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Understanding Individual Account Guarantees

Author

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  • Marie-Eve Lachance
  • Olivia S. Mitchell
Abstract
Demographic aging renders workers vulnerable to the inherent uncertainty of unfunded social security systems. This realization has set off a global wave of social security reforms, and numerous countries have now set up Individual Accounts (IA) plans in response. Strengths of IAs are that participants gain ownership in their accounts, and they also may diversify their pension investments; additionally, they produce a capitalized, funded system that enhances old-age economic security. While IAs reduce the risk participants face due to unfunded social security systems, participants holding capital market investments in IAs are exposed to fluctuations in the value of their pension assets. Concern over market volatility has prompted some to emphasize the need for guarantees' of pension accumulations. This paper offers a way to think about guarantees in the context of a social security reform that includes Individual Accounts. When a pension guarantee has economic value to participants, it will have economic costs. We illustrate how these costs can be important and vary significantly with time horizon, investment mix, and guarantee design. Our findings indicate that plan designers and budget analysts would do well to recognize such costs and identify how they can be financed.

Suggested Citation

  • Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:9195
    Note: AG PE
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    References listed on IDEAS

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    1. Martin Feldstein & Andrew Samwick, 2002. "Potential Paths of Social Security Reform," NBER Chapters, in: Tax Policy and the Economy, Volume 16, pages 181-224, National Bureau of Economic Research, Inc.
    2. Robert L. Clark & Olivia S. Mitchell, 2002. "Strengthening Employment-Based Pensions in Japan," NBER Working Papers 8891, National Bureau of Economic Research, Inc.
    3. Bodie, Zvi & Shoven, John B. & Wise, David A. (ed.), 1987. "Issues in Pension Economics," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226062846, August.
    4. 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.
    5. 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.
    6. Kent Smetters, 2001. "The Effect of Pay-When-Needed Benefit Guarantees on the Impact of Social Security Privatization," NBER Chapters, in: Risk Aspects of Investment-Based Social Security Reform, pages 91-112, National Bureau of Economic Research, Inc.
    7. 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.
    8. Zvi Bodie, 2001. "Financial Engineering and Social Security Reform," NBER Chapters, in: Risk Aspects of Investment-Based Social Security Reform, pages 291-320, National Bureau of Economic Research, Inc.
    9. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, June.
    10. Jensen, Bjarne Astrup & Sørensen, Carsten, 2000. "Paying for minimum interest rate guarantees: Who should compensate who?," Working Papers 2000-1, Copenhagen Business School, Department of Finance.
    11. 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.
    12. 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.
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    Cited by:

    1. Ishay Wolf, 2022. "Studying the equilibrium of pension designs when shifting to funded pension schemes: economic theory and links to political factors," SN Business & Economics, Springer, vol. 2(7), pages 1-21, July.
    2. Olivia S. Mitchell, 2018. "Enhancing risk management for an aging world," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 43(2), pages 115-136, September.
    3. World Bank, 2003. "The Pension System in Iran : Challenges and Opportunities, Volume 1. Main Report," World Bank Publications - Reports 14645, The World Bank Group.
    4. Daliana Luca & Hato Schmeiser & Florian Schreiber, 2023. "Investment guarantees in financial products: an analysis of consumer preferences," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 48(4), pages 906-940, October.
    5. Kaschützke, B. & Maurer, R., 2016. "Investing and Portfolio Allocation for Retirement," Handbook of the Economics of Population Aging, in: Piggott, John & Woodland, Alan (ed.), Handbook of the Economics of Population Aging, edition 1, volume 1, chapter 0, pages 567-608, Elsevier.
    6. Muermann, Alexander & Mitchell, Olivia S. & Volkman, Jacqueline M., 2006. "Regret, portfolio choice, and guarantees in defined contribution schemes," Insurance: Mathematics and Economics, Elsevier, vol. 39(2), pages 219-229, October.
    7. Börsch-Supan, Axel & Bucher-Koenen, Tabea & Goll, Nicolas & Maier, Christina, 2016. "15 Jahre Riester - eine Bilanz," Working Papers 12/2016, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung.
    8. Sule Sahin & Adem Yavuz Elveren, 2009. "A Cost Analysis of a Minimum Pension Guarantee for the Individual Pension System in Turkey," Working Paper Series, Department of Economics, University of Utah 2009_13, University of Utah, Department of Economics.
    9. 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.
    10. Alexander Kling & Jochen Russ & Hato Schmeiser, 2006. "Analysis of embedded options in individual pension schemes in Germany," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 31(1), pages 43-60, July.
    11. Marie-Eve Lachance & Olivia S. Mitchell, 2003. "Guaranteeing Individual Accounts," American Economic Review, American Economic Association, vol. 93(2), pages 257-260, May.

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    More about this item

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • H4 - Public Economics - - Publicly Provided Goods

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