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 in 1992 Age 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 Age

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

Single. 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