Current Developments in German Pension Schemes: What Are the Benefits of the New Target Pension?

Abstract

We analyze the newly introduced German occupational pension scheme called target pension ("Zielrente"), which links the beneficiaries' benefits during the retirement phase to the mortality experienced among the pension beneficiaries and the performance of the financial market, from a pension beneficiary's perspective. We model the contract payoffs related to the target pension according to the new enhancement law on German occupational law. Specifically, we include two parameters in the plan design, one to control the surplus participation and one to control the loss participation. These parameters are chosen in such a way that the initial wealth of the retiree equals the initial value of the target pension. With the help of expected lifetime utility and wealth equivalent, we find that the target pension provides a meaningful supplement to the first and third pillar. Further, we find some comparative advantages of the target pension over the traditional pure defined benefit and some defined contribution plans from a policyholder's point of view. Our analysis shows that target pension plans can be outperformed by defined contribution plans with variable annuities, while the latter are accompanied by a considerably higher ruin probability.

Keywords: Target pension, occupational pension schemes, collective risk sharing

JEL Classification: G22, J32