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Privatization of Social Security: Lessons from Chile

  • Peter Diamond

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

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4510.

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Date of creation: Oct 1993
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Publication status: published as Revista de Analisis Economico, June 1994, pp. 21-33
Handle: RePEc:nbr:nberwo:4510
Note: AG PE
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  1. Valdes-Prieto, Salvador & DEC, 1994. "Earnings-related mandatory pensions : concepts for design," Policy Research Working Paper Series 1296, The World Bank.
  2. Salvador Valdés & Peter Diamond, . "Social Security Reforms in Chile," Documentos de Trabajo 161, Instituto de Economia. Pontificia Universidad Católica de Chile..
  3. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March.
  4. Diamond, Peter, 1992. "Organizing the Health Insurance Market," Econometrica, Econometric Society, vol. 60(6), pages 1233-54, November.
  5. Robert C. Merton & Zvi Bodie, 1992. "On the Management of Financial Guarantees," Financial Management, Financial Management Association, vol. 21(4), Winter.
  6. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, vol. 8(3), pages 275-298, December.
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