“80 percent of participants have a risk preference that deviates from a constant gamma”

What is the focus of the paper?

This paper investigates whether the risk aversion of pension participants (expressed as gamma) is independent of income level. Pension providers are required to assess the risk preferences of their participants. A common assumption is that these preferences do not depend on the participant’s income level. From investment theory, we know that one should invest very differently when risk preferences are income-dependent. This paper tests the assumption that risk aversion is indeed the same for low and high income levels. Additionally, it examines whether a potentially non-constant gamma could be explained by participants considering a subsistence minimum when determining their risk aversion.

What are the key findings?

The results show that, on average, risk aversion is similar for low and high incomes. However, for individual participants, the picture is very different: about 80 percent of participants are either more or less willing to take risks at a higher income. The authors find no convincing evidence that this deviation from a constant gamma is due to most participants factoring in a subsistence minimum in their risk preferences.

What are the implications?

  • Pension providers should review assumptions about their participants’ risk preferences. If risk preferences strongly depend on income, a different type of investment policy is appropriate compared to one based on a constant gamma.
  • Pension providers face the choice of basing their investment policy on gammas calculated with or without the state pension (AOW). If the average gamma including AOW is relatively equal across incomes, this supports constant risk aversion. But in that case, lower income participants should take more investment risk than higher income participants in their second-pillar pension because the AOW—virtually risk-free—makes up a larger share of their total pension. If the gamma excluding AOW is roughly equal for low and high incomes, then the AOW serves as a subsistence minimum and a uniform investment policy may suffice.