Pensions

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Summary

In any pension system based on capitalization, affiliates have to cover explicit costs - which in a pay-as-you-go system are implicit - not only during their working life, but also during retirement. One of the main aims of any structural reform of a pension system is to increase the amount of pension payable. In a capitalization system with defined contributions, this will basically depend on the size of the contributions themselves, the return on the funds accumulated, administration costs during the accumulation period, and the cost of converting the contributions into benefits during the retirement period.

Administration costs are currently attracting the interest of various researchers for a number of reasons:
a) Many countries have introduced or are thinking of introducing systems of individual capitalization accounts in some form.
b) Measuring the cost of financial services is much more difficult than measuring that of other goods and services.
c) The cost is often not transparent and affects contributors in different ways according to income level and the amount accumulated in funds.
d) When administration costs are too high:

Higher administration costs will therefore generate a greater number of people needing to have their pensions supplemented. In this paper a model based on Whitehouse (2000) and Diamond (1999) is developed, enabling the administration costs borne by the affiliate during both working life and retirement to be evaluated. It also shows the relation between the different ways of measuring the costs included in the total amount ultimately paid by the contributors.

This model is applied to determine the administration costs of individual capitalization accounts in the countries of Latin America, and then a comparison is made with other countries, including Spain, which also have individual capitalization accounts. (JEL: G23, H55, J26).

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Pensions

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Summary

Pension systems based on individual capitalization with defined contributions generally offer a certain amount of freedom of choice to the individual in deciding the form in which he would like his pension paid when he reaches retirement. This freedom of choice, which does not exist in public pay-as-you-go systems, means that it is the pensioners themselves that have to make decisions about how they should be paid their pension in order to provide themselves with optimum consumption path during their retirement. To do this they need to take into account their life expectancy and their wish whether or not to leave a legacy, amongst others aspects. Unlike most recent literature, which concentrates on the problems of the accumulation phase, this paper looks into the problems involved with different types of pension from the point of view of the pensioner, an aspect into which as yet there has been little research. The structure of the paper is as follows: after a brief introduction, an analysis is carried out of the different types of pension available in those countries which have pension systems based on individual capitalization accounts with defined contributions, with special emphasis on the countries of Latin America. Afterwards we set out an optimization model based on ideas first put forward by Yaari (1965) and developed by Kotlikoff and Spivak (1981) and Brown and Poterba (2000), amongst others. This model is applied to determine the expected utility of each type of pension according to the different preferences and perceptions of the individual. We also carry out an analysis of individual welfare based on the concept of equivalent wealth. Finally, other characteristics are gradually incorporated into the basic model in order to answer the question as to whether the types of pension available should be limited exclusively to annuities, as is the case in most countries with pay-as-you-go systems and in some countries with capitalization systems, in order to avoid the problem of adverse selection.

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