Valuing Basic Pensions

Asia-Pacific Risk and Insurance Association
Publication Type:
Conference Proceeding
Proceedings of the 11th Annual Conference of the Asia-Pacific Risk and Insurance Association, 2007, pp. 1 - 35
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Governments around the world are reviewing basic pension systems in the light of increasing demands on public funds. In Australia, Government policy aims to in- crease reliance on private retirement savings and reduce demand on the targeted Age Pension. Using a new analytical valuation method for retirement income streams (Milevsky and Robinson 2005) we value the Age Pension by calculating the amount of wealth needed to sustain an annual draw-down equivalent to the Australian ba- sic pension, if pensioners were to be responsible for generating the income stream themselves. We account for both investment and longevity risk. A 65-year-old sin- gle retiree with average life-expectancy needs retirement wealth equivalent to 8.5 times average annual earnings to replicate the payments and insurance features of the public pension using standard draw-down products. Delaying retirement by 5 years reduces required savings by around 5%, but linking pension payments to earnings growth rather than price in.ation increases required wealth by up to 25%. Commercial single life annuities can replicate the pension more cheaply than the draw-down plans we evaluate, but remain unpopular with retirees. We conclude that the basic pension is very valuable, representing a large notional transfer of wealth at retirement.
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