Intertemporal Smoothing and Intergenerational Risk Sharing: The Impact on Objective Utility and Subjective Attractiveness of Retirement Savings Products

In traditional life insurance with a long-term savings element, many policyholders participate in the same pool of assets. This allows life insurers to perform different return smoothing mechanisms based on intertemporal smoothing as well as intergenerational risk sharing to reduce the uncertainty of policyholders’ returns. Kling et al. (2024) show that the concrete design of a smoothing mechanism can have a significant effect on the risk-return characteristics of the resulting product. This raises the question of which mechanisms have a high objective utility according to standard economic models of rational decision-making, and which have a high subjective attractiveness for policyholders according to decision models of behavioral economics. In this paper, we analyze exemplary smoothing mechanisms with different intensities of intertemporal and intergenerational components in an Expected Utility framework as well as under versions of Cumulative Prospect Theory (cf., Tversky and Kahneman, 1992) that have been proposed to assess the subjective attractiveness of long-term savings processes (cf., Ruß and Schelling, 2018). We illustrate the different effects of the product design and the model-components on the objective utility and the subjective attractiveness. In addition, following Ruß et al., (2023) we identify suitable “compromise products” in the sense that they create a high (albeit not the maximum possible) objective utility while at the same time being subjectively of high (albeit not maximum possible) attractiveness. Our results show that smoothing mechanisms with elements of intergenerational risk sharing can lead to a higher objective utility while intertemporal smoothing can increase subjective attractiveness. Consequently, the “compromise products” in this setting come with both features, i.e., intertemporal smoothing and intergenerational risk sharing. The results show that suitably designed return smoothing mechanisms can provide efficient retirement savings products that are at the same time subjectively attractive. BibliographyKling, A., Kramer, T., & Ruß, J. (2024). From Intertemporal Smoothing to Intergenerational Risk Sharing: The Effects of Different Return Smoothing Mechanisms in Life Insurance. Available at SSRN: https://ssrn.com/abstract=4744873 or http://dx.doi.org/10.2139/ssrn.4744873Ruß, J., & Schelling, S. (2018). Multi cumulative prospect theory and the demand for cliquet‐style guarantees. Journal of Risk and Insurance, 85(4), 1103-1125.Ruß, J., Schelling, S., & Schultze, M. B. (2023). What to offer if consumers do not want what they need? A simultaneous evaluation approach with an application to retirement savings products. European Actuarial Journal, 1-29.Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and Uncertainty, 5, 297-323.