DAVID A. LOVE, Williams College - Department of Economics
Email: dlove@williams.edu
PAUL A. SMITH, Federal Reserve Board of Governors
Email: paul.a.smith@frb.gov
DAVID W. WILCOX, Federal Reserve Board - Division of Research and Statistics
Email: David.Wilcox@frb.gov

We develop a simple model of pension financing to study the effects of pension risk on shareholder value. In the model, firms minimize costs, total compensation must clear the labor market, and a government pension insurer guarantees a portion of promised benefits. We find that in the absence of mispriced pension insurance, the optimal pension strategy under most specifications is to immunize all sources of market risk. Mispriced pension insurance, however, gives firms the incentive to introduce risk into their pension promises, offering an explanation for some of the observed prevalence of risky pensions in the real world.

BARBARA A. BUTRICA, The Urban Institute
Email: bbutrica@ui.urban.org
HOWARD IAMS, U.S. Social Security Administration
Email: Howard.m.iams@ssa.gov
KAREN E. SMITH, Urban Institute
Email: ksmith@ui.urban.org
ERIC J. TODER, National Bureau of Economic Research (NBER)

The long-term shift in coverage from defined benefit (DB) pensions to defined contribution (DC) plans may accelerate rapidly as more large companies freeze their DB pensions and replace them with new or enhanced DC plans. This paper uses the Model of Income in the Near Term to simulate the impact of an accelerated transition from DB to DC pensions on the distribution of retirement income among boomers. A scenario in which employers freeze all remaining private sector DB plans and a third of all state and local plans over the next five years will on balance produce more losers than winners among boomers and reduce their average incomes at age 67. Income changes will be largest among higher-income boomers, who have the highest DB coverage rates and projected pension incomes. Furthermore, the numbers of winners and losers and net income changes are much greater for the last wave of boomers (born between 1961 and 1965) than for earlier boomers. Younger boomers are most likely to have their DB pensions frozen with relatively little job tenure and to lose their high accrual years for DB pension wealth, but also to have relatively more years to accumulate DC pension wealth before retirement.

ALICIA H. MUNNELL, Boston College - Center for Retirement Research
Email: MUNNELL@BC.EDU
MAURICIO SOTO, Boston College - Department of Finance and Department of Economics
Email: rhoder@bc.edu
ALEX GOLUB-SASS, Boston College - Center For Retirement Research (CRR)

If Americans continue to retire at age 63, a great many will risk income shortfalls especially at older ages. Because work directly increases current income, Social Security benefits, retirement saving, and decreases the length of retirement, a logical solution would be to increase the age of retirement. But are Americans healthy enough to work longer? Using the National Health Interview Study, this paper shows that healthy life expectancy increased by about three years over 1970-2000 for the average 50-year old man. This increase is largely the result of men moving up the education ladder, with minimal increases within educational groups. Moreover, major disparities in healthy life expectancy remain between those in the bottom and top quartiles of the population. And these disparities mean that a vulnerable portion of the population - perhaps those who most need to work longer - might not be able to extend their work lives.

DAVID P. BLAKE, City University London - Cass Business School - The Pensions Institute
Email: d.blake@city.ac.uk

'An Unreal Number. How Company Pension Accounting Fosters an Illusion of Certainty' was published on 31st January 2008. This research paper, funded by the ICAEW's charitable trusts, is intended to be a 'state of the art' review of the ways in which companies account for their pension obligations. It explains how pension accounting has evolved both to reflect changing views of the nature of the pension promise and to help fulfil the accounting objectives of stewardship and decision-usefulness. The paper contends that the most useful information that accounts can provide about a defined benefit plan's funded status is the market, or fair, value of its assets and the amounts, timing and uncertainty of its projected pension payments. By reducing this information to a single number, pension accounting standards create an 'illusion of certainty' which supplementary cash flow projections and sensitivity analyses do not dispel.

RUSSELL COHEN, New York Law School
Email: russell.cohen@law.nyls.edu

The Pension Benefit Guaranty Corporation ("PBGC") insures single-employer pensions of over 34 million private sector workers covering nearly 30,000 employer-sponsored defined benefit ("DB") pension plans. Established in 1974 by the Employee Retirement Incomes Security Act ("ERISA") as a self-financing government corporation, the PBGC's primary responsibility is to insure, under statutory limits, the pension benefits of participants in qualified DB plans. In recent years, an increase in underfunded plan terminations has impacted both the number of plan participants receiving benefit payments and PBGC's funding liabilities. At the end of fiscal 2007, the PBGC reported a $14.1 billion deficit. Deficits are projected to continue according to 10-year forecasting models as a result of financial market volatility, increased funding shortfalls, and a projected surge in plan terminations as companies eliminate defined benefits.

BURKHARD HEER, Free University of Bozen-Bolzano - School of Economics, CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Email: burkhard.heer@unibz.it
ANDREAS IRMEN, Alfred-Weber-Institute, CESifo (Center for Economic Studies and Ifo Institute for Economic Research), Center for Economic Policy Research
Email: airmen@uni-hd.de

We study the effect of a declining labor force on the incentives to engage in labor-saving technical change and ask how this effect is influenced by institutional characteristics of the pension scheme. When labor is scarcer it becomes more expensive and innovation investments that increase labor productivity are more profitable. We incorporate this channel in a new dynamic general equilibrium model with endogenous economic growth and heterogeneous overlapping generations. We calibrate the model for the US economy. First, we establish that the net effect of a decline in population growth on the growth rate of per-capita magnitudes is positive and quantitatively significant. Second, we find that the pension system matters both for the growth performance and for individual welfare. Third, we show that the assessment of pension reform proposals may be different in an endogenous growth framework as opposed to the standard framework with exogenous growth.

JACK VANDERHEI, Temple University - Risk Management & Insurance & Actuarial Science, Employee Benefit Research Institute (EBRI)
Email: TEMPLE@VANDERHEI.COM

This Issue Brief discusses employment-based defined benefit (DB) and defined contribution (DC) pension plans. The number and percentage of individuals participating in private DC plans is increasing relative to the number and percentage participating in DB plans. The total number of participants in all DB plans was 33 million in 1975. Participation increased to 40 million in 1983, and has remained in the 39 million-41 million range since that time. The total number of participants in defined contribution plans increased from 12 million in 1975 to 44 million in 1993.

* Between 1985 and 1993, the net change in the number of primary DB plans was generally greater for plans with fewer active participants. The number of DB plans with 10-24 active participants decreased 55 percent between 1985 and 1993, while the number of DB plans with 500-999 active participants decreased 22 percent. Because most of the decline in primary DB plans occurred in plans with two to nine participants, the decline in the number of employees covered by a primary DB plan was relatively small.

* Research results suggest that, at least for single-employer private retirement plans with at least 100 participants, employers' contributions to DC plans have increased relative to DB plans significantly more than could be explained by employment shifts since 1985. After controlling for the impact of firm size, unionization, and industry composition, the percentage of total contributions devoted to DC plans increased 11 percentage points between 1985 and 1993. While this is an aggregate measure that does not control for the differential impact of various governmental constraints on plan sponsors (e.g., the full-funding limit modifications in 1987), it does provide insight into the degree to which retirement benefits are being financed in increasing measure through the DC approach. A significant portion of this movement may be attributed to DC plans with the 401(k) feature.

* Despite the many changes in government regulation regarding DB plans and the increased prevalence of DC plans, DB plans are still an important part of both the private and public retirement systems. The data in this report show that they are firmly entrenched in large companies and in plans covered by collective bargaining agreements. It is unlikely that many of these plans will be shifted - at least completely - to defined contribution plans.

* During the 1980s and the first half of the 1990s, despite increasing regulatory complexity and cost, reduction in marginal tax rates, increased minimum required contributions for underfunded plans, and tighter maximum contribution limits, large private employers continued to offer DB plans. Policy enacted in the future could provide incentives to encourage sponsorship of DB plans and/or DC plans, or it could discourage plan sponsorship.

PARASKEVI VICKY KIOSSE, Lancaster University - Department of Accounting and Finance
Email: v.kiosse@lancaster.ac.uk
KEN V. PEASNELL, Lancaster University - Department of Accounting and Finance
Email: k.peasnell@lancaster.ac.uk

The present paper reviews the research evidence on the impact of changes in pension accounting methods on pension provision. We show that decisions to freeze, terminate or convert defined benefit (DB) plans have been driven primarily by a desire to limit contributions, though financial reporting has played a part as well. The introduction of accrual accounting requirements for post-retirement health care benefits in the U.S. similar in character to those required for DB pension liabilities appear to have motivated some firms to curtail health care provision. Changes in accounting for DB schemes have affected how firms allocate pension plan assets. We conclude that accounting matters, though perhaps not as much as is sometimes claimed. Increased costs of providing DB pensions, coupled with the greater volatility of employers' cash contributions, have undoubtedly played the major part in the decline of DB schemes.