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Intergenerational risk sharing in a defined contribution pension system: analysis with Bayesian optimization

Published online by Cambridge University Press:  17 May 2023

An Chen ,
Motonobu Kanagawa  and
Fangyuan Zhang
An Chen
Affiliation:
Institute of Insurance Science, University of Ulm, Ulm, Germany
Motonobu Kanagawa
Affiliation:
Data Science Department, Eurecom, Biot, France
Fangyuan Zhang*
Affiliation:
Data Science Department, Eurecom, Biot, France
*
Corresponding author: Fangyuan Zhang; Email: fangyuan.zhang0069@gmail.com
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Abstract

We study a fully funded, collective defined contribution (DC) pension system with multiple overlapping generations. We investigate whether the welfare of participants can be improved by intergenerational risk sharing (IRS) implemented with a realistic investment strategy (e.g., no borrowing) and without an outside entity (e.g., shareholders) that helps finance the pension fund. To implement IRS, the pension system uses an automatic adjustment rule for the indexation of individual accounts, which adapts to the notional funding ratio of the pension system. The pension system has two parameters that determine the investment strategy and the strength of the adjustment rule, which are optimized by expected utility maximization using Bayesian optimization. The volatility of the retirement benefits and that of the funding ratio are analyzed, and it is shown that the trade-off between them can be controlled by the optimal adjustment parameter to attain IRS. Compared with the optimal individual DC benchmark using the life cycle strategy, the studied pension system with IRS is shown to improve the welfare of risk-averse participants, when the financial market is volatile.

Keywords

Intergenerational risk sharingdefined contributionautomatic adjustment ruleBayesian optimization
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 53 , Issue 3 , September 2023 , pp. 515 - 544
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of The International Actuarial Association

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