Abstract:
Governments around the world are reviewing basic pension systems in the light
of increasing demands on public funds. In Australia, Government policy aims to in-
crease reliance on private retirement savings and reduce demand on the targeted Age
Pension. Using a new analytical valuation method for retirement income streams
(Milevsky and Robinson 2005) we value the Age Pension by calculating the amount
of wealth needed to sustain an annual draw-down equivalent to the Australian ba-
sic pension, if pensioners were to be responsible for generating the income stream
themselves. We account for both investment and longevity risk. A 65-year-old sin-
gle retiree with average life-expectancy needs retirement wealth equivalent to 8.5
times average annual earnings to replicate the payments and insurance features of
the public pension using standard draw-down products. Delaying retirement by
5 years reduces required savings by around 5%, but linking pension payments to
earnings growth rather than price in ation increases required wealth by up to 25%.
Commercial single life annuities can replicate the pension more cheaply than the
draw-down plans we evaluate, but remain unpopular with retirees. We conclude
that the basic pension is very valuable, representing a large notional transfer of
wealth at retirement.
