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

Author

Listed:
  • Johanna Scheller

    () (ICMA Centre, University of Reading)

  • Jacques Pézier

    (ICMA Centre, University of Reading)

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.

Suggested Citation

  • 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.
  • Handle: RePEc:rdg:icmadp:icma-dp2008-09
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    File URL: http://www.icmacentre.ac.uk/files/2008_09.pdf
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    References listed on IDEAS

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    1. 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.
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    4. Døskeland, Trond M. & Nordahl, Helge A., 2008. "Optimal pension insurance design," Journal of Banking & Finance, Elsevier, vol. 32(3), pages 382-392, March.
    5. 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.
    6. 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.
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    11. 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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    More about this item

    Keywords

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

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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