_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 3, No. 10: May 23, 2002
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Publisher: LSN Employment, Labor, Compensation & Pension Journals
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Editor: PAMELA PERUN
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T A B L E of C O N T E N T S
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NEW and FORTHCOMING ARTICLES
"Distinguishing Risk: The Disparate Tax Treatment of Insurance
and Financial Contracts in a Converging Marketplace"
Tax Lawyer, No. 2, Winter 2002
DAVID S. MILLER
Cadwalader, Wickersham & Taft
WORKING PAPERS
"Why Social Preferences Matter - The Impact of Non-Selfish
Motives on Competition, Cooperation and Incentives"
ERNST FEHR
University of Zurich
Institute for Empirical Economic Research
CESifo (Center for Economic Studies and Ifo
Institute for Economic Research)
Centre for Economic Policy Research (CEPR)
URS FISCHBACHER
University of Zurich
Institute for Empirical Economic Research
"Company Stock in Pension Plans: How Costly Is It?"
LISA K. MEULBROEK
Harvard Business School
"For Better or For Worse: Default Effects and 401(k) Savings
Behavior"
JAMES J. CHOI
Harvard University
Department of Economics
DAVID I. LAIBSON
Harvard University
Department of Economics
National Bureau of Economic Research (NBER)
BRIGITTE MADRIAN
University of Chicago
National Bureau of Economic Research (NBER)
ANDREW METRICK
University of Pennsylvania
The Wharton School
National Bureau of Economic Research (NBER)
"Early Retirement"
JAN H.M. NELISSEN
Erasmus University Rotterdam (EUR)
Faculty of Economics
Tilburg University, CentER
"Minimum Standards and Insurance Regulation: Evidence from the
Medigap Market"
AMY FINKELSTEIN
Massachusetts Institute of Technology (MIT)
Department of Economics
National Bureau of Economic Research (NBER)
"Wealth Accumulation and the Propensity to Plan"
JOHN AMERIKS
Teachers Insurance and Annuity Association,
TIAA-CREF Institute
ANDREW CAPLIN
New York University
Department of Economics
National Bureau of Economic Research (NBER)
JOHN V. LEAHY
Boston University
Department of Economics
National Bureau of Economic Research (NBER)
University of Chicago
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"Distinguishing Risk: The Disparate Tax Treatment of Insurance
and Financial Contracts in a Converging Marketplace"
Tax Lawyer, No. 2, Winter 2002
BY: DAVID S. MILLER
Cadwalader, Wickersham & Taft
Contact: DAVID S. MILLER
Email: Mailto:david.miller@cwt.com
Postal: Cadwalader, Wickersham & Taft
100 Maiden Lane
New York, NY 10038 UNITED STATES
Phone: (212) 504-6000
Fax: (212) 504-6666
ABSTRACT:
The distinction between an insurance contract and a financial
instrument was once well understood. Insurance contracts
transferred primarily insurance risk-the risk of loss upon the
occurrence of an insurable hazard, such as a natural disaster,
death, or theft-and were issued only by regulated insurance
companies and only to a holder with an insurable interest.
Financial instruments, on the other hand, provided an investment
return or reflected primarily financial risk - the risk of
changes in the value of a business, a commodity or other
property, or a financial index - and could be issued by
unregulated entities and to a broad spectrum of investors.
However, investor sophistication, capital markets liquidity,
and financial innovation have blurred these nice distinctions.
The credit protection traditionally available only through bond
insurance is now offered by counterparties of financial
instruments, such as credit linked notes, credit default swaps,
and credit options. For instance, the risk of a natural
disaster, which historically was borne by only insurance
companies, is now assumed by the holders of catastrophe and
weather bonds and derivatives. Conversely, the investment
returns historically available only through conventional stocks,
bonds, mutual funds, and other financial instruments are now
available through whole-life and variable life insurance
products, residual value, finite, retroactive, and
retrospectively-rated insurance policies.
Part II of this Article explores the differences in tax
treatment between an insurance contract and an economically
similar non-insurance financial instrument that offers asset or
liability protection. These differences affect both the
purchasers and issuers of the protection in different ways. For
example, periodic insurance (and guarantee) premiums generally
give rise to current ordinary deductions, but periodic option
premiums give rise only to a capital loss, and only upon lapse.
In addition, life insurance proceeds are generally exempt from
all income taxes and offer favorable basis recovery rules and
tax-free access to appreciation.
Part III of this Article discusses the definition of insurance
for federal tax purposes. Formulated by the Supreme Court in
1941, the definition involves four separate elements: (i) the
form and local law regulatory treatment of the contract, (ii)
the predominance of "insurance risk," (iii) a net transfer of
that risk, and (iv) a "pooling" of that risk with other risks.
Part III explains that the test, which was originally crafted to
exclude the proceeds of a combination insurance and annuity
contract from a long-since-repealed estate tax exemption, is
less reflective of the broader tax policies surrounding the
distinction between insurance and other financial instruments,
and has been applied unevenly in the past 60 years. Part III
argues that the transfer of insurance risk only-and not
pooling-should be necessary for an insured to achieve the tax
consequences associated with insurance, that the scope of
insurance risk should be interpreted broadly, and that pooling
should be relevant only to determine the insurer's taxation,
whether as a domestic insurance company eligible for taxation
under Subchapter L, or as a foreign insurer or reinsurer subject
to the excise tax on premiums.
To demonstrate the limitations of the existing definition,
Part IV applies the current definition of insurance both to
insurance products with investment features and financial
instruments with insurance features.
Finally, Part V discusses the tax policies surrounding the
treatment of taxpayers that transfer and assume risk generally,
and insurance in particular, touching upon five different
topics: (i) the proper timing and character for taxpayers that
buy asset and liability risk protection, (ii) the proper scope
of Subchapter L and the proper timing of income and losses for
taxpayers subject to it, (iii) the proper tax treatment of
tax-exempt and foreign risk protectors, (iv) the proper tax
treatment of U.S. shareholders of foreign risk protectors and,
finally, (v) the appropriate scope and breadth of the existing
tax subsidy for life insurance.
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Why Social Preferences Matter - The Impact of Non-Selfish
Motives on Competition, Cooperation and Incentives"
BY: ERNST FEHR
University of Zurich
Institute for Empirical Economic Research
CESifo (Center for Economic Studies and Ifo
Institute for Economic Research)
Centre for Economic Policy Research (CEPR)
URS FISCHBACHER
University of Zurich
Institute for Empirical Economic Research
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=299142
Paper ID: IEW Working Paper No. 84
Contact: ERNST FEHR
Email: Mailto:efehr@iew.unizh.ch
Postal: University of Zurich
Institute for Empirical Economic Research
Bluemlisalpstrasse 10
CH-8006 Zurich, SWITZERLAND
Phone: +41 1 634 3709
Fax: +41 1 634 4907
Co-Auth: URS FISCHBACHER
Email: Mailto:fiba@iew.unizh.ch
Postal: University of Zurich
Institute for Empirical Economic Research
Bluemlisalpstrasse 10
CH-8006 Zurich, SWITZERLAND
ABSTRACT:
A substantial number of people exhibit social preferences, which
means they are not solely motivated by material self-interest
but also care positively or negatively for the material payoffs
of relevant reference agents. We show empirically that
economists fail to understand fundamental economic questions
when they disregard social preferences, in particular, that
without taking social preferences into account, it is not
possible to understand adequately (i) the effects of competition
on market outcomes, (ii) laws governing cooperation and
collective action, (iii) effects and the determinants of
material incentives, (iv) which contracts and property rights
arrangements are optimal, and (v) important forces shaping
social norms and market failures.
______________________________
"Company Stock in Pension Plans: How Costly Is It?"
BY: LISA K. MEULBROEK
Harvard Business School
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=303782
Paper ID: Harvard Business School Working Paper No. 02-058
Date: March 2002
Contact: LISA K. MEULBROEK
Email: Mailto:lmeulbroek@hbs.edu
Postal: Harvard Business School
Morgan Hall
Soldiers Field
Boston, MA 02163 UNITED STATES
Phone: 617-495-6992
Fax: 617-496-7357
Paper Requests:
Contact Harvard Business School Publishing, 60 Harvard Way,
Boston, MA 02163. Phone: (800)545-7685 or (001)617-783-7600
(outside US & Canada). Mailto:custserv@hbsp.harvard.edu
Web: http://www.hbsp.harvard.edu or contact author(s)directly.
ABSTRACT:
Firms' matching contributions to employees' defined contribution
pension plans are an important spur to employee retirement
savings. Firms frequently match employees' defined contribution
pension plan using company stock and prohibit employees from
selling; employees sometimes voluntarily invest their own
contributions in company stock. But their concomitant loss in
diversification is extremely risky and costly. While one might
reason that employees willing to take on the increased risk
should do so, holding company stock is inefficient for all
employees, even risk tolerant ones. This paper investigates the
extent of company stock ownership and estimates its cost,
finding that employee investors sacrifice an average 42% of
their company stock's market value by taking on risk that could
otherwise have been "diversified away." By matching with cash
rather than stock, firms could reduce this lost value, making
both employees and the firm better off. Indeed, with such
savings, firms could afford to increase their matching
contributions. Risk tolerant employees who want to "swing for
the fences" would be better off by investing in a diversified
portfolio and levering it to their desired risk levels. The
findings in this paper call into question the wisdom of
requiring or allowing company stock holding within retirement
plans.
Keywords: Defined contribution pensions, retirement savings,
401(k) asset allocation, company stock, employer securities,
diversification.
JEL Classification: D31, G18, G38, H31, J26, J32, J33, J38
______________________________
"For Better or For Worse: Default Effects and 401(k) Savings
Behavior"
BY: JAMES J. CHOI
Harvard University
Department of Economics
DAVID I. LAIBSON
Harvard University
Department of Economics
National Bureau of Economic Research (NBER)
BRIGITTE MADRIAN
University of Chicago
National Bureau of Economic Research (NBER)
ANDREW METRICK
University of Pennsylvania
The Wharton School
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=294089
Paper ID: NBER Working Paper No. W8651
Date: December 2001
Contact: JAMES J. CHOI
Email: Mailto:james_choi@post.harvard.edu
Postal: Harvard University
Department of Economics
Room M-14
Littauer Center
Cambridge, MA 02138 UNITED STATES
Co-Auth: DAVID I. LAIBSON
Email: Mailto:dlaibson@harvard.edu
Postal: Harvard University
Department of Economics
Room M-14
Littauer Center
Cambridge, MA 02138 UNITED STATES
Co-Auth: BRIGITTE MADRIAN
Email: Mailto:brigitte.madrian@gsb.uchicago.edu
Postal: University of Chicago
Graduate School of Business
1101 East 58th Street
Chicago, IL 60637 UNITED STATES
Co-Auth: ANDREW METRICK
Email: Mailto:metrick@wharton.upenn.edu
Postal: University of Pennsylvania
The Wharton School
Philadelphia, PA 19104-6367 UNITED STATES
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
In the last several years, many employers have decided to
automatically enroll their new employees in the company 401(k)
plan. Using several years of administrative data from three
large firms, we analyze the impact of automatic enrollment on
401(k) participation rates, savings behavior, and asset
accumulation. We find that although employees can opt out of the
401(k) plan, few choose to do so. As a result, automatic
enrollment has a dramatic impact on retirement savings behavior:
401(k) participation rates at all three firms exceed 85%, but
participants tend to anchor at a low default savings rate and in
a conservative default investment vehicle. We find that
initially, about 80% of participants accept both the default
savings rate (2% or 3% for our three companies) and the default
investment fund (a stable value or money market fund). Even
after three years, half of the plan participants subject to
automatic enrollment continue to contribute at the default rate
and invest their contributions exclusively in the default fund.
The effects of automatic enrollment on asset accumulation are
not straightforward. While higher participation rates promote
wealth accumulation, the low default savings rate and the
conservative default investment fund undercut accumulation. In
our sample, these two effects are roughly offsetting on average.
However, automatic enrollment does increase saving in the lower
tail of the savings distribution by dramatically reducing the
fraction of employees who do not participate in the 401(k) plan.
JEL Classification: J320, D120, G110, H000
______________________________
"Early Retirement"
BY: JAN H.M. NELISSEN
Erasmus University Rotterdam (EUR)
Faculty of Economics
Tilburg University, CentER
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=306099
Other Electronic Document Delivery:
http://www.tinbergen.nl/discussionpapers/02031.pdf
SSRN only offers technical support for papers
downloaded from the SSRN Electronic Paper Collection
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them into your browser eliminating all spaces.
Paper ID: Tinbergen Institute Working Paper No. TI 2002-031/3
Date: 2002
Contact: JAN H.M. NELISSEN
Email: Mailto:jnelissen@few.eur.nl
Postal: Erasmus University Rotterdam (EUR)
Faculty of Economics
Burgemeester Oudlaan 50
3062 PA Rotterdam, NETHERLANDS
Phone: +31 10 408 8900
Fax: +31 10 408 9031
ABSTRACT:
In the Netherlands a transition takes place from early
retirement schemes, which are characterized by high implicit tax
rates to schemes that have a higher degree of actuarial
fairness. in this paper we look at the impact of this change at
the labor participation rates of 55- to 65-year-old persons. The
analysis has been applied on repeated choices on the basis of
stated preferences. We estimate a mixed (or random parameters)
logit model. The most important finding is the independent role
that is played by the number of years for which has built up
pension claims. Its impact does not only run via the discounted
value of future pension streams. The results indicate that the
change in the early retirement schemes will considerably
increase labor participation. A participation rate of 50% for
the age group under consideration is within reach.
Keywords: Preretirement, labor participation, mixed logit,
stated preferences
JEL Classification: J26
______________________________
"Minimum Standards and Insurance Regulation: Evidence from the
Medigap Market"
BY: AMY FINKELSTEIN
Massachusetts Institute of Technology (MIT)
Department of Economics
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=310464
Paper ID: NBER Working Paper No. W8917
Date: May 2002
Contact: AMY FINKELSTEIN
Email: Mailto:afinkels@nber.nber.org
Postal: National Bureau of Economic Research (NBER)
50 Memorial Drive
Cambridge, MA 02142 UNITED STATES
Phone: 617-588-0361
Fax: 617-868-7242
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
This paper examines the consequences of imposing binding minimum
standards on the market for voluntary private health insurance
for the elderly. Theoretically, the effect of these standards on
insurance coverage and on welfare is ambiguous. I find robust
evidence of a substantial decline in insurance associated with
the minimum standards. The central estimates suggest that the
standards are associated with an 8 percentage point (25 percent)
decrease in the proportion of the population with coverage in
the affected market; I find no evidence of substitution to
other, unregulated sources of insurance coverage. Additional
evidence suggests that the minimum standards are also associated
with reduced coverage of non-mandated benefits among the
insured. The empirical results are most consistent with a model
of the effect of minimum standards on insurance markets with
adverse selection, and suggest that adverse selection
exacerbates the potential for unintended negative consequences
of minimum standards. The final section of the paper considers
the welfare implications of the changes in risk bearing
associated with the minimum standards. The results suggest that
the imposition of these standards was, even under relatively
conservative assumptions, welfare reducing on net.
JEL Classification: I18, I11, H51
______________________________
"Wealth Accumulation and the Propensity to Plan"
BY: JOHN AMERIKS
Teachers Insurance and Annuity Association,
TIAA-CREF Institute
ANDREW CAPLIN
New York University
Department of Economics
National Bureau of Economic Research (NBER)
JOHN V. LEAHY
Boston University
Department of Economics
National Bureau of Economic Research (NBER)
University of Chicago
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=310467
Paper ID: NBER Working Paper No. W8920
Date: May 2002
Contact: ANDREW CAPLIN
Email: Mailto:andrew.caplin@nyu.edu
Postal: New York University
Department of Economics
269 Mercer Street
New York, NY 10003 UNITED STATES
Phone: 212-998-8950
Fax: 212-995-3932
Co-Auth: JOHN AMERIKS
Email: Mailto:jameriks@tiaa-cref.org
Postal: Teachers Insurance and Annuity Association, TIAA-CREF
Institute
730 Third Avenue
New York, NY 10017-3206 UNITED STATES
Co-Auth: JOHN V. LEAHY
Email: Mailto:jleahy@bu.edu
Postal: Boston University
Department of Economics
270 Bay State Road
Boston, MA 02215 UNITED STATES
Paper Requests:
Full-Text downloads are available from SSRN Online for $5.
ABSTRACT:
Why do similar households end up with very different levels of
wealth? We show that differences in the attitudes and skills
with which they approach financial planning are a significant
factor. We use new and unique survey data to assess these
differences and to measure each household's 'propensity to
plan.' We show that those with a higher such propensity spend
more time developing financial plans, and that this shift in
planning effort is associated with increased wealth. The
propensity to plan is uncorrelated with survey measures of the
discount factor and the bequest motive, raising a question as to
why it is associated with wealth accumulation. Part of the
answer lies in the very strong relationship we uncover between
the propensity to plan and how carefully households monitor
their spending. It appears that this detailed monitoring
activity helps households to save more and to accumulate more
wealth.