Mutual funds and institutional investments - what is the most efficient way to set up individual accounts in a social security system?
Abstract
One of the main criticisms of the defined-contribution, individual-account components of social security systems is that they are too expensive. The authors investigate the cost-effectiveness of three options for constructing funded social security pillars: * Individual accounts invested in the retail market with relatively open choice. * Individual accounts invested in the institutional market with constrained choice among investment companies. * A centralized fund without individual accounts or differentiated investments across individuals. The authors asked several questions: What is the most cost-effective way to organize a system with mandatory individual accounts? How does the cost of an efficient individual account system compare with that of a single centralized fund? And are the cost differentials great enough to outweigh other important considerations? The authors concentrate on countries with well-functioning financial markets, such as the United States, but make comparative references to developing countries. Based on empirical evidence about U.S. mutual and institutional funds, the authors found that the retail market (option 1) allows individual investors to benefit from scale economics in asset management - but atthe cost of the high marketing expenses needed to attract large pools of small investments. By contrast, a centralized fund (option 3) can be much cheaper because it achieves scale economies without high marketing costs. But it gives workers no choice and is subject to political manipulation and misallocation of capital. The system of constrained choice (option 2) is much cheaper than the retail option and only slightly more expensive than a single centralized fund. It allows scale economies in asset management and record-keeping while incurring low marketing costs and allowing significant worker choice. It is also more effectively insulated from political interference than a single centralized fund. The authors estimate that option 2 would cost only 0.14 percent-0.18 percent of assets annually. Such large administrative cost savings imply a Pareto improvement - so long as choice is not constrained"too much".Download Info
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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2099.Length:
Date of creation: 30 Apr 1999
Date of revision:
Handle: RePEc:wbk:wbrwps:2099
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Keywords: Payment Systems&Infrastructure; Business Environment; International Terrorism&Counterterrorism; Economic Theory&Research; Agricultural Knowledge&Information Systems; International Terrorism&Counterterrorism; Economic Theory&Research; Business Environment; Business in Development; Agricultural Knowledge&Information Systems;Other versions of this item:
- Estelle James & Gary Ferrier & James H. Smalhout & Dimitri Vittas, 2000. "Mutual Funds and Institutional Investments -- What Is the Most Efficient Way to Set Up Individual Accounts in a Social Security System?," NBER Chapters, in: Administrative Aspects of Investment-Based Social Security Reform, pages 77-136 National Bureau of Economic Research, Inc.
- Estelle James & Gary Ferrier & James Smalhout & Dimitri Vittas, 1999. "Mutual Funds and Institutional Investments: What is the Most Efficient Way to Set Up Individual Accounts in a Social Security System?," NBER Working Papers 7049, National Bureau of Economic Research, Inc.
References
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- Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Luciano Greco, 2005. "The Optimal Design of Funded Pension Plans: Unbundling Financing and Investment," "Marco Fanno" Working Papers 0003, Dipartimento di Scienze Economiche "Marco Fanno".
- Whitehouse, Edward, 2000.
"Administrative charges for funded pensions : an international comparison and assessment,"
Social Protection Discussion Papers
23140, The World Bank.
- Whitehouse, Edward, 2000. "Administrative charges for funded pensions: An international comparison and assessment," MPRA Paper 14172, University Library of Munich, Germany.
- James,Estelle & Smalhout, James & Vittas, Dimitri, 2001. "Administrative costs and the organization of individual retirement account systems : a comparative perspective," Policy Research Working Paper Series 2554, The World Bank.
- Estelle James & Alejandra Cox Edwards & Rebeca Wong, 2012. "The Gender Impact of Pension Reform," World Bank Other Operational Studies 13046, The World Bank.
- Whitehouse, Edward, 2000. "Paying for pensions: An international comparison of administrative charges in funded retirement-income systems," MPRA Paper 14171, University Library of Munich, Germany.
- James E. Pesando, 2001. "The Canada Pension Plan: Looking Back at the Recent Reforms," The State of Economics in Canada: Festschrift in Honour of David Slater, in: Patrick Grady & Andrew Sharpe (ed.), The State of Economics in Canada: Festschrift in Honour of David Slater, pages 137-150 Centre for the Study of Living Standards.
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