Pensionmetrics: stochastic pension plan design and value-at-risk during the accumulation phase

We estimate values-at-risk (VaR) in the accumulation phase of defined-contribution pension plans. We examine a range of asset-return models (including stationary moments, regime-switching and fundamentals models) and a range of asset-allocation strategies (both static and with simple dynamic forms, such as lifestyle, threshold and constant proportion portfolio insurance). We draw four conclusions from our investigations. First, we find that defined-contribution (DC) plans can be extremely risky relative to a defined-benefit (DB) benchmark (far more so than most pension plan professionals would be likely to admit). Second, we find that the VaR estimates are very sensitive to the choice of asset-allocation strategy. The VaR estimates are also sensitive, but to a lesser extent, to both the asset-returns model used and its parameterisation. The choice of asset-returns model is found to be the least significant of the three. Third, a static asset-allocation strategy with a high equity weighting delivers substantially better results than any of the dynamic strategies investigated over the long term (40 years) of the sample policy. This is important given that lifestyle strategies are the cornerstone of many DC plans. Fourth, conservative bond-based asset-allocation strategies require substantially higher contribution rates than more risky equity-based strategies if the same retirement pension is to be achieved. © 2001 Elsevier Science B.V. All rights reserved. JEL classification: C15; D81; D91; E27; G11; G23