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Optimal Investment Strategies and Performance Sharing Rules for Pension Schemes with Minimum Guarantee

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  • Johanna Scheller

    ()
    (ICMA Centre, University of Reading)

  • Jacques Pézier

    (ICMA Centre, University of Reading)

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    Abstract

    There is a potential conflict of interest between a pension fund sponsor and future pensioners when they share unequally in the pension fund performance. Thus, when a scheme offers a yearly guaranteed minimum return to pensioners, as is presently the case with German Pensionskassen, the sponsors cannot afford to invest in risky assets and consequently, pensioners end up with safe but very low expected returns. We examine optimal investment strategies for sponsors under alternative performance sharing rules and seek the rules that are most beneficial to pensioners. We find that the current yearly performance sharing rule imposed on Pensionskassen could be tilted in favor of sponsors without impairing the welfare of pensioners. We also find that the welfare of pensioners would be greatly enhanced if the guaranteed minimum return were applied to the cumulative return since inception of the scheme rather than to yearly returns. The ensuing credit risk taken by pensioners on sponsors could be kept to a minimum by proper regulation; this would induce sponsors to adopt safe constant proportionality portfolio insurance (CPPI) style investment strategies.

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    File URL: http://www.icmacentre.ac.uk/files/2008_09.pdf
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    Bibliographic Info

    Paper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2008-09.

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    Date of creation: Nov 2008
    Date of revision: Oct 2009
    Handle: RePEc:rdg:icmadp:icma-dp2008-09

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    Postal: PO Box 218, Whiteknights, Reading, Berks, RG6 6AA
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    Web page: http://www.henley.reading.ac.uk/
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    Related research

    Keywords: Private pension schemes; benefit-sharing rules; capital guaranteed products; constant mix strategies; constant proportionality portfolio insurance strategies; utility theory;

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    1. Døskeland, Trond M. & Nordahl, Helge A., 2008. "Optimal pension insurance design," Journal of Banking & Finance, Elsevier, vol. 32(3), pages 382-392, March.
    2. Consiglio, Andrea & Saunders, David & Zenios, Stavros A., 2006. "Asset and liability management for insurance products with minimum guarantees: The UK case," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 645-667, February.
    3. Bjarne Astrup Jensen & Carsten Sørensen, 2001. "Paying for Minimum Interest Rate Guarantees: Who Should Compensate Who?," European Financial Management, European Financial Management Association, vol. 7(2), pages 183-211.
    4. Barsky, Robert B, et al, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 537-79, May.
    5. Deelstra, Griselda & Grasselli, Martino & Koehl, Pierre-Francois, 2003. "Optimal investment strategies in the presence of a minimum guarantee," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 189-207, August.
    6. Michael J. Brennan, 1993. "Aspects of Insurance, Intermediation and Finance*," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 18(1), pages 7-30, June.
    7. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    8. Deelstra, Griselda & Grasselli, Martino & Koehl, Pierre-Francois, 2004. "Optimal design of the guarantee for defined contribution funds," Journal of Economic Dynamics and Control, Elsevier, vol. 28(11), pages 2239-2260, October.
    9. Black, Fischer & Perold, AndreF., 1992. "Theory of constant proportion portfolio insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 403-426.
    10. Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2003. "Optimal investment strategies in the presence of a minimum guarantee," ULB Institutional Repository 2013/7598, ULB -- Universite Libre de Bruxelles.
    11. Boulier, Jean-Francois & Huang, ShaoJuan & Taillard, Gregory, 2001. "Optimal management under stochastic interest rates: the case of a protected defined contribution pension fund," Insurance: Mathematics and Economics, Elsevier, vol. 28(2), pages 173-189, April.
    12. Sandra Blome & Kai Fachinger & Dorothee Franzen & Gerhard Scheuenstuhl & Juan Yermo, 2007. "Pension Fund Regulation and Risk Management: Results from an ALM Optimisation Exercise," OECD Working Papers on Insurance and Private Pensions 8, OECD Publishing.
    13. Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2004. "Optimal design of the guarantee for defined contribution funds," ULB Institutional Repository 2013/7602, ULB -- Universite Libre de Bruxelles.
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