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A Behavioral Approach to Retirement Guarantees

The paper derives a mathematical model of a pension insurance contract which simultaneously provides an escalating guarantee for retirement income and allows for a life cycle asset allocation style of investing. Simulations show that life cycle strategies which incorporate guarantees to be welfare improving. The degree of guaranteed income does not change the result. The improvement in welfare comes from incorporating prospect theory behavioral characteristics in the utility function of the agents. The superiority of the insurance strategy seems to be most dependent on the behavioral trait of subjective probability weighting.