Intergenerational risk sharing under loss averse preferences

Abstract

Individual retirement savings schemes could benefit from risk-sharing mechanisms between generations that take behavioral aspects into account. We introduce a novel risk-sharing mechanism that incorporates nominal loss-aversion in two ways. First, the system avoids out-of-pocket wealth transfers by sharing only a fraction of positive returns over a high-water mark of pension assets. Secondly, payments from a generation insurance fund are targeted at nominal pension shortfalls below a reference point, which mitigates the loss experience at retirement. From a simulation of overlapping generations with stochastic asset returns and interest rates we find that the generation insurance scheme outperforms a pure individual retirement scheme by a significant margin: a similar risk of pension shortfall can be achieved with a contribution rate that is up to 20% lower. The efficiency gains vary with the extent of risk sharing over generations but remain large for sensible parameter values.

Optimal investment problem for a hybrid pension with intergenerational risk-sharing and longevity trend under model uncertainty

“…He also concludes that pension schemes with a wellstructured volatility-risk-adjusted component can be welfare enhancing for the entry and future cohorts. Similar researches can be found in Teulings and De Vries (2006), Beetsma et al (2012), Beetsma (2016), Boes and Siegmann (2018). Besides, there are other studies in the literature having tried to find optimal contributions and/or benefit adjustment policies within hybrid pension funds.…”

Saving with Group or Individual Personal Pension Schemes: How Much Difference Does It Make?

“…It also contributes to the regulatory literature on the effectiveness of different saving schemes (e.g. Poterba et al 1995, Choi et al 2002, Lindbeck and Persson 2003, Carroll et al 2009, Looney and Hardin 2009, Beshears et al 2015, Ahmed et al 2018, Boes and Siegman 2018, and to the literature on the importance of trust for market participation (El-Alttar and Poschke 2011, Ballock et al 2015). Finally, it contributes to the literature that documents the importance of relational contracts for the provision of financial services (Jiménez et al 2011, Belavina and Girotra 2012, Benczúr and Iluti 2016 and discriminatory practices of financial intermediaries (e.g.…”

Institutional and individual investors: Saving for old age

“…Sung, 1994, 2005;Rincón-Zapatero, 2004, 2006) and that contributions should be smoothed over time to help sponsors with financial decisions (Thaler and Benartzi, 2004). Boes and Siegman (2017) propose adopting nominal loss-aversion in an adjustment mechanism. They propose introducing an intergenerational insurance fund that would mitigate potential shortfalls of pension outcomes relative to a reference point of retirement benefits while insurance premiums would be collected only in situations where intermediate pension wealth was at an all-time high.…”