Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2006/13: Intergenerational Effects of Guaranteed Pension Contracts

Trond M. Døskeland () and Helge A. Nordahl ()
Additional contact information
Trond M. Døskeland: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Helge A. Nordahl: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: In this paper we show that there exist intergenerational cross-subsidization effects in guaranteed interest rate life and pension contracts as the different generations partially share the same reserves. Early generations build up bonus reserves, which are left with the company at expiry of the contract. These bonus reserves function partly as a subsidy of later generations, such that the latter earn a risk-adjusted return above the risk-free rate. Furthermore, we show that this subsidy may be large enough to explain why late generations buy guaranteed interest rate products, which otherwise would not have been part of the optimal portfolio allocation.

Keywords: Portfolio Choice; Life and Pension Insurance; Interest Rate Guarantees

JEL-codes: G11; G13; G22

26 pages, First version: October 18, 2006. Revised: June 21, 2007.

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