Pensionmetrics: stochastic pension plan design and value-at-risk during the accumulation phase

We estimate values-at-risk (VaR) in the accumulation phase of defined-contr ibution pension plans. We examine a range of asset-return models (including stationary moments, re gime-switching and fundamentals models) and a range of asset-allocation str ategies (both static and with simple dynamic forms, such as lifestyle, thre shold and constant proportion portfolio insurance). We draw four conclusion s from our investigations. First, we find that defined-contribution (DC) pl ans can be extremely risky relative to a defined-benefit (DB) benchmark (fa r more so than most pension plan professionals would be likely to admit). S econd, we find that the VaR estimates are very sensitive to the choice of a sset-allocation strategy. The VaR estimates are also sensitive, but to a le sser extent, to both the asset-returns model used and its parameterisation. The choice of asset-returns model is found to be the least significant of the three. Third, a static asset-allocation strategy with a high equity wei ghting delivers substantially better results than any of the dynamic strate gies investigated over the long term (40 years) of the sample policy. This is important given that lifestyle strategies are the cornerstone of many DC plans. Fourth, conservative bond-based asset-allocation strategies require substantially higher contribution rates than more risky equity-based strat egies if the same retirement pension is to be achieved. (C) 2001 Elsevier S cience B.V. All rights reserved.