Do Individual Accounts Postpone Retirement?

Evidence from ChileAlejandra C. Edwards and Estelle James

2

Work disincentives in old Chilean system

Like other DB countries--Gruber & Wise Early pension easy & not decreased on

actuarial basis so taking pension at first eligible age max PV of lifetime benefits

Public sector--pensioners couldn’t work Private sector—could work but

incremental benefit small (50%,1%,70%)

3

Chilean reform of 1981 Replaced DB with DC—contributions go into

individual accounts, pension depends on accumulation, on actuarial basis

Cut payroll tax, especially for pensioners Raised retirement age and made it more difficult to

retire early Most workers under 50 (born>1931) switched We expect this to raise lfpr of older workers

through 2 channels:– Postponed pensioning, so liquidity constrained workers

must work– Increased work propensities among pensioners

4

1) Postponed pensioning required=> raises lfpr through liquid income effect

Normal pension set at age 65 and 60 for men and women respectively

Early pension not permitted until 1987 Tighter conditions for early pension—pension must

be 50% of own-wage and 110% of minimum pension guarantee

If pension is postponed, it increases on actuarial basis (50% in 5 years because larger accumulation, fewer retirement years)

Therefore we expect postponed pensioning, which should increase work propensities of credit-constrained workers--liquidity effect

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2) Reduced work disincentives, espec. for pensioners (substitution effect)

Payroll tax fell from 23-25% to 12.5% so net wage rises

Pensioners exempt from pension payroll tax No penalty for work after pension These positive effects should be greater for

workers who were younger on date of reform and should be phased in over time as more older workers in new system

6

Data set from Greater Santiago Area Household Surveys 1960-2002

Individual level data on– Labor force participation– Demographic characteristics– Labor and pension income

We link to official macroeconomic data Shortcomings:

– Not longitudinal, no retrospective data– We don’t know retirement age or type pension,

new or old system affiliates or no affiliation– This leads us to underestimate impact of reform

on new system affiliates

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Aggregate trends are consistent with our hypotheses. We observe: a decrease in pensioning after mid-80’s an increase in labor force participation of 50+

after mid-eighties1981 higher participation rates among cohorts born

after 1931 these effects are stronger for pensioners Our strategy: do these trends pre and post

reform remain after adding individual and macro-economic variables? Answer: they do

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Pension probabilities were rising, but fell after reform

pension probabilities by age group over time

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

1957-61 62-66 67-71 72-76 77-81 82-86 87-91 92-96 1997-2002

year observed

pens

ion

prob

abili

ties

40 - 44

45 - 49

50 - 54

55 - 59

60 - 64

65 - 69

70 - 74

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Male 50+ lfp rates were falling, go up after the reform

labor force participation rate by age groups

0

0.2

0.4

0.6

0.8

1

1.2

1957-61 62-66 67-71 72-76 77-81 82-86 87-91 92-96 1997-2002

year observed

labo

r for

ce p

artic

ipat

ion

rate

s

40 - 44

45 - 49

50 - 54

55 - 59

60 - 64

65 - 69

70 - 74

10

Changes in lfp are more dramatic for pensioners

Participation rates by age groups, pensioners and non-pensioners compared

0

0.2

0.4

0.6

0.8

1

1.2

67-71 72-76 77-81 82-86 87-91 92-96 1997-2002

years observed

labo

r for

ce p

artic

ipat

ion

rate

s

NP50 - 54

NP55 - 59

NP60 - 64

NP65 - 69

Pen50 - 54

Pen55 - 59

Pen60 - 64

Pen65 - 69

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We use probit analysis to see if these results hold after controlling for

other variables, : 2 dependent variables: probability of being

pensioned, probability of being in labor force Individual characteristics: age, education, real

hh income, marital status, # children, spousal age, etc.

Macro-economic variables: unemployment rate, real annual GDP growth, deviations from trend GDP

Pension status and amount 3 reform indicators

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We model impact of reform in 3 alternative ways:

1) Change in time trends of pension rates and lfpr rates for 50+ and 65+ groups pre- and post-reform (reform effects start in 1987)

2) Change in cohort trends pre- and post-reform (1931 birth cohort is the first exposed to reform)

Time and cohort trends are interacted with pension status to allow for differences in trends

3) Dummies for groups of individuals exposed to post-reform incentives.

We expect an increasing fraction of 50+ individuals to respond to the new system’s incentives each year, starting in 1987

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The data set: men 30+ Series of 40 annual cross-sections from

1960 to 2002 (1963-64 missing). Sample representative of Greater

Santiago (most urban 1/3 of country’s population)– 95,000 individual cases organized by year

of observation– 93,000 individual cases organized by birth

cohort starting in 1900

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Trends in other variablesUnemployment Rate

0

0.05

0.1

0.15

0.2

0.25

Hodrick -Prescott filter and ln(realGDP)Year

lGDP Hodrick-Prescott filter

60 64 68 72 76 80 84 88 92 96 100

5.23164

6.92551

GDP deviations from trend

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

Median schooling

56789

10111213

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Explanatory power increases when co-variates are added, but

reform effect remains Pension prob higher and work prob lower for more

educated workers over 50– this increases gap explained by reform

Pension prob rise and lfp falls with UnE– there is a full cycle after 1987

Adding pensioner status into lfp equation raises R2, cuts pure age effect, and reduces negative impact of macro effects

Virtually entire downward trend in lfp before reform and upward trend after reform is due to pensioners

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Main reform effects, after controlling for co-variates:

Pension probability, age 50-64– fell 15 percentage points, cut in half by 2002– shift to non-pensioner status increased

aggregate work, since lfpr > for non-pensioners LFP among pensioners, age 50-64

– rose >2% per year, >30 percentage points by 2002, compared to pre-reform trend line

– more than doubled mid-1980’s to 2002

– Smaller effects for older groups, age 65+ These effects are increasing for retirees who

were younger on date of reform All 3 reform indicators give consistent results

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Estimated per year change in lfp (percentage points) at means

non-pensioners pensionersAge 50-64

Before reform .32 -.92After reform -.11 1.47Net change -.43 2.39

Age 65+Before reform .11 -.22After reform .07 .56Net change -.04 .78

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Estimated per year change in lfp (percentage points)

non-pensioners pensionersAge 60 in 1990

Before reform .22 -1.45After reform -.08 2.32Net change -.30 3.77

Age 66 in 1990Before reform .19 -.50After reform .12 1.30Net change -.07 1.80

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Policy implications and future research

Incentives from shift to DC system have had positive effects on supply of older workers

Which is more important—actuarial fairness or system constraints and taxes?– Larger drop in pension prob before 65 suggests that

early retirement constraints play major role– Larger lfpr effect among pensioners suggests that

exemption from payroll tax plays key role Future research using new longitudinal data:

– Do workers take pension as soon as eligible?– Has lfpr also increased among old system and no-

system affiliates (or does lfpr of those in new system increase more when we identify them)?