Defined Benefit Research Articles

Intergenerational risk sharing in pay-as-you-go pension schemes*

Population ageing undermines traditional social security pension systems that combine pay-as-you-go and defined benefits (DB). Indeed, demographic risk, if guaranteed benefits remain unaltered, will be borne entirely by workers through increases in the contribution rate. To avoid a substantial increase of the contributions and in order to maintain simultaneously the financial sustainability and the social adequacy of the public pension system, risk sharing and automatic balancing mechanisms need to be put in place. We present a two-step convex family of risk-sharing mechanisms. The first shares the risk between contributors and retirees through adjustments in the contribution rate, used to calculate the global covered wage bill, and the benefit ratio that represents the relationship between average pensions and wages. The second step studies how the retirees' risk should be shared between the different retirees' generations through adjustments in the replacement rate and a sustainability factor that affects pension indexation during retirement. We perform a detailed study of the effect of social planner's targets and solidarity weight between various generations in a deterministic and stochastic environment.

Effects of a defined‐contribution retirement plan on teacher attrition

AbstractIn 2006, Alaska reformed its defined‐benefit (DB) Teacher Retirement System by creating a mandatory 401(k)‐style defined‐contribution (DC) plan for new hires. The new plan increased benefit portability and transferred the investment risk from the employer to the employee. Using individual teacher data for 2005–2017, we show that the reform increased teacher attrition. We also observe, however, that it did not lead to the loss of human capital. The paper contributes to the discussion of the design of DB–DC transitions that can maintain incentives for public‐sector employment.

De-risking strategies of defined benefit plans and economic outcome: empirical evidence from U.S. Firms

ABSTRACT This paper examines the de-risking behaviour of defined benefit (DB) pension plans sponsored by U.S. firms. By analysing a range of strategies used in U.S. markets between 1994 and 2018, such as plan shifts, freezes, terminations, buyouts, buyins, and longevity hedges, we identify the key drivers and outcomes of pension de-risking. Our findings suggest that severe underfunding of pension plans is a major catalyst for de-risking, and firms facing a higher degree of financial distress are more likely to de-risk. Although de-risking varies across sectors, we find no significant evidence of improvements in firm operational performance or credit risk following de-risking. Additionally, de-risking decisions are influenced by the interest rate environment, becoming more likely when the projected long-term interest rates decline or when returns on risky assets are expected to increase.

Prediction of the Effectiveness of Deferred Retirement in the Labor Market Performance in China

Abstract: The analytical document touching upon the prospects of how delaying retirement affects labor market ability in China reveals some crucial information about the implications of the retirement age policy modifications. This test may indicate that the retirement age raise would be a huge factor in China's labor market status, such as employment level and national pension funds. Apart from this, the paper is a reminder for the authorities to have a broad policy discussion on diverse fiscal consequences that different retirement age policies may cause like wage inflexibility, disposable labor issues, and the aging population. These results demonstrate that the simulation should be considered for its interplay with individuals' lives as well as for the macro economy. To scrutinize the efficacy of postponing retirement within China's employment market performance, it's critical to deploy some economic theories. The first method involves the insights from both the Beveridge curve and job creation curve to dissect the nuances of job turnover rates, opportunities for finding new jobs, and their influence on unemployment figures. Delving deeper into pension fund ramifications necessitates assessing the shift from Defined Contribution (DC) schemes towards Defined Benefit (DB) plans, while also taking stock of how dependency ratios come into play. Moreover, gauging effects on incremental labor productivity alongside capital-to-labor ratio calls for an expansive view that considers changes across various industrial sectors and their broader consequences on the labor market as a whole.

Retirement Preparedness among Malaysia’s Low-Income Private Sector Employees: A Conceptual Model

Retirement in Malaysia starts when individuals reach 60 years old. This is when individuals’ income will stop streaming in, and they need to use their savings, pensions or retirement scheme to support themselves post-retirement. There are two primary retirement schemes in Malaysia, which include (1) Defined Benefit (DB) for government servants and (2) Defined Contribution (DC) for private-sector workers managed by the Employee Provident Fund (EPF). The increasing aging population and the rise in retirees in Malaysia with a lack of retirement savings emphasize the significance of retirement preparedness. The life expectancy in Malaysia has increased, with males and females having an average lifespan of 71.8 years and 77.2 years, respectively. Malaysia's income groups can be divided into three groups: T20 (top 20%), M40 (middle 40%), and B40 (bottom 40%). This study will only focus on private sector employees with EPF accounts and the B40 group with an income of RM4850 and below. The B40 has the lowest savings in EPF, with only 1.01%, compared to the M40, which amounts to 16.56%, and the T20, which holds the most savings at 82.42%. The main objective of this study is to investigate retirement preparedness among low-income (B40) private-sector employees. By focusing on the direct relationship between attitude and social influence and their impact on retirement preparedness, the findings are intended to support financial institutions, policymakers, and organizations in designing and implementing effective financial education and literacy programs tailored to the needs of the low-income (B40) group.

Trends in the retirement security of Black and Hispanic households in the US: A setback for Black Americans but continued progress for Hispanics

Retirement income security refers to the ability of households to provide an adequate stream of income during the period of their retirement from the labor force. Expected retirement income is based of four components: (i) standard non-pension wealth holdings, (ii) defined contribution (DC) pension holdings, (iii) actual or expected defined benefit (DB) pension entitlements, and (iv) actual or expected Social Security benefits. The first two components are converted into an annuity. All the data (except rates of return) for these calculations are available from the Survey of Consumer Finances. Results indicate that both Black and Hispanic households made remarkable progress in terms of mean and median retirement income, poverty reduction, and replacement rates from 1989 to 2007 in both absolute terms and relative to whites. However, for Black households, this was followed by a reversal of fortune from 2007 to 2019, with expected median retirement income declining, the projected poverty rate rising, and the projected replacement rate falling, though expected mean retirement income does rise. Hispanics also experienced a setback in mean retirement income but continued progress in replacement rates and reducing poverty from 2007 to 2019.

Identifying Teacher Salary Spiking and Assessing the Impact of Pensionable Compensation Reforms in Illinois

Defined benefit (DB) pension plans incentivize “salary spiking,” where sharp increases in pay are leveraged into significantly higher levels of retirement compensation. While egregious instances of salary spiking occasionally make headlines, there is little guidance on the definition of salary-spiking behavior or understanding of its prevalence. We develop empirical methods to quantify the prevalence of salary spiking by identifying cases where end-of-career compensation deviates from the expected level of compensation. We apply this method to teacher pension systems in Illinois to assess the prevalence of salary spiking before and after the implementation of a reform designed to dissuade salary spiking.

Why are pension schemes frozen, and how does a freeze affect the Employer's risk?

Defined benefit (DB) pension schemes involve substantial risks and costs for employers. So employers have frozen (or closed) their schemes. Using data on firms in the FTSE 100 index, we study the characteristics of employers who hard froze (no new members or accruals) their DB scheme, and the effect of this on the employer's risk. We find that the probability of a hard freeze is a negative function of employer size, operating cash flow and unionization; and a positive function of a previous soft freeze (no new members). We also find that a hard freeze reduces total, unsystematic and credit risk; and increases systematic and asset risk.

Why do firms adopt employee ownership? An industry perspective

PurposeThis paper offers a new perspective on the potential motivation for the adoption of employee ownership based on market power. Employee ownership may be linked to market power, either through contributing to firm growth that leads to market power or through industry leaders adopting employee ownership as part of rent sharing or a broader consolidation of market position. Both employee stock ownership plan (ESOP) coverage and product market concentration (PMC) have been increasing in the past two decades, providing a good opportunity to see if and how these are related.Design/methodology/approachThe authors predict ESOP adoption and termination using multilevel regressions based on 2002–2012 firm- and industry-level data from the Census Bureau, Compustat and Form 5500 pension datasets.FindingsThe authors find that the top four firms in concentrated industries are more likely to adopt Employee Stock Ownership Plans (ESOPs), while having an ESOP does not predict entering the top four, apart from firm-level predictors. Tests indicate the first result does not reflect simple rent sharing with employees but instead appears to reflect an effort by firms to consolidate market power through the attraction and retention (or “locking in”) of industry talent. Other positive predictors of ESOPs include company size, being in a high-wage industry and having a defined benefit (DB) pension.Research limitations/implicationsTo better distinguish among hypotheses, it would be helpful to have firm-level data on managerial attitudes, strategies, networks and monopsony measures. Therefore, future research using such data would be highly useful and encouraged.Practical implicationsThe paper includes implications for the potential usefulness of ESOPs in attracting and retaining talent and for the design of nuanced policy to encourage more broadly based sharing of economic rewards.Originality/valueWhile prior research focuses on firm-level predictors of employee ownership, this study uses market concentration and other industry-level variables to predict the use of ESOPs. This study makes a unique contribution, broadening the current thinking on firm motives and environmental conditions predictive of firm ESOP adoption.

Pandemic and Financial Performance: Pre and During Pandemic Effect of Covid-19 on Financial Performance of Pension Funds Defined Benefit Plans and Defined Contribution Plans

Assessment of the financial performance of a pension fund can be done by analyzing the pension fund's financial reports. Based on the program, employer pension funds (EPF) are divided into two types, namely Defined Benefit Plan (DBP) and Defined Contribution Plan (DCP). This research aims to assess the financial performance of the Defined Benefit Plan (DBP) pension fund industry when compared with Defined Contribution Plan (DCP) pension funds pre-pandemic and during-pandemic for each financial ratio. Research was conducted on Pension Funds in Indonesia as a whole for the period January 2018 – December 2021. The ratios used to test the performance of each group of pension funds are Return on Assets (ROA), Return on Investment (ROI), Operational Cost Efficiency (EBO), Investment Cost Efficiency (EBI) and Pension Fund Growth (PDP). By using the Shapiro-Wilk W Test, Paired t Test, and Wilcoxon Signed Rank Test, the test results show that in DBP-EPF there are significant differences between pre-pandemic and during-pandemic for ROI and ROA. Where the ROI and ROA performance values pre-pandemic were higher than during-pandemic. There are no significant differences between EBO, EBI and PDP between pre-pandemic and during-pandemic in the DBP-EPF. Meanwhile, in the DCP-EPF there were no significant differences between pre-pandemic and during-pandemic for all variables. This proves that DBP-EPF experienced significant shocks during-pandemic. DBP-EPF is anticipating a strategy by reducing asset allocation to equity investment instruments, resulting in returns received that are not as good pre-pandemic

Do Managers Change Pension Plan Assumptions to Meet/Exceed Earnings Threshold? Korean Evidence

This study examines whether managers are likely to exercise discretion in determining pension plan actuarial assumptions to meet or exceed earnings targets. According to current accounting standards, managers can exercise broad discretion in setting actuarial assumptions under a defined benefit (DB) pension plan. Existing literature documents that managers can manage earnings upward by manipulating pension plan assumptions. Based on sample firms with DB pension plans from 2011 to 2018, our results reveal the followings. First, managers tend to manipulate pension assumptions optimistically when the unmanaged earnings miss the targets. Second, investors do not recognize the effect of changing assumptions on reported earnings and thus react favorably to the overstated earnings. Third, manipulating firms under-perform in the long run compared to the control group despite favorable short-term performance, which suggests accrual reversal and managerial attribute effects.

Factors that Influence Preferences for Defined Benefit Plans Versus Defined Contribution Plans

The majority of public sector employees in the United States still have access to defined benefit (DB) retirement plans, with some retaining a choice between a defined benefit plan and a defined contribution (DC) plan when hired. This research was based on a survey assessing individuals’ financial literacy, risk tolerance, and time orientation and the influence those three variables had on preferences for DB versus DC plans. Greater financial skill and risk tolerance were associated with a preference for DC plans, while a time orientation focused on the present was associated with a preference for DB plans. This research could benefit employers as they determine retirement plan options that they choose to offer employees. Employers who offer both plan types may benefit from informing employees about the factors associated with preferences for each plan type as greater awareness of such factors could improve employee satisfaction and increase retention. JEL Codes: J32, H75, G53, G32

Non‐operating risk and cash holdings: Evidence from pension risk

Using a large sample of U.S. firms sponsoring defined benefit (DB) plans, we examine the impact of pension risk on firms’ cash management decisions. We document a positive curvilinear relationship between pension risk and cash holdings, finding that cash holdings by firms with high pension risk dramatically increase as their pension risk increases. However, this relationship appears only in the case of financially unconstrained firms, which suggests that the incentives to hedge against pension risk are only relevant when such risk is manageable. These results hold across different specifications, as well as when using several tests to address the potential endogeneity issue. We conduct multiple tests to examine alternative explanations of the findings, and we find that our results are mainly explained by the hedging incentives against pension risk and that the excess cash held by firms with higher pension risk is realized in a higher marginal value of cash.

Practical Applications of Maximizing Capital Efficiency in US Defined Benefit Pension Plan Immunizing Portfolio Construction Using Derivatives and a Power Law Relationship

In <b><i>Maximizing Capital Efficiency in US Defined Benefit Pension Plan Immunizing Portfolio Construction Using Derivatives and a Power Law Relationship</i></b>, from the April 2022 issue of <b><i>The Journal of Portfolio Management</i></b>, <b>Scott McDermott</b> of <b>Goldman Sachs Asset Management</b> explores the challenges of asset-liability risk management for the portfolios of defined-benefit pension plans. He first divides a plan’s portfolio into two components: one allocated to managing asset-liability matching (an “immunizing portfolio” or “IP”) and a second allocated to outperform the plan’s liabilities over time (a “growth portfolio” or “GP”). McDermott argues that an IP should be managed dynamically, to maximize capital efficiency, and that, when capital is scarce, managing interest rate risk takes priority over managing credit risk. However, the proportion of capital used for managing credit risk should increase as a plan’s funding status improves. The author proposes a power law relationship between the hedge ratios for interest rate risk and credit risk. He recommends using interest rate and other derivatives to maximize the efficiency of the strategy. The author thinks all managers should ask the following question: Which is riskier, interest rate or credit spread risk? Which has the most volatility, Treasury yields or corporate spreads? Which should we focus on hedging first, and how should we make the trade-off? His research provides fund managers with an approach to answer these questions and develop a more efficient hedging program.

Stochastic optimal control problems of discrete‐time Markov jump systems

AbstractIn this paper, we consider the indefinite stochastic optimal control problems of discrete‐time Markov jump linear systems. Firstly, we establish the new stochastic maximum principle, and by solving the forward‐backward stochastic difference equations with Markov jump (FBSDEs‐MJ), we derive the necessary and sufficient solvability condition of the indefinite control problem with non‐discounted cost, which is in an explicit analytical expression. Then, the optimal control is designed by a series of coupled generalized Riccati difference equations with Markov jump (GRDEs‐MJ) and linear recursive equations with Markov jump (LREs‐MJ). Moreover, based on the non‐discounted cost case, we deduce the optimal control problem with discounted cost. Finally, a numerical example for defined‐benefit (DB) pension fund with regime switching is exploited to illustrate the validity of the obtained results.

Commentary on Teacher Pension Papers

This commentary explains how changing labor market conditions have made it more important for schools to attract and retain skilled teachers and yet more difficult to do so. This is important context for considering the contributions of the five papers on teacher pensions in this special issue. I describe and comment on the evidence that defined benefit (DB) pension plans have deleterious impacts on the ability of public schools to provide students with an excellent education. I describe the merits of alternative strategies for responding to the central problem with DB plans as currently funded. I conclude by explaining the importance of considering the design of teacher pension plans as part of a multipronged strategy to provide all students with a high-quality education.

The Actuarial Sources of the Rise in Unfunded Liabilities in America’s Defined Benefit Plans in the 21st Century

The Actuarial Sources of the Rise in Unfunded Liabilities in America’s Defined Benefit Plans in the 21st Century

Perancangan Modul Persetujuan Otomatis dan Klasifikasi pada Sistem Persetujuan Lapor Diri Pensiun Menggunakan FSA

Retired Dana Pensiun Perkebunan Defined Benefit Pension Plan (PPMP) participants are required to certify annually that they still meet the criteria for being a valid pensioner. The retiree uses the Dapenbun online application to take a photo of himself and her ID card and wait for the data to be processed by the administrator. Pensioners who do not report will have their pension entitlements suspended. The number of retirees managed by the Plantation Pension Fund is over 216,000, and managers are overwhelmed with approval at the start of the re-data period. For this reason, authors design systems that can run automated approval and classification systems to facilitate data approval. Applying the FSA concept to this system reduces the processing of participant data as automation is applied to the first process of automatic termination of pensions for children aged 21 and over, second data with criteria for automatic approval. It will be faster. Categorizing data reduces approval errors and makes it easier for users to approve data.

Valuing Losses of Pension Benefits

Valuing Losses of Pension Benefits

Practical Applications of The Trouble with State Government Employee Pension Plans: The Case of Connecticut

In <b><i>The Trouble with State Government Employee Pension Plans: The Case of Connecticut</i></b>, from the Winter 2022 issue of <b><i>The Journal of Retirement</i></b>, author <b>Mark J. Warshawsky</b> of the <b>American Enterprise Institute</b> explores threats to the financial viability of state- and municipal-employee pension plans. Unlike the private sector, most public-sector employers still offer defined-benefit (DB) lifetime pensions to employees. However, many of these pensions are seriously underfunded. That threatens the retirement income security of public employees and puts taxpayers at risk of having to pay for bailouts. The author pinpoints several factors contributing to this problem. Most significantly, states and municipalities have contributed too little to their DB plans and have made optimistic assumptions about future investment returns. Using the State of Connecticut’s DB plans as a case study, the author finds they have tried to address these problems by extending amortization periods to pay off liabilities. The author tests these measures and finds that the Connecticut plans are still overly optimistic and at risk of shortfalls. He therefore suggests that the federal government regulate public-employee DB plans and that Connecticut close its DB plans and offer defined-contribution (DC) plans instead.