Optimal Investment Strategies and Performance Sharing Rules for Pension Schemes with Minimum Guarantee

Johanna Scheller () and Jacques Pézier
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Johanna Scheller: ICMA Centre, University of Reading
Jacques Pézier: ICMA Centre, University of Reading

ICMA Centre Discussion Papers in Finance from 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.

Keywords: Private pension schemes; benefit-sharing rules; capital guaranteed products; constant mix strategies; constant proportionality portfolio insurance strategies; utility theory (search for similar items in EconPapers)
JEL-codes: G22 G23 (search for similar items in EconPapers)
Date: 2008-11, Revised 2009-10
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