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Optimal Pension Insurance Design

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  • Døskeland, Trond M.

    () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Nordahl, Helge A.

    () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Abstract

In this paper we analyze how the traditional life and pension contracts with a guaranteed rate of return can be optimized to increase customers’ welfare. Given that the contracts have to be priced correctly, we use individuals’ preferences to find the preferred design. Assuming CRRA utility, we cannot explain the existence of any form of guarantees. Through numerical solutions we quantify the difference (measured in certainty equivalents) to the preferred Merton solution of direct investments in a fixed proportion of risky and risk free assets. The largest welfare loss seems to come from the fact that guarantees are effective by the end of each year, not only by the expiry of the contract. However, the demand for products with guarantees may be explained through behavioral models. We use cumulative prospect theory as an example, showing that the optimal design is a simple contract with a life-time guarantee and no default option.

Suggested Citation

  • Døskeland, Trond M. & Nordahl, Helge A., 2006. "Optimal Pension Insurance Design," Discussion Papers 2006/14, Norwegian School of Economics, Department of Business and Management Science, revised 21 Jun 2007.
  • Handle: RePEc:hhs:nhhfms:2006_014
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Mahayni, Antje & Schneider, Judith C., 2012. "Variable annuities and the option to seek risk: Why should you diversify?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2417-2428.
    2. Broeders, Dirk & Chen, An, 2010. "Pension regulation and the market value of pension liabilities: A contingent claims analysis using Parisian options," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1201-1214, June.
    3. Nielsen, J. Aase & Sandmann, Klaus & Schlögl, Erik, 2011. "Equity-linked pension schemes with guarantees," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 547-564.
    4. Johanna Scheller & Jacques Pézier, 2008. "Optimal Investment Strategies and Performance Sharing Rules for Pension Schemes with Minimum Guarantee," ICMA Centre Discussion Papers in Finance icma-dp2008-09, Henley Business School, Reading University, revised Oct 2009.
    5. Branger, Nicole & Mahayni, Antje & Schneider, Judith C., 2010. "On the optimal design of insurance contracts with guarantees," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 485-492, June.
    6. Trond M Døskeland & Helge A Nordahl, 2008. "Intergenerational Effects of Guaranteed Pension Contracts," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 33(1), pages 19-46, June.
    7. Berkelaar, Arjan & Kouwenberg, Roy, 2009. "From boom 'til bust: How loss aversion affects asset prices," Journal of Banking & Finance, Elsevier, vol. 33(6), pages 1005-1013, June.
    8. Chen, An & Hentschel, Felix & Klein, Jakob K., 2015. "A utility- and CPT-based comparison of life insurance contracts with guarantees," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 327-339.
    9. Antje Mahayni & Judith C. Schneider, 2016. "Minimum return guarantees, investment caps, and investment flexibility," Review of Derivatives Research, Springer, pages 85-111.

    More about this item

    Keywords

    Household Finance; Portfolio Choice; Life and Pension Insurance; Prospect Theory;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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