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S O C I A L S C I E N C E R E S E A R C H N E T W O R K
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 7, No. 10: April 27, 2006
Editor: PAMELA J. PERUN
Urban Institute
PAMELA@PLANETNOW.COM
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Topic of This Issue:
Pension Finance
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T A B L E O F C O N T E N T S
"Pensions: Corporate Finance and Capital Markets"
J. MICHAEL ORSZAG, Watson Wyatt Worldwide - Reigate, Surrey
Office, Institute for the Study of Labor
(IZA)
NEHA SAND, Watson Wyatt Worldwide
"Let Us Trade Pension Claims"
BERNARD DUMAS, INSEAD, Centre for Economic Policy Research
(CEPR), National Bureau of Economic Research
(NBER)
JUERG M. SYZ, Cantonal Bank of Zurich
"Implications of Optimal Investment Policies for Hybrid Pension
Plans: Sponsor and Member Perspectives"
RAIMOND MAURER, Goethe University Frankfurt
"The Cost of Minimum Pension Guarantee"
TAPEN SINHA, Instituto Tecnológico Autónomo de México
(ITAM) - Division of Actuarial Science,
Statistics and Mathematics, University of
Nottingham - Nottingham University Business
School (NUBS)
ALEJANDRO RENTERIA, Instituto Tecnológico Autónomo de
México (ITAM) - Division of Actuarial
Science, Statistics and Mathematics
"The Optimal Design of Funded Pension Plans: Unbundling
Financing and Investment"
LUCIANO G. GRECO, University of Padua - Department of
Economics
"Defined Benefit Plan Freezes: Who's Affected, How Much, and
Replacing Lost Accruals"
JACK VANDERHEI, Temple University - Risk Management &
Insurance & Actuarial Science, Employee
Benefit Research Institute (EBRI)
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"Pensions: Corporate Finance and Capital Markets"
Watson Wyatt Technical Paper No. 2005-5
Contact: J. MICHAEL ORSZAG
Watson Wyatt Worldwide - Reigate,
Surrey Office, Institute for the Study of Labor
(IZA)
Email: Michael.Orszag@eu.watsonwyatt.com
Auth-Page: http://ssrn.com/author=23495
Co-Author: NEHA SAND
Watson Wyatt Worldwide
Email: Neha.Sand@watsonwyatt.com
Auth-Page: http://ssrn.com/author=600037
Full Text: http://ssrn.com/abstract=892302
Because a significant portion of corporate financing is
implicitly handled through pension vehicles, pensions are a quite
important part of corporate finance and corporate financial
policy. Yet many aspects of the interaction between pensions and
corporate finance are imperfectly understood at both the
theoretical and empirical level. This paper reviews the
literature on the link between corporate pensions, corporate
finance and capital markets.
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"Let Us Trade Pension Claims"
Contact: BERNARD DUMAS
INSEAD, Centre for Economic Policy
Research (CEPR), National Bureau of Economic
Research (NBER)
Email: bernard.dumas@insead.edu
Auth-Page: http://ssrn.com/author=30590
Co-Author: JUERG M. SYZ
Cantonal Bank of Zurich
Email: juerg.syz@zkb.ch
Auth-Page: http://ssrn.com/author=507511
Full Text: http://ssrn.com/abstract=827267
Trading pension claims would kill many birds with one stone: an
accurate valuation of pension liabilities would provide a
measurable yardstick for plan managers; beneficiaries would be
able to diversify the idiosyncratic risk of their plan sponsors;
systematic risk could be reallocated to comply with individual
risk/return preferences. The consequence would be an alignment of
incentives to fully fund plans, lower agency and governmental
bail-out costs, and an increase in general welfare.
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"Implications of Optimal Investment Policies for Hybrid Pension
Plans: Sponsor and Member Perspectives"
PRC Working Paper Series
Contact: RAIMOND MAURER
Goethe University Frankfurt
Email: investment@finance.uni-frankfurt.de
Auth-Page: http://ssrn.com/author=459549
Abstract: http://ssrn.com/abstract=830024
This paper analyzes pension plan costs and investment strategies
in the context of alternative hybrid pension plans which are
optimal either from the perspective of the plan sponsor or the
beneficiaries.
The focus is in particular on how the introduction of minimum and
maximum limits for pension benefits as well as minimum guarantees
and caps on the return of the members' individual investment
accounts affect investment decisions and plan costs. Within a
comparative static analysis framework, it is shown that for low-
to medium-risk portfolios, minimum benefit guarantees tend to be
more expensive than minimum return guarantees while for the
latter costs increase exponentially with investment risk. The
study also finds that the portfolio choice of the sponsor and the
beneficiaries shows substantial differences depending on the
exact plan design and the beneficiaries' risk aversion. Combining
minimum return guarantees and caps on investment returns emerged
as a possible means to reduce such differences, to share
investment risks and returns more equally between sponsor and
beneficiaries, and to keep pension plan costs under control.
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"The Cost of Minimum Pension Guarantee"
Contact: TAPEN SINHA
Instituto Tecnológico Autónomo de
México (ITAM) - Division of Actuarial Science,
Statistics and Mathematics, University of
Nottingham - Nottingham University Business School
(NUBS)
Email: tapen@itam.mx
Auth-Page: http://ssrn.com/author=58705
Co-Author: ALEJANDRO RENTERIA
Instituto Tecnológico Autónomo de
México (ITAM) - Division of Actuarial Science,
Statistics and Mathematics
Email: arentes@gmail.com
Auth-Page: http://ssrn.com/author=545381
Full Text: http://ssrn.com/abstract=839213
We model minimum pension guarantee using a simulation approach.
Lachance and Mitchell (2002) have shown that it could be
important if and when individual accounts are introduced in the
United States. We model ours with real data from Mexico where
individual accounts are already a reality and the minimum pension
guarantee is already enshrined by law. We calculate the
probability of the government needing to honor the guarantee and
estimate the cost of such a promise using a real options
approach. Higher investment in the stock market turns out to be
the key. The higher the proportion of investment allowed by law
in stocks, the lower the probability of government support.
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"The Optimal Design of Funded Pension Plans: Unbundling
Financing and Investment"
University of Bocconi Econpubblica Working Paper
Contact: LUCIANO G. GRECO
University of Padua - Department of
Economics
Email: greco@decon.unipd.it
Auth-Page: http://ssrn.com/author=359274
Full Text: http://ssrn.com/abstract=824727
The design of fully funded pension plans is affected by
governance and incentive problems, as underlined by the
experience of several countries. The analytic perspective of
contract theory allows to detect the nature of such problems:
pension-fund managers have strong incentives to manipulate market
expectations about their capacity through wasteful activities
(e.g., marketing). The design of funded pension plans has, thus,
to trade-off efficiency losses and gains linked to high-powered
incentives associated to the competition among fund managers. By
means of a simple theoretical setting, this trade-off is shown to
be driven by the integration of financing (contribution
collection) and investment (asset allocation and management)
activities. A separation of financing and investment allows to
centralize the former and allocate collected money to a sector of
competitive fund managers, via an auction mechanism. Under
contract incompleteness, the quasi-competitive setting of funded
pillar is proven to be Pareto-superior to the market of
competitive pension funds (integrating financing and investment).
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"Defined Benefit Plan Freezes: Who's Affected, How Much, and
Replacing Lost Accruals"
EBRI Issue Brief, No. 291, March 2006
Contact: JACK VANDERHEI
Temple University - Risk Management &
Insurance & Actuarial Science, Employee Benefit
Research Institute (EBRI)
Email: TEMPLE@VANDERHEI.COM
Auth-Page: http://ssrn.com/author=265706
Full Text: http://ssrn.com/abstract=891170
This paper quantifies how workers are likely to be affected by
pension freezes, and how much they would have to save in a 401(k)
plan - whether provided by their employer and/or saved by
themselves - to offset the loss of accrued benefits from the
pension freeze. The analysis notes that how an individual worker
might be affected by a pension freeze varies widely, based on the
unique nature of each pension plan and the terms of each plan
that is frozen; the variation in workers' age, and tenure; and
future investment results. The analysis presents its findings in
terms of additional compensation (in a 401(k) plan, whether
provided by an employer or worker) needed to cover the accruals
lost to a pension freeze. In some cases, the pension plan sponsor
offsets the pension freeze by increasing its match in the
workers' 401(k) plan, but each case is different, and in some
cases the lost pension benefit is not replaced.
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