Journal of Pension Economics and Finance

Articles

Optimal investment strategies and performance sharing rules for pension schemes with minimum guarantee

JACQUES PÉZIERa1 c1 and JOHANNA SCHELLERa2 c2

a1 ICMA Centre, Henley Business School, University of Reading

a2 ICMA Centre, Henley Business School, University of Reading

Abstract

There is a potential conflict of interest between a pension fund sponsor and future pensioners when they share unequally in the pension fund performance. Thus, when a scheme offers a yearly guaranteed minimum return to pensioners, as is presently the case with German Pensionskassen, the sponsors cannot afford to invest in risky assets and consequently, pensioners end up with safe but very low expected returns. We examine optimal investment strategies for sponsors under alternative performance sharing rules and seek the rules that are most beneficial to pensioners. We find that the current yearly performance sharing rule imposed on Pensionskassen could be tilted in favor of sponsors without impairing the welfare of pensioners. We also find that the welfare of pensioners would be greatly enhanced if the guaranteed minimum return were applied to the cumulative return since inception of the scheme rather than to yearly returns. The ensuing credit risk taken by pensioners on sponsors could be kept to a minimum by proper regulation; this would induce sponsors to adopt safe constant proportionality portfolio insurance (CPPI) style investment strategies.

(Online publication October 14 2010)

Footnotes

The contents of this paper are presented in good faith, and neither the authors, the ICMA Centre, nor the University, will be held responsible for any losses, financial or otherwise, resulting from actions taken on the basis of its contents. Any persons reading the paper are deemed to have accepted this.