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Administrative costs and the organization of individual retirement account systems : a comparative perspective

Author

Listed:
  • James,Estelle
  • Smalhout, James
  • Vittas, Dimitri

Abstract

What is the most cost-effective way to organize individual accounts that are part of a mandatory social security system? Defined-contribution individual account components of social security systems are criticized for being too expensive. The authors investigate the cost-effectiveness of two methods for constructing mandatory individual accounts: a) Investing through the retail market with relatively open choice among investment companies (the method first used by Chile and adopted by most Latin American countries). b) Investing through the institutional market with constrained choice. For the retail market, they use data from mandatory pension funds in Chile and other Latin American countries and from voluntary mutual funds in the United States. For the institutional market, they use data from systems in Bolivia and Sweden and from larger pension plans and the federal Thrift Saving Plan in the United States. The institutional approaches aggregate numerous small accounts into large blocks of money and negotiate fees on a centralized basis, often through competitive bidding. They retain workers'choice o some funds. Fees and costs are kept low by reducing incentives for marketing, avoiding excess capacity at system start-up, and constraining choice to investment portfolio that are inexpensive to manage. In developed financial markets, the biggest potential cost saving stems from constrained portfolio choice, especially from a concentration on passive investment. The biggest cost saving for a given portfolio and for countries with weak financial markets comes from reduced marketing activities. In the retail market, where annualized fees and costs range from 0.8 percent to 1.5percent of assets, use of the institutional market in individual retirement account systems has reduced those fees and costs to less than 0.2 percent to 0.6 percent of assets. This reduction can increase pensions by 10 - 20 percent relative to the retail market. Countries that can surmount rebidding problems, weaker performance incentives, inflexibility in the face of unforeseen contingencies, and an increased probability of corruption, collusion, and regulatory capture should seriously consider the institutional approach, especially at the start-up of a new multipillar system or for systems with small asset bases.

Suggested Citation

  • 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.
  • Handle: RePEc:wbk:wbrwps:2554
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    References listed on IDEAS

    as
    1. 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.
    2. D. K. Malhotra & Robert W. McLeod, 1997. "An Empirical Analysis Of Mutual Fund Expenses," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 175-190, June.
    3. Shah, Ajay & Fernandes, Kshama, 2000. "The relevance of index funds for pension investment in equities," Policy Research Working Paper Series 2494, The World Bank.
    4. 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.
    5. Olivia S. Mitchell, 1998. "Administrative Costs in Public and Private Retirement Systems," NBER Chapters,in: Privatizing Social Security, pages 403-456 National Bureau of Economic Research, Inc.
    6. Blake, David, 2000. "Does It Matter What Type of Pension Scheme You Have?," Economic Journal, Royal Economic Society, vol. 110(461), pages 46-81, February.
    7. Malhotra, D K & McLeod, Robert W, 1997. "An Empirical Analysis of Mutual Fund Expenses," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 175-190, Summer.
    8. Queisser, Monika & Vittas, Dimitri, 2000. "The Swiss multi-pillar pension system : triumph of common sense?," Policy Research Working Paper Series 2416, The World Bank.
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    Cited by:

    1. Estelle James & Alejandra Cox Edwards & Rebeca Wong, 2012. "The Gender Impact of Pension Reform," World Bank Other Operational Studies 13046, The World Bank.
    2. Dariusz Stanko, 2003. "Polish Pension Funds, Does The System Work? Cost, Efficiency and Performance MeasurementIssues," Public Economics 0302001, EconWPA.
    3. Luis Chávez-Bedoya & Nelson Ramírez-Rondán, 2014. "Comparando Comisiones por Flujo y Saldo en Fondos de Pensiones con Cuentas Individuales de Capitalización," Working Papers 2014-9, Peruvian Economic Association.
    4. Jacob Bikker, 2013. "Is there an optimal pension fund size? A scale-economy analysis of administrative and investment costs," DNB Working Papers 376, Netherlands Central Bank, Research Department.
    5. Viebrok, Holger & Himmelreicher, Ralf K., 2001. "Verteilungspolitische Aspekte vermehrter privater Altersvorsorge," Working papers of the ZeS 17/2001, University of Bremen, Centre for Social Policy Research (ZeS).

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