Understanding Individual Account Guarantees
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 more than 20 countries have 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 system, holding capital market investments in IAs could expose participants 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 reform that includes Individual Accounts. We illustrate that guarantee costs can be important and they can vary significantly with time horizon, investment mix, and guarantee design. The findings indicate that plan designers and budget analysts would do well to recognize such costs and identify how they can be financed.
This MRRC working paper was subsequently published as:
Lachance, Marie-Eve, and Mitchell, Olivia S. “Understanding Individual Account Guarantees.” American Economic Review Papers and Proceedings 93, no.2 (May 2003): 257-260.
Lachance, Marie-Eve; Mitchell, Olivia S.; and Smetters, Kent. “Guaranteeing Defined Contribution Pensions: The Option to Buy Back a Defined Benefit Promise.” Journal of Risk and Insurance 70, no.1 (2003): 1-16.
Lachance, Marie-Eve, and Mitchell, Olivia S. “Guaranteeing Individual Accounts.” In Olivia S. Mitchell & Kent Smetters, eds. The Pension Challenge: Risk Transfers and Retirement Income Security. Oxford, UK: Oxford University Press, (2003):
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- UM02-D2: Guaranteeing Defined Contribution Pensions: the Option to Buy-back a Defined Benefit Promise
Paper IDWP 2003-035