Advanced Search
MyIDEAS: Login

A Lifecycle Analysis of Defined Benefit Pension Plans

Contents:

Author Info

  • David McCarthy

    (Oxford University)

Registered author(s):

    Abstract

    This paper employs a lifecycle model from the consumption-savings literature to examine the tradeoffs between defined benefit and defined contribution pension plans. We examine the effects of varying risk aversion, varying initial income and financial wealth, and varying wage processes (that may be correlated with returns on the risky asset). Results indicate that wage-indexed claims are not an optimal vehicle for retirement policy if the decision to participate is made early in life, because individuals hold most of their wealth in their human capital and would not wish to increase their exposure to income shocks. Later in life, after most of a worker’s human capital has been converted to financial assets, defined benefit pension plans help increase diversification by reducing exposure to financial market risk. The access that defined benefit plans provide to annuities markets and possible guaranteed rates of return over the risk-free rate increase the value of defined benefit plans to workers. The model also predicts that wage-indexed claims will be more valuable when equity markets provide low expected returns or are highly variable and when annuity markets are inefficient. The model illustrates two economic functions performed by defined benefit plans. Firstly, DB plans pool individual wage risks. This allows older workers to buy a wagelinked security that increases their exposure to wage risks. Secondly, they create a group annuities market that reduces the cost of adverse selection.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.mrrc.isr.umich.edu/publications/Papers/pdf/wp053.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by University of Michigan, Michigan Retirement Research Center in its series Working Papers with number wp053.

    as in new window
    Length: 46 pages
    Date of creation: Feb 2003
    Date of revision:
    Handle: RePEc:mrr:papers:wp053

    Contact details of provider:
    Postal: P.O. Box 1248, Ann Arbor, MI 48104
    Phone: (734) 615-0422
    Fax: (734) 647-4575
    Email:
    Web page: http://www.mrrc.isr.umich.edu/publications/papers/
    More information through EDIRC

    Related research

    Keywords:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Stuart Dorsey & Christopher Cornwell & David Macpherson, 1998. "Pensions and Productivity," Books from Upjohn Press, W.E. Upjohn Institute for Employment Research, number pp.
    2. Laurence J. Kotlikoff & David A. Wise, 1987. "Labor Compensation and the Structure of Private Pension Plans: Evidence for Contractual Versus Spot Labor Markets," NBER Working Papers 1290, National Bureau of Economic Research, Inc.
    3. Christopher D. Carroll & Miles S. Kimball, 1995. "On the Concavity of the Consumption Function," Macroeconomics 9503003, EconWPA.
    4. John Y. Campbell & Luis M. Viceira, 1998. "Consumption and Portfolio Decisions When Expected Returns Are Time Varying," Harvard Institute of Economic Research Working Papers 1835, Harvard - Institute of Economic Research.
    5. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-48, September.
    6. Edward P. Lazear, 1982. "Severance Pay, Pensions, and Efficient Mobility," NBER Working Papers 0854, National Bureau of Economic Research, Inc.
    7. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
    8. Zvi Bodie & Alan J. Marcus & Robert C. Merton, 1985. "Defined Benefit versus Defined Contribution Pension Plans: What are the Real Tradeoffs?," NBER Working Papers 1719, National Bureau of Economic Research, Inc.
    9. Christopher D. Carroll & Andrew A. Samwick, 1998. "How Important Is Precautionary Saving?," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 410-419, August.
    10. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
    11. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
    12. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-84, December.
    13. Zvi Bodie & Robert C. Merton & William F. Samuelson, 1992. "Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model," NBER Working Papers 3954, National Bureau of Economic Research, Inc.
    14. Olivia Mitchell, 1999. "New Trends in Pension Benefit and Retirement Provisions," NBER Working Papers 7381, National Bureau of Economic Research, Inc.
    15. Zeldes, Stephen P, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 275-98, May.
    16. Heaton, John & Lucas, Deborah, 2000. "Portfolio Choice in the Presence of Background Risk," Economic Journal, Royal Economic Society, vol. 110(460), pages 1-26, January.
    17. Chris Carroll & Wendy Dunn, 1997. "Unemployment Expectations, Jumping (S,s) Triggers, and Household Balance Sheets," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 165-230 National Bureau of Economic Research, Inc.
    18. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
    19. Pemberton, James, 1997. "Modelling and measuring income uncertainty in life cycle models," Economic Modelling, Elsevier, vol. 14(1), pages 81-98, January.
    20. Glenn R. Hubbard & Jonathan Skinner & Stephen P. Zeldes, . "Precautionary Saving and Social Insurance," Rodney L. White Center for Financial Research Working Papers 3-95, Wharton School Rodney L. White Center for Financial Research.
    21. James E. Pesando, 1985. "The Usefulness of the Wind-Up Measure of Pension Liabilities: A LabourMarket Perspective," NBER Working Papers 1559, National Bureau of Economic Research, Inc.
    22. Christopher D. Carroll, 1996. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," NBER Working Papers 5788, National Bureau of Economic Research, Inc.
    23. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
    24. Steven G. Allen & Robert L. Clark & Ann A. McDermed, 1991. "Pensions, Bonding, and Lifetime Jobs," NBER Working Papers 3688, National Bureau of Economic Research, Inc.
    25. Alan L. Gustman & Olivia S. Mitchell & Thomas L. Steinmeier, 1993. "The Role of Pensions in the Labor Market," NBER Working Papers 4295, National Bureau of Economic Research, Inc.
    26. Alan L. Gustman & Thomas L. Steinmeier & Olivia Mitchell, 1994. "The role of pensions in the labor market: A survey of the literature," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 47(3), pages 417-438, April.
    27. Jeremy I. Bulow & Myron S. Scholes, 1982. "Who Owns the Assets in a Defined Benefit Pension Plan," NBER Working Papers 0924, National Bureau of Economic Research, Inc.
    28. Marianne Baxter, 2001. "Social Security as a Financial Asset: Gender-Specific Risks and Returns," NBER Working Papers 8329, National Bureau of Economic Research, Inc.
    29. Gustman, Alan L. & Steinmeier, Thomas L., 2001. "How effective is redistribution under the social security benefit formula?," Journal of Public Economics, Elsevier, vol. 82(1), pages 1-28, October.
    30. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series 95-42, Board of Governors of the Federal Reserve System (U.S.).
    31. Ippolito, Richard A, 1985. "The Labor Contract and True Economic Pension Liabilities," American Economic Review, American Economic Association, vol. 75(5), pages 1031-43, December.
    32. Alan L. Gustman & Thomas L. Steinmeier, 1995. "Pension Incentives and Job Mobility," Books from Upjohn Press, W.E. Upjohn Institute for Employment Research, number pijm.
    33. Steven G. Allen & Robert L. Clark & Ann A. McDermed, 1993. "Pensions, Bonding, and Lifetime Jobs," Journal of Human Resources, University of Wisconsin Press, vol. 28(3), pages 463-481.
    34. Jeremy I. Bulow, 1985. "The Relationship between Wages and Benefits," NBER Chapters, in: Pensions, Labor, and Individual Choice, pages 379-398 National Bureau of Economic Research, Inc.
    35. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    36. Heaton, John & Lucas, Deborah, 1997. "Market Frictions, Savings Behavior, And Portfolio Choice," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 76-101, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:mrr:papers:wp053. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (MRRC Administrator).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.