Mimicking a Real Deferred Annuity - Or How I Learned to Stop Worrying and Love DC
The global pension sector has seen a dramatic shift from defined benefit (DB) plans to defined contribution (DC). In parallel, this has meant a shift from secure real pension benefits to investment dependent nominal benefits which pension economics has shown to be clearly inferior in terms of welfare.
This has lead to the discussion on how DB-like benefits can be offered within a DC scheme. With this in mind, a new analytic framework is proposed in which the funding ratio is the main indicator and the real deferred annuity is the risk-free asset. This is done based on the idea that the analysis of investment strategies in a pension fund should be done in terms of guaranteeing benefits rather than achieving levels of return. A simulation study is done which concludes that traditional fixed asset mix allocation strategies are not likely to be capable of financing such benefits and that risk-based strategies may lead the way in solving this issue.