Crowd-out, Adverse Selection and Information in Annuity Markets: Evidence from the payout phase of the Chilean DC plan Edwards and James MRRC workshop, Ann Arbor, 2007

Pensioners in Chile choose Annuity: – stable income stream guaranteed for life by insurance company Programmed withdrawals (PW) – workers retirement savings stay in AFP system – Worker retains rights over investments and bequests – payout formula is set by regulator – individual bears the risk of pension reduction due to lower investment returns or greater longevity, unless she qualifies for publicly financed longevity insurance via MPG – In general, the PW formula leads to a pension that is higher than annuities at first but lower later on Retirement age is 65/6- but can retire early if annuity is >110% MPG and 50% RR

No choice for individuals with low accumulations If, upon retirement, the workers own accumulation is not large enough to cover a lifetime pension at or above the MPG floor she must take PW and Draw down her account at the MPG level – With payments continuing after funds are exhausted if she had a minimum of 20 years of contributions Draw down her account at or below the MPG level – With payments stopping when funds are exhausted if she had less than 20 years of contributions (not covered by the MPG guarantee)

Clearly, the MPG reduces the retirees longevity and investment risk from PW among those who qualify for the guarantee and would get annuities close to the MPG the reduced risk to the pensioner is matched by an increased risk to the public treasury, which is left with a contingent liability For those with annuities well above the MPG, this guarantee provides weak protection

2/3 of stock of pensioners, especially early pensioners, annuitize

Questions Does publicly provided longevity insurance crowd-out private insurance? ( Does the propensity to annuitize fall with accumulation)? Is there adverse selection into annuities?(Does the probability of annuitization fall with bad health)? Does the propensity to annuitize vary with knowledge of the system? WE USE MICRO DATA TO GET ANSWERS data collected in 2002; sample representative of new and old system affiliates; we focus on 676 new-system old-age pensioners data shortcomings -some retirees had choice some didnt -some retirees qualify for MPG, some dont

To get around data shortcomings We look at early pensioners separately – With a minimum accumulation to finance an annuity >110% of MPG, they clearly have choice – and are usually well above MPG so get little insurance – EP are asked if they took EP because of bad health Normal age pensioners – Have choice or dont have choice – Qualify for the MP guarantee (have 20+ years of contributions) or dont qualify – We proxy qualification by size of pension

Different behavior for early and normal age pensioners Strong public insurance driving out private annuity insurance for normal age pensioners (close to MPG or dont qualify for annuity). Some adverse selection by health status among early pensioners, who have choice Self insurance among contributors with large accumulations Among early pensioners, preference for annuities enhanced by knowledge about the system. Some who take PW seem to be misled by larger initial payouts. Better information obviously needed.