Moving Beyond the ‘DB Vs. DC’ Debate: The Appeal of Hybrid Pension Plans

Abstract

This article analyzes the tradeoffs between uncertainties in contributions and benefits embedded in different pension arrangements. The two key criteria for evaluating the risk-sharing characteristics of a private pension plan from the perspective of the plan member are the funding ratio (ratio of assets to liabilities) and the replacement rate (ratio of benefits to salaries). The stochastic simulations performed (considering financial risks only) show that hybrid plans (those in between traditional defined benefit and individual defined contribution) can offer efficient and sustainable forms of risk-sharing. The appeal of different hybrid plans depends very much on the regulatory, social, and economic environment. In situations where funding excesses can be efficiently and fairly apportioned, conditional indexation plans appear to have the greatest potential as sustainable forms of risk-sharing. However, the appropriate design of hybrid plans requires careful consideration of the relative pension plan risks that can be borne by working and retired individuals.

Keywords: Defined Benefit, Defined Contribution, Funding, Hybrid Plans, Pension Benefits, Pension Funds