Sustainability of participation in collective pension schemes: An option pricing approach

• Published in: Insurance, mathematics & economics mathematics & economics, 2017-05, Vol.74, p.182-196
• Main Authors: Chen, Damiaan H.J., Beetsma, Roel M.W.J., Broeders, Dirk W.G.A., Pelsser, Antoon A.J.
• Format: Article
• Language: English
• Subjects: Collective defined-contribution and hybrid pension funds; Contribution; Defined benefit plans; Defined-benefit; Explicit finite difference method; Indexation; Labor force; Least Squares Monte Carlo method; Liabilities; Monte Carlo simulation; Older people; Option; Participation; Participation decision; Pension funds; Pension plans; Sustainability; Workers
• ISSN: 0167-6687; 1873-5959
• DOI: 10.1016/j.insmatheco.2017.03.007

This paper contributes to the discussion about mandatory participation in collective funded pension schemes. It explores under what circumstances individual participants exercise the option to exit such a scheme if participation is voluntary. We begin by showing how the willingness to participate increases if the period over which the option is valid becomes longer. Then, we demonstrate how the pension fund’s set of policy instruments can be deployed to minimize the likelihood that any cohort exits the pension scheme. The instruments consist of contribution and indexation policies. Recovery of the funding ratio, i.e. the ratio of assets over liabilities, to its regulatory target level may be based on uniform contributions or age-dependent contributions. Specifically, while the value of the exit option deters younger workers from exiting the pension fund, a uniform contribution policy encourages older workers to stay in the pension scheme.