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Pension Plan Integration As Insurance Against Social Security Risk

In: Issues in Pension Economics

Author

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  • Robert C. Merton
  • Zvi Bodie
  • Alan Marcus

Abstract

The manifest purposes of integrating an employer-provided pension plan with social security are:(1) to ensure retirement income adequacy for all covered employees; and (2) to ensure retirement income equity, defined as equal total replacement rates for all employees regardless of salary level. The focus of this paper, however, is on an equally important (and perhaps latent) consequence of integration: the alteration of the risk-bearing relationships between employees, employers and the government vis-a-vis social security benefits. The main alteration is that the employer in effect insures his covered employees against adverse changes in their social security retirement benefit. Using the option-pricing methodology of modern contingent claims analysis,we develop a formal model to explore the quantitative aspects of this change.While the focus of the analysis is on full integration, we do explicitly deal with various degrees of partial integration as is currently practiced. We also analyze the effects of a switch from a non-integrated to an equivalent-cost integrated plan when private benefits are fixed in nominal terms and when they are indexed. In this connection we examine how integrated plans are affected when the sponsor makes ad hoc post-retirement benefit increases. We also consider the incentive effects on worker mobility of the adoption of integrated plans. The analysis is also used to highlight what we believe to be important unintended consequences of integrating pension plans with social security.
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Suggested Citation

  • Robert C. Merton & Zvi Bodie & Alan Marcus, 1987. "Pension Plan Integration As Insurance Against Social Security Risk," NBER Chapters,in: Issues in Pension Economics, pages 147-172 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:6857
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    References listed on IDEAS

    as
    1. Merton, Robert C & Scholes, Myron S & Gladstein, Mathew L, 1982. "The Returns and Risks of Alternative Put-Option Portfolio Investment Strategies," The Journal of Business, University of Chicago Press, vol. 55(1), pages 1-55, January.
    2. Lawrence H. Summers, 1983. "Observations on the Indexation of Old Age Pensions," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 231-258 National Bureau of Economic Research, Inc.
    3. Jeremy I. Bulow, 1982. "The Effect of Inflation on the Private Pension System," NBER Chapters,in: Inflation: Causes and Effects, pages 123-138 National Bureau of Economic Research, Inc.
    4. Zvi Bodie & James E. Pesando, 1983. "Retirement Annuity Design in an Inflationary Climate," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 291-324 National Bureau of Economic Research, Inc.
    5. Peter A. Diamond & James Mirrlees, 1985. "Insurance Aspects of Pensions," NBER Chapters,in: Pensions, Labor, and Individual Choice, pages 317-356 National Bureau of Economic Research, Inc.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    7. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, vol. 33(2), pages 603-616, May.
    8. Fischer, Stanley, 1978. "Call Option Pricing when the Exercise Price Is Uncertain, and the Valuation of Index Bonds," Journal of Finance, American Finance Association, vol. 33(1), pages 169-176, March.
    9. Modigliani, Franco. & Cohn, Richard A., 1984. "Inflation and corporate financial management," Working papers 1572-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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    Citations

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    Cited by:

    1. Giuseppe Grande & Ignazio Visco, 2010. "A public guarantee of a minimum return to defined contribution pension scheme members," Temi di discussione (Economic working papers) 762, Bank of Italy, Economic Research and International Relations Area.
    2. repec:kap:iaecre:v:23:y:2017:i:2:d:10.1007_s11294-017-9636-x is not listed on IDEAS
    3. Zvi Bodie & Alan J. Marcus & Robert C. Merton, 1988. "Defined Benefit versus Defined Contribution Pension Plans: What are the Real Trade-offs?," NBER Chapters,in: Pensions in the U.S. Economy, pages 139-162 National Bureau of Economic Research, Inc.
    4. R. Glenn Hubbard, 1984. "'Precautionary' Saving Revisited: Social Security, Individual Welfare, and the Capital Stock," NBER Working Papers 1430, National Bureau of Economic Research, Inc.
    5. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
    6. Rodrigue Mendez & Lionel Ragot, 2010. "Quel avenir pour le Fonds de réserve pour les retraites ?," Economie & Prévision, La Documentation Française, vol. 0(3), pages 57-78.
    7. 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.
    8. Peter A. Diamond & James Mirrlees, 1985. "Insurance Aspects of Pensions," NBER Chapters,in: Pensions, Labor, and Individual Choice, pages 317-356 National Bureau of Economic Research, Inc.
    9. Dutta, Jayasri & Kapur, Sandeep & Orszag, J. Michael, 2000. "A portfolio approach to the optimal funding of pensions," Economics Letters, Elsevier, vol. 69(2), pages 201-206, November.
    10. Olivia S. Mitchell, "undated". "Developments in Pensions," Pension Research Council Working Papers 98-4, Wharton School Pension Research Council, University of Pennsylvania.
    11. Bender, Keith A., 2009. "How are pension integration and pension benefits related?," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(1), pages 26-41, February.

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