Pension Freezes and Household Saving Over the Life Cycle

David Love and Paul A. Smith
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David Love: Williams College, http://econ.williams.edu
Paul A. Smith: Federal Reserve Board of Governors, http://www.federalreserve.gov/

No 2008-21, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: Defined benefit (DB) pension freezes in large healthy firms such as Verizon and IBM, as well as terminations of plans in the struggling steel and airline industries, highlight the fact that these traditional pensions cannot be viewed as risk-free promises from the employee's perspective. Indeed, the current turmoil in financial markets and difficult economic outlook for many firms suggest that many more pension plans could be frozen soon. In this preliminary paper we develop an empirical dynamic programming framework to investigate household saving decisions in a model economy with freezeprone DB pensions. The model incorporates important sources of uncertainty facing households, including asset returns, employment, income, and mortality, as well as pension freezes. Applying a compensating variation measure of welfare, we find that pension freezes reduce welfare by a maximum of about $6,000 for individuals with a high school degree and about $2,000 for individuals with a college degree. We close by highlighting a few important issues that are missing from our preliminary analysis, including a labor supply decision and the effects of market-clearing conditions in the labor market. We hope to address these issues in future work.

Pages: 29 pages
Date: 2008-10
New Economics Papers: this item is included in nep-age and nep-mac
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