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Default investment strategies in a defined contribution pension system: a pension risk model application for the chilean case

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  • BERSTEIN, SOLANGE
  • FUENTES, OLGA
  • VILLATORO, FÉLIX

Abstract

In a defined contribution pension system, one of the main risks faced by members refers to the investment of funds. In this context, we discuss which is the most suitable risk measurement for the affiliates to the pension system. Different life-cycle investment strategies are evaluated under this measure for different types of workers. We point out the importance of designing well-suited default investment options in light of the economic behavior of members, characterized by low financial knowledge, inertia and myopia in decision-making. We calibrate a pension risk model for the Chilean economy, including measures of life-cycle income, human capital risk, investment and annuitization risks. Our results suggest that affiliates can gain (loss) around 0.85 percentage points in terms of average replacement rates in return for an increase (decrease) of 1 percentage point in risk, measured as standard deviation of replacement rates. Using a stochastic dominance analysis, we find that there are no dominated strategies when subsidies from the Solidarity Pillar are excluded. When the Solidarity Pillar is considered, the most appropriate investment strategies for affiliates that receive these subsidies are concentrated on the riskier funds. However, this also means that there could be increased pressure on Government spending in order to grant additional benefits to affiliates. Our model has a wide range of practical applications that go from informing affiliates about the degree of uncertainty associated to their expected replacement rate to a guide to evaluate how different investment strategies affect the expected values of affiliates' pensions and their associated risk.

Suggested Citation

  • Berstein, Solange & Fuentes, Olga & Villatoro, Félix, 2013. "Default investment strategies in a defined contribution pension system: a pension risk model application for the chilean case," Journal of Pension Economics and Finance, Cambridge University Press, vol. 12(4), pages 379-414, October.
    • Handle: RePEc:cup:jpenef:v:12:y:2013:i:04:p:379-414_00
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    Cited by:

    1. Butt, Adam & Khemka, Gaurav, 2015. "The effect of objective formulation on retirement decision making," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 385-395.
    2. Pablo Antolin & Olga Fuentes, 2012. "Communicating Pension Risk to DC Plan Members: The Chilean Case of a Pension Risk Simulator," OECD Working Papers on Finance, Insurance and Private Pensions 28, OECD Publishing.
    3. Miguel Lorca, 2021. "Effects of COVID‐19 early release of pension funds: The case of Chile," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(4), pages 903-936, December.
    4. Andrey Kudryavtsev & Shosh Shahrabani & Yaniv Azoulay, 2017. "Frequency of Adjusting Asset Allocations in the Life-Cycle Pension Model: When Doing More Is Not Necessarily Better," Bulletin of Applied Economics, Risk Market Journals, vol. 4(1), pages 13-33.
    5. I. Koetsier & J.A. Bikker, 2018. "Herding behavior of Dutch pension funds in asset class investments," Working Papers 18-04, Utrecht School of Economics.
    6. Olga M. Fuentes & Richard K. Fullmer & Manuel García-Huitrón, 2024. "A sustainable, variable lifetime retirement income solution for the Chilean pension system," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 49(2), pages 234-258, April.
    7. Kees de Van & Daniele Fano & Herialt Mens & Giovanna Nicodano, 2014. "A Reporting Standard for Defined Contribution Pension Plans," CeRP Working Papers 143, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    8. Yaniv Azoulay & Andrey Kudryavtsev & Shosh Shahrabani, 2016. "Accumulating approach to the life-cycle pension model: practical advantages," Financial Theory and Practice, Institute of Public Finance, vol. 40(4), pages 413-436.
    9. Byron J. Idrovo-Aguirre & Javier E. Contreras-Reyes, 2021. "Monetary Fiscal Contributions to Households and Pension Fund Withdrawals during the COVID-19 Pandemic: An Approximation of Their Impact on Construction Labor Supply in Chile," Social Sciences, MDPI, vol. 10(11), pages 1-10, November.
    10. Madeira, Carlos, 2022. "The impact of the Chilean pension withdrawals during the Covid pandemic on the future savings rate," Journal of International Money and Finance, Elsevier, vol. 126(C).
    11. Adam Butt & M. Scott Donald & F. Douglas Foster & Susan Thorp & Geoffrey J. Warren & Tom Smith, 2017. "Design of MySuper default funds: influences and outcomes," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 57(1), pages 47-85, March.
    12. Kristjanpoller, Werner D. & Olson, Josephine E., 2021. "The effect of market returns and volatility on investment choices in Chile’s defined contribution retirement plan," Journal of International Money and Finance, Elsevier, vol. 112(C).
    13. Fong, Joelle H., 2020. "Taking control: Active investment choice in Singapore’s national defined contribution scheme," The Journal of the Economics of Ageing, Elsevier, vol. 17(C).
    14. Castañeda, Pablo & Castro, Rubén & Fajnzylber, Eduardo & Medina, Juan Pablo & Villatoro, Félix, 2021. "Saving for the future: Evaluating the sustainability and design of Pension Reserve Funds," Pacific-Basin Finance Journal, Elsevier, vol. 68(C).
    15. Felipe Menares & Nicolás Rivera & Claudio Palominos & Ximena Quintanilla, 2020. "Estudio Actuarial De Los Fondos Del Seguro De Cesantía," Working Papers 65, Superintendencia de Pensiones, revised May 2020.
    16. I. Koetsier & J.A. Bikker, 2018. "Herding behavior of Dutch pension funds in asset class investments," Working Papers 18-04, Utrecht School of Economics.
    17. repec:idb:brikps:7677 is not listed on IDEAS

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