Inflation for retirees is different from and mostly higher than the macro-economic (average) inflation rate for the entire population. In the U.S.A, for example, the Consumer Price Index for the Urban population (CPI-U) calculated and reported by the Bureau of Labor Statistics (BLS) has a lesser known cousin called the CPI-E (for the elderly) in which the sub-component weights are based on the consumption patterns of Americans above the age of 62. This suggests that Inflation-Linked Bond Funds (ILBFs) – whose individual component bond adjustments are based on broad population (CPI-U) inflation – might not be the best hedge for individual retirees’ cost of living. But then again, broad shocks to inflation are likely to impact both indices. So, motivated by the question – is it good enough? – the current paper uses lifetime ruin minimization (LRM) techniques to investigate the optimal allocation between an ILBF and a nominal investment fund for a retiree facing an exogenous liability. Our model trades off the benefit of an imperfect hedge against the cost of lower investment growth. However, our numerical results suggest that although ILBFs can be a large part of the optimal retirement portfolio, it should be treated as just another asset class in the broad optimization problem as opposed to a special or unique category.

We explore the implications of alternative methods of discounting future pension outlays for the valuation of funded pension liabilities. Measured liabilities affect the asset–liability ratio of pension funds and, thereby, their policies. Our framework for analysis is an applied many-generation OLG model describing a small open economy with heterogeneous agents and a two-pillar pension system (with pay-as-you-go and funded tiers) calibrated to that in the Netherlands. We compare mark-to-market discounting against various alternatives, such as discounting against a moving average of past market curves or a curve that is constant over time. The pension buffer is stabilized by adjusting indexation and contribution rates in response to demographic, economic and financial shocks in the economy. Mark-to-market valuation of liabilities produces substantially higher volatility in the pension buffers, but it also generates slightly higher aggregate welfare.

We compute minimum nominal funding ratios for defined-benefit (DB) plans based on the expected utility that can be achieved in a defined-contribution (DC) pension scheme. Using Monte Carlo simulation, expected utility is computed for three different specifications of utility: power utility, mean-shortfall, and mean-downside deviation. Depending on risk aversion and the level of sophistication assumed for the DC scheme, minimum acceptable funding ratios are between 0.87 and 1.20 in nominal terms. For relative risk aversion of 5 and a DC scheme with a fixed-contribution setup, the minimum nominal funding ratio is between 0.87 and 0.98. The attractiveness of the DB plan increases with the expected equity premium and the fraction invested in stocks. We conclude that the expected value of intergenerational solidarity, providing time-diversification to its participants, can be large. Minimum funding ratios in real (inflation-adjusted) terms lie between 0.56 and 0.79. Given a DB pension fund with a funding ratio of 1.30, a participant in a DC plan has to pay a 2.7 to 6.1% point higher contribution on average to achieve equal expected utility.

The occurrence in firms of occupational pensions is investigated with a linked employer–employee dataset, supplemented with actuarial calculations of tax savings when labour compensation is in the form of pensions compared to wages. Tax gains, which can be shared between employers and employees, and expected increases in average tenure are both clearly associated with the occurrence of an occupational pension. Occupational pensions are typically found in large firms, with decentralized wage negotiations, a high degree of unionization, and the requirement of long training. The results and the approach provide a basis for analyzing also the trend towards DB pensions.

This study uses a unique data set of retiree characteristics and salary histories for administrators, teachers, and non-professional employees of the Denver Public School Retirement System (DPSRS) to analyze surplus deferred compensation for DPSRS and four state K-12 defined benefit pension plans. We find sizable levels of surplus deferred compensation for each plan, with significant differences across plans, job classes, and age groups. Across plans, differences in cost of living allowances impact the expected present value of retirement benefits more than benefit table differences when controlling for each respective factor. Somewhat surprisingly, the plans in our study with the largest present value of future benefits had lower employee contribution rates. Pension wealth for reduced benefits showed larger wealth accrual at younger ages than full, unreduced benefits, and younger cohorts starting work at an earlier age received significantly higher surplus deferred compensation.