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Government Mandated Private Pensions: A Dependable and Equitable Foundation for Retirement Security?
We develop a model of an overlapping generations economy characterized by private pensions where risk averse agents face both longevity and investment risks. The government mitigates the effects of longevity risk by mandating that individuals purchase annuities. Investment risk arises since the returns on annuities deviate randomly from actuarial fairness as a result of differences in the costs of administering pension funds (or, equivalently, deviate randomly from the market return as a result of differences in fund manager portfolio choice). Thus, identical agents’ pensions may yield drastically different returns: the government's pension policy is not horizontally equitable. We define policies that achieve horizontal equity, and discuss heuristically the costs and benefits of implementing these policies.