Veritas propter investigationem [Truth through research]
TitleInvestor Behavior and Fund Performance under a Privatized Retirement Accounts System: Evidence from Chile (2009)
AuthorsElena Krasnokutskaya
 Petra Todd
InstitutionRetirement Research Center
TopicsTier 2 provision
 Compulsory private provision
 Investment restrictions
 Regulatory issues
Date Published2009
Date posted on PR22 Jul 2014
Krasnokutskaya, E Todd, P, (2009). Investor Behavior and Fund Performance under a Privatized Retirement Accounts System: Evidence from Chile (2009) Retirement Research Center,

PensionReforms’ summary and comments

When a government decides that citizens need to be told how to make financial provision for retirement, thickets of rules are needed both to protect savers and also to limit the political risk of aberrant providers.  As ever, the law of unintended consequences plays a role in outcomes, as this 2009 report from Chile illustrates.


Chile has the oldest Tier 2, pre-funded, compulsory retirement savings framework (started 1981) and many countries have applied the model.


“The design of the Chilean pension system includes insurance features, in the form of a minimum return guarantee and a minimum pension guarantee, that are intended to protect investors against low levels of pension accumulations.  These guarantees create the potential for moral hazard in consumers’ investment decisions.”


If the State’s Tier 1 pension effectively underwrites the Tier 2 account-based benefit, we should expect savers to take greater risks with their investment strategy than in the absence of that underwrite.


On the other hand, because the AFPs are obliged to deliver a return that is no more than 2% a year away from the industry average, we might have expected risk aversion to underpin investment decisions.  We should assume this was the regulators’ intention.


The report describes a model that looks at the trade-offs from both the savers’ and providers’ perspectives.


“We find that [the] Chilean regulatory rule that mandates firms to guarantee returns within 2% of the industry average creates incentives for the AFP firms to invest in the riskier portfolios than they would choose under an alternative regulation that instead restricts the riskiness of their portfolio limited.”


This, the authors conclude, is “an unanticipated effect of the regulation” and might help to explain the low coverage of the supposedly ‘compulsory’ Tier 2.


“Also, the choice of the portfolios under the current regulation is riskier than would be the selection of portfolios that a social planner would choose.  Not surprisingly, it leads to a higher than desirable (by social planner) volatility in accumulated balances.”


The answer, according to the report, is to have a different set of regulations that “…restricted directly the investment instruments of the pension fund rather than requiring them to achieve a performance near the mean…”


PensionReforms thinks that the authors are too optimistic.  Given that the current rules have had unintended consequences (increased, rather than reduced risks) why wouldn’t a new set of rules have different unintended consequences?  The AFPs are in business to make money for their shareholders (nothing wrong with that) and so their imperatives are quite likely to diverge from both members and regulators.  Commission-driven behaviour of selling agents is a natural outcome.


PensionReforms thinks the reasons for the low coverage of workers are more fundamental and go to the heart of regulatory justifications for compulsory Tier 2 schemes.  We doubt whether savers are sophisticated enough to understand volatility, investment strategy and whether one provider is ‘better’ than another on these scores.  Even comparing fees is beyond most.


Most Chileans probably have more pressing things to spend today’s income on than saving for retirement, perhaps decades hence.  The 2008 reforms to Tier 1 (see here) show that, after 33 years, compulsion just isn’t delivering.  The improvements to Tier 1 pensions ironically increase the risks of gaming by savers with their investment strategy.  The real trouble with compulsory private provision is the complexity that inevitably flows from attempts to force people into doing something they would rather not do.  The more they don’t want to do those things, the more complex must be the rules that try to force a behaviour change and the more likely are unintended consequences.  (File size KB; 33 pp) 689