Privatization of Social Security: Lessons from Chile

Peter A. Diamond

122 citations0/0 files storedNational Bureau of Economic Research

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Financial Literacy, Pension, Retirement Analysis Social Policy and Reform Studies Economic Policies and Impacts

Abstract

In Chile, all covered workers must place 10% of monthly earnings in a savings account with a highly regulated intermediary that manages a single fund and provides survivors and disability insurance.Workers pay a commission charge, in addition to the mandatory 10%, to finance this insurance and to cover the costs and profits of the intermediaries.On becoming eligible to receive benefits, a worker can choose between a sequence of phased withdrawals and a real annuity.In addition, there is a sizable guaranteed minimum pension.Unlike the purchased annuities, the minimum pension is not indexed, but adjusted by the government from time to time.The Chilean reform gets high marks for defending the system from political risk and for its effects on capital accumulation and on the functioning of the capital market.The Chilean reform gets low marks for the provision of insurance and for administrative cost.Perhaps the most surprising aspect of the Chilean reform is the high cost of running a privatized social security system, higher than the "inefficient" system that it replaced.Valdes-Prieto has estimated that the average administrative charge per effective affiliate while active is U.S. $89.10 per year (for 1991) which is 2.94% of average taxable earnings.This is close to 30% of the 10% mandatory savings rate.The cost per person is not far from costs observed in other privately-managed pension systems, such as defined-benefit private pensions in the U.S.However, it compares unfavorably with administrative costs in well-run unified government managed systems.The issue here is the administrative efficiency of reliance on the private market, not anything particularly costly about the Chilean system.

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References

1990Bureaucracy: what government agencies do and why they do it 1977A framework for social security analysis 1991Social Security in Developing Countries 1992On the Management of Financial Guarantees 1985The Cost of Annuities: Implications for Saving Behavior and Bequests

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2002Social Protection and Economic Integration 1998Rethinking Public Pension Reform Initiatives 2004Rethinking Pension Reform 1999Toward Better Regulation of Private Pension Funds 2006Taxes and Growth in a Financially Underdeveloped Country: Evidence from the Chilean Investment Boom 1999Social Security in Theory and Practice (II): Efficiency Theories, Narrative Theories, and Implications for Reform 2007Chapter 2 The Chilean Pension Reform Turns 25: Lessons from the Social Protection Survey 1998The Future of Retirement Protection in Southeast Asia

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