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This paper investigates whether exchanging the Social Security delayed retirement credit, currently paid as an increase in lifetime annuity benefits, for a lump sum would induce later claiming and additional work. We show that people would voluntarily claim about half a year later if the lump sum were paid for claiming any time after the Early Retirement Age, and about two-thirds of a year later if the lump sum were paid only for those claiming after their Full Retirement Age. Overall, people will work one-third to one-half of the additional months, compared to the status quo. Those who would currently claim at the youngest ages are likely to be most responsive to the offer of a lump sum benefit.
This paper examines heterogeneity in time discounting among a representative sample of elderly Americans, as well as its role in explaining key economic behaviors at older ages. We show how older Americans evaluate simple (hypothetical) inter-temporal choices in which payments today are compared with payments in the future. Using the indicators derived from this measure, we then demonstrate that differences in discounting patterns are associated with characteristics of particular importance in elderly populations. For example, cognitive deficits are associated with greater impatience, whereas bequest motives are associated with less impatience. We then relate our discounting measure to key economic outcomes and find that impatience is associated with lower wealth, fewer investments in health, and less planning for end of life care.
Public employee pension systems throughout the developed world have traditionally been of the pay-as-you-go (PAYGO) defined benefit (DB) variety, where pensioner payments are financed by taxes (contributions) levied on the working generation. But as the number of retirees rises relative to the working-age group, such systems have begun to face financial distress. This trend has been exacerbated in many countries, among them Germany, by high unemployment rates producing further deterioration of the contribution base. In the long run, public sector pension benefits will have to be cut or contributions increased, if the systems are to be maintained. An alternative path sometimes offered to ease the crunch of paying for public employee pensions is to move toward funding: here, plan assets are gradually built up, invested, and enhanced returns devoted to partly defray civil servants’ pension costs. In this study, we evaluate the impact of introducing partial prefunding, paired with a strategic investment policy for the German federal state of Hesse. The analysis assesses the impact of introducing a supplementary tax-sponsored pension fund whose contributions are invested in the capital market and used to relieve the state budget from (some) pension payments. Our model determines the expectation and the Conditional Value-at-Risk of economic pension costs using a stochastic simulation process for pension plan assets. This approach simultaneously determines the optimal contribution rate and asset allocation that controls the expected economic costs of providing the promised pensions, while at the same time controlling investment risk. Specifically, we offer answers to the following questions: 1. How can the plan be designed to control cash-flow shortfall risk, so as to mitigate the potential burden borne by future generations of taxpayers? 2. What is the optimal asset allocation for this fund as it is built up, to generate a maximum return while simultaneously restricting capital market and liability risk? 3. What are reasonable combinations of annual contribution rates and asset allocation to a state-managed pension fund, which will limit costs of providing promised public sector pensions? We anticipate that this research will interest several sorts of policymaker groups. First, focusing on the German case, the state and Federal governments should find it relevant, as these entities face considerable public sector pension liabilities. Second, our findings will also be of interest to other European countries, as most have substantial underfunded defined benefit plans for civil servants. In what follows, we first offer a brief description of the structure of civil servant pensions in Germany, focusing on their benefit formulas, their financing, and the resulting current as well as future plan obligations for taxpayers. Next, we turn to an analysis of the actuarial status of the Hesse civil servants’ pension plan and evaluate how much would have to be contributed to fund this plan in a nonstochastic context. Subsequently we evaluate the asset-liability and decision-making process from the viewpoint of the plan sponsor, to determine sensible plan asset allocation behavior. A final section summarizes findings and implications.
The paper discusses an additional reform proposal for enhancing Social Security solvency which reframes the existing debate in a different light. In our research, we focus on incentives to prolong working years and to delay benefits claiming as a way of sustaining Social Security. Specifically, we analyze how the offer of a budget-neutral, actuarially fair lump sum payment - instead of the current delayed retirement credit – would encourage people to delay claiming their OASI benefits and work longer. The results of our research will be useful for policymakers, namely in (1) measuring who would delay claiming benefits if offered a lump sum instead of higher annuity payments, (2) examining how long they would wait, and (3) how much longer, if at all, they would continue working in the interim.
Shares of open-end real estate funds are typically traded directly between the investor and the fund management company. However, we provide empirical evidence for the growth of secondary market activities, i.e., the trading of shares on stock exchanges. We find high trading levels in situations where the fund management company suspends the issue or redemption of shares. Shares trade at a discount when the fund management company suspends the redemption, whereas shares trade at a premium when the fund management company suspends the issue. We also find evidence that secondary market trading activity is increasing since German regulation introduced a minimum holding period and a mandatory notice period for open-end real estate funds.
Open-end real estate funds (so called “Offene Immobilienfonds”) play a major role in the German market for securitised real estate investments. Such funds are pools of money from many investors, which are invested in real estate by special investment management companies. This study seeks to identify the risk and return profile of this investment vehicle (before and after income taxes), to compare them with those of other major asset classes, and to provide implications for their appropriate role in a mixed-asset portfolio. Addition-ally, an overview of the institutional architecture and role of German open-end real estate funds is given. Empirical evidence suggests that the financial characteristics of open-end real estate funds are in many respects similar to those reported for direct real estate invest-ments. Accordingly, German open-end real estate funds qualify for medium and long-term investment horizons, rather than for shorter holding periods.
The US Treasury recently permitted deferred longevity income annuities to be included in pension plan menus as a default payout solution, yet little research has investigated whether more people should convert some of the $18 trillion they hold in employer-based defined contribution plans into lifelong income streams. We investigate this innovation using a calibrated lifecycle consumption and portfolio choice model embodying realistic institutional considerations. Our welfare analysis shows that defaulting a modest portion of retirees’ 401(k) assets (over a threshold) is an attractive way to enhance retirement security, enhancing welfare by up to 20% of retiree plan accruals.
A recent US Treasury regulation allowed deferred longevity income annuities to be included in pension plan menus as a default payout solution, yet little research has investigated whether more people should convert some of the $15 trillion they hold in employer-based defined contribution plans into lifelong income streams. We investigate this innovation using a calibrated lifecycle consumption and portfolio choice model embodying realistic institutional considerations. Our welfare analysis shows that defaulting a small portion of retirees’ 401(k) assets (over a threshold) is an attractive way to enhance retirement security, enhancing welfare by up to 20% of retiree plan accruals.
Most defined contribution pension plans pay benefits as lump sums, yet the US Treasury has recently encouraged firms to protect retirees from outliving their assets by converting a portion of their plan balances into longevity income annuities (LIA). These are deferred annuities which initiate payouts not later than age 85 and continue for life, and they provide an effective way to hedge systematic (individual) longevity risk for a relatively low price. Using a life cycle portfolio framework, we measure the welfare improvements from including LIAs in the menu of plan payout choices, accounting for mortality heterogeneity by education and sex. We find that introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA. We also compare the optimal LIA allocation versus two default options that plan sponsors could implement. We conclude that an approach where a fixed fraction over a dollar threshold is invested in LIAs will be preferred by most to the status quo, while enhancing welfare for the majority of workers.
The tax codes in many countries allow for special tax advantages for investments in special retirement plans. Probably the most important advantage to these plans is that profits usually remain untaxed. This paper deals with the question, which assets are preferable in a taxdeferred account (TDA). Contrary to the conventional wisdom that one should prefer bonds in the TDA, it is shown that especially in early years, stocks can be the preferred asset to hold in the TDA for an investor maximizing final wealth, given a certain asset allocation. The higher the performance of stocks compared to bonds, the higher the tax burden put on stocks compared to bonds. Simultaneously, the longer the remaining investment horizon, the larger the relative outperformance of the optimal asset location strategy compared to the myopic strategy of locating bonds in the TDA. An algorithm is provided to determine the investment strategy that maximizes (expected) funds at the end of a given investment horizon when there is an analytical solution.
Portfolio choice and estimation risk : a comparison of Bayesian approaches to resampled efficiency
(2002)
Estimation risk is known to have a huge impact on mean/variance (MV) optimized portfolios, which is one of the primary reasons to make standard Markowitz optimization unfeasible in practice. Several approaches to incorporate estimation risk into portfolio selection are suggested in the earlier literature. These papers regularly discuss heuristic approaches (e.g., placing restrictions on portfolio weights) and Bayesian estimators. Among the Bayesian class of estimators, we will focus in this paper on the Bayes/Stein estimator developed by Jorion (1985, 1986), which is probably the most popular estimator. We will show that optimal portfolios based on the Bayes/Stein estimator correspond to portfolios on the original mean-variance efficient frontier with a higher risk aversion. We quantify this increase in risk aversion. Furthermore, we review a relatively new approach introduced by Michaud (1998), resampling efficiency. Michaud argues that the limitations of MV efficiency in practice generally derive from a lack of statistical understanding of MV optimization. He advocates a statistical view of MV optimization that leads to new procedures that can reduce estimation risk. Resampling efficiency has been contrasted to standard Markowitz portfolios until now, but not to other approaches which explicitly incorporate estimation risk. This paper attempts to fill this gap. Optimal portfolios based on the Bayes/Stein estimator and resampling efficiency are compared in an empirical out-of-sample study in terms of their Sharpe ratio and in terms of stochastic dominance.
Many Americans claim Social Security benefits early, though this leaves them with lower benefits throughout retirement. We build a lifecycle model that closely tracks claiming patterns under current rules, and we use it to predict claiming delays if, by delaying benefits, people received a lump sum instead of an annuity. We predict that current early claimers would defer claiming by a year given actuarially fair lump sums, and the predictions conform with respondents’ answers to a strategic survey about the lump sum. In other words, such a reform could provide an avenue for encouraging delayed retirement without benefit cuts or tax increases. Moreover, many people would still defer claiming even for smaller lump sums.
People who delay claiming Social Security receive higher lifelong benefits upon retirement. We survey individuals on their willingness to delay claiming later, if they could receive a lump sum in lieu of a higher annuity payment. Using a moment-matching approach, we calibrate a lifecycle model tracking observed claiming patterns under current rules and predict optimal claiming outcomes under the lump sum approach. Our model correctly predicts that early claimers under current rules would delay claiming most when offered actuarially fair lump sums, and for lump sums worth 87% as much, claiming ages would still be higher than at present.
We compute the optimal dynamic asset allocation policy for a retiree with Epstein-Zin utility. The retiree can decide how much he consumes and how much he invests in stocks, bonds, and annuities. Pricing the annuities we account for asymmetric mortality beliefs and administration expenses. We show that the retiree does not purchase annuities only once but rather several times during retirement (gradual annuitization). We analyze the case in which the retiree is restricted to buy annuities only once and has to perform a (complete or partial) switching strategy. This restriction reduces both the utility and the demand for annuities.
We have designed and implemented an experimental module in the 2014 Health and Retirement Study to measure older persons' willingness to defer claiming of Social Security benefits. Under the current system’ status quo where delaying claiming boosts eventual benefits, we show that 46% of the respondents would delay claiming and work longer. If respondents were instead offered an actuarially fair lump sum payment instead of higher lifelong benefits, about 56% indicate they would delay claiming. Without a work requirement, the average amount needed to induce delayed claiming is only $60,400, while when part-time work is stipulated, the amount is slightly higher, $66,700. This small difference implies a low utility value of leisure foregone, of under 20% of average household income.
We designed and fielded an experimental module in the 2014 HRS which seeks to measure older persons’ willingness to voluntarily defer claiming of Social Security benefits. In addition we evaluate the stated willingness of older individuals to work longer, depending on the Social Security incentives offered to delay claiming their benefits. Our project extends previous work by analyzing the results from our HRS module and comparing findings from other data sources, which included very much smaller samples of older persons. We show that half of the respondents would delay claiming if no work requirement were in place under the status quo, and only slightly fewer, 46 percent, with a work requirement. We also asked respondents how large a lump sum they would need with or without a work requirement. In the former case, the average amount needed to induce delayed claiming was about $60,400, while when part-time work was required, the average was $66,700. This implies a low utility value of leisure foregone of only $6,300, or about 10 percent of older households’ income.
In this paper we study the benefits derived from international diversification of stock portfolios from German and Hungarian point of view. In contrast to the German capital market, which is one of the largest in the world, the Hungarian Stock Exchange is an emerging market. The Hungarian stock market is highly volatile, high returns are often accompanied by extremely large risk. Therefore, there is a good potential for Hungarian investors to realize substantial benefits in terms of risk reduction by creating multi-currency portfolios. The paper gives evidence on the above me ntioned benefits for both countries by examining the performance of several ex ante portfolio strategies. In order to control the currency risk, different types of hedging approaches are implemented.
The present paper seeks to study the possible diversification potential by the integration of indirect real estate investments in international portfolios. To this end, monthly index-return time-series in the time-period from January 1985 till December 1998 from real estate investment companies as well as common stocks and bonds in Germany, France, Switzerland, Great Britain and the USA were used. We utilize, due to the critical normal distribution assumption, a mean/lower-partial-moment framework. In order to take into account the influence of the currency risk for international investments the analyses have been undertaken both with as well as without hedging the currency risk. We take the viewpoint of a German as well as that of a US-investor to gain insight into the dependency of the diversification potential on the reference currency of the investor.
In this paper we have developed a financial model of the non-life insurer to provide assistance for the management of the insurance company in making decisions on product, investment and reinsurance mix. The model is based on portfolio theory and recognizes the stochastic nature of and the interaction between the underwriting and investment income of the insurance business. In the context of an empirical application we illustrate howa portfolio optimisation approach can be used for asset-liability management.
The focus of this article is the analysis of the inflation risk of European real estate securities. Following both a causal and a final understanding of risk, the analysis is twofold. First, to examine the causal influence of inflation on short- and long-term asset returns, different regression approaches are employed based on the methodology of Fama and Schwert (1977). Hedging capacities against expected inflation are found only for German open-end funds. Secondly, different shortfall risk measures are used to study whether an investment in European real estate securities protects against a negative real return at the end of a given investment period.