The choice of private pension plans under uncertainty
Individuals in the UK now face an effective choice between joining different types of pension plan. We model this choice in a life cycle utility- maximising framework, for risk averse individuals. It is assumed that no pension plan can guarantee every individual a fair annuity at the risk-free rate of interest. By opting for a 'defined contribution' (money purchase) pension, the individual is assumed to incur investment risk (uncertainty of outcome in the capital market). By opting for a final salary based 'defined benefit' plan, the individual incurs a risk of reduced pension rights associated with job turnover. Assuming that the expected return to the two plans is identical, and equal to the risk free rate of interest, utilities are evaluated consequent upon choice of pension plan, including mixed strategies, in a multiperiod framework. The sensitivity of utility, and choice of pension arrangement, to variations in the individual risk of job severance, to capital market risk, and to the nature of risk aversion, are examined.
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