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Revealed preference and self-insurance - Can we learn from the self-employed in Chile?

Listed author(s):
  • Barr, Abigail
  • Packard, Truman

Financial sector development is a critical area of effective social protection policy. A well-regulated financial sector can complement government efforts to keep households from falling into poverty - by supplying the instruments needed to pool risks, or to self-insure against losses because of the death, or disability of a household member, unexpected loss of employment, or inability to work in old age. But many of the policy recommendations that can be drawn from the social risk management framework, rest on the strong assumption that risk, and time preferences are uniform across individuals, or households. Policies meant to encourage participation in public pension systems, and to reduce evasion where such systems are mandatory (by more closely aligning benefits with payroll contributions, or introducing individual retirement accounts) implicitly attempt to emulate the savings behavior of individuals, and households faced with fully functioning capital markets, and perfect information. If no allowance is made for variation in preferences, however, the welfare effects of policy reforms will vary across the target population. Mandated social security, even if actuarially fair for most, is likely to impose welfare losses on those less inclined to save, and insure. That said, a clearer picture of individual and household preferences, and how they vary across the population, can help governments design social security systems that complement private savings, and insurance instruments. The authors present the results of a field experiment, designed to produce an empirical measure of risk aversion, and time preferences of selected groups in Chile, which in 1981 pioneered social security reform with a transition to individual retirement accounts. The experiment was designed primarily to establish whether the time, and risk preferences of the self-employed differ significantly from those of wage, and salaried workers. They find no significant differences in mean risk, and time preferences between the self-employed, and employees, or between the contributing, and non-contributing employees. But they find significant differences in these preferences between the contributing, and non-contributing self-employed. Among the self-employed, those who are more patient choose to contribute to the pension system. However, the contributing self-employed are significantly more tolerant of risk than the non-contributing self-employed, a finding that conflicts with the assumption that the formal pension system is the only source of insurance against poverty in old age. The Chilean pension system may be viewed with some trepidation by its pool of potential clients. Since risk aversion declines with education, the participation of the economically active who are free to choose, could be enhanced by a campaign carefully designed to raise awareness, allay fears, and inform people of the benefits of saving for retirement in the formal pension system.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2754.

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Date of creation: 31 Jan 2002
Handle: RePEc:wbk:wbrwps:2754
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  1. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
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