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Did Chileans Maximize Pensions when Choosing between PAYG and DC?

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  • Ximena Quintanilla

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    (Studies Division, Chilean Pension Supervisor)

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    Abstract

    In 1981 Chile was the first country in the world to privitise its pension system moving from a traditional unfunded pay-as-you-go scheme (PAYG), where benefits are defined ex-ante by a final salary formula, to a Defined Contributions (DC) scheme where each individual's benefit depends entirely on his own pension savings. Individuals in the labour market at the time of the reform were given the choice to either stay in the old PAYG system or to opt-out to the DC scheme, whereas new entrants must join the DC system. Exploiting the wide differences in pension formulas across schemes, in this paper we analyse for whom it was financially optimal (in terms of higher net present value of expected pension wealth, EPW) to opt-out and for whom to stay in the PAYG system. Using self-reported employment and contribution histories, we compute the net present value of EPW each individual in our sample will get in the pension scheme he is currently enrolled to and the pension he would have got had he made the opposite staying/opting-out out decision. We find that overall 87% of individuals would have got a higher pension in the DC system than what they would have got in the PAYG scheme. This share varies significantly by cohort but not so much by education or sex. When looking at who actually maximised the net present value of EPW when choosing pension arrangement the results show that 57% did. Thus, when faced with the choice of pension system, only over half of individuals took the financially right decision. Responses vary across current pension system: while 90% of men and 80% of women currently in the PFA maximised the net present value of EPW, less than 15% of individuals currently in the PAYG did.

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    File URL: http://www.spensiones.cl/redirect/files/doctrab/DT00046.pdf
    File Function: Revised version, 2011
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    Bibliographic Info

    Paper provided by Superintendencia de Pensiones in its series Working Papers with number 46.

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    Date of creation: Sep 2011
    Date of revision: Sep 2011
    Handle: RePEc:sdp:sdpwps:46

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    Web page: http://www.spensiones.cl/
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    Keywords: pension system design; individual choice;

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    1. Orazio P. Attanasio & Susann Rohwedder, 2003. "Pension Wealth and Household Saving: Evidence from Pension Reforms in the United Kingdom," American Economic Review, American Economic Association, vol. 93(5), pages 1499-1521, December.
    2. Solange Berstein & Guillermo Larraín & Francisco Pino, 2005. "Cobertura, densidad y pensiones en Chile: Proyecciones a 20 años plazo," Working Papers 12, Superintendencia de Pensiones, revised Nov 2005.
    3. James Banks & Carl Emmerson & Gemma Tetlow, 2005. "Estimating pension wealth of ELSA respondents," IFS Working Papers W05/09, Institute for Fiscal Studies.
    4. Dante Contreras & Esteban Puentes & David Bravo, 2005. "Female labour force participation in greater santiago, Chile: 1957-1997. A synthetic cohort analysis," Journal of International Development, John Wiley & Sons, Ltd., vol. 17(2), pages 169-186.
    5. Alberto Arenas de Mesa & Jere Behrman & David Bravo, 2001. "Characteristics of and determinants of the density of contributions in a Private Social Security System," Working Papers wp077, University of Michigan, Michigan Retirement Research Center.
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