New working papers from MRRC

The Michigan Retirement Research Center released three new working papers:

Investor Behavior and Fund Performance under a Privatized Retirement Accounts System: Evidence from Chile by Elena Krasnokutskaya and Petra Todd

Abstract: In the U.S. and in Chile, there have been heated debates about the relative merits of a decentralized privatized pension system relative to a more traditional social security system. On the firm side, there are concerns that pension funds engage in anticompetitive behavior and take advantage of consumers' by charging high fees and account maintenance changes. On the consumer side, there are concerns that consumers do not select wisely among funds and take on too much risk. Any pension system with insurance features to protect against low levels of pension accumulations is potentially subject to moral hazard problems, in the form of consumers' taking on too much risk. In the case of Chile, the government provides a minimum pension benefit to those with low pension accumulations, which can make some consumers more willing to take risks. For these reasons, the Chilean government introduced regulations on pension fund firms' investments designed to limit risk. This paper analyzes the determinants of consumers' choices of pension fund and of pension fund characteristics (performance and fees), taking into account governmental regulations. In particular, it estimates a demand and supply model of the pension fund investment market using a longitudinal household dataset gathered in 2002 and 2004 in Chile, administrative data on fund choices, and longitudinal data on cost determinants of pension funds. We find that the existing regulation actually increases the level of risk in the market, reduces heterogeneity across firms, and reduces incentives for consumers to participate in the pension fund program. We suggest alternative more effective forms of regulation.

Key Findings:

* Low participation in the Chilean pension system, which is mandatory only for full-time workers in the formal sector, is due in part to the large informal sector of the economy.

* Regulation requiring that pension fund administrators deliver a return within 2% of the industry average encourages more risk taking than if portfolio risk were regulated.

* Fewer people also participate in the pension plan because of the risk taking by pension firms.

* Older and younger individuals are more averse to risk.

* The market is efficiently served by more than one firm.

Social Security Literacy and Retirement Well-Being by Hugo A. Benítez-Silva, Berna Demiralp and Zhen Liu

Abstract: We build upon the growing literature on financial literacy, which studies the prevalence of lack of knowledge about various financial issues, and analyze how much people know about the Social Security rules using a small pilot survey conducted in 2007, and a follow-up and extended survey funded by MRRC conducted in December of 2008. We then assess the consequences of the apparent prevalence of lack of information by individuals about the rules governing the Social Security system using a realistic and empirically-based life-cycle model of retirement behavior under uncertainty. We investigate the individual's retirement and savings decisions under incomplete information and unawareness, in which a portion of the population does not know some or all of the rules of the system. We compare the outcomes in these cases to the outcome under full information, computing the welfare gain resulting from the acquisition of information regarding the Social Security system. Our analysis can illuminate the need for policies that foster knowledge of the system, which can improve welfare, and can result in better policy outcomes.

Key Findings:

* Lack of basic knowledge about rules for obtaining Social Security benefits is widespread.

* Younger people are less informed than older people, however, only 70% of individuals aged 55 to 64 are aware of the minimum retirement age.

* Individuals who are reinterviewed show a large increase in knowledge about Social Security.

* The benefits of being fully informed about Social Security vary by age.

* Awareness could be increased by targeting messages pertinent to individuals based on their age or income level.

The Displacement Effect of Public Pensions on the Accumulation of Financial Assets by Michael Hurd, Pierre-Carl Michaud and Susann Rohwedder

Abstract: The generosity of public pensions may depress private savings and provide incentives to retire early. While there is plenty of evidence supporting the latter effect, there remains considerable controversy as whether or not public pensions crowd out private savings. This paper uses international micro-datasets collected over recent years to investigate whether public pensions displace private savings. The identification strategy relies on differences in the progressivity or non-linearity of pension formulas across countries. We also make use of large heterogeneity in earnings across education group and country. The evidence we present is consistent with previous studies using cross-sectional and time-series variation in savings and pensions. We estimate that an extra dollar of pension wealth depresses accumulated financial assets at the time of retirement by 23 to 44 cents and that an extra ten thousand dollars in pension wealth reduces the average retirement age by roughly 1 month.

Key Findings:

* The generosity of public pension systems affects both private saving rates and the timing of retirement.

* Our study of 12 countries shows that generous public pensions depress lifetime asset accumulation.

* For every dollar of pension wealth, financial assets are reduced by 23 to 44 cents.

* Higher public pension levels also induce earlier retirement.

* Retirement comes one month earlier for every $10,000 of pension wealth.