A New Contributory Pension Model – Evidence from Chile

Authors

1 Department of Mathematics, Physics and Statistics, Universidad Catolica del Maule, Talca, Chile.

2 Department of Educational Foundations, Universidad Catolica del Maule, Talca, Chile.

3 Department of Actuarial Sciences, Institute of Insurance and Risk Management, Hyderabad, India.

Abstract

We develop a model of individual account pension systems with heterogeneous agents. When the individual enters the labor market, his/her initial wage is assigned randomly. The probability of being employed in the informal sector in the following period is a decreasing function of wage levels. People with lower wages are more likely to work in the informal sector where they do not contribute to their individual pension accounts. This model allows us to find the entire distribution of pensions; with the possibility to evaluate the effects of policies on average pensions as well as changes in distribution. We calibrate the model to the Chilean pension system and make a Monte Carlo experiment to simulate different scenarios related to public policies. We find that for workers who have contributed less than 18 years, a marginal increase in contribution rates has a greater effect on the average pension level than a marginal increase in the interest rate. We further examine simulation to study three public pension policies– a) An increase in contribution rates from 10% to 14% b) A five-year increase in the retirement age for both genders (Men from 65 to 70 and Women from 60 to 65) and c) A contribution of $3000 at birth in the individual account. We find that the simulations carried out for all three policies increase the average pension level and Replacement Rate. However, the last policy is the only one wherein there is a decrease in pension inequality.

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