We use information from Social Security earnings records to examine the accuracy of survey responses regarding participation in tax-deferred pension plans. As employer-provided defined benefit pensions are replaced by voluntary contribution plans, employees’ understanding of the link between their annual contributions and their post-retirement wealth is becoming increasingly important. We examine the extent to which wage-earners in the Health and Retirement Study (HRS) correctly report their inclusion in tax-deferred contribution plans and, conditional on inclusion, their annual contributions. We use three samples representing different cohorts in three different periods: the original HRS cohort interviewed in 1992 at ages 51–56, the War Babies cohort interviewed in 1998 at ages 51–56, and the Early Baby Boomer cohort interviewed in 2004 at the same ages. Our findings indicate that while respondents interviewed in 1998 and 2004 were more likely to correctly report whether they were included in defined contribution plans, they were no more accurate when reporting whether they had contributed to their plans than respondents interviewed in 1992. Contributors in the three cohorts, moreover, overstated their annual contributions and thus would be likely to realize lower than expected account balances at retirement. The magnitude of this error is not negligible. In all three cohorts, the mean reporting error (the absolute difference between respondent-reported and Social Security earnings record contributions) was approximately 1.5 times larger than the mean contribution in the W-2 earnings record.

The Pension Benefit Guaranty Corporation's (PBGC) Pension Insurance Modeling System (PIMS) is used to evaluate the financial security and resilience of the national program backstopping private defined benefit plans. The Pension Research Council of the Wharton School at the University of Pennsylvania recently convened a Technical Review Panel of experts to review key inputs, outputs, and model assumptions. Our review was intended to provide a formal evaluation of the technical adequacy of the model by outside experts. The papers herein summarize views of each expert on this project. Key findings are as follows:

• • The PIMS models are an important and valuable tool in modeling the Pension Benefit Guaranty Corporation's liability risk. To the best of our knowledge, there is no other model that can do a comparable job.

• • Nevertheless, some improvements could be integrated in the Agency's approach to modeling. Those deserving highest priority attention, in the experts’ view, include incorporating systematic mortality risk (i.e., treat mortality and longevity as stochastic variables); including new asset classes increasingly found in defined benefit plan portfolios (e.g., commercial real estate, private equity funds, infrastructure, hedge funds, and others); developing a more complex model for the term structure of interest rates; and incorporating an option value approach to pricing the insurance provided.

• • The Agency could also do more to communicate the range of uncertainty and potential for problems associated with the PBGC's financial status. This could include additional information including the conditional value-at-risk, and perhaps an ‘intermediate,’ ‘optimistic’, and ‘pessimistic’ set of projected outcomes, as well as the expected ‘date of exhaustion’ for assets backing pension benefits insured by the PBGC.

We provide the first analysis of annuity rates in the Netherlands for the period 2001–2012. During this period, the number of annuity providers was high and stable, and we find that falls in annuity rates can be explained entirely by changes in yields and life expectancy. We show that annuitants could have increased their annuity income by about 5%, by shopping around and purchasing their annuities from alternative providers. Money's worth calculations show that the market is efficient by international standards, with a money's worth above 0.9 for the whole period and close to unity by the end of the period. We present conflicting evidence on the existence of adverse selection because although we find money's worths are inversely related to age of purchase, we find that they are positively related to size of purchase.

In this paper, I show that traditional earnings related pay-as-you-go pension systems as we see them in many OECD countries subsidize human capital formation. The reason is that these systems come along with an implicit tax structure that features high tax rates at the beginning of working life and low tax rates toward the end. When the costs of human capital investment are mainly time costs, such an implicit tax structure lowers the costs of human capital investments and simultaneously increases the payoff. The fact that higher skilled workers tend to have steeper wage profiles over the working phase than the unskilled enforces this mechanism. I first show this result in a simple analytical model and then quantify the macroeconomic and welfare effects of making the implicit tax structure age independent in a large-scale overlapping generation model, in which households can invest in human capital both by going to college and through on-the-job training. In terms of welfare, such a reform comes along with a lot of intergenerational redistribution. Although the welfare of current retirees may increase by about 4.5% of their remaining life-time resources, current older workers will lose due to an increase in their implicit tax rates. The welfare of future generations slightly declines by 0.1%.

Hedging against tail events in equity markets has been forcefully advocated in the aftermath of recent global financial crisis. Whether this is beneficial to long horizon investors like employees enrolled in defined contribution (DC) plans, however, has been subject to criticism. We conduct historical simulation since 1928 to examine the effectiveness of active and passive tail risk hedging using out of money put options for hypothetical equity portfolios of DC plan participants with 20 years to retirement. Our findings show that the cost of tail hedging exceeds the benefits for a majority of the plan participants during the sample period. However, for a significant number of simulations, hedging result in superior outcomes relative to an unhedged position. Active tail hedging is more effective when employees confront several panic-driven periods characterized by short and sharp market swings in the equity markets over the investment horizon. Passive hedging, on the other hand, proves beneficial when they encounter an extremely rare event like the Great Depression as equity markets go into deep and prolonged decline.

We analyze a national sample of Americans with respect to their debt literacy, financial experiences, and their judgments about the extent of their indebtedness. Debt literacy is a component of broader financial understanding that measures knowledge about debt and self-assessed financial knowledge. Financial experiences are the participants’ reported experiences with traditional borrowing, alternative borrowing, and investing. Overindebtedness is a self-reported measure. Debt literacy is low, with only about one-third of the population grasping the basics of interest compounding. Even after controlling for demographics, we find a relationship between debt literacy and both financial experiences and debt loads. Individuals with lower levels of debt literacy tend to transact in high-cost manners, incurring higher fees and using high-cost borrowing. We provide a rough estimate of the national implications of debt ignorance on credit card costs by consumers. Less knowledgeable individuals also report that their debt loads are excessive or that they are unable to judge their debt position.

Sponsors of defined contribution plans often hire financial advisors to help them design and monitor their plans. I find that advisors have a significant impact on the menu of investment options of their clients’ plans. Clients of the same advisor tend to hold the same funds and fund families. They also tend to delete and add the same funds. Advisors’ plans are similar to their clients’ plans in that they tend to hold identical funds, use the same fund families, and fund categories. Thus, to a large extent, advisors take their own advice. However, funds that are in clients’ plans but not in their advisors’ plans have higher expense ratios than the funds held by advisors. Since advisors’ compensation is often tied to the expense ratio of their clients’ funds, this pattern is consistent with misaligned incentives on the part of advisors and their clients.

Following the research approach of Hann et al. (2007), this study investigates how discretion in the determination of the defined benefit obligation (DBO) is perceived by investors using a sample of listed German companies in the period of 2005–2011. For this, actuarial assumptions – discount interest rates, compensation growth rate and projected future pension increases – are replaced by their respective industry medians to obtain that component of the DBO, which can be attributed to discretion. We find that the discretionary component is not value relevant in overall terms, which is in contrast to prior research. We provide an explanation in the country-specific characteristics of Germany. Furthermore, we find weak evidence that the discretionary component is incorporated in investor's equity valuations when pension plans are distinctly underfunded.

The financial market assumptions of the Pension Benefit Guaranty Corporation (PBGC)'s Pension Insurance Modeling System model are critical inputs to simulations for most apparent uses of the system. They currently appear to be based on a reduced form, ‘classical’ approach to assessing and forecasting the distribution of returns on various classes of input assets, allowing for a fairly sophisticated and useful approach to understanding simulated distributions of potential pension insurance outcomes as well as the net financial status of the PBGC. This technical note discusses some of the capital market side assumptions utilized in the model. It also comments on important related assumptions including the assumed asset allocations of insured plans, making suggestion for possible modification of input assumptions of the model to reflect time variation in financial market return behavior as well as time variation in observed plan allocations.

We present an intertemporal portfolio choice model where individuals invest in financial literacy, save, allocate their wealth between a safe and a risky asset, and receive a pension when they retire. Financial literacy affects the excess return from and cost of stock-market participation. Investors simultaneously choose how much to save, their portfolio allocation, and the optimal investment in financial literacy. The model implies that one should observe a positive correlation between stock-market participation (and risky asset share, conditional on participation) and financial literacy, and a negative correlation between the generosity of the social security system and financial literacy. The model also implies that financial literacy accumulated early in life is positively correlated with the individual's wealth and portfolio allocations in later life. Using microeconomic cross-country data, we find support for these predictions.

This paper contributes to research on defined contribution (DC) retirement plans by examining how financial knowledge and demographic factors influenced Chile's pension holders' choice between a default life-cycle retirement plan and active management. About one third of Chileans held default funds in 2009; younger people, men, people with lower incomes, and people with low financial knowledge were more likely to choose the default. For active investors, we examined what variables influenced their choice. Nearly three quarters of active investors chose more risky funds that the defaults for their age group. However, risk taking tended to decrease with age and to increase with income, financial knowledge and risk tolerance.

Financial economics holds that payment streams should be valued using discount rates that reflect the cash flows’ risks. In the case of pension liabilities, the appropriate discount rate for a pension fund's liabilities is the expected rate of return on a portfolio that would be held under a liability-driven investment policy. The valuation of defined benefit pension obligations involves choices revolving around deciding: (1) what future benefit payments to recognize today (i.e., which liability concept to use); and (2) from whose point of view to value the liabilities. Moving towards modeling, the distribution of future liabilities using a ‘risk-neutral’ framework, would allow for calculating the present value of the future liabilities more accurately. This would provide policymakers with information more relevant for the decision-making, and it would also permit easier communication of the risks facing the Pension Benefit Guaranty Corporation's PIMS model via a single univariate statistic.

We provide new empirical evidence on the importance of defined contribution pension wealth in England, and the nature of annuitization decisions taken by older adults who retire with such sources of wealth. Other things equal, financial literacy, and numeracy in particular, are important factors governing individuals’ choices over whether to shop around for an annuity as opposed to taking the ‘path of least resistance’ option and purchasing from their original pension fund provider. This has important policy and welfare implications given that buying an annuity on the open market has significant financial benefits for most people. In the context of the increasing reliance on private provision for retirement, the importance of individuals having the financial literacy to successfully navigate complex financial decisions late in life should not be underestimated.

The reform of the pension system of the Mexican Social Security Institute (IMSS) in 1997, limited the growing fiscal cost of the previous pay-as-you-go scheme. Sixteen years on from its creation, the Retirement Savings System (SAR) has had favourable macroeconomic effects for Mexico, as it has significantly increased financial savings and encouraged the development of local financial markets.

However, the employment and pension coverage has not developed as hoped, due to the high rate of informality in the labour market. In addition, the replacement rates (RR) forecast for old-age pensions from the defined-contribution scheme will be low, due to problems exogenous to the pension system, such as low contribution rates and low contribution densities. The main objective of this study is to develop a macroeconomic and actuarial projection model to simulate the expected coverage and RR for the period 2012–2050, within the framework of a demographic and economic forecast that will allow a detailed diagnosis of the current conditions of the pension system. The results reveal the unpromising scenario that the pension system has and will continue to have in the long term, with limited improvements in coverage rates. The possibility of obtaining adequate pensions will be restricted to those who have socioeconomic conditions with a long employment history, who can thus make contributions to their individual accounts.

Taking into account this baseline projection scenario, we simulate the expected effects of applying a set of proposals with the aim of tackling the main problems, such as the low coverage, low RR, and low level of participation by young people in the system.

The expectations of economic agents play a crucial role in almost any inter-temporal economic model. Using 2009–12 panel data for a representative sample of the Dutch population, we analyze consumers’ income and pension expectations. We focus on heterogeneity across socioeconomic groups and associations with how consumers perceive the economic and financial crisis. We find that pension expectations become more pessimistic over the 4 years, in line with pension reforms and the crisis. We find substantial differences across groups that are generally plausible and in line with financial theory.

Considering the substantial systematic longevity risk threatening annuity providers’ solvency, indexing benefits on actual mortality improvements appears to be an efficient risk management tool, as discussed in Denuit et al. (2011) and Richter and Weber (2011). Whereas these papers consider indexing annuity payments, the present work suggests that the length of the deferment period could also be subject to revision, providing longevity-contingent deferred life annuities.

The Pension Benefit Guaranty Corporation (PBGC) insures private sector defined benefit (DB) pension plans, when an employer becomes insolvent and is unable to pay the pension liabilities. In principle, the insurance premiums collected by PBGC should be sufficient to cover potential losses; this would ensure that PBGC could pay the insured benefits of terminated pension plan without additional external funding (e.g., from taxpayers). Therefore, the risk exposure of the PBGC from insuring DB pension plans arises from the probability of the employer insolvencies; and the terminating plans’ funding status (the excess of the value of the insured plan liabilities over the plan assets). Here we explore only the second component, namely the impact of plan underfunding for the operation of the PBGC. When a DB plan is fully funded, the PBGC's risk exposure for an ongoing plan is low even if the plan sponsor becomes insolvent. Thus the questions most pertinent to the PBGC are: what key risk factors can produce underfunding in a DB plan, and how can these risk factors be quantified? We discuss the key risk factors that produce DB pension underfunding, namely, investment risk and liability risk. These are interrelated and must be considered simultaneously in order to quantify the risk exposure of a DB pension plan. We propose that an integrated risk management model (an Integrated Asset/Liability Model) can help better understand DB pension plan funding risk. We also examine the Pension Insurance Modeling System developed by the PBGC in terms of its own use of some of the building blocks of an integrated risk management model.