Collar design for age-dependent indexation policy

The traditional Dutch second pillar pension scheme is challenged by the aging of pension funds and by the recommendation of life cycle investment theory. An age-dependent indexation (ADI) policy which enables risk differentiation to age and is in line with life cycle theory has been proposed some time ago. However, this policy may be perceived as too risky, especially for the young. This paper adds a collar option for an ADI plan. The purpose of adding an indexation collar is to avoid negative indexation scenarios and to reduce the indexation volatility of an ADI plan. Collar options are structured in such a way that their initial value is zero so that they do not require upfront costs to be implemented. We make use of an asset-liability management study to evaluate a collar contingent ADI plan by comparing its indexation distribution, funding ratio distribution and certainty equivalent benefit with an ADI plan without collar and with a regular plan having a conditional indexation policy. Three conclusions are drawn from our ALM studies. First, a collar strategy successfully cuts down the indexation risk of an ADI plan. Second, in the long run, both ADI plan and collar contingent ADI plans have a lower funding ratio volatility than a traditional plan with a policy ladder. Third, an ADI plan with collar is more beneficial to the participants than an ADI plan without collar and a traditional plan with a policy ladder.

Netspar, Network for Studies on Pensions, Aging and Retirement, is een denktank en kennisnetwerk. Netspar is gericht op een goed geïnformeerd pensioendebat.


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