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Who pays for occupational pensions?

The purpose of this paper is to estimate the effect of occupational pensions (OPs) on wages for a large sample of Norwegian private sector firms. Knowledge about the offset between pensions and wages is becoming increasingly important, as OPs are expected to play a more prominent role in retirement provision in many countries where governments seek to reduce their pension commitments.

In Norway, mandatory OPs were introduced in 2006 as part of an ongoing reform of the public pension system. One of the arguments behind this new mandate was based on a concern that workers not covered by an OP would be left with insufficient pension benefits under a new and less generous public pension regime. Mandatory OPs along with cuts in public pensions may be a politically attractive alternative to higher taxes and less drastic cuts in public pensions, and an assessment of the extent to which the costs of such mandated benefits are shared between firms and workers is crucial if one wants to know who bears the costs of pension reforms.

Occupational pensions are part of compensation packages offered by firms to workers, and identification of the offset between pensions and wages is complicated by the joint determination of pensions, wages and other forms of compensation. The positive coefficient on pensions which is typically found in cross section wage regressions (see e.g. Hernæs et al. (2010)) is thus likely to be corrupted by simultaneity bias and the imperfect observability of productivity. In this paper, a difference-in-differences strategy is used to exploit the introduction of mandatory OPs in Norway as a source of exogenous variation in pension coverage. Provided that the counter-factual trends in firm level wages are independent of pre-reform OP status, conditional on observed covariates, this
approach gives unbiased and consistent estimates of the offset factor between pensions and wages.

As only half the workers in the Norwegian private sector were covered by an occupational pension prior to the reform, a natural question to ask is the following: What motivates some firms to offer an OP while others choose not to? Gustman et al. (1994) point to several possible reasons, one being that firms offer OPs simply because they are demanded by workers. Such a demand from workers may be motivated by the fact that both contributions and benefits tend to be tax-favoured, so that the after-tax return to savings in OP schemes may exceed the return earned in other savings vehicles.

This feature makes OPs more attractive to high-wage workers than to workers with lower wages, given that taxes on wage income are progressive. There may also exist economies of scale, making group-saving more cost effective than individual saving, which may help explain the stylized fact that OPs have been a large firm phenomenon. A third reason why workers may desire OPs is that they often provide insurance of a type that is hard to obtain otherwise than through OP schemes, such as for instance disability insurance.