Revealed Preference and Self-Insurance: Can We Learn from the Self-Employed in Chile?
26 Pages Posted: 20 Apr 2016
Date Written: January 4, 2002
In Chile the appropriate focus for policymakers interested in the welfare-enhancing effects of participation in the pension system are the self-employed, who are free to reveal their preferences. Among the self-employed, the more patient and less risk averse contribute to the pension system.
Financial sector development is a critical area of effective social protection policy. A well-regulated financial sector can complement government efforts to keep households from falling into poverty - by supplying the instruments needed to pool risks or to self-insure against losses because of the death or disability of a household member, unexpected loss of employment, or inability to work in old age. But many of the policy recommendations that can be drawn from the social risk management framework rest on the strong assumption that risk and time preferences are uniform across individuals or households.
Policies meant to encourage participation in public pension systems and to reduce evasion where such systems are mandatory (by more closely aligning benefits with payroll contributions or introducing individual retirement accounts) implicitly attempt to emulate the savings behavior of individuals and households faced with fully functioning capital markets and perfect information. If no allowance is made for variation in preferences, however, the welfare effects of policy reforms will vary across the target population. Mandated social security, even if actuarially fair for most, is likely to impose welfare losses on those less inclined to save and insure. That said, a clearer picture of individual and household preferences, and how they vary across the population, can help governments design social security systems that complement private savings and insurance instruments.
Barr and Packard present the results of a field experiment designed to produce an empirical measure of the risk aversion and time preferences of selected groups in Chile, which in 1981 pioneered social security reform with a transition to individual retirement accounts. The experiment was designed primarily to establish whether the time and risk preferences of the self-employed differ significantly from those of wage and salaried workers.
Barr and Packard find no significant differences in mean risk and time preferences between the self-employed and employees or between contributing and noncontributing employees. But they find significant differences in these preferences between the contributing and noncontributing self-employed. Among the self-employed, those who are more patient choose to contribute to the pension system. However, the contributing self-employed are significantly more tolerant of risk than the noncontributing self-employed, a finding that conflicts with the assumption that the formal pension system is the only source of insurance against poverty in old age.
The Chilean pension system may be viewed with some trepidation by its pool of potential clients. Since risk aversion declines with education, the participation of the economically active who are free to choose could be enhanced by a campaign carefully designed to raise awareness, allay fears, and inform people of the benefits of saving for retirement in the formal pension system.
This paper - a product of the Social Protection Unit, Latin America and the Caribbean Region - is part of a forthcoming regional study on social security reform. The authors may be contacted at email@example.com or firstname.lastname@example.org.
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