New papers from the Social Science Research Network

SOCIAL SECURITY, PENSIONS & RETIREMENT INCOME eJOURNAL

"What Causes EBRI Retirement Readiness Ratings™ to Vary: Results from the 2014 Retirement Security Projection Model®"
EBRI Issue Brief, No. 396 (February 2014)

JACK VANDERHEI, Employee Benefit Research Institute (EBRI)
Email: vanderhei@ebri.org

This paper begins with a brief overview of the Retirement Security Projection Model® (RSPM), a national model developed by the Employee Benefit Research Institute (EBRI) in 2003, and then updates the results for 2014. It then provides basic sensitivity analysis of the model to show the impact of changing assumptions with respect to rate of return, utilization of housing for financing retirement, and potential modifications to future Social Security retirement benefits. The final section focuses on how the probability of not running short of money in retirement (measured by the EBRI Retirement Readiness Ratings® (RRRs)) varies with respect to longevity, investment return, and potential long-term health care costs in retirement (e.g., nursing home costs). Due to the increase in financial market and housing values during 2013, the probability that Baby Boomers and Generation Xers would NOT run short of money in retirement increases between 0.5 and 1.6 percentage points, based on EBRI’s Retirement Readiness Ratings (RRRs). Eligibility for participation in an employer-sponsored defined contribution plan remains one of the most important factors for retirement income adequacy. RRR values double for Gen Xers in the lowest-income quartile when comparing those with 20 or more years of future eligibility with those with no years of future eligibility, while those in the middle income quartiles experience increases in RRR values by 27.1-30.3 percentage points. Future Social Security benefits make a huge difference for the retirement income adequacy of some households, especially Gen Xers in the lowest-income quartile. If Social Security benefits are subject to proportionate decreases beginning in 2033 (according to the values in Figure 8), the RRR values for those households will drop by more than 50 percent: from 20.9 percent to 10.3 percent. Longevity risk and stochastic health care risk are associated with huge variations in retirement income adequacy. For both of these factors, a comparison between the most “risky” quartile with the least risky quartile shows a spread of approximately 30 percentage points for the lowest income range, approximately 25 to 40 percentage points for the highest income range, and even larger spreads for those in the middle income ranges. A great deal of the variability in retirement income adequacy could be mitigated by appropriate risk-management techniques at or near retirement age. For example, the annuitization of a portion of the defined contribution and IRA balances may substantially increase the probability of not running short of money in retirement. Moreover, a well-functioning market in long-term care insurance would appear to provide an extremely useful technique to help control the volatility from the stochastic, long-term health care risk, especially for those in the middle income quartiles.

"Topping Up and the Political Support for Social Insurance"
IFN Working Paper No. 993

ANDREAS BERGH, Research Institute of Industrial Economics (IFN), Lund University - Department of Economics
Email: andreas.bergh@nek.lu.se

This paper analyzes how the possibility to complement social income insurance schemes with private insurance affects the political support for social insurance. It is shown that political support for social insurance is weakly decreasing in the replacement rate. Policy makers seeking to maintain support for social insurance schemes can do so by lowering the replacement rate and allowing topping up contracts. The strategy is likely to be a partial explanation for the continued political support for welfare states with universal social insurance schemes such as those in Scandinavia.

"Tontine Pensions: A Solution to the State and Local Pension Underfunding Crisis"

JONATHAN BARRY FORMAN, University of Oklahoma College of Law
Email: JFORMAN@OU.EDU
MICHAEL J. SABIN, Consultant, Independent
Email: mike.sabin@att.net

Tontines are investment vehicles that can be used to provide retirement income. Basically, a tontine is a financial product that combines features of an annuity and a lottery. In a simple tontine, a group of investors pool their money together to buy a portfolio of investments, and, as investors die, their shares are forfeited, with the entire fund going to the last surviving investor. Over the years, this last-survivor-takes-all approach has made for some great fiction. For example, on the television show “Mash,” Colonel Sherman T. Potter, as the last survivor of his World War I unit, got to open the bottle of French cognac that he and his buddies bought (and share it with his Korean War compatriots). On the other hand, sometimes the fictional plots involved nefarious characters trying to kill off the rest of the investors and “inherit” the fund.
To be sure, a tontine can be designed to avoid such mischief. For example, instead of distributing all of the contributions to the last survivor, a tontine could make periodic distributions. Each time a member dies, her contribution would be distributed among the survivors. The tontine could solicit new investors to replace those that die. In that regard, elsewhere, one of us (Sabin) has described how these tontine funds could be used to create perpetual “tontine annuities” that could be sold to individual investors.
In this Article, we consider how the tontine principle could be used to create “tontine pensions” that could be adopted by large employers to provide retirement income for their employees. We also show that these tontine pensions would have several major advantages over most of today’s pensions, annuities, and other retirement income products.
At the outset, Part II of this Article explains how the current U.S. retirement system works and how retirees can use pensions, annuities, and other financial products to generate retirement income.
Next, Part III of this Article offers a step-by-step explanation of how tontine funds, tontine annuities, and tontine pensions could work today. Part III then compares tontine pensions with traditional defined benefit pension plans, with defined contribution plans, and with so-called “hybrid pensions” (i.e., cash balance plans). In particular, Part III shows that tontine pensions have the two major advantages over traditional pensions. First, unlike traditional pensions — which are frequently underfunded, tontine pensions would always be fully funded. Second, unlike a traditional pension — where the pension plan sponsor must bear all the investment and actuarial risks, with a tontine pension, the plan sponsor bears neither of those risks. These two features should make tontine pensions a particularly attractive alternative for employers who care about providing retirement income security for their employees but who want to avoid the risks associated with having a traditional pension.
Part IV of this Article then develops a model tontine pension for a typical large employer, and we use that model to estimate the benefits that would be paid to retirees. For simplicity, the model assumes that, each year, an employer would contribute 10% of salary to a tontine pension for each employee each year (in the real world, employers could choose to contribute a greater or lesser percentage of salary on behalf of their employees). The model generates tontine pension benefits for each retiree that would closely resemble an actuarially fair variable annuity (i.e. one without high insurance company fees [“loads”]). More specifically, unlike commercial annuities which must support insurance agent commissions and insurance company reserves, risk-taking, and profits; the management and recordkeeping fees involved with running a tontine pension would be minimal. That means that tontine pensions would provide significantly higher retirement benefits than commercial annuities.
Part V of this Article then shows how such a model tontine pension could be used to replace a typical, large traditional pension plan like the California State Teachers’ Retirement System (CalSTRS). Pertinent here, like so many other state-run pension plans, CalSTRS is underfunded; for example, as of June 30, 2012, the CalSTRS traditional pension plan was just 67.0% funded, with an unfunded liability of almost $71 billion. While replacing CalSTRS with a tontine pension would do nothing to reduce that $71 billion obligation, it would ensure that California would never again have to worry about underfunding attributable to future benefit accruals.
Finally, Part VI of this Article discusses how to solve some of the technical problems that would arise in implementing a tontine pension, and Part VII of this Article offers some concluding remarks.

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Should we shift Social Security’s “start-up costs” to the rich?

Boston College economist Alicia Munnell, writing for MarketWatch, discusses the so-called “start-up costs” involved with Social Security, which are often referred to as the system’s “legacy debt.” This represents the extra benefits paid to early participants in the program over and above what they paid in taxes. This amount – which is somewhere north of $20 trillion – is the main reason Social Security is underfunded going into the future.

Munnell argues that these costs should be shifted from Social Security to the general Treasury. In other words, they should be financed by income taxes, which are predominantly paid by high earners, rather than payroll taxes. She argues that doing so would “produce a more equitable tax system.”

I can understand making this kind of change and I might even support something like it. But I’m not sure why shifting Social Security costs from a tax that is more or less proportional to income to one that is paid predominantly by a very few high earners is more “equitable.”

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New MRRC newsletter

The Michigan Retirement Research Center has released its Winter 2014 Newsletter. Here are the contents with links:

Volume 14 Issue 1 - February 2014
Director's Corner by John P. Laitner
This Newsletter features MRRC research on health status and the well-being of older Americans.

Who Benefits from Medicaid in Old Age?
MRRC Researcher Eric French discusses the research behind his paper “Medicaid Insurance in Old Age,” coauthored with Mariacristina De Nardi and John Bailey Jones (WP 2012-278)

Call for Paper Proposals: Social Insurance and Lifecycle Events Among Older Americans Conference
With support from AARP, a conference on Social Insurance and Lifecycle Events Among Older Americans will be held on December 5, 2014, in Washington, DC.

Featured Key Findings

MRRC Researchers in the Media

MRRC Researchers in Publication

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Upcoming event: Mark Warshawsky at the Savings and Retirement Foundation

TOMORROW: LUNCH FORUM
Discussing
Commission on Long-Term Care
"Report to the Congress"
with Mark Warshawsky

February 25, from Noon to 1:30 at the
Investment Company Institute
1401 H Street, NW #1100
Washington, DC 20005
RSVP

(Lunch will be provided)

Mark Warshawsky is a prominent researcher on retirement plans and products and the risks facing retirees. He is a coauthor of “Fundamentals of Private Pensions” and author of “Retirement Income: Risks and Strategies,” as well of more than a hundred published professional papers. He was a member of the Social Security Advisory Board from 2006 to 2012 and is now Vice Chair of the federal Commission on Long-Term Care. From 2004 to 2006, Warshawsky served as assistant secretary for economic policy at the US Department of the Treasury, playing a key role in the development of the Pension Protection Act of 2006, the Social Security and Medicare Trustees’ Reports, and the terror risk insurance program.

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Upcoming event: “The retirement crisis: A statistical mirage?”

The retirement crisis: A statistical mirage?

Friday, February 21, 2014 | 8:30 a.m. – 10:00 a.m.

American Enterprise Institute

Twelfth Floor
1150 Seventeenth Street, NW
Washington, DC 20036

RSVP

About This Event

There is a widespread perception that many Americans are inadequately prepared for retirement. Some even call this a crisis. Policymakers have responded with proposals to expand the Social Security program and reduce or eliminate tax incentives for 401(k) and Individual Retirement Account (IRA) plans that many believe have served Americans poorly.

But some analysts question this perceived retirement crisis, arguing that official statistics significantly understate the benefits that retirees receive from 401(k) plans and IRAs. At this event, retirement experts will discuss how proposed policy changes to Social Security or private pensions may be ill-considered.

Agenda

8:15 AM
Continental Breakfast and Registration
8:30 AM
Presenter:
Sylvester J. Schieber, Former Chairman of the Social Security Advisory Board
Discussant:
John Sabelhaus, Board of Governors of the Federal Reserve System
Moderator:
Andrew G. Biggs, AEI
10:00 AM
Adjournment

Event Contact Information

For more information, please contact Kelly Funderburk at Kelly.Funderburk@aei.org, 202.862.5920.

Media Contact Information

For media inquiries, please contact MediaServices@aei.org, 202.862.5829.

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Brown: Think Twice About State-Run Retirement Plans

University of Illinois economist Jeffrey Brown writes for Forbes on proposals to have state or federal governments run retirement plans designed to supplement Social Security. Brown, an expert on the public employee plans that governments already do run, argues that we should think carefully regarding both how much these plans are needed and how well they might be run.

Check out his article here.

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Pensions and labor supply in the OECD

From the National Center for Policy Analysis

February 12, 2014

The employment rate among the older segments of Organization for Economic Cooperation and Development (OECD) populations have decreased significantly over the last 50 years, says Gabriel Heller Sahlgren, a research fellow at the Institute of Economic Affairs (U.K.).

As employment rates for older generations have fallen, more pressure has been put on state pension systems to fund their retirement, leaving fewer people to fund larger groups of pensioners.

• The male employment rate for ages 55 to 59 in OECD countries decreased from above 90 percent to less than 70 percent between 1968 and the end of the 1900s. In 2008, that number was at 80 percent.
• By 2040, the ratio of dependency supporting pensions is expected to increase by 17 percent relative to 2008.

Evidence suggests that this drop in employment is tied directly to the financial incentives of state pension systems.

• One simulation found that delaying eligibility for pensions by just three years would increase labor force participation by 36 percent among men aged 56-65.
• Looking across countries, one study found that an increase in 10 percent in public pension wealth leads to a decrease in the average retirement age by 1.5 percent.
• Italy has such strong incentives in place that reaching pension eligibility increases a person's likelihood of retirement by 30 percentage points.
• Conversely, a Swiss study found that permanently reducing retirement benefits by 3.4 percent would result in a 50 percent decline in retirement probability.

Sahlgren suggests linking the pension age with life expectancy in order to encourage labor force participation. He also argues for a private pension system that gives workers more control over their own retirement savings and encourages them to bear the costs of their own retirement.

Lastly, evidence suggests that workers use unemployment benefits and disability insurance as "alternative" retirement plans. Those programs should be reformed to discourage such behavior. When the United Kingdom recently undertook such reforms and provided incentives for disability insurance recipients to return to work, the country saw a response in higher employment rates.

Source: Gabriel Heller Sahlgren, "Income From Work -- the Fourth Pillar of Income Provision in Old Age," Institute of Economic Affairs (U.K.), January 2014.

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Samuelson: Retirees are better off than we think

The Washington Post’s Robert Samuelson discusses the state of retirement income today, including a reference to my recent Wall Street Journal piece with Syl Schieber. We argued that common references to retirees’ well-being, including SSA’s Income of the Aged series, undercount retirement income because their datasource, the Current Population Survey, doesn’t count most withdrawals from IRAs or 401ks as income.

I thought this table, which Samuelson draws from CBO data, to be interesting:

Average Incomes of Older Americans, 2010

Poorest fifth: $19,900

Second fifth: $34,400

Middle fifth: $55,100

Fourth fifth: $82,100

Richest fifth:$219,500

There’s a lot more you need to know in order to judge the severity of any retirement crisis Americans are facing, but getting a better view of retirees’ incomes is a good start.

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Social Security Outlook Worsens Again

Investors Business Daily’s Jed Graham reports on the CBO’s new projections for Social Security, which have been overshadowed by the agency’s estimate that the Affordable Care Act will reduce employment in future years. But the two are at least partially related: CBO’s projections of larger cash deficits for Social Security are mostly driven by forecasts of a weaker economy and lower tax revenues. The ACA’s disincentives to work account for part of the growing revenue gap, though other macro factors appear to play a larger role.

Check out Jed’s story here.

 

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New paper: “Social Security Reform Could Benefit All Workers”

From the National Center for Policy Analysis:

Congress is once again considering changes to Social Security in an attempt to "save" the program. Social Security benefit payments have exceeded tax revenues since 2010; the funding deficit is growing and, barring reform, will continue to grow indefinitely. Higher tax revenues are necessary to fund benefits as they are currently calculated, say Liqun Liu, a research scientist, Andrew J. Rettenmaier, executive associate director, and Thomas R. Saving, director, at the Private Enterprise Research Center at Texas A&M University.

The system is financed on a pay-as-you-go basis where current tax payments are transferred to current retirees. Changing demographics have resulted in a reduction in the number of workers supporting each retiree and a corresponding need for higher tax rates. Retaining the current benefit structure will require an immediate and permanent increase in the Social Security payroll tax of 3.3 percentage points.

In contrast, a long-run balanced budget for Social Security could also be achieved by retaining the current tax rate, but making the following two benefit reforms.

• Gradually raising the retirement age for workers who become eligible for benefits in 2023 and after.
• Making the benefit formula less generous for higher earning workers through progressive price indexing.

Both the current program with the taxes necessary to close its financing gap (the baseline) and the reformed program produce comparable net results for workers across birth years and across income classes.

• With the baseline program, average-earning men born in 1985 will have to pay 13.5 percent of their lifetime income in taxes and receive benefits equal to 9.6 percent of their income.
• However, the same workers in the reformed program would pay a lower tax rate of 10.2 percent to receive reformed benefits of 8.2 percent.

If the baseline and reformed program are comparable in terms of net lifetime tax rates within income classes and birth years, is there a reason to prefer one to the other? Liu, Rettenmaier and Saving suggest that the smaller reformed program is preferable, primarily for the following reasons:

• Given current debt levels along with ongoing and forecast budget challenges, reducing the size of federal spending is critical in the long run.
• Collecting the higher tax revenues necessary to retain the current benefit formula inevitably produces welfare losses.
• Reducing the scope of a pay-as-you-go financed retirement program will result in the real prepayment of retirement benefits, leading to greater investment and higher national income.
• The reformed program can be complemented with voluntary, individually directed personal retirement accounts.

Source: Liqun Liu, Andrew J. Rettenmaier and Thomas R. Saving, "Social Security Reform Could Benefit All Workers," National Center for Policy Analysis, February 2014.

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New paper: “How Financial Incentives Induce Disability Insurance Recipients to Return to Work”

How Financial Incentives Induce Disability Insurance Recipients to Return to Work

Andreas Ravndal Kostol and Magne Mogstad

Using a local randomized experiment that arises from a sharp discontinuity in Disability Insurance (DI) policy in Norway, we provide transparent and credible identification of how financial incentives induce DI recipients to return to work. We find that many DI recipients have considerable capacity to work that can be effectively induced by providing financial work incentives. We further show that providing work incentives to DI recipients may both increase their disposable income and reduce program costs. Our findings also suggest that targeted policies may be the most effective in encouraging DI recipients to return to work.

Full-Text Access | Supplementary Materials

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