Sustainability of participation in collective pension schemes: An option pricing approach

Abstract

This paper contributes to the discussion about mandatory participation in collective funded pension schemes. It explores under what circumstances individual participants exercise the option to exit such a scheme if participation is voluntary. We begin by showing how the willingness to participate increases if the period over which the option is valid becomes longer. Then, we demonstrate how the pension fund’s set of policy instruments can be deployed to minimize the likelihood that any cohort exits the pension scheme. The instruments consist of contribution and indexation policies. Recovery of the funding ratio, i.e. the ratio of assets over liabilities, to its regulatory target level may be based on uniform contributions or age-dependent contributions. Specifically, while the value of the exit option deters younger workers from exiting the pension fund, a uniform contribution policy encourages older workers to stay in the pension scheme.