Working Paper: NBER ID: w14332
Authors: Raimond Maurer; Olivia S. Mitchell; Ralph Rogalla
Abstract: Using a Monte Carlo framework, we analyze the risks and rewards of moving from an unfunded defined benefit pension system to a funded plan for German civil servants, allowing for alternative strategic contribution and investment patterns. In the process we integrate a Conditional Value at Risk (CVaR) restriction on overall plan costs into the pension manager's objective of controlling contribution rate volatility. After estimating the contribution rate that would fully fund future benefit promises for current and prospective employees, we identify the optimal contribution and investment strategy that minimizes contribution rate volatility while restricting worst-case plan costs. Finally, we analyze the time path of expected and worst-case contribution rates to assess the chances of reduced contribution rates for current and future generations. Our results show that moving toward a funded public pension system can be beneficial for both civil servants and taxpayers.
Keywords: public pension; funded plans; CVaR; contribution rate volatility
JEL Codes: G11; G15; G2; G23; H3; H55; H71; J26; J32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Transitioning from an unfunded defined benefit pension system to a funded plan (H55) | Enhanced pension security for civil servants and reduced costs for taxpayers (H55) |
| Optimal contribution and investment strategy minimizing contribution rate volatility (G11) | Lower overall contribution rates compared to traditional unfunded systems (H55) |
| Controlling solely for costs (D61) | High regular contribution rates (around 40% of covered payroll) (H55) |
| Focusing only on contribution rate volatility results in low-risk asset allocations but high supplementary transfers (G11) | High supplementary transfers (H87) |
| Balanced approach combining both strategies (C73) | Moderate contribution rates alongside substantial equity holdings (G19) |
| Investing in a diversified portfolio rather than solely in bonds (G11) | Mitigating capital market risks and supporting a more sustainable funding strategy for public pensions (G23) |