Competition, Asymmetric Information, and the Annuity Puzzle: Evidence from a Government-Run Exchange in Chile

Purchasing an annuity insures an individual against the risk of outliving their money, by promising a steady stream of income until death. The value of annuities is high in theory, but in practice annuity markets tend to function poorly, with low annuitization rates and high markups. Chile provides an interesting counterexample to this phenomenon, as over 60 percent of eligible retirees purchase annuities from the private market and observed markups are low. This paper shows that Chilean Social Security policy promotes private annuitization, in contrast to U.S. Social Security policy. To study this effect, we build a lifecycle consumption-savings model and show through calibrations that the Chilean setting is likely to have lower welfare loss from adverse selection and is more robust to markets unraveling than the U.S. We then use a novel administrative dataset on all annuity offers made to Chilean retirees between 2004 and 2013 to estimate a flexible demand system built on top of the consumption-savings model. The model estimates allow us to simulate how the Chilean equilibrium would shift under alternative regulatory regimes. We find that reforming the Chilean system to more closely resemble the U.S. Social Security system would likely make the annuity market fully unravel. This result highlights the impact of the rules governing how retirees can access their pension balances on the annuity market equilibrium.