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DEFINED CONTRIBUTION PENSION SCHEMES: OPTIMAL INVESTMENT STRATEGIES
VIGNA, ELENA
2000-02-14
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Contributor(s)
ZECCHIN, MARCO
•
HABERMAN, STEVEN
Abstract
Pension schemes are usually divided into two groups: defined benefit and defined contribution schemes. The main difference between these two groups is the way the financial risk is treated. In defined contribution pension schemes the contribution rate is defined in the scheme's rules ( usually as a percentage of the salary) and the leve l .of the pension achieved a t retirement depends · on the performance of the investment retums achieved during the membership. That is, the member knows exactly in advance ·how much he/she will pay in the fund, but does not know the amount of pension he/she will receive at retirement Therefore, the member bears the financial risk in defined contribution pension schemes. In defined benefit pension schemes the final pension is defined in the scheme's rules (usually as a percentage of the final salary) and the contribution rate is adjusted regularly by the actuary depending on the experienced retums and on the final pension guaranteed at retirement. Most defined benefit pension schemes are occupational and usually the member pays the same fixed percentage (eg 5% ofthe salary) while the.employer pays the remaining (and aleatory) part ofthe adjusted contribution rate. In particular, if the investment performance is too low the employer will pay a high contribution rate, if it is higher than expected will pay a low contribution rate or even will not pay for a while ( contribution ho li day). The member knows exactly in advance how much he/she will pay and al so the leve l of pension received at retirement, whereas the employer does not know how much he/she will pay in orderto match the liability. In other words, the employer bears the finanèial risk in defined benefit pension schemes. Summarising, the main difference between defined benefit and defined contribution pension schemes is that in defined benefit the financial risk is ·bome by the employer, whereas' in defined contribution it ·i s bome by the member who does not know in advance the amount of pension, the latter being strongly linked to the investment performance during membership. In the thesis the problem offinancial risk in defined contribution.pension.schemes is considered. The choice of considering a defined contribution pension scheme is due mainly to two reasons. The first one is the increasing switching in most developed countries from defined benefit to defined contribution pension schemes (due to the unpredictable cost of providing pension for the employer): it is likely that in Europe in the next 2-3 decades defined benefit pension schemes will be very rare. The second one is that in Italy the occupational pension schemes have to be "defined contribution" by law. Therefore it seems to be of more interest nowadays, and especially in Italy, to· analyse problems related to this kind of pension schemes. In a first part the mentioned problem is introduced and a panorama of the existing literature about this theme is exposed. Literature has also been explored which deals with dynamic programming applied to actuarial problems and portfolio selection. In a second part a mode l is constructed, a problem is formulated. and solved using the 'mathematical tools of the dynamic stochastic programming. A defined contribution pension scheme is introduced. in a two-asset ·(low-risk and · high-risk ), discrete-time world, the equation of the fund growth of the member is derived ·- allowing. for lognormal retums - and the following problem is defined: what is the optimal investment allocation of the fund every year which .minimises the deviations of the actual fund from some final. and interim targets, reasonably chosen? This problem seems to be consistent with·the real investment
Insegnamento
Publisher
Università degli studi di Trieste
Languages
en
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