A1492
Title: A regime-driven investment strategy for funded pension plans with intergenerational payout-smoothing
Authors: Stefan Mittnik - University of Munich (Germany) [presenting]
Abstract: In the face of demographic developments, pension systems in countries that rely on pay-as-you-go systems tend to lack sustainability. The introduction of an additional funded defined contribution component to the pension system, with funds invested in capital markets, has often been proposed to alleviate this problem. However, because of the exposure to market risk, contributors from different retirement cohorts who made identical contributions may end up with very different pension benefits. This potential for intergenerational inequality is a major criticism of funded pension plans. An investment strategy is presented that provides for intergenerational risk sharing. In this system, the intergenerational transfer of market risk is achieved through the establishment of a collective reserve fund whose inflows and outflows are driven by market risk regimes. It is shown that this risk-driven strategy significantly smoothes payouts across cohorts and can also improve the overall performance of the pension system.