1. Adequacy of savings for old-age in Europe Elsa Fornero, University of Turin and CeRP Annamaria Lusardi, Dartmouth College and NBER Chiara Monticone, University of Turin and CeRP CeRP Conference 2008 "Financial security in retirement" September 18-19 th 2008, Collegio Carlo Alberto

2. An American prologue: the “worrisome” baby boomers  A lively US debate on the adequacy of retirement provisions of the large baby boom generation  fears of “inadequate” savings are echoed in the press and in the political discussion  Research has produced mixed results:  more than 43% of American households are considered “at risk” according to the National Retirement Risk Index (CRR at Boston College)  financial illiteracy is widespread (i.e., according to a survey, 60% of Americans do not understand the difference between social security, a company pension and a 401 (K) plan)  Yet models based on (enriched versions of) the life cycle model find less than 20% of households have inadequate resources

3. 3 1. Motivation and relevance for Europe Dramatic changes in the European population structure: declining fertility rates and increasing longevity are expected to hamper economic growth, and to challenge the welfare state Old-age dependency ratios (Visco 2006)

4. 2. Definition and measurement of “retirement saving adequacy” The concept of retirement saving adequacy should combine two closely related dimensions: Individual dimension:  has to do with a sensible intertemporal allocation of resources in a given market and institutional context (e.g. generosity of public provision and presence of saving instruments)  the life cycle model is the natural normative benchmark  “a household is said to be saving adequately if it is accumulating enough wealth to be able to smooth its marginal utility of consumption over time in accordance with the optimizing model of consumption” (Engen et al. 1999, p. 70) Pension system dimension:  refers to a well structured institutional design for an efficient sharing and diversification of risks, given individual preferences and financial sustainability, and requires:  intergenerational and intragenerational risk sharing (Shiller, 1998)  a mixed system (Lindbeck and Persson, 2003), combining PAYGO and funding  an appropriate combination of DB and DC formulae (Gomes and Michaelides, 2003)  enhancement of individual responsibility, through information and financial education (Lusardi 2007)  an appropriate design of workers’ choice situations, e.g. pension schemes’ default options (Madrian and Shea, 2001; Holzmann et al, 2005)

5. Elements of realism …and difficulties in computation All measures can be made more realistic by considering: (a) Real life complications  Taxes  Imperfect indexation of social security benefits  Risks of too early retirement because of health shocks, firms restructuring or other contingencies  Imperfect annuity markets  Illiquidity of retirement wealth (housing wealth, in particular)  Risks of “catastrophic” health expenditure in retirement  Risk of divorce (typically for a woman) (b) … and facilitations  Public health, subsidies and care  Changes in the family composition (couples are normally better situated than singles because of their greater “moderation”)  Changes in consumption/leisure mix at retirement and opportunities to economize (c) Heterogeneity of individual situations  Typically poor individuals have higher pension RR because of progressivity in both the pension and the tax system  Cohort and gender aspects (women’s longer longevity)

6. W P C Y Age € Retirement W/Y C r /C a P/Y Measures

7. W P C Y Age € Ret A more realistic life-cycle Imperf annuity mkt Illiquidity (house) Investment risk Longevity risk Smoothing of mg ut/cons Bad health outcomes Economies of scale in hh Home production Work-related expenses Imperf indexation Progressivity Household composition - Children in & out - Divorce Early ret (health or job shock)

8. Greater income and pension uncertainty have made P/Y more elusive While retirement planning is difficult in a stable environment, pension reforms greatly complicate the task by downsizing past promises and limiting both guarantees and indexation mechanisms  the PAYGO pillar as a source of retirement income has been retrenched  retirement ages have been raised  replacement rates have been reduced  benefits have been de-indexed from wages to prices  occupational and personal pension plans, where workers have greater choice but also greater responsibility and risks, have been strengthened  DB schemes are being replaced with DC schemes based on financial accumulation and actuarial principles