Investment Risk and Pensions - Impact on Individual Retirement Incomes and Government Budgets
Pensions are inherently risky because they are long-term contracts. These contracts can involve up to four groups of actors: individuals, governments, employers and financial-services providers. Uncertainty about the future complicates planning for all these actors: if things turn out better than expected, who will reap the gains? If things turn out worse, who will bear the cost? No one wants to bear risk, but, in most cases, someone has to. Risks in pension systems have, in the past, been poorly measured or even just
ignored.
This paper is part of a series that examines how different kinds of uncertainty affect retirement
incomes. The first of these papers (Whitehouse, 2007) looked at life-expectancy risk: how much of the cost to retirement-income systems of longer lives will be borne by individual retirees, in the form of reduced benefits or later retirement? How should this life-expectancy risk be allocated between generations? The second (Whitehouse, 2009), looked at purchasing-power risk: examining how pension systems react to changes in costs and standards of living.
This, the fourth paper in the series on risk and pensions, analyses investment risk. It covers countries where defined-contribution pension plans are part of mandatory retirement-income provision and a number of countries where voluntary private pensions are widespread. A companion paper – D’Addio, Seisdedos and Whitehouse (2009) – measures the degree of investment risk. This paper uses these results to look at the effect of uncertainty in investment returns on individual retirement incomes and on public revenues and expenditures.