Risk and Portfolio Choices in Individual and Collective Pension Plans

Abstract

The current financial crisis is expected to have a considerable impact on the pension benefits to be paid in the future in most countries in which funded schemes play an important role in the social security system. Typically, pension funds invest more than 50% of their reserves in equity – with the remaining being invested in bonds, bills, real estate or private equity. Because of the crash in equity markets, and the bad health of other asset markets, Argentina had to nationalise its insolvent pension funds, whereas many defined-benefit (DB) pension funds in both the US and the UK are expected to rely on national solidarity to be able to pay the promised pension benefits to their members. At the same time, many workers with an individual pension plan (such as the 401k in the US) are considering the possibility of compensating their own huge losses of pension wealth by increasing their contributions, or by delaying their retirement. Does this mean that funded pension systems and individual workers around the world have relied too much on risky assets to improve their expected pension benefits? More generally, what are the determinants of the optimal allocation of pension wealth, for individual and collective plans? Given the difficulty of most households to plan for the long term, what default options should defined-contribution (DC) retirement plans propose to their members (Cui, 2008)?