Disability Insurance with Pre-funding and Private Participation: The Chilean Model

This paper asserts that the disability insurance system in Chile is much less well-known than the pension part, but it is equally innovative. It differs from traditional public disability insurance in two important ways: 1) it is largely pre-funded--through the accumulation in the retirement account and later through an additional payment made when the person becomes permanently disabled, sufficient to cover a lifetime defined benefit annuity; and 2) the disability assessment procedure includes participation by private pension funds (AFPs) and insurance companies, who finance the benefit and have a direct pecuniary interest in controlling costs. Survivors' insurance is handled in the same way, through a combined D&S fee. The authors argue that pre-funding will raise disability fees in the early years of a new system as funds are built up but reduce them in the long run as benefits are covered out of accumulated funds. They further hypothesize that the participation of private pension funds in the assessment procedure will keep system costs low, by cutting the incidence of successful disability claims. Finally, the paper expects that these incentives will also lead to cost-shifting-to other AFP's by selection and to the public treasury via the minimum pension guarantee (MPG). Using simulations based on a special data set that was provided to the authors by the Association of AFPs and applying the Cox proportional hazard model to a retrospective sample of new and old system affiliates (ESP 2002), they conclude that these hypotheses are broadly consistent with observed behavior.