Tomasz Sulka, The University of Edinburgh

“Savings Contracts for Naive Agents”

Abstract 

Recent pension reforms in OECD countries endow individuals with more responsibility for their financial security in retirement, raising concerns about their ability to select appropriate pension arrangements and save adequately. This paper analyses the interaction between a present-biased individual and a financial provider in order to examine the properties of equilibrium savings contracts and the impact of common policy interventions. Using a tractable model, I find that naïve present-biased agents are offered exploitative contracts that are either ‘inefficiently cheap' (low-yield, low-fee) or ‘inefficiently expensive' (high-yield, high-fee), depending on whether the income or the substitution effect of an interest rate change dominates in the agent's utility function. Subsequently, I embed the interaction with a pension provider in a numerical life-cycle framework with hyperbolic discounting. Under the benchmark calibration, the equilibrium contract is Pareto inefficient, lowers the agent's wealth at retirement by 10%, and generates a small, but non-trivial loss of consumer welfare of 0.17% per annum.

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