Optimal intergenerational risk sharing with reference-dependent preferences

In December 2020, the Dutch government published a pension bill which sets out the main features of a reform of Dutch occupational pensions. A key characteristic is that participants in the new pension contract no longer accumulate pension entitlements but acquire a share in a collective pool of assets. Furthermore, each pension fund must reserve a part of the collective pool of assets as a solidarity buffer that can be used for wealth transfers between generations.

An important question is: what are optimal investment and allocation rules for the new Dutch pension system? The standard results on optimal investment and risk-sharing for pension funds regarding lifecycle investment are quite specific for the choice of “standard” power utility (or CRRA utility) functions and may not reflect the desire for a “fair” allocation between generations.

We want to analyse optimal allocation rules in the new Dutch pension system by considering more general (“habit-forming”) utility functions where each generation’s utility is explicitly benchmarked against the accumulated pension capital of previous generations. For example: how does the inclusion of “intergenerational benchmarking” in the utility specification affect the optimal risk-sharing rules for pension funds? And what are the benefits of intergenerational risk-sharing for pension funds considering these extended utility functions? Furthermore, we want to take a full life-cycle perspective, where we explicitly consider human capital and housing (and labour income risk and house price risk) when analysing the implications for optimal pension savings and investment behaviour.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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