Measuring the consequences of pension reform applying liquidation and longevity considerations

Abstract

Around the world, the longer life expectancy of the population raises important questions for policy-makers about how citizens can maintain their basic standard of living after retirement. Pension schemes tend to be the major source of retirement incomes, at least, in the developed world. Facing this aging problem, the Taiwanese government offered persons insured under the Labor Insurance Pension Scheme the choice of whether or not to annuitize their retirement benefits from January 1, 2009. Following the implementation of this pension program, the insured may now select the old-age one-time benefit or a monthly pension benefit when they retire. The puzzle is that very few people would choose to annuitize their wealth in practice. This is contrary to the suggestions made by the financial literature. In this study, we apply the liquidity premium and the implied longevity yield (ILY) to compare the old-age one-time benefit with the monthly pension benefit. The results demonstrate that the ILY minus the risk-free rate is greater than the liquidity premium in most scenarios and these findings encourage the insured to choose the old-age pension benefit. This result is consistent with the financial literature. Moreover, we find that those insured with the lowest insurance salary and fewer years of coverage earn the highest ILY. This shows that the program has been designed with the purpose of wealth re-distribution.

Keywords:

• Labor Insurance
• one-time benefit
• pension benefit
• liquidity premium
• implied longevity yield

JEL Classifications:

• D81
• G23
• G28
• G11

Acknowledgments

The authors are grateful to the National Science Council of Taiwan for its financial supports (project number NSC 100-2410-H-035-017). We are grateful to the anonymous referees and the editor for their comments on an earlier draft.

Notes

1. The statistics on life expectancy are obtained from the website of the Taiwanese Department of Statistics, Ministry of The Interior. (http://sowf.moi.gov.tw/stat/year/list.htm)

2. Annual Report 2009 & 2010, Bureau of Labor Insurance.

3. Annual Report 2009 & 2010, Bureau of Labor Insurance.

4. Self-annuitization means that a retiree does not purchase annuity products, but manages his/her own account and withdraws a constant amount in each period until the balance of the account is zero or he/she dies. Therefore, the retiree should find investment assets that can provide the equivalent amount in each period in the financial market.

5. and B ₀ = 0. The formal definition can be found in Section 4.1 of Bjork (2009).

6. Note that there are other factors involved when the participants decide the method of pension payments, such as the education level, the number and the age of children and the bequests. In this paper, we do not consider these factors. In other words, we assume that the participants have the same background situations and then we compare the old-age pension benefit and one-time benefit while taking liquidity into consideration.

7. In this paper, we only consider insured persons who have insurance coverage before January 1, 2009.

8. In this paper, we only consider the insured person who has insurance coverage before January 1, 2009.

9. In Figure 4, we fix σ at 20%.

10. The report of the sources of retirement income is investigated by the Directorate-General of Budget, Accounting and Statistics, Executive Yuan, Taiwan. (http://www.dgbas.gov.tw/public/Attachment/25216224871.pdf.)