Fair pensions

Ilja Boelaars, Dirk Broeders

Research output: Working paperProfessional

Abstract

This paper examines the allocation of market risk in a general class of collective
pension arrangements: Collective Defined Contribution (CDC) schemes. In a CDC
scheme participants collectively share funding risk through benefit level adjustments. There is a concern that, if not well designed, CDC schemes are unfair and will lead to an unintended redistribution of wealth between participants and, in particular, between generations. We define a pension scheme as fair if all participants receive an arbitrage-free return on the market risk they bear. The fact that the participants’ claim the CDC schemes’ collective assets is expressed in terms of a stochastic future, makes the arbitrage-free allocation of market risk non-trivial. It depends crucially on the specification of the discount rate process in combination with the benefit adjustment process. We show that fair CDC schemes may use a default-free market interest rate in combination with a specific horizon-dependent benefit adjustment process. Alternative discount rates are also permissible, but require additional correction terms in the benefit adjustment process.
Original languageEnglish
PublisherDe Nederlandsche Bank
Number of pages46
Volume630
Publication statusPublished - 2019

Publication series

SeriesDNB Working Paper
Number630

JEL classifications

  • h55 - Social Security and Public Pensions
  • g13 - "Contingent Pricing; Futures Pricing; option pricing"
  • g23 - "Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors"
  • j26 - "Retirement; Retirement Policies"
  • j32 - "Nonwage Labor Costs and Benefits; Private Pensions"

Keywords

  • pension
  • retirement
  • asset pricing
  • fair value
  • intergenerational risk-sharing
  • funded pension systems

Cite this

Boelaars, I., & Broeders, D. (2019). Fair pensions. De Nederlandsche Bank. DNB Working Paper, No. 630