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18.12.2015  

Hybrid Pensions Schemes with Risk-Sharing: Are They the Future of Occupational Pensions?

Published December 18, 2015

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> 10 minutes

Introduction


The sustainability of occupational pension systems is under threat in many countries. Setbacks include a structural increase in liabilities due to longer life expectancy, the harmful effects of financial crises on investment returns, unusually low interest rates that prompt a search for yield from riskier or less liquid investments, and stricter pension regulation.

This inability of funds to cope with the current situation has sparked intense debate about reforming pension systems around the world. One promising line of thought–is to redefine the pension contract. These hybrid pension schemes embody elements of the traditional defined-benefit (DB) and defined-contribution (DC) schemes.

DB and DC schemes are at the opposite ends of the risk sharing spectrum between employers and employees. Under a DC arrangement, the members shoulder all the risks. In DB schemes, on the contrary, the employer bears all of the risks, including investments (financial market returns fluctuating around the expectation), macro-longevity (death probability estimates can be inaccurate)1, interest rates (the cost of annuities is unpredictable due to interest rate changes), and in some cases inflation (the real value of benefit payments may fall more than expected). Hybrid plans are designed as a compromise between DB and DC schemes. They alleviate the employer’s high costs of DB provision, yet provide more certainty about the individual’s financial security in retirement than a DC scheme does. Numerous hybrid pension plans exist around the world, including collective defined-contribution plans in the Netherlands, Cash Balance plans in the US, and target benefit plans in Canada. These schemes address some of the shortcomings of traditional DB and DC contracts by allowing risk sharing between employers and employees. The continuous effort to find hybrid solutions has led to the more recent suggestions of the Defined Ambition scheme, and the Personal Pension Accounts with Risk-Sharing in the Netherlands. This note highlights innovations in pension contracts in selected countries, and orients the discussion around risk sharing. While the contract names may be country-specific, the fundamental issues tackled and the characteristics of the revised schemes are comparable.

To find out more, download the full paper


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