Intergenerational Risk Sharing and Labour Supply in Collective Funded Pension Schemes with Defined Benefits

Abstract

In many countries, collective funded pension schemes with defined benefits (DB) are being replaced by individual schemes with defined contributions. Collective funded DB pensions may indeed reduce social welfare. This will be the case when the schemes feature income-related contributions that distort the labour-leisure decision. However, these schemes also share risks between generations. This adds to welfare if these risks cannot be traded on capital markets. This paper compares the welfare gains from intergenerational risk sharing with the welfare losses that are due to labour market distortions. We adopt a two-period overlapping-generations model for a small open economy with risky returns to equity holdings. We derive analytically that the gains dominate the losses for the case of Cobb-Douglas preferences between labour and leisure. Numerical simulations for the more general CES case confirm these findings which also withstand a number of other model modifications, like the introduction of a short-sale constraint for households and the inclusion of a labour income tax. These results suggest that collective funded schemes with well-organized risk sharing are preferable over individual schemes, even if labour market distortions are taken into account.

Defined benefit pension schemes: a welfare analysis of risk sharing and labour market distortions

“…Unlike Gollier (2008) we investigate the potential welfare gain of pension schemes when households can save by their own, too. Furthermore, our model distinguishes more than two overlapping generations contrary to for instance Bonenkamp and Westerhout (2010). Lastly, our model holds capital market risk exogenous which is realistic for small open economies, but which deviates from closed economy models like that of Krueger and Kubler (2006).…”

Intergenerational Risk Sharing, Pensions, and Endogenous Labour Supply in General Equilibrium*

“…Like all of the other papers mentioned thus far, however, they have not considered endogenous labour supply. The paper by Bonenkamp and Westerhout (2010) is one of the few papers that has combined both funded DB pension systems and endogenous labour supply. They have compared the welfare gains from intergenerational risk sharing with the losses due to labour‐market distortions caused by the income‐dependent contributions in such systems.…”

Risk Reallocation in Defined-Contribution Funded Pension Systems

“…2. However, some other papers do allow endogenous labor supply-for example, Bonenkamp and Westerhout (2010), Mehlkopf (2010), and Beetsma et al (2013).…”