Pension Plans Research Articles

Assessing the Efficiency of Defined Benefit Private and Public Pension Plans using Data Envelopment Analysis Adjusted Estimator

This study uses data envelopment analysis (DEA) adjusted estimator to assess the efficiency of defined benefit private and public pension plans in the Republic of Congo. We also incorporate the industry fund in the assessment. The authors apply constant return to scale (CRS) adjusted estimator input and output orientation. In input orientation, we intellectualize efficiency as the ability of defined benefit pension funds to reduce costs, whereas assets remain constant. In output orientation, we conceive efficiency as raising the return on investment in existing contribution, administrative, and investment cost capacities. CRS-adjusted scores depict that the defined benefit private pension fund is on the efficient frontier regarding its input and output. The defined benefit public and industry pension funds are off the efficient frontier. Hence the private sector ranked first, is more efficient than the public sector, ranked third. The industry sector is less efficient compared to the private sector but more efficient than the public sector. As far as efficiency studies are concerned, this study is the first in sub-Saharan Africa to use the DEA-adjusted estimator to assess the efficiency of defined benefit pension funds.

Modelling mortality: A bayesian factor-augmented var (favar) approach

AbstractLongevity risk is putting more and more financial pressure on governments and pension plans worldwide due to pensioners’ increasing trend of life expectancy and the growing numbers of people reaching retirement age. Lee and Carter (1992, Journal of the American Statistical Association, 87(419), 659–671.) applied a one-factor dynamic factor model to forecast the trend of mortality improvement, and the model has since become the field’s workhorse. It is, however, well known that their model is subject to the limitation of overlooking cross-dependence between different age groups. We introduce Factor-Augmented Vector Autoregressive (FAVAR) models to the mortality modelling literature. The model, obtained by adding an unobserved factor process to a Vector Autoregressive (VAR) process, nests VAR and Lee–Carter models as special cases and inherits both frameworks’ advantages. A Bayesian estimation approach, adapted from the Minnesota prior, is proposed. The empirical application to the US and French mortality data demonstrates our proposed method’s efficacy in both in-sample and out-of-sample performance.

Asset allocation for a DC pension plan with minimum guarantee constraint and hidden Markov regime-switching

This paper is devoted to the study of the asset allocation problem for a DC pension plan with minimum guarantee constraint in a hidden Markov regime-switching economy. Suppose that four types of assets are available in the financial market: a risk-free asset, a zero-coupon bond, an inflation-indexed bond and a stock. The expected return rate of the stock depends on unobservable economic states, and the change of states is described by a hidden Markov chain. In addition, the CIR process is used to describe the evolution of the nominal interest rate. The contribution rate is also assumed to be stochastic. The goal of investment management is to minimize the convex risk measure of the terminal wealth in excess of the minimum guarantee constraint. First, we transform the partially observable optimization problem into the one with complete information using the Wonham filtering technique and deal with the minimum guarantee constraint by constructing auxiliary processes. Furthermore, we derive the optimal investment strategy by the BSDE approach. Finally, some numerical results are presented to illustrate the impacts of some important parameters on investment behaviors.

Analisis Pendukung Keputusan Dalam Menentukan Pemberian THR Kepada Pensiunan Menggunakan Metode Moora di Kantor Dana Pensiun Perkebunan (Studi Kasus: Dana Pensiun Perkebunan (Dapenbun)

<p>The Plantation Pension Fund is a pension fund that manages the defined benefit pension plan (PPMP) for employees of PT. Perkebunan Nusantara, besides that DAPENBUN also provides holiday allowances to retirees in accordance with the regulations set by the company. The purpose of this study is to provide good decisions, provide clear assessments and calculations with criteria that are in accordance with the eligibility to be selected. The method used in this research is the Multi-Objective Optimization On The Basic Ratio (MOORA) method using Hypertext Multi Language (HTML), Hypertext Processor (PHP). In this study, it can be seen that the highest optimization value is (A3) with Yi(max) = (0.381023) with a total THR of Rp. 3,814,406.08 then followed by (A4) which has Yi(max) = 0.303950 with a total THR of Rp. 3,040,792.46 ,(A2) with a value of Yi(Max) = (0.238024) with a total THR of Rp. 2,380,330.24, (A1) with a value of Yi(mx) = (0.227268) with a total THR of Rp. 2,275.423.68 and the smallest (A5) with a value of Yi(Max) = (0.162676) with a total THR of Rp 1,627,251.58.</p><p> </p><p><strong>Keywords:</strong> holiday allowance, decision support system, MOORA, PHP, HTML, MYSQL.</p>

Portfolio choice with illiquid asset for a loss-averse pension fund investor

This paper explores the optimization of liquid and illiquid assets investment for a defined contribution (DC) pension plan and investigates the impact of illiquidity on portfolio choice. In addition to three kinds of liquid assets, there is an illiquid asset that can only be traded at time 0, and it provides returns at retirement. The investor exhibits both risk-seeking and loss-averse behaviors, with S-shaped utility from the return on investment at retirement. In the long run, the investor also faces the risks caused by the time-varying income and inflation. The martingale method is adopted first to analyze the characteristics of the optimal investment strategy in a complete market. Then the optimal illiquid asset trading strategy is identified and determined. The results are proven to be applicable in a variety of market model settings through some extended analyses. Finally, several numerical findings are illustrated.

Toward a Sustainable Pension System

This article presents a pension plan model aimed at maintaining the resilience of a nation’s social security infrastructure and ensuring retirees’ welfare. The aging population, labor market shifts, legislative changes, and unexpected economic crises (including the COVID-19 pandemic) have created distortions between annuity expenditures and national income. Many countries are experiencing rising life expectancy and in turn increasing public pressure to ensure a dignified existence for the growing elder population. This is challenging decision-makers and government-supervised pension funds to strengthen the financial soundness and solvency, stability, and distributive equity of public and supervised private annuity systems. We present a three-tier pension model that is unique because it is implemented in a small OECD country, and its implementation is flexible and changes according to the country’s demographic and financial changes. The presented model can be used as an example by other countries facing similar problems in their pension systems.

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.

Replacement Rates of Public Pensions in Canada: Heterogeneity across Socio-Economic Status

Several income sources can help retirees maintain their welfare and consumption levels once they leave the workforce. One source is public pensions. Their importance as an income source varies greatly according to socio-economic status (SES). In this article, we analyze how replacement rates (RRs) of public pensions (Old Age Security and Guaranteed Income Supplement) and mandatory public pension benefits (Canada/Quebec Pension Plan [C/QPP]) vary across SES by using the Longitudinal and International Study of Adults dataset. Taking advantage of the longitudinal nature of this survey, we compute and compare average RRs by SES. We specifically consider the role of education and health to understand variations in RRs. Our results show that the average RR of public pensions for individuals in bad health is 32 percent, whereas for those who report being in good health, it is 21 percent. When public pensions and C/QPP benefits are included, these percentages become 54 percent for those in bad health and 41 percent for those in good health. When estimating a multivariate regression model and controlling for past income, we look at couples and find that past income does not eliminate differences in RR by education level and health status. Our results suggest that assortative matching could play a role in explaining the variation in RRs across individuals’ education.

Pension Plan Types and Social Security Knowledge: New Survey Evidence

ABSTRACT Knowledge of the Social Security Old-Age and Survivors Insurance program affects people’s work, consumption, and savings decisions before retirement and in turn impacts financial well-being in retirement. This study examines whether the type of employer-sponsored pension is associated with varying levels of Social Security knowledge using data from the Understanding America Study. Results indicate that people with various pension types are consistently more knowledgeable about disability benefits, age adjustment, claiming upon retirement, and spousal benefits, relative to pensionless individuals. Interventions to enhance Social Security knowledge may benefit from targeting the most financially vulnerable individuals, particularly women without a pension, for enhanced retirement security.

Financial fraud and individual investment behavior

We show that, after the revelation of financial fraud in a major pension fund manager, two-thirds of affected investors fail to divest. Inert investors are on average younger, of lower SES and more influenced by default options. The majority of those who divest move their money to the only state-run option on the fund menu. The revelation of fraud also induces a small movement of investors from non-fraudulent private investment funds to the state alternative. We further show that most fraud victims end up in underperforming high-fee funds through their prior affiliation with a subscription-based financial advisor. Our analysis is based on the remarkable events surrounding the expulsion of Allra from the Swedish Premium Pension, and administrative, individual-level data on mutual fund choices and background characteristics. Our results illustrate that fraudulent fund managers may exploit widespread consumer biases in choice-oriented pension plans, and that information interventions by the government are important but far from fully effective in nudging victimized investors to take the right action. Pension plans may be characterized by investor inertia even under extreme circumstances such as fraud.

Paying for Performance in Public Pension Plans

We examine the relation between public pension plan chief investment officer (CIO) compensation and plans’ investment performance. Higher paid CIOs outperform their counterparts by 47–60 basis points per year, largely through increased and superior investment in private equity and real estate. This outperformance generates an additional $74.91–$95.63 million in economic value. Plans offering higher compensation hire better educated CIOs and are more likely to retain their CIOs. Higher CIO compensation is positively correlated with the use of incentive compensation, but incentive compensation does not directly affect performance. Demand- and supply-side frictions help explain the variation in CIO pay and the persistent low compensation paid by some plans despite the positive relation between compensation and performance. This paper was accepted by Victoria Ivashina, finance. Funding: S. Ray gratefully acknowledges a summer research grant from the Culverhouse College of Business at the University of Alabama. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4554 .

Surplus Optimization in Defined Benefit Pensions Using the Regime‐Switching Model: Occupational Pension Plans in South Korea*

AbstractWe assume a hypothetical defined benefit (DB) pension plan that reflects the characteristics of the occupational pension in South Korea and propose a surplus optimization strategy using a regime‐switching model. Using conditional surplus at risk, we construct an optimized portfolio that limits extreme tail risks. Furthermore, we identify the surplus risk and return conditional on global macroeconomic status using a hidden Markov model. The main results are that (i) the DB pension portfolio should move from principal‐protected products to diverse capital market products, and (ii) the DB pension portfolio using the regime‐switching model outperforms an unconditional static portfolio.

Consumer Informal Financial Education and Retirement Financial Behaviors: Financial Knowledge as a Mediator

Whether in developed or developing countries, the aging population has become a worldwide concern, and retirement financial behaviors also receive more attention. This study uses the data of American NFCS in 2018 to study the influence of consumer informal financial education on retirement financial behaviors. Moreover, financial knowledge is taken as a mediator variable to examine whether it will affect the mechanism of action. In addition, the empirical model is replaced, the outliers of income are removed, and heterogeneity analysis among different regions is conducted to ensure the robustness of the results. The empirical results show that consumer informal financial education positively contributes to retirement financial behaviors. Financial knowledge mediates the relationships between consumer informal financial education and retirement financial behaviors. Hence, to improve consumer financial wellbeing, it is necessary to increase financial education and pension publicity, employ various education methods for consumers of different age groups, enrich the variety of pension financial products, and promote scientific and reasonable pension plans.

Pension plans’ funded status volatility and corporate credit risk

We investigate whether and how U.S. pension plans’ funded status volatility affects firm credit risk. We first show that a firm's funded status volatility is positively related to its bond yield spread. We then find that the adoption of SFAS No.158 (2006) requiring the recognition of pension funding status on the statement of financial position renders the pension plan information more value-relevant, thereby increasing the effect of funded status volatility on bond yield spread. Furthermore, the predictions that funded status volatility affects asset value volatility and incomplete accounting information, which in turn affects corporate credit risk, are empirically supported. Our findings reinforce the need for firms to disclose reliable information about funded status volatility—a major pension plan risk—to external investors.

Multiple Population Mortality Jointly Forecasting in China Using PCF Model

Based on the data of population mortality in China since 1994, this paper studies the changing trend of sex differences of mortality by proposing and implementing some novel approaches. First of all, this paper proposes a new method using the Poisson common factor (PCF) model to forecast the mortality jointly by both sexes. The study finds that the PCF model effectively captures the common trend of mortality between two sexes and uses additional factors to reflect differences of between two sexes, which can reduce the errors caused by low quality or large fluctuation of the mortality in China. Meanwhile, the forecasting values of mortality based on the PCF model can abide by the human biological law well, and the sex ratio of mortality converges to a fixed constant in the long run without increasing too much statistical error. Second, this paper improves the parameter estimation method of PCF model, and the innovative two-step method is used to estimate the model, which can make the maximum likelihood estimator converge more easily. Finally, as an application of the novel methods which are proposing in this study, we measure the longevity risk of pension by using the PCF model and find that the PCF model can make up the underestimation of longevity risk from traditional models and provide more scientific information to the sponsor of pension plan.

The asset allocation of defined benefit pension plans: the role of sponsor contributions

What percentage of its assets should a defined benefit pension plan invest into stocks as its funding ratio varies? We show that the answer to this question depends on the institutional setting and in particular on the extent to which the sponsoring company contributes to the fund as the funding ratio varies. We consider two settings: in one setting, the sponsoring company contributes to its pension fund only if the funding ratio is below the target level (as is the case, for example, in the US); in the other setting, the sponsoring company always contributes to its pension fund (as is the case, for example, in Switzerland). We show that these two institutional frameworks lead to two different dynamics, conditional distributions of the funding ratios, and relationships between the current funding ratio and investment into stocks. For settings like the US, that relation is non-monotonic while for settings like in Switzerland, it is monotonically decreasing. Previous empirical findings point towards a similar pattern.

Collective longevity swap: A novel longevity risk transfer solution and its economic pricing

To mitigate the hedger’s longevity risk exposure, this paper proposes a collective longevity swap between a reinsurer (hedge provider) and a group of hedgers (pension plans and annuity providers), and an economic framework to price longevity risk and longevity swaps. Combining the appealing features of two widely discussed longevity swaps, i.e., the indemnity swap and index-based swap, the collective longevity swap requires that reinsurer’s payments are based on the longevity risk of the aggregate portfolio of all hedgers, whereas each hedger could receive indemnity payments on their own portfolio. In a general principal-agent pricing model under the incomplete market setting, we determine the optimal risk premiums and hedge rates that maximize the reinsurer’s expected profit under a set of the hedgers’ participation constraints. We find that, in a competitive market, the proposed collective swap could lead to a higher expected profit for the reinsurer than the indemnity and the index-based swap, and simultaneously improve the benefits of the majority of hedgers without worsening the benefits of the rest. Finally, using a stochastic multi-population mortality model and real-world mortality data, a series of numerical analyses are performed to verify the theoretical findings.

Optimal Investment Strategy for DC Pension Plan with Deposit Loan Spread under the CEV Model

This paper is devoted to determining an optimal investment strategy for a defined-contribution (DC) pension plan with deposit loan spread under the constant elasticity of variance (CEV) model. As far as we know, few studies in the literature have taken loans into account when using the CEV model in financial market contexts. The contribution of this paper is to study the impact of deposit loan spread on DC pension investment strategy. By considering a risk-free asset, a risky asset driven by CEV model, and a loan in the financial market, we first set up the dynamic equation and the asset market model, which are instrumental in achieving the expected utility of ultimate wealth at retirement. Second, the corresponding Hamilton–Jacobi–Bellman (HJB) equation is derived by means of the dynamic programming principle. The explicit expression for the optimal investment strategy is obtained using the Legendre transform method. Finally, different parameters are selected to simulate the explicit solution, and the financial interpretation of the optimal investment strategy is provided. We find that the deposit loan spread has a great impact on the investment strategy of DC pension plans.

Optimal Investment Strategy of Defined Contribution Pension Based on Bequest Motivation and Loss Aversion

Under the S-shaped utility of loss aversion, this paper considers the bequest motivation of pension plan participants, random salary income before retirement and the substitution rate between receiving pension benefits after retirement and wages before retirement, and studies the optimal investment strategy of defined contribution (DC) pension. Assuming that pension funds can invest in a financial market consisting of three assets (risk-free asset cash, rolling bonds and stocks), inflation is considered by discount. Under the S-shaped utility, the Lagrange method is used to find the terminal optimal surplus of pensions in retirement, so as to find the terminal optimal wealth, and then the martingale method is used to find the optimal wealth process and investment strategy. Finally, a sensitivity analysis is carried out on the the influence of bequest motivation and loss aversion on the optimal investment strategy of DC pension.

Socioeconomic differentials in mortality: implications on index-based longevity hedges

In this paper, we address the mortality modeling needs for pension plan sponsors who wish to use index-based solutions to mitigate their longevity risk exposures. Specifically, we propose the three-way Li-Lee (TWLL) model, which enforces a certain extent of coherence between the population to which the index-based hedging instrument is linked and the population of pension plan members, and at the same time incorporates the empirical fact that mortality improvement rates of different socioeconomic subgroups in the pension plan are persistently different. We further develop a delta longevity hedging strategy that is compatible with the TWLL model. With the aid of real mortality data, we demonstrate that if persistent socioeconomic differentials in mortality improvement rates exist but are not considered in an index-based longevity hedge, the performance of the hedge could be compromised, and the extent of underperformance would depend on the distributions of pension plan members and pension amounts across different socioeconomic subgroups. This problem can be alleviated if the longevity hedge is calibrated on the basis of the TWLL model.