The Private Value of Public Pensions

Abstract

As individual retirement savings accounts replace public pensions and de…ned ben-e…t schemes, more retirees will decumulate using commercial income streams rather than public or corporate annuities. Here we use an approximation to the retirement income problem (Huang, Milevsky and Yang 2004) to compute the cost of replicating a public real life annuity (the Australian Age Pension) using commercial decumulation products. We treat the public pension as a phased withdrawal plan, matching insurance and payment features, and back out the stochastic present value of the plan under an arbitrarily small ruin probability. To reproduce the pension payment with 99% certainty, a male retiree needs 3.6 times the current average retirement savings account balance, and a female retiree needs more than 10 times the average female account balance. At 95% certainty, required wealth falls by around 25%. We measure separately the impact of gender, investment strategy, retirement age and management fees on this valuation.

Means‐Tested Public Pensions, Portfolio Choice and Decumulation in Retirement*

“…A single pensioner who owns their own home is paid around 28 per cent of Male Total Average Weekly Earnings (MTAWE) and partnered pensioners receive 75.5 per cent of the single payment each 6 . Compared with other OECD countries, the Age Pension creates low replacement rates (Harmer, 2008), but eligibility is highly valued: generating a similar stream of income from private savings via commercial income stream products would require an accumulation of around seven times average annual incomes (Petrichev & Thorp, 2008). The base single pension is recalculated every 6 months (March and September) to keep up with changes in the Consumer Price Index (CPI) or the Pensioner and Beneficiaries Living Cost Index (PBLCI) and also to ensure that it does not fall below 25 per cent of MTAWE.…”

Superannuation in Australia: A Survey of the Literature

“…It follows that unless Australian retirees change the way they manage SG accumulations, retirement incomes will become more volatile in the future. It also follows that many retirees will depend more on the Age Pension's capacity to buffer against investment risk (Petrichev & Thorp, 2008;Hulley et al, 2012;Andreasson et al, 2017) Retirees could turn to conventional insurance products to smooth their retirement incomes. In Australia, however, households have not compensated for their heavier reliance on defined contribution savings with voluntary purchase of longevity insurance.…”

“…It follows that unless Australian retirees change the way they manage SG accumulations, retirement incomes will become more volatile in the future. It also follows that many retirees will depend more on the Age Pension's capacity to buffer against investment risk (Petrichev & Thorp, ; Hulley et al ., ; Andreasson et al ., )…”