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.