Adequacy of Saving for Old-Age in Europe

Discussion by Michael Hurd

Topic most developed in U.S.

• Data

• But more interesting topic in U.S. because of greater dependence on savings and private pensions

• If public pension is sole source of financing, debate is whether pensions are large enough.

Popular press and some research

• “Baby-boomers headed for poverty in retirement!”

• “60% not adequately prepared!”

• “Need $2M in retirement assets!”

• Etc.

Yet..

• Current retired doing fine

• Cohort studies show improvements (or at least not getting worse)

• Age 51-56 in 1992

• Age 51-56 in 2004 at least as well off as measured by saving plus pension wealth

What is going on?

How to think about problem?

Two persons with different lifetime earnings

Should have different levels of economic resources in retirement...which one “more adequate”

Comparison requires comparing economic resources with lifetime earnings for each person

Most common comparison

Income replacement rate

Income at retirement relative to income before retirement

Simple case• r = 0• annuitization so that consumption = income after

retirement

earnings

annuity

consumption

replacement rate = A/E (70%)

A

E

6520 85Age

Slightly more complex case

Increasing income with age

earnings

annuity

consumption

replacement rate = A/E (60%)

A

E

Better comparison

Average lifetime earnings rather than final earnings

Already more difficult...data requirements, interest rate assumptions etc

But what about changes in household composition?

Ann born

Aunt Tilly visits

replacement rate = A/E (35%)

This household will want to allocate fewer resources to retirement

phase

• Will want lower replacement rate whether measured with respect to final income or life-time income

• Thus in relatively simple situation, no universal replacement rate

Another situation

• No pensions

• Only savings

• Income in retirement is small...interest on wealth

• Clear: income replacement rate makes no sense

Actual situation

• Mix between pension and savings– Varies across people and across countries

• Solution in literature: annuitize savings– But people don’t annuitize– Not an accurate description of saving

adequacy

Other issues

• the differing role of taxes for households at different points in the income distribution;

• work-related expenses;

• the time horizon or survival curve of the household;

• returns to scale in consumption: reduced spending once one of the partners dies;

• the changing consumption profile with age;

• Differential mortality

Survival curves for men

0

20

40

60

80

100

120

62 72 82 92 102

sngl. E=1

sngl. E=2

sngl. E=3

sngl. E=4

mrd. E=1

mrd. E=2

mrd. E=3

mrd. E=4Single. Less than high school education

Married. College graduate

Those with fewer resources need fewer resources

One additional problem

• Different uncertainties after retirement

• Insurance incomplete and varies from person to person and across countries

All these problems remain when savings annuitized and added to pensions

And no solution to this problem

Ann born

Aunt Tilly visits

replacement rate = A/E (35%)

Inevitably drawn to an economic model to make comparisons

• But what model?

• Life-cycle model says what an informed utility maximizer would do.

• Obvious starting point

• Does not lead to income replacement rate concept

What do we see in U.S. when use life-cycle model?

• Compare actual wealth with optimal wealth– Over-saving! (Schulz et al, 2006)

– But lifetime utility below optimum

• Compare consumption at retirement (and associated with life-cycle path) with economic resources

Almost 80% adequately prepared (Hurd and Rohwedder, 2008)

How did households achieve this?

• We don’t know

• All we can do is to assess outcome

Relevance for Europe

• With reduction in state DB pensions larger mix of savings and private pensions

• U.S. experience may be relevant for future

This paper

• Conceptualize situation

• Input into debate

• But to implement measures of economic preparation need data– Is there something between income

replacement and full-scale life-cycle model?

• Excellent start