Working Paper: NBER ID: w0956
Authors: James E. Pesando
Abstract: Pensions provided in the public sector are often indexed, while pensions in the private sector typically are not. To conduct the total compensation comparisons that ostensibly guide government pay policy, one must value annuities which differ in their degree of inflation protection. This paper conducts this exercise from the viewpoint of modem finance theory, and contrasts the results with those of a representative government, the Government of Canada. The results suggest that governments may typically understate the value of indexed pensions and overstate the value of pensions which receive incomplete inflation protection. A contributing factor is the apparent belief that standardizing actuarial assumptions is sufficient to ensure comparability, in spite of the fact that risk is ignored and that interest rate and inflation assumptions are typically not those of the market.
Keywords: Pensions; Inflation Protection; Total Compensation
JEL Codes: H55; J32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government valuation methods (H82) | Systematic undervaluation of indexed pensions (H55) |
| Actuarial valuations ignoring risk (G22) | Systematic undervaluation of indexed pensions (H55) |
| Interest rate and inflation assumptions not reflecting market conditions (G19) | Systematic undervaluation of indexed pensions (H55) |
| Expected real return on minimum variance portfolio (G17) | Upper bound for competitive interest rate of fully indexed annuities (G12) |
| Government policies (H59) | Pension valuations (J32) |
| Reliance on standard actuarial valuations (G22) | Systematic errors in pension valuations (J32) |
| Systematic errors in pension valuations (J32) | Flawed total compensation comparisons (J33) |
| Total compensation comparisons (J33) | Perceived public sector compensation being excessively high (J45) |