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Sunday, February 27, 2005

Social Security Reform

The National Center for Policy Analysis has an excellent article on just how other countires have dealt with the issue of "privatizing" or "reforming" social security-type retirement income systems. The Chilean example is instructive:

The Chilean individual account system started more than 20 years ago and many workers have retired under the reformed system. Two-thirds of them have purchased an annuity at retirement.

An annuity is a contract with an insurance company that provides the purchaser with a monthly income. The prices of lifetime annuities reflect the predicted life expectancy at retirement for individuals born in a particular year.

These annuities are offered by insurance companies that compete for retirees’ business. Because of the highly competitive annuities market, retirees get the same rate of return they would get on government bonds, plus longevity and inflation insurance. The insurance companies cover their costs by investing in higher-yielding financial instruments such as corporate bonds or mortgage-backed securities. The annuity industry in Chile has grown by leaps and bounds over the past 20 years.
Annuities are popular in large part because regulations encourage workers to annuitize. For example:

  • Chile requires workers to purchase an annuity or take their money out of the system in very gradual installments. Lump-sum withdrawals are not permitted unless very stringent conditions are met.
  • Insurers offer annuities that are required to adjust for inflation, protecting workers against a rise in the price level.

  • The government guarantees three-fourths of an annuity’s value in case the insurance company becomes insolvent; however, insurance companies are heavily regulated to make sure that doesn’t happen.
  • A worker can withdraw money from his account before the normal retirement age of 65 only if his account balance is adequate to purchase a pension that replaces at least 70 percent of his preretirement wage and 150 percent of the minimum guaranteed pension.
  • After adjusting for inflation, accounts in Chile earned an average annual rate of return of more than 10 percent from 1982 to 2002.

Because of these high returns — and the favorable terms of annuities — many workers are able to purchase an annuity or start gradually withdrawing their personal account funds in their 50s. If they continue working after retirement, they are exempt from the pension payroll tax. This reduction in payroll taxes has led to a dramatic rise in the labor supply of older workers — which is good for the economy.

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1 comment:

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