Managing Contribution and Capital Market Risk in a Funded Public Defined Benefit Plan: Impact of CVaR Cost Constraints

34 Pages Posted: 26 Aug 2008 Last revised: 26 Nov 2011

See all articles by Raimond Maurer

Raimond Maurer

Goethe University Frankfurt - Finance Department

Olivia S. Mitchell

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Ralph Rogalla

St. John's University - Tobin College of Business - School of Risk Management, Insurance, and Actuarial Science; Goethe University Frankfurt - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: August 25, 2008

Abstract

We analyze the risks and rewards of moving from an unfunded defined benefit pension sys-tem to a funded plan for civil servants in Germany, allowing for alternative strategic contribu-tion and investment patterns using a Monte Carlo framework. For this purpose, we integrate traditional pension plan manager objectives (i.e. contribution rate volatility) and a Conditional Value at Risk restriction on overall plan costs. First, we estimate contributions as a percent of salary that would fully fund future benefit promises for active employees. Second, we identify a contribution and investment strategy that will minimize contribution rate volatility while at the same time restrict worst-case plan costs to the deterministic plan liability; this turns out to be a contribution rate of 13.4% of the payroll, combined with an asset mix of 41% in equities, 59% in bonds. Third, we analyze the time path of expected and worst-case contribution rates under the optimal strategy to explore chances of contribution rate cuts for current and future generations. We show that moving toward a funded pension system for German civil servants can be beneficial to both taxpayers and civil servants.

Suggested Citation

Maurer, Raimond and Mitchell, Olivia S. and Rogalla, Ralph, Managing Contribution and Capital Market Risk in a Funded Public Defined Benefit Plan: Impact of CVaR Cost Constraints (August 25, 2008). 21st Australasian Finance and Banking Conference 2008 Paper. Available at SSRN: https://ssrn.com/abstract=1256374 or http://dx.doi.org/10.2139/ssrn.1256374

Raimond Maurer

Goethe University Frankfurt - Finance Department ( email )

Gr├╝neburgplatz 1
House of Finance
Frankfurt, 60323
Germany

Olivia S. Mitchell

University of Pennsylvania - The Wharton School ( email )

Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ralph Rogalla (Contact Author)

St. John's University - Tobin College of Business - School of Risk Management, Insurance, and Actuarial Science ( email )

101 Astor Place
New York, NY 10003
United States

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

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