The impact of private participation on disability costs: evidence from Chile

1. The impact of private participation on disability costs: evidence from Chile by Estelle James October 2007

2. Problems with disability systems • High and rising costs (D & S-side factors) • Prone to type 1 and 2 errors (false positive and negatives)—difficult to draw line • Need to integrate with individual accounts • Pension is small for young disabled if DC • But if DB, moral hazard =>excessive claims • Systems often discourage return to work

3. How Chile differs from traditional systems • Largely pre-funded: • through accumulation in retirement accounts • through additional payment to cover DB life annuity when person is permanently disabled • simulations show pre-funding raises cost in short run, reduces them in long run; • increases sensitivity to interest rate changes but reduces sensitivity to population aging • Financing and assessment procedure include participation by private pension funds (AFPs) and insurance companies, who have a pecuniary interest in controlling costs. I focus on this feature.

4. Hypotheses: Costs and inflow • Disability insurance fees only .7% of wages, compared with 2-6% in most OECD countries • Disability inflow rate also much lower in Chile • We argue that private participation in assessment procedures cuts rate of successful disability claims, compared with old system (traditional) • We test by applying Cox proportional hazard model to sample of old and new system affiliates. • New system cuts hazard of becoming disabled pensioner by 65-80%, selects most severely disabled with highest mortality rate

5. Age group Age group 20-34 20-34 35-44 35-44 45-54 45-54 55-59 55-59 60-64 60-64 Chile Chile .2 .2 .9 .9 2.9 2.9 7.2 7.2 12.3 12.3 US US 2.7 2.7 4.5 4.5 7.8 7.8 13.9 13.9 12.8 12.8 OECD OECD 2.3 2.3 4.2 4.2 8.6 8.6 14.9 14.9 14.1 14.1 • Table 1: Inflow to disability benefit status, Chile vs. US and OECD, 1999(new inflow, per thousand insured)

6. Role of private companies in financing benefits • Individual contributes 10% of wage to pension fund (AFP) for retirement saving • If worker becomes disabled, he is guaranteed a DB (70% total, 50% partial disability) by his AFP • Disabled worker purchases lifetime annuity with money in his account, but if this is not enough it is topped up by additional payment • Each AFP purchases term group insurance policy that covers cost of top-up for its affiliates • Insurance fee is included in general administrative fee that AFP charges workers—about .7% of wage (1.8% in US up to age 65, 2-6% in OECD)

7. Pecuniary interest of AFPs to control costs • Suppose total fee is 2.4% of wage, of which 1% insurance cost, 1% admin cost, .4% profit. • If insurance cost cut to .8% and fee is unchanged, profit increases by 50% • AFPs have incentive and are given role in assessment procedure to control costs • Contrast with traditional systems where assessment is run by public agency or medical experts who have no direct incentives to cut cost • sometimes too generous, use disability as substitute for UnE insurance or early retirement; or bribes

8. Role of AFPs in assessment procedure • Initial claims evaluated by 21 Regional Medical Boards—each has 3 doctors + AFP observer • AFP Association has medical observers who attend regularly, monitor procedure, don’t vote • Assessment depends purely on medical grounds • 60% approved for temporary disability • 3 years later, assessment for permanent disability • AFPs and insurance companies participate. • if granted, workers keeps for life, even if he works

9. Other roles in procedure • AFPs & ins. companies can appeal approved claims to Central Medical Board (26% appealed) • To be insured--work & contribute last 12 months • AFPs have contribution records, check eligibility • Counteracts adverse selection in informal market • In 2004 40% of successful claims were ineligible • If disabled but not insured, get access to own account but not top-up • Reference wage: average earnings during past 10 years (price-indexed). Low contribution density means low reference wage. AFPs check records • AFPs have reps on Technical Commission that determines medical criteria for granting total and partial disability

10. Results: Out of 100 claimants, 2004-06: • About 60 approved at the first stage • 37 of approved claims deemed eligible for insurance • 42 reevaluated in 3 years for permanent disability • 40 of these accepted • 28 of these eligible for insurance • Successful appeals by workers, AFPs and insurance companies net out to 0 (contrast with U.S.--+15-20%) • Thus, only 28% of original claimants end up permanently disabled and insured • ¼ partially disabled • reference wage often 60% full time wage, pension 42% • Lower than other countries. We test new vs. old systems

11. Testing disability hazards in new vs. old systems • We apply Kaplan-Meier survival function and Cox proportional hazard model • The sample: EPS2002—retrospective sample in 2002 of 17000 new & old system affiliates, in systems between 1982-2002 • Our subsample—8324 individuals born 1932-62; 172 were disability pensioners (1/3 in new system) • Younger affiliates in new system but overlap and we control for age • Focus on age-specific hazard of disability 40-64

12. Kaplan-Meier survival functions • Shows prob that an individual who is member of at risk group will remain without disability pension up to given age, t • At risk group at t is all individuals who reach that age without pension • Hazard of disability is prop of at risk group who become disabled at t; rest are survivors • Old age pensioners at t are drop-outs • New-system affiliates have much higher prob of surviving than old-system affiliates

13. Kaplan-Meier survival as non-disability-pensioner, by system

14. Cox proportional hazard model • Enables us to establish baseline hazard (old system, by age) + size and significance of deviations from baseline due to other variables—effects must be proportional • Main variable of interest—new system • Other variables—UnE rate, education • We estimate Cox model stratified by sex and marital status • Baseline hazard lower for women and marrieds • To meet prop. requirement, we estimate separate coefficients for 5-yr age groups

15. Determinants of Hazard of Disability Pension: Cox model Covariates 1932-62 cohorts 1932-62 cohorts Exclude 1982-87 1922-62 cohorts New System:Age 40 to 44 .355 (-2.71)* .337 (-2.88)* .579 (-1.24) .497 (-1.83)*** Age 45 to 49 .21 (-4.12)* .213 (-4.1)* .145 (-4.41)* .300 (-3.24)* Age 50 to 54 .325 (-3.5)* .307 (-3.71)* .368 (-2.64)* .383 (-3.14)* Age 55 to 59 .296 (-3.23)* .317 (-3.25)* .299 (-3.18)* .397 (-2.87)* Men -Age 60 to 64 .493 (-1.63)*** .553 (-1.33) .493 (-1.63)*** .638 (-1.24) Unemployment: 50-54 1.054 (1.84)*** 1.111 (1.99)** 1.010 (0.42) Age 55-59 1.093 (1.98)** 1.094 (1.98)** 0.980 (-0.87)

16. Summary of results—strong new system effect in all cases • New system hazard is 21-35% of old system, ages 40-59 (significant at 1% level), 49% for men age 60-64 (marginally signif.) • Col. 1 with UnE , col. 2 without (1 pp UnE raises hazard 5-9 pp ages 50-59) • Col. 3—eliminates 1982-7 (selection bias) • Col. 4—expands sample to include 1922-62 cohorts (survival bias) • Similar results for no-choice groups alone (eliminates selection bias)

17. New vs. old system disability hazards for married men

18. Survival as non-disability pensioner, married men—Cox model

19. Mortality rates as indicator of system accuracy • Expect lower mortality for new system affiliates and for pensioners if old-new equally accurate • But better targeting in new system would imply equal or higher mortality among pensioners • Probit model compares prob of death by 2002, controlling for age, ed, gender, disability status, year of dis-pension (yrs of exp)--all significant • New system affiliates have 4% smaller prob. of death; new system*dispensioners have 13% higher prob of death (18% for men)—better targeting

20. KM life survival function by age • At risk group is all dis-pensioners or all other affiliates; survivors are those who live • In old system, age-specific KM survival prob. are same for dis and other affiliates—no targeting • In new system, wide disparity: survival prob rises for affiliates, falls for dis-pensioners—much better targeting, smaller type 1 error

21. Kaplan-Meier: Survival rates (not dying) by disability status and system

22. Cox proportional hazard model • Estimates hazard of dying by years of exposure to dis status (dis-pensioners only, small number so results preliminary) • Same in new and old system for first 3 years, but hazard of dying in next 12 yrs is much greater in new system

23. Death hazard among disability pensioners, by system

24. Survival rates among disability pensioners, by system, Cox model

25. What can other countries learn? • Chilean disability system includes participation by private AFPs and insurance companies in financing and assessment process—cuts costs substantially • Hazard of becoming disabled pensioner is 65-80% lower in new than in old system • Mortality rates among disabled pensioners are much higher in new system—targeting toward those with most severe medical conditions

26. Is Chile doing right thing? • Cuts costs in accurate way, but may not have picked the right mix of benefits vs. costs, type 1 vs. type 2 errors, pension size vs. incidence. This involves value judgments. • Minimizes type 1 error (false positives). Old system vv. • May face high cost of minimum pension guarantee—25-29% of average wage after 10 years work for dis-pensioners (uninsured, low ref. wage, partial dis) • Countries with traditional systems that consider their costs excessive might want to mimic Chilean scheme--agency might have right to appeal, use lawyers, etc.—save money with greater accuracy