Mike Otsuka (LSE): How to guard against the risk of living too long: a Hobbesian voluntarist case for socialized pensions

Abstract: I defend the view that a defined benefit pension plan can be justified as a social union of social unions, where each social union is a Hobbesian Leviathan of our cohorts that it is to the mutual benefit of each to contract into, to pool and tame the longevity risks that we face as individuals by taking advantage of the law of large numbers. The different cohorts in turn will find it rational to enter into covenants with one another in order to pool and tame the investment risks that remain. The immortal corporate body that arises can, given realistic assumptions, remain forever invested in high risk, high expected yield assets, in order to provide each of the individual cells (i.e., workers) that constitute it a better pension than she could hope to generate through her own private defined contribution pension pot. Although the defined benefit pension is derided as an obsolete, collectivist, socialist relic, it is in fact a voluntary mutual association that it would be rational for each to contract into, were it not for the fact that it is now being regulated out of existence, to the mutual disadvantage of employers and employees, in a manner contrary to the free market ideals of those who champion the replacement of defined benefit by defined contribution. The assumptions of prudence and risk aversion that underpin such regulation actually imply that the defined contribution pensions that these regulations are forcing us to adopt are a very bad for us to have, so long as we assume that individual workers should be at least as risk averse and prudent as the large institutions that form our employers and our pension funds.