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Target benefit versus defined contribution scheme: a multi-period framework

Published online by Cambridge University Press:  01 September 2023

Ping Chen ,
Haixiang Yao Open the ORCID record for Haixiang Yao [Opens in a new window] ,
Hailiang Yang  and
Dan Zhu Open the ORCID record for Dan Zhu [Opens in a new window]
Ping Chen
Affiliation:
Centre for Actuarial Studies, Department of Economics, University of Melbourne, Melbourne, Australia
Haixiang Yao*
Affiliation:
School of Finance, Institute of Financial Openness and Asset Management, Southern China Institute of Fortune Management Research, Guangdong University of Foreign Studies, Guangzhou 510006, China
Hailiang Yang
Affiliation:
Department of Financial and Actuarial Mathematics, Xi’an Jiaotong-Liverpool University, Suzhou, China
Dan Zhu
Affiliation:
Department of Econometrics and Business Statistics, Monash University, Melbourne, Australia
*
Corresponding author: Haixiang Yao; Email: yaohaixiang@gdufs.edu.cn
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Abstract

A target benefit plan (TBP) is a collective defined contribution (DC) plan that is growing in popularity in Canada. Similar to DC plans, TBPs have fixed contribution rates, but they also implement pooling of longevity and investment risk. In this paper, we formulate a multi-period model that incorporates two sources of risk – asset risk and labor income risk for active members. We present an optimal investment and retirement benefits schedule for TBP members with a fixed contribution rate. Using Australian data from 1965 to 2018, we evaluate the performance of the optimal TBP scheme and compare it to the optimal DC scheme. By adopting the benefit–investment strategy derived in this paper, we demonstrate the stability of benefit distribution over time for a TBP scheme in this stochastic formulation. To outperform the DC scheme’s benefit payment, careful consideration shall be given to the benefit target in the TBP scheme. A high target may not be achievable, while a low target can impede the accumulation momentum of the fund’s wealth in its early stages. Moreover, a TBP fund’s investment strategy is primarily influenced by the wealth target, with more aggressive investments in risky assets as the wealth target increases. This analysis may shed light on the possible improvements to retirement planning in Australia. Although the results are sensitive to the choice of model parameters, overall, the proposed TBP promotes system stability in various scenarios.

Keywords

Collective defined contributionmulti-periodoptimal investmentreplacement ratestochastic wage
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 53 , Issue 3 , September 2023 , pp. 545 - 579
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of The International Actuarial Association

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Footnotes

*

This research is supported by grants from the National Natural Science Foundation of China (Nos. 71871071, 72071051, 71721001).), the Key Program of the National Social Science Foundation of China(No. 21AZD071), and the Guangdong Basic and Applied Basic Research Foundation (Nos. 2023A1515011354, 2018B030311004).

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