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Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints

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Author Info
Maurer, Raimond
Mitchell, Olivia S.
Rogalla, Ralph

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Abstract

Using a Monte Carlo framework, we analyze the risks and rewards of moving from an unfunded defined benefit pension system to a funded plan for German civil servants, allowing for alternative strategic contribution and investment patterns. In the process we integrate a Conditional Value at Risk (CVaR) restriction on overall plan costs into the pension manager's objective of controlling contribution rate volatility. After estimating the contribution rate that would fully fund future benefit promises for current and prospective employees, we identify the optimal contribution and investment strategy that minimizes contribution rate volatility while restricting worst-case plan costs. Finally, we analyze the time path of expected and worst-case contribution rates to assess the chances of reduced contribution rates for current and future generations. Our results show that moving toward a funded public pension system can be beneficial for both civil servants and taxpayers.

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Publisher Info
Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

Volume (Year): 45 (2009)
Issue (Month): 1 (August)
Pages: 25-34
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Handle: RePEc:eee:insuma:v:45:y:2009:i:1:p:25-34

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Web page: http://www.elsevier.com/locate/inca/505554

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Related research
Keywords: Public pensions Defined benefit Funding Investing Contribution rate risk Conditional Value at Risk;

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    Other versions:
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    Other versions:
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  7. Olivia S. Mitchell & David McCarthy & Stanley C. Wisniewski & Paul Zorn, . "Developments in State and Local Pension Plans," Pension Research Council Working Papers 99-4, Wharton School Pension Research Council, University of Pennsylvania. [Downloadable!]
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  10. Chang, S. C. & Tzeng, Larry Y. & Miao, Jerry C. Y., 2003. "Pension funding incorporating downside risks," Insurance: Mathematics and Economics, Elsevier, vol. 32(2), pages 217-228, April. [Downloadable!] (restricted)
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  14. Haberman, Steven, 1997. "Stochastic investment returns and contribution rate risk in a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 19(2), pages 127-139, April. [Downloadable!] (restricted)
  15. Hoevenaars, Roy P.M.M. & Molenaar, Roderick D.J. & Schotman, Peter C. & Steenkamp, Tom B.M., 2008. "Strategic asset allocation with liabilities: Beyond stocks and bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 32(9), pages 2939-2970, September. [Downloadable!] (restricted)
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