Pension COLAs

This paper studies cost of living adjustments in pensions from the perspective of labor economics. Evidence from longitudinal data on pension and annuity incomes of retirees suggests that pension COLAs are less important in the 1980s than in the 1970s, but that through 1987 they continued to cover about half of cost of living increases. Data from a longitudinal sample of pension benefit formulae and COLA provisions collected by the Wyatt Company for the fifty largest industrial companies indicate that if the 1968-78 decade persisted, cost of living adjustments would increase basic pension benefits for retirees by a half; while if the inflation experience were that of the 1978-88 period, pension COLAs would raise the present value of pensions by only fourteen percent. Simulation analysis allows an examination of the effects of pension COLA provisions on the key incentives emphasized in the pension literature, incentives affecting the retirement, turnover and shirking decisions. Pension COLAs are found to have very small effects on these incentives. Finally a simulation analysis demonstrates that when the contribution side of COLAs is taken into account, pension COLAs do not necessarily dampen the variation among generations in real incomes realized under alternative inflation shocks.