227 research outputs found

    Betting on Death and Capital Markets in Retirement: A Shortfall Risk Analysis of Life Annuities versus Phased Withdrawal Plans

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    How might retirees consider deploying the retirement assets accumulated in a defined contribution pension plan? One possibility would be to purchase an immediate annuity. Another approach, called the “phased withdrawal” strategy in the literature, would have the retiree invest his funds and then withdraw some portion of the account annually. Using this second tactic, the withdrawal rate might be determined according to a fixed benefit level payable until the retiree dies or the funds run out, or it could be set using a variable formula, where the retiree withdraws funds according to a rule linked to life expectancy. Using a range of data consistent with the German experience, we evaluate several alternative designs for phased withdrawal strategies, allowing for endogenous asset allocation patterns, and also allowing the worker to make decisions both about when to retire and when to switch to an annuity. We show that one particular phased withdrawal rule is appealing since it offers relatively low expected shortfall risk, good expected payouts for the retiree during his life, and some bequest potential for the heirs. We also find that unisex mortality tables if used for annuity pricing can make women’s expected shortfalls higher, expected benefits higher, and bequests lower under a phased withdrawal program. Finally, we show that delayed annuitization can be appealing since it provides higher expected benefits with lower expected shortfalls, at the cost of somewhat lower anticipated bequests.

    Tax-Induced lntertemporal Restrictions on Security Returns

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    This paper derives testable restrictions on equilibrium prices when capital gains and losses are taxed only when realized. We use the Generalized Method of Moments (GMM) procedure to estimate and test the restrictions. The empirical results show evidence of capital gains tax effects on the pricing of common stock. The restrictions are not rejected by the data and estimates of the coefficient of risk aversion and the dividend tax rate are precise and economically plausible. Estimates of the capital gains tax rate, however, are often imprecise and economically implausible. Further results indicate that this can be attributed to the fact that our model does not accommodate differential long and short-term tax rates. The data appear to favor the martingale hypothesis for after-tax asset returns over a before-tax consumption-based asset pricing model

    Optimal Policyholder Behavior in Personal Savings Products and its Impact on Valuation

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    Policyholder exercise behavior presents an important risk factor for life insurance companies. Yet, most approaches presented in the academic literature – building on value maximizing strategies akin to the valuation of American options – do not square well with observed prices and exercise patterns. Following a recent strand of literature, in order to gain insights on what drives policyholder behavior, I first develop a life-cycle model for variable annuities (VA) with withdrawal guarantees. However, I explicitly allow for outside savings and investments, which considerably affects the results. Specifically, I find that withdrawal patterns after all are primarily motivated by value maximization – but with the important asterisk that the value maximization should be taken out from the policyholders’ perspective accounting for individual tax benefits. To this effect, I develop a risk-neutral valuation methodology that takes these different tax structures into consideration, and apply it to our example contract as well as a representative empirical VA. The results are in line with corresponding outcomes from the life cycle model, and I find that the withdrawal guarantee fee from the empirical product roughly accords with its marginal price to the insurer. I further consider the implications of policyholder behavior on product design. In particular – due to differential tax treatments and contrary to option pricing theory – the marginal value of such guarantees can become negative, even when the holder is a value maximizer. For instance, as I illustrate with both a simple two-period model and an empirical VA, a common death benefit guarantee may indeed yield a negative marginal value to the insurer

    On improving pension product design

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    An investigation on portfolio choice and wealth accumulation in fully funded pension systems with a guaranteed minimum benefit

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    In this thesis, we investigate the welfare implications of two risk management measures to reduce the market risk faced by retirees in compulsory defined-contribution (DC) systems. The measures are: investment restrictions on the retirement account and providing a guaranteed minimum benefit. We solve calibrated life-cycle models of optimal consumption and portfolio choice of the retirement account as well as of private savings for borrowing constrained rational agents with incomplete markets. We first investigate the welfare implications of portfolio restrictions in the retirement account. Here, we assume that the retirement account has a favorable tax treatment during working years, whereas the private savings account is subject to taxation. The model is set in partial equilibrium. We find that if one were to compensate agents for giving up their right to invest freely their retirement account, the compensation was substantial. We also show that the tax differential of financial assets has a major effect on the portfolio allocation of the retirement account. We then evaluate the cost of a minimum benefit in a compulsory DC system in partial equilibrium. Here, we assume that there is no taxation on capital gains or interest. We assess the cost of the minimum benefit of two types of guarantees: a flat minimum benefit and an earnings related one. We find an optimal portfolio restriction on the retirement account such that the cost of a flat minimum benefit is minimized. Our results show that reducing the level of a flat minimum benefit does not have a significant impact on social welfare. We also find that the reduction in the cost of the minimum benefit due to portfolio restrictions does not compensate for the welfare loss of portfolio restrictions in the retirement account. Finally, we evaluate the cost of a flat minimum benefit in a general equilibrium framework. Moreover, we investigate the aggregate implications of compulsory DC systems with and without a minimum benefit compared to economies with no pension system assuming economies in steady state and economies with aggregate uncertainty. We find that economies with a compulsory DC pension system are welfare increasing compared to economies with no pension system. We show that this result depends on the definition of the government budget equation. We also find that DC pension systems with a minimum benefit do not improve social welfare compared to DC systems with no minimum benefit either in steady state or outside the steady state.Open acces

    A Litner Model of Payout and Managerial Rents

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    We develop a dynamic agency model where payout, investment and financing decisions are made by managers who attempt to maximize the rents they take from the firm, subject to a capital market constraint. Managers smooth payout in order to smooth their flow of rents. Total payout (dividends plus net repurchases) follows Lintner's (1956) target-adjustment model. Payout smooths out transitory shocks to current income and adjusts gradually to changes in permanent income. Smoothing is accomplished by borrowing or lending. Payout is not cut back to finance capital investment. Risk aversion causes managers to underinvest, but habit formation mitigates the degree of underinvestment.

    Policyholder Exercise Behavior in Life Insurance: The State of Affairs

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    The paper presents a review of structural models of policyholder behavior in life insurance. We first discuss underlying drivers of policyholder behavior in theory and survey the implications of different models. We then turn to empirical behavior and appraise how well different drivers explain observations. The key contributions lie in the synthesis and the systematic categorization of different approaches. The paper should provide a foundation for future studies, and we describe some important directions for future research in the conclusion
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