Pension accumulation as a semi-Markov reward process, with applications to pension reform

Abstract

A fundamental point of departure of the economic analysis of savings by individuals is Samuelson’s consumption loan model. Although prevalent in the analysis of social security and saving behavior, this “representative consumer life cycle model” is inappropriate for the study of private (employment) pensions due to a number of important characteristics of these latter arrangements that distinguish them from social security. In addition to wage and benefit levels, accrual of employment pension benefits are based on the applicable vesting provisions (see below) and therefore on mobility. In addition, while the wage factors entered in social security benefit calculations are indexed until retirement, in the case of employment pensions there is either no indexing or only partial indexing until employment termination which may precede retirement by many years. It is well-known that these differences between the two systems have very important consequences in the face of high labor mobility, especially during periods of high wage growth. It is the interaction of labor mobility, inflation, and pension coverage and portability (see below) that results in an unequal distribution of pension benefits to individuals with comparable working lives and lifetime wage profiles. These characteristics are not reflected by the consumption loan model.