We analyze the optimal balance between social security taxation and private saving in the provision of retirement income in dynamically efficient economies, a question at the center of policy debates in Europe and the United States. We consider the relative importance for this question of the return to capital, the internal return of the pay-as-you-go system, and the variabilities and correlation (or independence) of labor earnings and the capital return. We analyse these influences theoretically in the context of a two-period, overlapping generations model with uncertainty. We use a new method to calibrate the model using annual data on GDP per worker and the total real return on equities, from 1950 to 2002, from which we infer the stochastic characteristics of lifetime labor income and the return to lifetime savings in the US, UK, France and Japan. We obtain a range of optimal, steady-state values of the social security tax and the rate of lifetime savings. When the relative rate of risk aversion is assumed to be 2.5, the computed optimal tax varies from 5% in the United States to 22% in Japan. France is similar to Japan, and the UK is in between.

Our first issue of the fifth volume of the JPEF features 4 research articles, an issues & policy piece and a book review section. The lead article is by Georges de Menil (PSE, Paris and Stern School, NYU), Fabrice Murtin (CREST(INSEE) and PSE, Paris) and Eytan Sheshkinski (Hebrew University of Jerusalem and Princeton University). The paper on “Planning for the Optimal Mix of Paygo Tax and Funded Savings” looks at the classical question of what the right balance is between pay-as-you-go and funded pension provision. Using a stochastic two period overlapping generations model, the authors show how optimal pension provision depends on the variances and correlations of labour earnings, return on capital and the internal rate of return on the pay-as-you-go pension system.

This paper empirically examines the strategic asset allocation and the asset/liability issues in the Finnish defined benefit pension funds. The results indicate that there is a relationship between the liability structure and the asset allocation. While pension funds with younger participants have more equity exposure, more mature pension funds have more fixed income investments.

Wide dispersion in asset allocations is also found between the funds. One fund holds its entire portfolio in fixed income securities, whereas other funds have none or only few fixed income holdings. Equity investments also vary dramatically, ranging from 0% to over 70% of the asset allocation. The same applies to investments in a sponsor, real estate investment, and money market investments. A portion of these different asset allocations is explained by the liability structure, but another part remains unexplained. The other variables affecting strategic asset allocation of a pension fund are not obvious, but they could include factors such as regulatory environment, historical reasons, mean-variance optimization instead of ALM, sponsor's own preferences or pension fund's irrationality. Analyzing these factors would be a fruitful topic for further research. Additionally, international comparisons would be a fruitful topic for further investigation.

Increasingly, individuals are being required to take more responsibility for their own retirement saving. Lifecycle theories of resource allocation provide a framework to examine work, retirement, consumption, and saving decisions. However, optimal decision making requires adequate knowledge of financial mathematics, risk and return properties of investments, and expectations concerning wage growth and tax policy. This paper explores the response of individuals to financial education seminars. Using data from three surveys of participants in seminars offered by TIAA-CREF, we estimate changes in retirement goals and saving behavior after the respondents have attended a seminar which discusses keep components of saving for retirement. The results indicate that financial education can produce significant changes in how individuals think and plan for retirement. Throughout the analysis, women were found to be more responsive to the seminar and were more likely to raise their desired retirement age, increase their target income replacement goal, and alter their savings behavior.

The present paper compares the distributional and risk-sharing consequences of two pension reform options in Germany, which both aim to improve the sustainability of the current system by introducing demographic variables to the benefit calculation. While the first reform proposes a so-called ‘sustainability factor’, which measures the changes in the dependency ratio, the second reform proposes a so-called ‘demographic factor’, which takes into account the changes in life expectancy. Our simulations indicate that both reforms imply a double burden for currently middle-aged generations and a double relief for future living generations. On the one side, resources are redistributed from currently towards future living generations. In addition, part of the risk from demographic uncertainty is shifted from future living towards currently living middle-aged generations. The reforms differ, however, with respect to the magnitude of the resource distribution and risk implications. Therefore, future generations are much better off with the ‘sustainability factor’, while it is not clear whether middle-aged generations are better off with the ‘demographic factor’ or the ‘sustainability factor’.

Government-sponsored inquiries into trustee competence, and legislation regarding the protocols and practice of trustee decision making, have raised questions about the competence of trustees to make investment decisions consistent with the long-term interest of defined benefit pension plan beneficiaries. In this paper, we report the results of an analysis of trustee competence in solving problems relevant to their investment responsibilities. Based upon a set of widely recognized problems drawn from the psychology literature, we assess their discount functions, their willingness to risk their own money and others' money, their appreciation of probability, and their use of evidence to solve problems. For comparison, where appropriate we report the results of the same testing regime applied to a group of Oxford undergraduates. Our goals are fourfold: first, to demonstrate the nature of trustee competence in decision making; second, to demonstrate the range of trustee responses to problems relevant to investment; third, to assess trustees' risk appetites in relation to their own and others' money; and fourth, to draw implications from these results for the governance of trustee boards and their relationships with advisers and service providers. It is shown that trustee competence is surprisingly heterogeneous, and the lack of common approaches to problems relevant to investment practice has significant implications for fund governance.