Pension Reforms and the Allocation of Retirement Saving Renata Bottazzi University of Bologna, IFS and CHILD Tullio Jappelli University of Naples “Federico II”, CSEF and CEPR Mario Padula University “Ca’ Foscari” of Venice and CSEF Prepared for the Annual Conference on Financial Security in Retirement September 2008

Motivation Assess people awareness of retirement outcome innovations. What do people know about their pensions? Provide the anatomy of the offset between social security and private wealth. If social security wealth falls, do people increase more financial or real wealth? Study the demand for targeted retirement products. Why are Italian pension funds still small?

The framework We exploit a decade of pension reforms, use data on subjective probabilities on retirement outcomes, and look at several components of private wealth, including financial (risky and safe) and real (business and housing) wealth.

Main results Large revision of pension expectations, but many individuals have not completely updated their expectations yet. Financial and real wealth have increased following the reforms, but the increase is more pronounced for real assets and housing in particular. No effect on the propensity to hold targeted saving plans.

Offset and portfolio choice Standard life-cycle framework: if social security wealth falls, private wealth should increase accordingly. In a complete market world, the reduction of social security wealth should not affect portfolio rules. With uninsurable income risk, borrowing (and short sale) constraints, portfolio rules become a function of age and wealth.

Background literature Estimate social security by using current and projected legislation on pension eligibility: Gale (1998), Gruber and Wise (1999), Attanasio and Brugiavini (2003), Attanasio and Rohwedder (2003) using subjective expectations of retirement age and benefits: Bernheim (1990), Gustman and Steinmeier (2001), Bottazzi, Jappelli and Padula (2006) The effect of the reform Miniaci and Weber (1999): 1993 consumption drop partly due to the 1992 pension reform Attanasio and Brugiavini (2002): offset between private saving and pension wealth (coefficient of -0.3)

The Italian pension reforms Three main reforms (1992, 1995, 1997) Features: retirement age and minimum years of contributions for pension eligibility abolishment of seniority pensions (if started working after 1995) indexation of pension benefits to prices instead of wages less generous pension award formulas

The Italian pension reforms The eligibility rules and the pension award formula change according to the years of contribution at the end of 1992 Three groups of workers: Old, more than 18 years of contribution as of 31/12/1995 Middle–aged, less than 18 years of contribution as of 31/12/1995 Young, enter labor market in 1996

The Italian pension reforms: retirement age

The Italian pension reforms: the pension award formula

Data Survey of Household Income and Wealth (SHIW) – representative of Italian population Subjective expectations on retirement age and replacement rate: Retirement age: - all survey years - “When do you expect to retire? ” Replacement rate: - years 1989, 1991, 2004, 2006 “Consider the moment when you will retire. Setting your final monthly income before retirement equal to 100, what do you expect your first monthly pension to be? ”

Expected pension wealth at retirement Use subjective expectations on retirement age and replacement rate to construct the ratio of expected pension wealth at retirement to earnings (evaluated at each survey yeart): expected retirement age expected replacement rate P()=survival probability (by age and gender, before and after the reform) g=growth rate r=interest rate

Social security wealth

Expectation error distribution of social security wealth before and after the reform

Trends in financial and real wealth

Offset between pension wealth and private wealth: the estimating equation Financial (Real) wealth - to-income ratio Social security wealth-to- income ratio  SSWY: - weighted sum of both partners’ SSWY  - Gale adjustment factor  - Instrument with the statutory SSWY  - Sample split: Informed (Expectation error less than the median) vs. Uninformed Year, cohort, and employment dummies and their interaction, dummies, age and education of the hh, area of residence

Offset between pension wealth and private wealth: the results

The anatomy of the offset

The anatomy of the offset: Informed vs. Uninformed

Summary A reduction in social security wealth equivalent to 1 year’s income brings about an increase in financial wealth of just below 1 month’s income, and an increase in real assets of about 6 times monthly income. The effect is larger for the “Informed” and for housing wealth. Other possible channels through which retirement saving increases

Targeted retirement saving products

Conclusions Large revision of expected social security wealth. Larger effects of reform for real, smaller for financial wealth. Information on pension outcomes is still important, But the effect of pension reforms on the demand of targeted retirement saving products is small

Implications Improving the dissemination of information about pension rights, but increasing awareness of pension reforms might not be sufficient to prompt households to increase private wealth. Pension reforms don’t seem to have diminished the propensity to invest in real estate. Annuity markets are still at an infant stage.