Managing Uncertainty: The Search for a Golden Discount-Rate Rule for Defined-Benefit Pensions

Abstract Unlike defined benefit pensions, 401(k) plans provide little guidance on how to turn accumulated assets into income. The key risk that retirees face is outliving their assets. Insurance against such risk is available through several routes, including immediate annuities, deferred annuities, and additional Social Security through delayed claiming. Under this Social Security bridge option, participants would tap their 401(k) for payments equal to their Social Security to delay claiming. This paper compares these three options in simulations against a baseline in which no assets are used to obtain lifetime income. In each option, assets not allocated to purchasing lifetime income are consumed following the Required Minimum Distribution rules. The analysis finds that, when market and health shocks are included alongside longevity uncertainty, the Social Security bridge option is generally the best for households with median wealth. Wealthier households can benefit from combining the bridge option with a deferred annuity. Part of a symposium sponsored by the Economics of Aging Interest Group.

Download Full-text

Financing UK Pensions

Britain's Pensions Crisis ◽

10.5871/bacad/9780197263853.003.0012 ◽

2006 ◽

Cited By ~ 2

Author(s):

John Hills

Keyword(s):

Life Expectancy ◽

Occupational Pension ◽

Defined Benefit ◽

Occupational Pensions ◽

The Past ◽

The Government ◽

Future Policy ◽

Set Up ◽

Defined Benefit Pensions

A key feature of the pension challenges currently facing Britain is the decline of the system of occupational pensions, particularly the decline of defined-benefit pensions. Here, it is often argued that the villain has been the government (in fact a succession of governments). In this view, over the past decades successive governments have delivered a catalogue of regulation and legislation that, though often well intentioned, has ultimately worked to the detriment of occupational pension provision. Alternatively, one might argue that we could have seen it all coming. It is important that future policy should be set up in a way that is sustainable and robust enough to cope with the huge uncertainty around the increase in life expectancy which we are hoping for. This chapter examines why, and when, things began to go wrong with the financing of British pensions.

Download Full-text

The Evolution of Private Sector Retirement Income From Defined-Benefit Pensions to Target-Date 401(k) Plans

Compensation & Benefits Review ◽

10.1177/0886368719864480 ◽

2019 ◽

Vol 51 (2) ◽

pp. 77-85

Author(s):

John G. Kilgour

Keyword(s):

Private Sector ◽

Pension Reform ◽

Pension Plans ◽

Retirement Income ◽

Defined Benefit ◽

Investment Control ◽

Target Date ◽

Target Date Funds ◽

Market Plan ◽

Defined Benefit Pensions

Traditional employer-sponsored defined-benefit pension plans in the private sector that provided lifetime benefits have declined precipitously since 1985. They have been largely replaced by Section 401(k) plans in which investment control, market risk and longevity risk have been transferred from the employer to the participant. Most participants opted for the low-yielding money market plan default option, which proved inadequate for providing viable retirement income. The Pension Reform Act of 2006 made two important changes to 401(k) plans: (1) allowed automatic enrollment and (2) allowed target-date funds as a “qualified default investment alternative.” This article examines the evolution from defined-benefit pensions to target-date funds and the closely related collective investment trusts.

Download Full-text

Individual Biases in Retirement Planning and Wealth Management

10.1093/acprof:oso/9780190269999.003.0019 ◽

2017 ◽

Author(s):

James E. Brewer ◽

Charles H. Self

Keyword(s):

Retirement Planning ◽

Developed Countries ◽

Defined Benefit ◽

Defined Contribution ◽

Market Returns ◽

Wealth Transfer ◽

Investor Returns ◽

Certified Financial Planner ◽

And Behavior ◽

Defined Benefit Pensions

Around the globe, the gradual move from defined benefit pensions to defined contribution pensions has increased the need for individual retirement planning. Examples of this include U.S. savings rates at historic lows, poor retirement prospects for citizens in developed countries, and the disparaging gap between investor returns and market returns. Research indicates that individuals working with a financial advisor generally receive better results than those who do not. Working with a Certified Financial Planner (CFP) gives an added level of security because a CFP takes an oath to keep the client’s interests ahead of his or her own. This chapter puts describes giving nudges to help individuals close the savings, investing, and behavior gaps that will improve their total wealth and wealth-transfer picture.

Download Full-text

Actuarial valuations to monitor defined benefit pension funding

British Actuarial Journal ◽

10.1017/s1357321720000173 ◽

2020 ◽

Vol 25 ◽

Author(s):

Christopher D. O’Brien

Keyword(s):

Discount Rate ◽

Current Practice ◽

Cash Flows ◽

Defined Benefit ◽

Expected Return ◽

Code Of Practice ◽

Market Values ◽

Using Data ◽

Risk Free Rate ◽

Risk Disclosures

Abstract This paper is motivated by The Pensions Regulator (TPR)’s review of its Code of Practice on funding for defined benefit schemes and aims to suggest how trustees and regulators should monitor the extent to which scheme assets are adequate to cover liabilities. It concludes that current practice is inadequate and needs to change. A review is carried out of papers on not only this subject but also (to collect ideas rather than automatically apply them to pensions solvency valuations) pensions and insurance accounting and regulation. Current practice is “scheme-specific funding” which permits discretion on choice of discount rates and other assumptions; the paper is concerned that this can lead to bias, and that trends in a scheme’s solvency can be obscured by changing assumptions. This also leads to the funding ratio communicated to scheme members having little meaning. The paper suggests that regulators should require a valuation that is based on sound principles, objective, fair, neutral, transparent and feasible. A prescribed methodology would replace discretion. It concludes that the benefits to be valued are those arising on discontinuance of the scheme, without allowing for future salary-related benefit increases, which are felt to no longer be a constructive obligation of employers. The valuation should, it is suggested, use market values of assets, which is largely current practice. Liabilities should reflect the trustees fulfilling their liabilities, rather than transferring them to an insurer (which may introduce artificialities). The discount rate should follow the “matching” approach, being a market-consistent risk-free rate: this is consistent with several papers to the profession in recent years. It avoids the problems of the “budgeting” approach, where the discount rate is based on the expected return on assets – this can be used to help set contribution levels but is not suitable for determining the value of liabilities, which depends on salary, service, longevity, etc and (very largely) not on the assets held. In principle, the liability value can be adjusted for illiquidity. Credit risk of the employer should not be allowed for. Liabilities should reflect the (probability-weighted) expected value of future cash flows and should not be increased by prudent margins or risk margins (which would lead to a non-neutral figure). Risk disclosures are needed to understand and manage risks. The resulting funding ratio is a consistent measure, to be disclosed to members, which can be used to manage the scheme, and by regulators as the basis for requiring action. Scheme-specific management using data such as the employer covenant means that immediate action to ensure 100% solvency on the proposed basis would not necessarily be appropriate. The author encourages the profession to advise TPR on the above lines.

Download Full-text