Feasibility test for Defined Contribution pension schemes

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Abstract

In the Netherlands Dutch pension funds perform the feasibility test. This test is originally designed for DB pension schemes. Nowadays DC pension schemes are getting a more prominent role in the Dutch pension system. Therefore an improved design of the feasibility test for DC pension schemes would be beneficial. In this research we search for a new definition for the pension result in DC pension schemes. The pension result is an important part of the feasibility test. We prefer to stay close to the concept of pension result in DB schemes and we conclude that a pension result based on indexed pension entitlements is an appropriate definition for DC pension schemes since it measures the maintenance of purchasing power similar to how it is done in the current feasibility test. We investigate how robust this new definition of the pension result is by considering an alternative premium policy, an alternative investment strategy, an alternative pension payment policy and an extension of the financial market model. All factors have an influence on the pension result. The pension result is calculated using economic scenarios which are based on the financial market model from Koijen, Nijman and Werker (KNW model). The pension result is highly sensitive to the interest rate and inflation rate development during the pension accrual period and the retirement period. Historical data give a motivation for the use of a jump diffusion model for both the interest rate and inflation rate. These variables are modeled as diffusion only in the KNW model. An extension of the KNW model is proposed in which jumps are added to the interest rate process and the inflation rate process. The addition of jumps influences the pension result in DC schemes.