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The Demand for Guarantees in Social Security Personal Retirement Accounts

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  • Olivia S. Mitchell

    (The Wharton School of the University of Pennsylvania)

  • Alexander Muermann

    (The Wharton School of the University of Pennsylvania)

Abstract

This project evaluates how workers might invest their Personal Retirement Account (PRA) funds between safe and risky assets, depending on whether they are offered a rate of return guarantee on the risky asset. We focus on how asset allocation decisions might differ depending on participants’ attitudes about risk and regret. If, for example, the return on the risky asset turns out to be very high when a worker retires, he might regret not having allocated a large enough portion of his contributions to the risky asset. On the contrary, if the stock market does poorly, the retiree might regret having invested at all in that asset. We show that anticipated disutility from regret can have a potent effect on investment choices in a PRA. If there is no guarantee, regret induces investors to move away from extreme decisions: that is, investors who take regret into account hold less stock if the risk premium is high, but more stocks if the risk premium is low. Further, a rate of return guarantee provided at no cost to the plan participant induces him to hold more stocks, with or without regret. We also show that, with or without regret, investors' willingness to pay for a guarantee rises with the level of the guaranteed return. This research could be informative regarding the potential profitability of the guaranteed pension business, which would help determine whether a government subsidy would be required to bring these products to market.

Suggested Citation

  • Olivia S. Mitchell & Alexander Muermann, 2003. "The Demand for Guarantees in Social Security Personal Retirement Accounts," Working Papers wp060, University of Michigan, Michigan Retirement Research Center.
    • Handle: RePEc:mrr:papers:wp060
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    References listed on IDEAS

    as
    1. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324, Elsevier.
    2. Martin Feldstein & Elena Ranguelova, 2001. "Accumulated Pension Collars: A Market Approach to Reducing the Risk of Investment-Based Social Security Reform," NBER Chapters, in: Tax Policy and the Economy, Volume 15, pages 149-166, National Bureau of Economic Research, Inc.
    3. John F. Cogan & Olivia S. Mitchell, 2002. "The Role of Economic Policy in Social Security Reform: Perspectives from the President's Commission," NBER Working Papers 9166, National Bureau of Economic Research, Inc.
    4. Marie-Eve Lachance & Olivia S. Mitchell, 2003. "Guaranteeing Individual Accounts," American Economic Review, American Economic Association, vol. 93(2), pages 257-260, May.
    5. Smetters, Kent, 2002. "Controlling the cost of minimum benefit guarantees in public pension conversions," Journal of Pension Economics and Finance, Cambridge University Press, vol. 1(1), pages 9-33, March.
    6. Martin Feldstein, 2009. "Reducing the Risk of Investment-Based Social Security Reform," NBER Chapters, in: Social Security Policy in a Changing Environment, pages 201-218, National Bureau of Economic Research, Inc.
    7. Julie Agnew & Pierluigi Balduzzi & Annika Sundén, 2003. "Portfolio Choice and Trading in a Large 401(k) Plan," American Economic Review, American Economic Association, vol. 93(1), pages 193-215, March.
    8. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249, December.
    9. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
    10. Maurer, Raimond H. & Schlag, Christian, 2002. "Money-back guarantees in individual pension accounts: Evidence from the German pension reform," CFS Working Paper Series 2002/03, Center for Financial Studies (CFS).
    11. Marie‐Eve Lachance & Olivia S. Mitchell & Kent Smetters, 2003. "Guaranteeing Defined Contribution Pensions: The Option to Buy Back a Defined Benefit Promise," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(1), pages 1-16, March.
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