Target benefit versus defined contribution scheme: a multi-period framework
In this paper, the authors propose a multi-period model for a target benefit plan (TBP) with the objective of incorporating asset risk and labour income risk for active members. A key feature of the TBP is that it implements pooling of longevity and investment risks. An optimal investment and retirement benefits schedule for TBP members with a fixed contribution rate is presented. The performance of the optimal TBP scheme is evaluated and compared with the performance of an optimal defined contribution (DC) plan using Australian data. The stability of benefit distribution over time for the TBP scheme is also illustrated in a stochastic environment. An attention has been given to the benefit target in the TBP scheme with a view to outperforming the benefit payment of the DC scheme. It is found that overall, the proposed TBP scheme promotes system stability in different scenarios, though the results are sensitive to the choice of model parameters. Section 2 of the paper formulates the optimization problem of a TBP into an optimal control problem in terms of the overall stability of the fund from the perspective of its members in a discrete-time modelling set up. Section 3 presents the solution to the optimal control problem using the dynamic programming principle. The value function is represented in terms of a series of matrices satisfying a system of backward recursive equations. Proposition 1 shows that the system of backward recursive equations is well-defined. Theorem 1 gives the main result of the paper. Specifically, Theorem 1 gives the expressions for the value function and the optimal strategy based on the series of matrices satisfying the system of backward recursive equations. Theorem 2 shows that the value function is quadratic in nature and that the optimal strategy is in the form of a linear feedback control. Section 4 provides the optimal investment strategy for a DC plan under a similar model formulation. In Section 5, empirical results are presented, and the qualitative features of the TBP structure are discussed. Specifically, the impacts of model parameters on the benefit distribution and investment strategy of a TBP are studied. The long-term behaviour of the wealth process and funding ratio process is studied. Comparison between a TBP and a DC plan is provided.
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