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Controlling the cost of minimum benefit guarantees in public pension conversions

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  • SMETTERS, KENT

Abstract

Reformed public DC plans typically contain a minimum benefit guarantee (DC-MB). This paper explores risk management techniques to control the cost of these guarantees in DC systems with minimum benefit guarantees (DC-MB). The paper finds two approaches are particularly useful. The first approach borrows an idea from the recent catastrophic insurance literature. The guarantee is placed over a standardized portfolio, requiring agents to accept any basis risk if they chose a non-standard portfolio. However, for large conversions from DB to DC-MB plans, in which there is little or no DB benefit remaining, the government must still worry about any implicit guarantee that might extend beyond the standardized portfolio which might entice agents to accept a lot of basis risk (a Samaritan s Dilemma ). The second method, therefore, uses a more brute force approach: private portfolio returns in the good states of the world are taxed while returns in the bad states are subsidized. Both options are very effective at controlling guarantee costs, and they can be used separately or together. Calculations demonstrate that all of the unfunded liabilities associated with modern pay-as-you-go public pension programs can be eliminated under both approaches even at a modest contribution rate.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Journal of Pension Economics and Finance.

Volume (Year): 1 (2002)
Issue (Month): 01 (March)
Pages: 9-33

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Handle: RePEc:cup:jpenef:v:1:y:2002:i:01:p:9-33_00

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  1. Marcus, Alan J, 1985. " Spinoff-Terminations and the Value of Pension Insurance," Journal of Finance, American Finance Association, vol. 40(3), pages 911-24, July.
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Cited by:
  1. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
  2. Sule Sahin & Adem Yavuz Elveren, 2009. "A Cost Analysis of a Minimum Pension Guarantee for the Individual Pension System in Turkey," Working Paper Series, Department of Economics, University of Utah 2009_13, University of Utah, Department of Economics.
  3. Sergi Jiménez-Mart�n & Alfonso R. Sánchez Mart�n, 2007. "An evaluation of the life cycle effects of minimum pensions on retirement behavior," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(5), pages 923-950.
  4. Marie-Eve Lachance & Olivia S. Mitchell, 2003. "Guaranteeing Individual Accounts," American Economic Review, American Economic Association, vol. 93(2), pages 257-260, May.
  5. Olivia S. Mitchell & Alexander Muermann, 2003. "The Demand for Guarantees in Social Security Personal Retirement Accounts," Working Papers wp060, University of Michigan, Michigan Retirement Research Center.
  6. Richard Johnson, 2003. "Portfolio choice in tax-deferred and Roth-type savings accounts," Research Working Paper RWP 03-08, Federal Reserve Bank of Kansas City.
  7. Muermann, Alexander & Mitchell, Olivia S. & Volkman, Jacqueline M., 2006. "Regret, portfolio choice, and guarantees in defined contribution schemes," Insurance: Mathematics and Economics, Elsevier, vol. 39(2), pages 219-229, October.
  8. Hoevenaars, Roy P.M.M. & Ponds, Eduard H.M., 2008. "Valuation of intergenerational transfers in funded collective pension schemes," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 578-593, April.

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