Exploitative Contracting in a Life Cycle Savings Model


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 profit-maximising financial provider in order to examine the properties of exploitative savings contracts and the impact of common policy interventions. Using a tractable theoretical model, I find that naive present-biased agents are offered contracts that are `inefficiently cheap' (low-yield, low-fee) when the income effect of an interest rate change dominates in the agent's utility function, and `inefficiently expensive' (high-yield, high-fee) otherwise. Subsequently, I embed the interaction with a pension provider in a numerical life-cycle framework with hyperbolic discounting. The  calibrated model indicates that due to naivete, the contract offered in market equilibrium is Pareto-inefficient. Inefficient contracting reduces the agent's pension wealth by 8%, lowering expected annual consumption in retirement by 3%. The associated loss of consumer welfare corresponds to 0.23% of annual consumption.