout, and Vittas investigate the cost-effectiveness of two methods for constructing mandatory individual accounts: Investing through the retail market with relatively open choice among investment companies (the method first used by Chile and adopted by most Latin American countries). Investing through the institutional market with constrained choice. For the retail market, they use data from mandatory pension funds in Chile and other Latin American countries and from voluntary mutual funds in the United States. For the institutional market, they use data from systems in Bolivia and Sweden and from larger pension plans and the federal Thrift Saving Plan in the United States. The institutional approaches aggregate numerous small accounts into large blocks of money and negotiate fees on a centralized basis, often through competitive bidding. They retain workers' choice on some funds. Fees and costs are kept low by reducing incentives for marketing, avoiding excess capacity at system start-up, and constraining choice to investment portfolios that are inexpensive to manage.
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