Risk Reallocation in Defined Contribution Funded Pension Systems
In many countries pension systems are being reformed, because their sustainability is threatened. In particular, a number of countries have set up funded pension arrangements to complement or replace non-funded, pay-as-you-go arrangements, while other countries already featuring a sizable funded pillar are reconsidering its design. This paper explores the introduction of collective risk-reallocation elements in defined contribution pension contracts.
We consider status-contingent, age-contingent and asset-contingent arrangements to reallocate risk among participants. Eliminating asset market risk for the retired raises their welfare, while it lowers welfare of the workers, despite the fact that they benefit later from the same arrangement. Overall welfare falls. The welfare effects are largest when personal and pension portfolios are optimally chosen. Allowing for intragenerational heterogeneity, the highest-skilled retirees benefit most, while the highest-skilled workers lose most. Our main results are qualitatively robust to a number of model variations and extensions.