The design of pension contracts: on the perspective of customers

This paper introduces a new pension contract which provides a smoothed return for the customer. The new contract protects customers from adverse asset price movements while keeping the potential of positive returns. It has a transparent structure and clear distribution rule, which can be easily understood by the customer. We compare the new contract to two other contracts under Cumulative Prospect Theory (CPT); one has a similar product structure but without guarantees and the other provides the same guarantee rate but with a different structure. The results show that the new contract is the most attractive contract for a CPT-maximising customer. Yet, we find different results if we let the customer be an Expected Utility Theory-maximising one. Moreover, this paper presents the static optimal portfolio for an individual customer. The results conform to the traditional pension advice that young people should invest more of their money in risky assets while older people should put more money in less risky assets.