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Intergenerational Effects of Guaranteed Pension Contracts

  • Døskeland, Trond M.

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Nordahl, Helge A.

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

In this paper we show that there exist intergenerational cross-subsidization effects in guaranteed interest rate life and pension contracts as the different generations partially share the same reserves. Early generations build up bonus reserves, which are left with the company at expiry of the contract. These bonus reserves function partly as a subsidy of later generations, such that the latter earn a risk-adjusted return above the risk-free rate. Furthermore, we show that this subsidy may be large enough to explain why late generations buy guaranteed interest rate products, which otherwise would not have been part of the optimal portfolio allocation.

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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2006/13.

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Length: 26 pages
Date of creation: 18 Oct 2006
Date of revision: 21 Jun 2007
Handle: RePEc:hhs:nhhfms:2006_013
Contact details of provider: Postal: NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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  1. Robert Dammon & Chester Spatt & Harold Zhang, . "Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing," GSIA Working Papers 2003-E44, Carnegie Mellon University, Tepper School of Business.
  2. Francisco Gomes & Alexander Michaelides, 2005. "Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence," Journal of Finance, American Finance Association, vol. 60(2), pages 869-904, 04.
  3. Døskeland, Trond M. & Nordahl, Helge A., 2008. "Optimal pension insurance design," Journal of Banking & Finance, Elsevier, vol. 32(3), pages 382-392, March.
  4. Grosen, Anders & Lochte Jorgensen, Peter, 2000. "Fair valuation of life insurance liabilities: The impact of interest rate guarantees, surrender options, and bonus policies," Insurance: Mathematics and Economics, Elsevier, vol. 26(1), pages 37-57, February.
  5. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  6. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  7. Rui Yao, 2005. "Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 197-239.
  8. Bjarne Astrup Jensen & Carsten Sørensen, 2001. "Paying for Minimum Interest Rate Guarantees: Who Should Compensate Who?," European Financial Management, European Financial Management Association, vol. 7(2), pages 183-211.
  9. Michael J. Brennan, 1993. "Aspects of Insurance, Intermediation and Finance*," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 18(1), pages 7-30, June.
  10. Consiglio, Andrea & Saunders, David & Zenios, Stavros A., 2006. "Asset and liability management for insurance products with minimum guarantees: The UK case," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 645-667, February.
  11. Joao F. Cocco, 2005. "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 491-533.
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