Benefits of collective risk sharing in defined contribution pension systems
This paper compares pension benefits in individual and collective pension contracts with a simulation study. An advantage of collective contracts is the ability to share gains and losses with generations that have not yet started working. Even collective contracts that allocate surpluses and deficits only to current participants slightly outperform individual contracts, because collective schemes implicitly allow the young to borrow against future labour income. A hybrid IDC/CDC contract also slightly outperforms a purely individual contract for the same reason. A regulatory ban on equity investment during the retirement period significantly worsens the performance of individual contracts. The benefits of collective contracts are lower in simulations with a smaller equity premium.