Minimum Funding Ratios for Defined-Benefit Pension Funds
AbstractWe compute minimum funding ratios for Defined Benefit (DB) plans based on the expected utility that can be achieved in a Defined Contribution (DC) pension scheme. Using Monte Carlo simulation, expected utility is computed for three different specifications of utility: power utility, mean-shortfall and mean-downside deviation. Depending on risk aversion and the level of sophistication assumed for the DC-scheme, minimum acceptable funding ratios are between 0.87 and 1.20. If the DC-scheme is constrained to a fixed-contribution setup, minimum funding ratios are between 0.87 and 0.98. Furthermore, the attractiveness of the DB plan increases with the expected equity premium and the fraction invested in stocks. We conclude that the expected value of intergenerational solidarity, implicit in the DB pension fund, can be large. Given a pension fund with a funding ratio of 1.30, a participant in a DC plan has to pay a 2.7 to 6.1%-point higher contribution to achieve equal expected utility.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 180.
Date of creation: Sep 2008
Date of revision:
defined-benefit pension fund; individual efficiency; defined-contribution;
Other versions of this item:
- Siegmann, Arjen, 2011. "Minimum funding ratios for defined-benefit pension funds," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(03), pages 417-434, July.
- E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- J50 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-10-28 (All new papers)
- NEP-IAS-2008-10-28 (Insurance Economics)
- NEP-MAC-2008-10-28 (Macroeconomics)
- NEP-RMG-2008-10-28 (Risk Management)
- NEP-UPT-2008-10-28 (Utility Models & Prospect Theory)
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