Portability, Salary and Asset Price Risk: A Continuous-Time Expected Utility Comparison of DB and DC Pension Plans

• Main Authors: An Chen, Filip Uzelac
• Format: Article
• Language: English
• Published: MDPI AG 2015-03-01
• Series: Risks
• Subjects: defined benefit plan; defined contribution plan; portability risk; asset price risk; salary risk
• Online Access: http://www.mdpi.com/2227-9091/3/1/77

This paper compares two different types of private retirement plans from the perspective of a representative beneficiary: a defined benefit (DB) and a defined contribution (DC) plan. While salary risk is the main common risk factor in DB and DC pension plans, one of the key differences is that DB plans carry portability risks, whereas DC plans bear asset price risk. We model these tradeoffs explicitly in this paper and compare these two plans in a utility-based framework. Our numerical analysis focuses on answering the question of when the beneficiary is indifferent between the DB and DC plan. Most of our results confirm the findings in the existing literature, among which, e.g., portability losses considerably reduce the relative attractiveness of the DB plan. However, we also find that the attractiveness of the DB plan can decrease in the level of risk aversion, which is inconsistent with the existing literature.