Thursday, March 11, 2010

New Pensions Papers from the Social Science Research Network


"Forced Savings and Annuitisation with Cross-Subsidies: A Mutation of the Beast" 

UNSW Australian School of Business Research Paper No. 2009ACTL09

BENJAMIN AVANZI, Australian School of Business at UNSW
SACHI PURCAL, University of New South Wales (UNSW) - School of Actuarial Studies

We formulate a two-tiered economic approach to classify national schemes which mandate retirement savings (defined contribution type schemes). We extend the plain vanilla concept of a system of forced savings advocated by the World Bank (1994) by allowing for annuitization and cross-subsidies. In this way we treat both the accumulation and decumulation phases of lifetime savings.

The first tier of our model is controlled by government, which mandates contribution rates, interest rates, and conversion into benefits. In contrast, agents make voluntary contributions to the second tier, which earns interest at a rate broadly reflecting market conditions and any cross-subsidy between both tiers. Cross-subsidies within the mandated tier and between both tiers allow for social redistribution as well as fostering the creation of a liquid market of privately provided annuities.

We conclude with a discussion of the Swiss and Australian systems of retirement savings as seen through the lens of our model. The former is system with cross-subsidies and annuities, while the latter is one without.

"The Impact of Changing Earnings Volatility on Retirement Wealth" 

AUSTIN NICHOLS, The Urban Institute
MELISSA FAVREAULT, The Urban Institute

Over the last several decades, the volatility of family income has increased markedly, and own earnings volatility has remained relatively flat. Volatility may affect retirement wealth, depending on whether volatility affects accrued pension contributions or withdrawals or earnings credited toward future Social Security benefits. This project assesses the effect of the volatility of individual and family earnings on asset accumulation and projected retirement wealth using survey data matched to administrative earnings records.

"Evaluating Micro-Survey Estimates of Wealth and Saving" 

BARRY BOSWORTH, Brookings Institution - Economic Studies Program
ROSANNA SMART, affiliation not provided to SSRN

This paper presents an overview of changes in household wealth accumulation and saving using wealth data from three micro-level surveys: Survey of Consumer Finances (SCF), Panel Study of Income Dynamics (PSID), and Health and Retirement Study (HRS). We provide comparisons to the macroeconomic estimates of wealth accumulation and saving, explore problems in constructing household-level valuations of wealth, and assess the value of using household-level datasets to examine wealth accumulation and saving behavior in the United States.

Our first analysis compares the macroeconomic estimates of wealth from the Flow of Funds to comparable measures from the SCF, PSID and HRS. The Flow of Funds and SCF valuations of net worth correspond closely up to 1998. Yet, after1998, the SCF reports a much more rapid acceleration of wealth, concentrated in equity-type assets. The estimates of wealth in the PSID and HRS are very similar to the SCF for the bottom 95 percent of the wealth distribution, diverging only for the top five percent of households...

"Taxes and Pensions" 

PETER A. DIAMOND, Massachusetts Institute of Technology (MIT) - Department of Economics, National Bureau of Economic Research (NBER), CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Pension benefit rules depend on individual history far more than taxes do, and age plays a much larger role in pension determination than in tax determination. Apart from some simulation studies, theoretical studies of optimal tax design typically contain neither a mandatory pension system nor the behavioral dimensions that lie behind justifications commonly offered for mandatory pensions. Conversely, optimizing models of pension design typically do not include annual taxation of labor and capital incomes. After spelling out this contrast and reviewing (and rejecting) zero taxation of capital income based on the Atkinson-Stiglitz and Chamley-Judd results, this article raises the issue of tax-favored retirement savings, a topic where the two subjects come together.

"Your Nest Egg on Auto Pilot" 

LEWIS MANDELL, Aspen Institute - Initiative on Financial Security
PAMELA J. PERUN, Aspen Institute - Initiative on Financial Security
LISA MENSAH, Aspen Institute - Initiative on Financial Security
RAYMOND O'MARA III, Aspen Institute - Initiative on Financial Security

The Obama administration has proposed bold new policies to expand retirement savings. Through a program of Automatic IRAs, the approximately 78 million American workers not currently covered by a plan at work would be able to save through workplace-based individual retirement accounts. As important as money flowing into the Automatic IRA is, the central test of the Automatic IRA policy will be how much money will be available to flow out at retirement. How can the Automatic IRA insure that significant assets are built for retirement? To that end, the investment menu will be critical because it is the engine that grows contributions into retirement assets.

The Initiative on Financial Security at the Aspen Institute has designed an investment vehicle suitable for use as the default investment for the Automatic IRA. Real Savings Plus offers an automatic, inexpensive blend of TIPS and a market index to provide savers with a guaranteed return of their contributions along with the likelihood of upside potential through equity investing. Real Savings Plus thus protects the value of each dollar saved from the most likely risks to retirement income while offering the opportunity for significant growth as well.

We demonstrate in this brief that Real Savings Plus is highly likely to outperform the "R-Bond", another proposed default investment for the Automatic IRA, in building financial assets for retirement. At the same time we show that Real Savings Plus, like the R-bond, is able to guarantee the full return of a saver's contributions adjusted for inflation even under the worst imaginable economic circumstances. Finally, we briefly describe other benefits of Real Savings Plus beyond investment performance, such as its low-cost structure, automatic asset allocation, and potentially wide availability throughout the financial services industry.

"Performance Evaluation of Balanced Pension Plans" 

LAURA ANDREU, University of Zaragoza - Faculty of Business and Economics
LAURENS A. P. SWINKELS, Robeco Quantitative Strategies, Erasmus University Rotterdam (EUR)

This paper examines the ability of balanced pension plan managers to successfully time the equity and bond market and select the appropriate assets within these markets. In order to evaluate both market timing abilities in these balanced pension plans, we extend the traditional equity market timing models to also account for bond market timing. As far as we know, we are among the first to apply this multifactor timing model to investigate equity and bond market timing simultaneously. This performance evaluation has been conducted on two samples of Spanish balanced pension plans, one with Euro Zone and one with World investment focus. This allows us to decompose managers' skills in three components: selectivity, equity market timing, and bond market timing. Our findings suggest that the average stock picking ability of pension plans is positive. World schemes tend to have positive bond timing skills, while Euro Zone pension plans are on average not able to time equity or bond markets.

"Are Age - 62/63 Retired Worker Beneficiaries at Risk?" 

ERIC R. KINGSON, Syracuse University - School of Social Work
MARIA BROWN, affiliation not provided to SSRN

This paper provides a longitudinal view, spanning 10 to 12 years, of persons first accepting retired worker benefits at ages 62 or 63 in 1994 or 1996. Using HRS data, matched to Social Security administrative files, we present: 1) findings of variation in income, wealth, health insurance coverage and employability, along such dimensions as race, Hispanic ethnicity, gender, reported health status and functional ability; 2) findings of economic, health and survival outcomes in 2006 for the 1994/1996 pooled sample, paying special attention to variations within the sub-sample of persons who accepted Social Security early retirement benefits by 1996; and 3) estimates of the proportion of persons accepting such benefits who are at risk. The findings indicate that persons first accepting Social Security retired worker benefits at ages 62 and 63 experience varying degrees of risk to their well being at these ages, and that these risks condition their well-being in retirement and survival probabilities. The major policy implication is that consideration should be given to providing a health insurance option for persons first accepting retired worker benefits prior to age 65. The major research implication is that retirement researchers should consider utilizing a range of measures - as opposed to a singular and potentially narrow measure - of risk when assessing the magnitude of risks existing for those accepting retired worker benefits at early ages.

"Financial Hardship Before and After Social Security's Early Eligibility Age" 

W. RICHARD JOHNSON, affiliation not provided to SSRN
GORDON MERMIN, affiliation not provided to SSRN

Although poverty rates for Americans ages 65 and older have plunged over the past half century, many people continue to fall into poverty in their late fifties and early sixties. This study examines financial hardship rates in the years before qualifying for Social Security retirement benefits at age 62 and investigates how the availability of Social Security improves economic well-being at later ages. The analysis follows a sample of adults from the 1937-39 birth cohort for 14 years, tracking their employment, disability status, and income as they age from their early 50s until their late 60s. It measures the share of older adults who appear to have been forced into retirement by health or employment shocks and the apparent impact of involuntary retirement on low-income rates. The study also estimates models of the likelihood that older adults experience financial hardship before reaching Social Security's early eligibility age.

The results show that the likelihood of experiencing financial hardship increases significantly as people approach Social Security's early eligibility age. The increase in hardship rates is concentrated among workers with limited education and health problems. For example, among those who did not complete high school, hardship rates increase from 23 percent at ages 52 to 54 to 31 percent at ages 60 to 61, a relative increase of 36 percent. Hardship rates decline after age 62, when most people qualify for Social Security retirement benefits. These findings highlight the fragility of the income support system for Americans in their fifties and early sixties.

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