Pension Wealth Uncertainty

• Author: Tullio Jappelli,Mario Padula,Luigi Guiso
• DOI: http://doi.org/10.1111/j.1539-6975.2012.01491.x
• Date: 01 December 2013
• Published date: 01 December 2013

© The Journal of Risk and Insurance, 2013, Vol. 80, No. 4, 1057–1085

DOI: 10.1111/j.1539-6975.2012.01491.x

1057

PENSION WEALTH UNCERTAINTY

Luigi Guiso

Tullio Jappelli

Mario Padula

ABSTRACT

Using a representative sample of Italian investors, we measure the uncer-

tainty of social security benefits by eliciting for each individual the subjective

distribution of the replacement rate as a summary indicator of pension un-

certainty.We find that pension uncertainty varies across individuals in a way

that is consistent with what one would expect apriori, given different infor-

mation sets and pension schemes. In particular, individuals who are a long

way from retirement, and thus face more career uncertainty, report more

subjective pension uncertainty. Since expectations revealinformation about

people’s understanding of pension reforms, our findings suggest that they

should also be an important determinant of how people respond to reforms.

INTRODUCTION

As a reflection of the still incomplete process of pension reform and of the nature

of the reforms adopted, there is a widespread belief that for the citizens of most

industrialized countries, pension entitlements have become much more uncertain

than in the past. It is fair to say that even an informed worker can find it difficult to

estimate her pension benefits at retirement.

The long-term nature of pension arrangements makes it all the moredifficult to predict

what the eventual pension will be, particularly for younger people. Their longer time

horizons mean that young people are more subject to fundamental sources of pension

Luigi Guiso is at EIEF and CEPR. Tullio Jappelli is at the University of Naples “Federico II,”

CSEF, and CEPR. Mario Padula is at the University of Venice “Ca’ Foscari,” CSEF, and CEPR.

The authors can be contacted via e-mail: mpadula@unive.it. Weare grateful to two anonymous

referees, and Didier Blanchet, Michael Hurd, Federica Teppa, Mathis Wagner, and participants

in the 2008 Fundaci´

on Ram´

on Areces Conference on Population Ageing and Its Economic

Consequences (Madrid), the 2009 Netspar-SIFR Conference on Pension Plans and Product

Design (Stockholm), the 2009 CERP Conference on Saving for Old Age in a Financial Turmoil:

New Challenges for Households, Providers and Policymakers (Torino), and the 2011 Banque

de France Conference on Saving and Portfolio Choice: Micro and Macro Approaches (Paris)

for helpful comments and suggestions; and to the UniCredit Group, and particularly Daniele

Fano and Laura Marzorati, for allowing us contribute to the design of the UniCredit Customer

Survey. Part of this research was carried out when the third author was visiting the Stanford

Department of Economics on a Fulbright scholarship.

1058 THE JOURNAL OF RISK AND INSURANCE

uncertainty, which occur particularly in countries such as Italy, where future benefits

will be closely linked to contributions.

The first source of uncertainty is based on the reforms already undertaken, which

have resulted in lower public pension coverage, and also, and by design, in greater

benefit uncertainty: future pensions will reflect idiosyncratic income uncertainty dur-

ing a working life, future fluctuations in aggregate GDP growth, and population-wide

survival rates. The second source of uncertainty lies in the reforms that have still to be

introduced, because the reform process is incomplete. Being unable to predictpension

benefits can be of first-order importance to consumer welfare, particularly if percep-

tions of the true uncertainty are biased, and not sufficient action is taken to buffer

against future risk of exhausting lifetime resources. Thus, understanding how much

uncertainty people perceive, whether what is perceived is consistent with reality, and

how individuals respond to this uncertainty are issues of primary relevance.

In this article, we investigate these issues, focusing on the first two, in the context

of the Italian economy. We perform our analysis in three steps. In a first step, we

simulate pension benefits according to the Italian pension rules and show that un-

der realistic assumptions pension uncertainty can be summarized by uncertainty

about the replacement rate. The simulations show that replacement rate uncertainty

is higher for young workers and for workers with more uncertain incomes such as

the self-employed. In the new regime in which pensions are tightly linked to con-

tributions, demographic and aggregate income uncertainty are also associated with

higher pension uncertainty.

In the second step, we rely on the 2006 Unicredit Customer Survey (UCS), which

covers a representative sample of its clients. Since Unicredit is one of the two leading

Italian banks and has over 5 million customers, the sample is also representative of

the Italian population with a bank account.1The survey asks for detailed information

on income, assets, and demographic variables and, quite uniquely, elicits the sub-

jective probability distribution of the replacement rate (the ratio of the first pension

to the final year’s income) for each individual in the sample. We rely on subjec-

tive distributions to quantify the amount of uncertainty about future pensions that

working-age individuals perceive and construct, for each household, the expected

replacement rate, and the standard deviation of the replacement rate. Our simple

elicitation method of subjective probabilities delivers a high response rate (92 percent

of the eligible sample). Wefind substantial heterogeneity in the expected replacement

rate, ranging from 20 percent to the maximum 100 percent, with a sample average of

67 percent. There is also considerable uncertainty about the replacement rate: the sam-

ple average of the standard deviation of the subjective replacement rate is 20 percent,

with considerable differences across sample participants.

In the final step of our analysis, we show that subjective uncertainty varies across

individuals in ways that are consistent with what one should expect apriori,on

1According to the Bank of Italy Survey of Household Income and Wealth (SHIW), 85 percent

of households have a bank account. In the Appendix (Table A2), we show that if we compare

UCS and SHIW respondents with bank accounts, we find that the two samples are quite

similar in terms of demographic characteristics (age, gender, education). See also Alvarez

et al. (2012) for further evidence on UCS and comparison with SHIW.