Quantifying Inter-generational Equity under Different Target Benefit Plan Designs

In this research, we investigate the value of inter-generational transfers under various target benefit plan designs. The contingent retirement benefits are decomposed into embedded options, and the risk-adjusted values of these options are calculated and compared across generations. For this purpose, an economic scenario generator is implemented: the economic variables’ dynamics are generated by a model that combines the first-order vector autoregressive model and the generalized autoregressive conditional heteroscedasticity process. A corresponding risk-neutral model is derived and estimated using the prices of financial assets; the latter is helpful to price the embedded options. We study four target benefit plans with different design elements. We find that intergenerational value transfers arise by simply joining the collective pension scheme even without the inclusion of any intertemporal benefit smoothing designs. Without additional source of funding, we show that benefit security and stability can be achieved by adopting plan designs that allow temporary inter-generational subsidization, e.g., plan designs with noaction range. We show that adding a symmetric no-action range can reduce the volatility of retirement benefits without triggering significant value transfers, at least under the assumption of stationary demographic profile and when the simulation of economic scenarios starts from its long-term equilibrium level.