The rising longevity gap by lifetime earnings - distributional implications for the pension system

By Peter Haan, Daniel Kemptner and Holger Lüthen

In most OCED countries, life expectancy has been strongly increasing over the last decades.   At the same time, there is large country-specific heterogeneity in life expectancy within a birth cohort; for example by education, region, wealth, and income. This heterogeneity can induce strong distributional effects through the pension system, if - as present in most countries - pension income is linked to earnings in working life. Specifically, since, ceteris paribus, individuals with high lifetime earnings have a higher life expectancy, they will receive their monthly pension income for a longer period than individuals with lower lifetime earnings. In this case, the pension system redistributes from the lifetime rich to lifetime poor individuals.  

BCCP Fellow Peter Haan, Daniel Kemptner and Holger Lüthen analyze these distributional implications for the German pension system and document how the distribution effects have changed over time.

Based on administrative data covering the universe of German retirees, first they analyse the heterogeneity in life expectancy by lifetime earnings of West German male employees and show how the earnings-related longevity gap has evolved over 24 cohorts, born from 1926 through 1949. They document a strong association between lifetime earnings and life expectancy at age 65, showing that the longevity gap is increasing across cohorts. For West German male employees born between 1926 and 1928, the difference in life expectancy at age 65 between the top and bottom deciles amounts to about 4 years or close to 30%. For this group, the gap increases to about 7 years (almost 50%) for the 1947-49 cohorts. Further, they show that the increase in the longevity gap is driven by a larger increase in life expectancies in the upper deciles. For individuals in the bottom decile, life expectancy hardly changed over time.

In the second part of the study, the authors focus on the distributional implications of heterogeneous life expectancy for the pension system. The earnings-related heterogeneity in life expectancy has sizable and relevant distributional consequences for the pension system. The author shows that, under the hypothetical assumption of homogenous life expectancy, the German pension system is progressive, which is mainly explained by early retirement programs. However, when accounting for the empirical heterogeneous life expectancy, the distributional implications turn around: since the relation between lifetime earnings and life expectancy is so strong in Germany, the authors find that the pension system is regressive for West German male employees despite the strong link between benefits and prior contributions in the German pension formula. Finally, they document -- consistent with the increasing longevity gap -- an increase of the regressive structure across cohorts.

The study The Rising Longevity Gap by Lifetime Earnings: Distributional Implications for the Pension System is recently published in the Journal of the Economics of Ageing.