Investing for retirement through a with-profits pension scheme: a client's perspective

Saving for retirement by with-profits pension contracts is markedly different from traditional savings vehicles in at least two aspects: premia committed to the company are managed according to the preferences of the company – which may not coincide with the long-term interests of the client – and the return on investments is not directly transferred to client's savings but awaits a decision by the company to spend it as bonus. We show that a management's general aversion to (short term) insolvency risk results in investment strategies dynamically scaling investment risk up and down with the current funding status of the company. The resultant dynamics hugely impacts the long-term funding status of the pension company and thereby the investment outcome of with-profits contracts. We show that for a one-period optimizing company there exists a stationary regime only for moderately aggressive investment strategies, and we derive an analytical approximation to the stationary funding ratio distribution when it exists. In contrast to the one-period case, we show that the highest expected bonus level in stationarity is not achieved for the most aggressive investment strategy available. The reason being that if investments become too aggressive the company will spend a lot of time at low funding ratios where bonus cannot be attributed impairing the average bonus.