A comparison of three different pension savings products with special emphasis on the payout phase

Abstract

The purpose of this article is to illustrate how the pension benefits a pension saver will (expect to) receive will depend on the type of pension scheme chosen. We compare three widely different pension savings products: the “traditional” with-profits scheme involving bonus entitlement (average interest rate product), a market-based Unit Link scheme and, finally, a formula based smoothed investment-linked annuity scheme – TimePension in short – which is on many points a cross between the two prior-mentioned types of savings products.The three product types mentioned above have been analysed in previous literature, but those comparisons were based almost entirely on the values of pension savings accounts at the expiry of the accumulation period. This article will include the payout phase (decumulation phase) in the analysis, enabling us to analyse the size of paid-out pension benefits themselves as well as the possibilities of adjusting these benefits periodically. Compared to earlier articles, we have also improved the underlying model for the uncertainty of the underlying financial market.The article demonstrates that expected pension benefits from the three schemes are an increasing function of the allocation to shares in the underlying investment portfolios. TimePension involves the highest allocation to shares and therefore offers, on average, the highest pension benefits, followed by the Unit Link scheme. In the third and last place comes the traditional with-profits scheme, which has a relatively low allocation to shares, but which, in return, also provides relatively safe and stable pension benefits. We also show, however, that the stability of pension benefits from a TimePension scheme is completely level with the stability of benefits from the traditional scheme. Unit Link-based pension benefits, on the other hand, vary far more, and pension savers in this product segment will experience much higher annual adjustments – in a both negative and positive direction – than savers in the other product segments.

The Impact of Guarantees on the Performance of Pension Saving Schemes: Insights from the Literature

“…We, thereby, take two typical guarantees in traditional and innovative life insurance into account, which comprise cliquet-style and point-to-point guarantees. In this comparative overview, we consider the contributions by Gatzert and Schmeiser [26], Jørgensen and Linnemann [27], Faust, Schmeiser, and Zemp [28], Graf, Kling, and Russ [29], Gatzert [30], Guillé n et al [31,32], and Mahlow, Schmeiser, and Wagner [33]. Our study shows that there are two different approaches in the literature how to assess the performance of pension saving contracts with guarantees.…”

“…On the basis of the payoff distribution, several risk and performance measures are calculated to enable a comparison of different guarantee schemes. These risk measures include, inter alia, the mean and standard deviation, and several quantiles of the payoff distribution (see, e.g., Gatzert and Schmeiser [26]; Jørgensen and Linnemann [27]; Faust, Schmeiser, and Zemp [28]). Performance measures, such as the Sharpe ratio, the omega, and the Sortino ratio, are determined, which are in line with maximizing expected utility for an individual decision-maker (see, e.g., Gatzert and Schmeiser [26]).…”

“…First, different contracts are calibrated that their guarantee costs calculated under the risk-neutral measure Q are equal for different types of guarantees (see, e.g., Gatzert and Schmeiser [26]) and second, risk-neutral guarantee costs are charged as guarantee fees and, thus, subtracted from a contract's account value (see, e.g., Graf, Kling, and Russ [29]). The impact of guarantees on the performance of pension 1 The case of the decumulation phase is considered in Jørgensen and Linnemann [27], where the distribution of the annual payouts is determined.…”

“…In case of the cliquet-style guarantees or interest rate guarantees, three different product types can be found in the papers, namely a mutual fund investment with a yearly interest rate guarantee (see Gatzert and Schmeiser [26]), participating life insurance contracts (see Faust, Schmeiser, and Zemp [28]; Jørgensen and Linnemann [27]; Guillé n et al [32]; and Mahlow, Schmeiser, and Wagner [33]), and a Danish formula based smoothed investment-linked annuity scheme called TimePension (see Jørgensen and Linnemann [27]; and Guillé n et al [31]). Traditional participating life insurance contracts or also called traditional with-profits products have been a prominent way for pension savings and are available in several countries, e.g., in Denmark or Germany (see Faust, Schmeiser, and Zemp [28]; and Jørgensen and Linnemann [27]), where some specifics differ due to different national regulations.…”

“…Traditional participating life insurance contracts or also called traditional with-profits products have been a prominent way for pension savings and are available in several countries, e.g., in Denmark or Germany (see Faust, Schmeiser, and Zemp [28]; and Jørgensen and Linnemann [27]), where some specifics differ due to different national regulations. However, the basic product is very similar in essence.…”